CLEVELAND, Ohio — The stock market has been on an amazing eight-year bull run and we are well past the time for a big drop.
Since the end of World War II, we’ve averaged a 20 percent decline every five years. We’re past due, since this market has been on fire since March 2009. We’re one geopolitical event, one North Korean bomb, one Sept. 11-type attack from a devastating market plunge. Maybe a 20 percent drop. Maybe 30 percent or more.
What if that drop happened tomorrow and happened to your retirement savings or kids’ college fund?
It may seem out of place to think about a decline in a market that has more than tripled in value in eight years and is up about 14 percent so far this year alone. But, this is exactly the time you should plan for the next market downturn, particularly if you’re in or near retirement, or have money in the market to pay for college or a home down-payment in the next few years, investment experts say.
It’s also good for investors, of any age, to cash in gains when investments are up, and not wait until they go down.
“We’re overdue for a big downturn. It’s not if it will happen, but when it’s going to happen,” said Jesse Hurst, a certified financial planner and accredited investment fiduciary with Impel Wealth Management in Akron.
People who retired or needed investment savings for other expenses probably grimaced if they were selling investments soon after August 2011, when markets dropped 19 percent after government default scares. Or if they were pulling money out soon after the September 2014 Ebola virus scare pushed the market down 10 percent.
The problem with pulling money out soon after a big drop is you’re selling low. You lose money when you sell low. You make money when you sell high.
“It is important for new or recent retirees to think through now what they would do after a 10 percent or 20 percent market correction,” said Westlake certified financial planner Scott Snow. “They will think much more rationally now than when it actually happens.”
Hurst has a simple strategy for any investors who expect to need money from their investments in the next few years. He calls it the short-term bucket.
You should have a separate bucket for money you’re going to need in the next three years. During times like this, when the market is soaring, you should gradually sell some of your big winners and put the money in safe, low-priced and low-yield bond funds. Maybe you commit to getting that three years’ worth of expenses in its short-term bucket within six months, and achieve it by selling high-flying investments once a month until you hit your goal.
And then you keep it there in the short-term bucket, which “won’t get clocked if the market tanks,” Hurst said.
This way, you never have to worry about needing money and being forced to sell investments that have dropped in value after a market decline, Hurst said. If the market is fine and continuing its gains and you need money for retirement or college, you sell out of your regular investments. If the market is down, you take money out of your short-term bucket. With this strategy, you avoid selling low.
And if you take money out of your short-term bucket, say for retirement, you can refill it when the markets rebound.
“This keeps you from ever having to sell low,” Hurst said. For the short-term bucket, you should aim for short- or intermediate bond funds with AA or A ratings.
This strategy would have worked fantastically for someone who retired or needed money from investments in late 2007, 2008 or 2009. The markets dropped by a breathtaking 50 percent from October 2007 to March 2009.
Kevin Myeroff, president and CEO of NCA Financial Planners in Mayfield, said that when markets are at high points, like now, or are falling fast, people need to remember the three R’s: relax, re-evaluate and reallocate. Investors should relax and avoid “the emotions of greed or fear,” he said.
When markets are booming, it’s also a good time to evaluate whether your asset allocation has gotten out of whack. Maybe you wanted 70 percent large-cap and 20 percent in small-cap, and now those percentages are out of line because investments don’t gain or lose at the same rates.
If your investments have shifted away from the asset allocation you want, you need to reallocate to get the percentages back in line, Myeroff said.
Maybe you’re in or near retirement and want a portfolio with 60 percent stocks and 40 percent bonds. With the way stocks have been gaining, you’re probably at 70 or 75 percent stocks if you haven’t re-balanced in a while, Hurst said. So you should sell some of those stocks to lock in gains, buy lower-price bonds and get your 60-40 ratio back in line.
People who are still working can make adjustments in their existing 401(k) balances or future contributions themselves. And parents with 529 Plans for college savings can shift investments once a year.
Snow said investors need to harvest gains or losses in the most tax-efficient way possible, which would vary based on the type of account.
And investors need to remember this strategy for those days after the next correction, Scott said. That may be the time to sell bonds to lock in gains and use those proceeds to buy stocks at a discount.
Hurst offers another point of levity for all investors. Over the long haul, stocks average gains of 9 to 10 percent. We’ve been averaging 13 to 14 percent recently. To make up for that, it’s likely that gains in the near future will drop below 9 to 10 percent, possibly 5 percent a year, to bring the long-term average back in line.
You shouldn’t be surprised when this happens. And since U.S. stocks have tripled in value in the past eight years and international stocks have doubled, “if you have re-balanced your portfolio, then you have more risk in your portfolio than you understand,” Hurst said.
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