Much like Midwestern weather in March, which in a span of hours can go from bitter cold to a pleasant and sunny spring warmth, financial markets can change between pleasant or painful rather quickly. While we can't predict when changes happen, we do expect more ups and downs than we've had in recent years. This can be uncomfortable. It's important to remember what we do control is how we prepare and respond. Below are a few suggestions for helping to ensure you're prepared no matter what happens in the market.
Preparing for the road ahead
A key part of preparing is to ensure you have an adequate amount of cash to meet any near-term spending needs as well as an emergency fund for unexpected dips in income or expenses. You'll have a lot more comfort knowing that invested assets have time to recover when your near-term needs are already covered.
Right-size your risk – When it comes to your investment portfolio, it's best to get your portfolio properly positioned before rough times. Almost everyone has heard the adage of "no risk, no reward," but taking the right amount of risk is key to weathering any market storms. And this is a balancing act. That's why your financial advisor helps you balance your risk tolerance (the amount of risk you're comfortable taking) with your risk capacity (how much risk you can afford to take) and your required risk (the amount of risk you need to take to achieve your goals).
Diversify – Once you've determined that risk level, you'll want to make sure you're properly diversified, which is akin to having a variety of layers of clothes so you can be comfortable even as the weather changes around you. Because your mix of assets may shift as their performance varies, don't forget to revisit your allocation from time to time to make sure it still reflects your desired risk level and mix of assets (known as rebalancing).
Handling an unpleasant market
Just as bad weather is inevitable, so are tough markets. If history is any guide, all markets eventually experience a downturn. In fact, according to Bloomberg, we experience about a 20% decline in the markets every four years. Because most downturns have been temporary, it's not always the market that hurts our portfolios so much as how we respond to them. Many people, potentially because they've taken more risk than they actually should, end up selling out at an unfortunate time. So even if we've financially prepared, how do we keep our behavior and emotions from becoming our own worst enemy?
Find an accountability partner – We may be biased, but we believe your financial advisor can be a great accountability partner to help make sure you stay on track. They can help revisit why you're invested in the first place and determine if anything has changed, like your financial goals or risk tolerance, that may warrant a change in your portfolio. They can also help you work through any underlying concerns and what (if anything) to do about them, including running scenarios to highlight the effects of any changes you may be wanting to make. Money can be emotional, especially when it's your own. Having a partner who is objective, knowledgeable about finances and understands you and what you're trying to accomplish can be incredibly valuable.
Take a break – Especially in markets with lots of ups and downs, it can be tempting to check your portfolio daily or even hourly. However, if you aren't needing the funds anytime soon, this can cause unnecessary stress and make it more likely you want to buy or sell something at an inopportune time. You may benefit from taking a break, and you may even want to turn off the news for a while (headlines are meant to elicit strong emotions, not to help you stay disciplined about your investments).
Give yourself time – Set up rules ahead of time that create friction between a strong emotion and a financial decision. For example, promise yourself you won't execute on a large financial decision unless you've had some time to properly consider (and reconsider) it. For instance, you could choose at least a night to sleep on it, or three days, or a weekend.
Take action if needed – Sometimes when things seem out of our control, we simply feel the need to do something. If this is the case, make the "something" as productive as possible.
- Consider if you can reduce spending and potentially increase your savings rate (market downturns are usually good times to buy).
- Talk to your tax professional about if strategically realizing gains and/or losses would be beneficial.
- And if you have taken more risk than you can stomach, rather than de-risk all at once, consider putting a plan in place to de-risk over time. This essentially adds a sort of time diversification to repositioning your portfolio.
If you don't like the weather…
A fellow Midwesterner, Mark Twain famously said, "If you don't like the weather in New England, just wait a few minutes." While down markets can last longer than that and feel very scary or frustrating at the time, they've also historically always been followed by a recovery. If you can just hold on, odds are that better days are around the corner. And if you've prepared in advance, it's much easier to weather the storm.
Past performance does not guarantee future results.
Meagan Dow leads the Analyst team within Edward Jones Client Needs Research. This team focuses on creating advice and guidance helping investors prepare for retirement, enjoy their retirement, save for education, plan their estates and protect their financial goals.
Meagan is a Chartered Financial Analyst and a Certified Financial PlannerTM.