Retirement Answer Man #24 Strategies for Handling Market Corrections
Is the stock market correction here? In the last week of July the S&P 500 index lost 2.7%. The worst weekly loss in over two years. It didn't take long for the sensationalist headlines to pop up. Here are two of my favorites. Warning: That plunge in stocks is just the beginning
MarketWatch.com 3 market warning signs predict 20% stock tumble Insight: When these indicators flash together, it’s time to sell
Strategies to Help You Handle Market Corrections
I'm all about investing wisely for retirement. If you are a trader, market timer, trend follower, etc. you might want to click away. For the rest of you, here are my suggestions to help you invest wisely and sleep better at night. 1. Have a Plan
Sounds simple but most people don't. They invest based on intuition, emotion and trust rather than facts, process and purpose. Your plan doesn't have to be elaborate it just needs to be clear and actionable. It should include:
- Goal for investment assets
- Investment timeframe
- Risk/reward target
- Target investment allocation
- Rebalancing policy
- Communication and evaluation schedule
2. Have adequate cash reserves
More than anything, this may the most practical strategy to weather market corrections. One of the biggest mistakes you can make is to sell an investment at the wrong time because you need the money.
With interest rates on savings accounts near 0%, it is tempting to put all your money "to work". Don't. Cash reserves give you the flexibility to weather uncertain times in your life as well as the markets. (in episode #17 I discuss cash reserves). Here are the basics of cash reserves
Emergency fund (3 months to 2 years living expenses) + Expected expenses within the next 12 months=Less emotional decisions
3. Have at Least a 3 Year Investment Timeframe
Anything under a three year time frame is speculating not investing. Investing wisely requires time.
4. Be Well Diversified
Every time I say this I feel like the teacher in the Peanuts cartoons...Blah, Blah, Blah. Diversification and asset allocation help you avoid the trap of trying to pick winners and losers. They position you to participate in the economic growth of the world. That is the point of investing. The more you try to game the system, the more likely you'll miss out (Here is a recent episode on investing mistakes).
One thing you can do right now is make sure your allocation is rebalanced back to the target you should have set in the beginning. Over the last 4 years, the stock markets have done quite well. If you haven't rebalanced to your target you probably have a lot more equities than you originally intended. This could mean you have more volatility than you bargained for. Studies have shown that rebalancing your portfolio regularly helps you achieve better results. Rebalancing Feels bad, but works good.
5. Understand Market Corrections are Healthy for the Markets and Your Portfolio
You've heard it said that investing is like gambling. In a sense that's true. If you invest based on intuition, emotions and the advice of the financial press, you're just one of the suckers walking into the casino. If, however, you invest based on history, research, process and prudence you are more likely to have the odds of the casino over the long-term. That is investing wisely.
Retirement Tip of the Week Try it Before You Buy it
You need to be very careful when you are in the Retirement Nesting stage of life. Retirement Nesting occurs during the 3 years prior to retirement and the 2 years after you retire. This is the time of retirement lifestyle dreams. AND a time when you are susceptible to marketers selling the retirement dream.
The Retirement Nesting stage is a danger zone for poor financial decisions. Don't fall for the emotional urges to buy an R.V., vacation lot, condo or big toy. They can be great but you need to be certain, very certain, that it is something you will truly use. Just recently, I had to help a gentleman unload a beach condo he purchased on a whim 5 years ago. He lost over $100k on the deal (and only used once). Don't be that guy.
Here are some tips to avoid the same mistake:
- Do LOTS of research over a 12 month period before you buy
- Always pay cash.
- Rent the object of your desire for the first 2 years to see how much you actually use it. It is easy to rent anything anywhere nowadays.
- Test drive vacation homes, R.V.s and resorts over the first 5 years of you retirement. It can be great fun and save you from making a costly mistake.
Resources Discussed