Uncertainty has returned to the stock market. Well, it never really left, it is just much more pronounced now.
Investors often hear that they should tune out the market's noise and not pay attention to market turbulence. But tuning out can be hard to do--and in some cases, it could be a mistake.
I often cringe when I hear market commentators suggest that investors shouldn't sell stocks amid market downturns. It's true that it's rarely a good idea to panic-sell; you're more likely to let your emotions get the best of you and you could make decisions that bring short-term relief but longer-term angst.
But the right response to market downdrafts really depends on you, your life stage, and what your financial priorities are.
If you’re within 10 years of retirement and are spooked about the potential for declining markets to wreak havoc on your plan, here are the key steps to take.
- DON’T rely too much on timing.
If retirement is on the horizon within the next five or so years, does it seem like a generally reasonable time to reduce equity exposure.
As is so often the case after periods of market distress, stocks could well shoot up again. Getting every last drop out of a strong market seems enticing. But if you’re getting close to retirement and expect to begin tapping your portfolio, it’s a mistake to try to find the absolute top before you lighten up on stocks.
And here's the really crucial part: It won't be at all obvious when stocks hit their top. The market peak, whatever it turns out to be, will only be apparent in hindsight.
- DON’T exit equity entirely.
Even if retirement is close at hand, you still need stocks. If you’re in good health, retirement could be a 25- to 30-year proposition, or even longer, so you absolutely need the growth that they can provide; an all-safety portfolio isn’t going to cut it.
If retirement is close at hand and you haven’t de-risked your portfolio along the way, you’ve probably already accumulated a tidy sum for retirement. Falling short by not investing enough or investing aggressively enough isn’t your biggest risk factor. Because your portfolio’s equity exposure has likely grown as a percentage of your portfolio, sequencing risk--the chance that you’ll encounter a terrible market just as you’re entering drawdown mode--is the bigger land mine to avoid.
Having to sell off depressed equity assets, which is what you might be forced to do if you don’t have a cash/bond buffer to draw living expenses from, could force you to push retirement further into the future, reduce your standard of living in retirement, or run short later on.
Balance is key.
I like the idea of using your proximity to spending to drive allocations to higher-risk/higher-returning assets like stocks and safer assets like cash and bonds. I consider a decade as a minimum holding period for equities. In other words, if you expect to spend from your portfolio in fewer than 10 years, give yourself a 10-year buffer of bonds and cash to ensure that you don’t have to risk selling stocks when they’re even further down.
- DON’T do it all at one go.
This need not be a single-point-in-time decision, especially if you’re not already retired and don’t expect to be within the next couple of years. You don’t have to take your equity exposure down all in one go, much as it seems a reasonable time to do so.
You can see chunks of stocks during bear market rallies. You can also adjust your allocations gradually through other means than selling. Instead of SIPs into equity funds, you could direct all new contributions to cash and bonds. Another underdiscussed way to address portfolio imbalances would be to take the dividends and capital gains distributions from your appreciated stock holdings and steer them into other positions.
I know, you probably don't want to look. But if market gyrations are giving you jitters, your first step is to take a close look at where your retirement plan stands today. Will you have more than enough, or is there a realistic chance that you’ll run out during your lifetime unless you take action?
The best way to get your arms around those questions is to sit down with a financial planner who will consider your plan in its totality, including your portfolio, your anticipated retirement date and tax issues.
- DO turbocharge your savings.
If you’re looking at a looming retirement-income shortfall and facing down-market volatility at the same time, that can be an unnerving combination. One of the best ways to seize control is to scrutinize your budget in an effort to step up your savings rate. Of course, investing more in a down market can be a heavy lift, both logistically and psychologically. But if you’re able to put more money to work in the market when it’s down, you’ll have added to your portfolio at attractive valuations, thereby improving its long-run prospects.
On the plus side, many people getting close to retirement have already funded their short- and intermediate-term goals; they may have also paid off their houses and done with their child’s education. That can free up discretionary cash for retirement savings. Financial planning guru Michael Kitces notes that “the empty nest transition" provides an opportunity for people in their 50s and 60s to avert a looming retirement shortfall. He estimates that 15 years of saving 30% of income--no small feat, of course--before retirement can help bring a too-small retirement portfolio back from the brink.
