How Retirees Should Think About Market Corrections
Stock market corrections are a part of life when it comes to investing, and they happen more often than investors may think. Consider this: Since 1900 there have been 123 market corrections, according to Ned Davis Research, a global investment firm. A market correction occurs when the stock market declines between 10% and 20%. A bear market happens when the sell-off is greater than 20%. Pretty scary for retirees, for sure. But after every stock market correction, it took an average of less than a year for stocks to recover. Even with the stock market crash of 2008, when the Dow Jones Industrial Average fell more than 50%, stocks rebounded quickly and six years later are trading at all-time highs.
Leave Panic at the Door
Despite the short-term nature of stock market corrections, investors, particularly ones in retirement, tend to go into panic mode when stocks take a dive, selling their shares in droves and pulling all their money out of the markets. It is understandable. After all, retirees are watching their life savings seemingly evaporate before their eyes.
“There should be a bumper sticker that says ‘market corrections happen.’ Sort of like a road sign that indicates ‘rough road ahead.’ Neither one should overly affect our life,” says Craig Israelsen, Ph.D., designer and owner of 7Twelve Portfolio, based in Springville, Utah.
But that knee jerk reaction almost always ends up costing them. When emotion rules, investors end up selling low and buying high. Yes, retirees want to preserve their wealth, but they also need it to grow, which means a calmer approach to market corrections.
“Retirees should understand their emotional risk tolerance before investing and make sure that they are not in a portfolio that will subject them to losses that they cannot emotionally tolerate,” says Adam Glassberg, CFP®, CIMA®, financial counselor, D3 Financial Counselors, LLC, in Downers Grove, Ill.
Take Stock Before Making a Move
Nobody wants to turn on the TV, go online or listen to the radio and hear the stock market is tanking and is in market correction or worse – bear market territory. But when it happens, retirees have to take a few moments before they pick up the phone and call their broker or start placing sell order after sell order. After digesting the news, investors would be best served by going over their portfolio to determine their risk. A call to their stock broker or wealth manager may be warranted – not to tell them to sell, but to discuss the overall exposure and risk of the portfolio.
“Retirees doing their own investing must have an understanding of how to value stocks,” says Joshua Hall, ChFC, investment advisor at True Vine Investments in Williamsport, Pa. “Retirees who have been shopping at the grocery store for decades immediately know a bargain when they see one and they immediately know when to pass on something that may be overpriced. Investing in stocks is no different. Without a valuation framework, investors will be tossed to and fro by every headline.”
Re-Asset Allocation May Be Required
For retirees, risk is an enemy, which means they want to reduce the amount they have in their investment portfolio during a market correction. And that means overhauling their asset allocation for a little while. For instance, retirees can rearrange their allocation, moving some money that is in stocks or equity mutual funds into bonds or bond mutual funds. Retirees do have to keep an eye on interest rates if they are investing in bonds. If the Federal Reserve continues to raise interest rates, bonds with long-term maturities stand to suffer. Short-term bonds and bond funds with maturities of less than five years are a better bet. Money market funds and U.S. Treasury bills are other places to park some money. But again, investors have to be mindful of the prospect for an interest rate increase.
“Volatility is a useful tool to reduce weightings in over-appreciated positions and/or increase weightings in oversold positions. If one maintains the right allocation, there is better flexibility to make modest adjustments to a portfolio throughout market cycles. The old political saying, ‘never let a crisis go to waste’ comes to mind,” says Stephen J. Taddie, managing partner, Stellar Capital Management, LLC, Phoenix, Ariz.
Don’t Abandon Stocks Altogether
While moving into safer investments can cushion the fall in a market correction, retirees should still have money invested in the stock market. As history has shown, market corrections don’t last too long and by pulling all of the money out of the stock market, a retiree won’t get to participate in the run back up.
“Most investors still need an allocation to stocks, even if it is only 20% to 30% of their portfolio. During times where interest rates are near historic lows, like we are in today, stocks can help keep up with inflation and allow for potential growth that allows retirees to maintain their income needs,” says Mark Hebner, founder and president, Index Fund Advisors, Inc., Irvine, Calif., and author of “Index Funds: The 12-Step Recovery Program for Active Investors.”
When it comes to stock investing, retirees are going to want to avoid being over weighted in one stock. They also want to own stock in multiple companies, not just one or two. If retirement investors only have a couple of stocks in their portfolio, they are going to feel much bigger pain than if they have their stock investments spread out in different areas. Undoubtedly on a day when the Dow falls 200 points, everything is going to suffer, but on a non-eventful trading day, not every stock is going to be down at the same time. Because of that, retirees should have a diversified stock portfolio that covers different sectors. The same goes for mutual funds. Investors do not want to have a mutual fund heavily weighted toward large cap stocks when the Dow is tanking.
Take Advantage of Bargains
Another reason why retirees want to stay in the stock market during a correction is because there is the potential to get some good stocks on the cheap. Called “bottom fishing,” savvy investors will take advantage of downturns in the stock market to buy shares at depressed prices. Let’s say a retiree always dreamed of owning shares of Google Inc. (GOOG) but could never afford its hefty share price. If the market tanks 10%, the opportunity to buy Google shares arises.
Dial Back the Risk
With retirement lasting more than 20 years in many cases, a segment of the population is going to take on more risk with their stock choices in hopes of greater returns. In a market correction, risk-welcoming retirees are going to want to dial back some of that aggressiveness. That could mean scaling back on emerging market stocks, emerging international stock funds or pricey small cap stocks that could fall hard.
Keep Some of Your Money in Cash
During market corrections, retirees are undoubtedly going to see their investments decline and in many cases they may be forced to sell stocks to cover their living expenses. But if retirees can live off the interest their bond investments yield them or have money that’s easy to access in CDs and savings accounts they are better off. Because a market correction doesn’t last forever, retirees want to, if possible, leave their stock holdings alone and let them go back up before using them to support their lifestyle in retirement.
“The safest place for clients to park money is in a risk-free asset (i.e., cash). Although cash doesn’t offer inflation protection, this is the trade-off of receiving protection but no loss (save the opportunity cost of investing, but no loss of principal),” says Dominique J. Henderson, Sr., CFP®, founder and wealth advisor, DJH Capital Management, LLC, in Desoto, Texas.
The Bottom Line
Stock market crashes can be scary, particularly for people who are in retirement and do not have 30-plus years to grow their wealth. Because income generation and simultaneous wealth preservation are the name of the game, retirees understandably are going to feel fear when the stock market falls more than 10%. But panic is the worst thing they can do. Shifting their allocation more toward bonds and yield-generating investments while staying in the stock market should cushion the blow from a market correction. Remembering that after every correction stocks went back up can go a long way in giving retirees peace of mind during tumultuous times in the stock market.
“Fear causes us to over-think. Don’t over-think. Stick to your plan. And, if fear takes over, call your financial advisor – we are used to providing a bit of therapy,” says Diane M. Manuel, CRPC®, CFP®, financial advisor, Urban Wealth Management, El Segundo, Calif.