How to Handle the Next Market Crash
There are a lot of conflicting reports from financial “experts” about when the next stock market crash will occur. Some say a crash is imminent and we are on borrowed time while others say we are in for continued market growth. Realistically, no one really knows for sure when the next market correction will occur. I can only tell you that eventually we will have another drop in the market. What do you do about it? Move all your money to cash? Buy gold? Cash out your 401(k) and buy scratch tickets?
Most people will fall under one of three financial situations:
10 Plus Years Before Retirement Age
When you have a long enough time horizon, you’re first instinct should not be to overreact to any market drop. Over a rolling ten-year span, the S&P 500 has lost money ~3% of the time and it’s never happened over a 20 year rolling period*. The key is to stay invested.
In fact, a market drop represents a buying opportunity since stock prices will be trading at a lower value compared to the height of the market. The approach for someone with a longer time horizon should be to consistently save and invest in the market. When you do this, you engage in dollar cost averaging which means you buy more equities when prices are lower and you buy less when the prices are higher.
Takeaway: Stay invested and continue to systematically save. Don’t try to time the market.
10 Years or less Before Retirement Age
At this point in your life, retirement is no longer a faraway dream, it’s on the horizon. A market crash can be scary, but it doesn’t have to be the end of the world if your portfolio is set up correctly. There are a few ways to create a market drop buffer for your portfolio, but I’m going to focus on two. One option is to move some of your equites into safer bond funds. You’ll still want to keep a healthy amount in equities to capture some of the market recovery. Another alternative would be to introduce insurance products as a part of your portfolio. For example, there are variable annuities available that will allow your portfolio to have market exposure, but also have a guaranteed income rider that earns a fixed rate of return. Depending on which ones does better, you’ll have the opportunity to create a stream of income**.
Takeaway: Stay invested as you have some time to recover, but consider hedging risk by adding an insurance product or looking at different asset classes.
See Also: The Biggest Financial Mistake Millennials are Making
Retired
If your portfolio isn’t set up to handle a market drop, it can have a significant impact on the quality of your retirement. The most common thought process for retirees is to have a large portion of their portfolio in “safe” investments like bonds or cash. The issue with this particular strategy is a typical retirement can last 20 plus years. Owning too many bonds or too much cash won’t allow a retiree to keep up with inflation. One option would be to look at a tiered investing strategy. A tiered strategy allocates money into three time frames; 1-4 years (Short-term), 5-7 years (Mid-term) and 7+ years plus (Long-term). Money investing in the Short-term bucket is invested conservatively to handle a market down turn. The Mid-term and Long-Term buckets contain more equity in order to keep up with inflation.
Takeaway: Evaluate your portfolio and diversify your investments so that they can handle multiple market conditions.
Whichever category you find yourself in, be sure to make sure your investment portfolio is allocated in a way that fits your specific goals and risk tolerance. Market corrections will happen and it’s important to know how your portfolio will react to it.