After 6 straight down days in the stock market, and 2 consecutive days of significant losses, traders and investors struggled to answer this question today. The market rallied, then fell back - then finished the day (and a tumultuous week) sharply higher. The vote of market participants - for today at least - is "It Was Just a Tremor".
Just as a big earthquake in California is inevitable (it's only a matter of WHEN!), so too the market will suffer a more severe drawdown. We WILL see a bear market drawdown of 20% or more at some point. After all, such events have occurred every few years for a century or more, so it is only a matter of time. Although we can't know what will happen next week, I am of the opinion this weeks events were just a tremor in the markets, not the start of something big. But even if I am right, it should serve as a timely reminder for investors to do a portfolio sanity check. Just as an earthquake tremor might make a homeowner in California double check on their emergency plans or their earthquake insurance policy - an investor would do well to take the selloff of the last few days to make sure that they are in fact ready in case "The Big One" hits.
Is your asset allocation out of whack? After so many years of stocks going up, many people have seen the stock part of their portfolio grow. What may have started out 10 years ago as 60% of a portfolio might very well be 80% or more now. And if you are 10 years older - that may be far too much risk exposure. Don't wait until The Big One hits to realize that you are underinsured. Now is the time to consider your asset allocation. There are lots of fixed income alternatives now to stocks, since income has risen. Bonds are much maligned but now pay decent interest rates with some potential for capital gains. CD's are offering the best rates we have seen in years (and are available right on your brokerage platform). And simple no load fixed annuities are offering competitive fixed interest rates (with no market risk). There is no reason to NOT be well diversified.
Reassess your REAL risk tolerance. When markets are calm, most investors will consider themselves to be "risk tolerant". The best time to do an honest assessment of your ability to tolerate risk is during, or in the immediate aftermath, of a market "tremor" such as we experienced this week. If the weeks market news had you checking your portfolio every hour - your risk tolerance is likely pretty low. If your portfolio is more aggressive than necessary, you may find riding out "The Big One" will be difficult or impossible.
Taking Distributions? Consider Funding a "Distribution Bucket". No matter how risk tolerant you are, it is never helpful to take distributions from an account that has fallen dramatically. We like to fund several years worth of distributions using a "ladder" of CD's or investment grade bonds such that an instrument matures every 3 to 6 months, providing just enough income fo fund my distribution. As each product matures, we sell some investments and buy a new product at the long end of the ladder, so there is always several years worth of nice safe income. If the market is down severely, we can always wait for a better market before selling investments to replace the maturing bonds/CDs. It takes a little work to implement - but this is a great way to limit what experts call "sequence of returns risk" - or the risk that you will encounter bad market conditions when you first start to withdraw funds from your account.
Look - if you knew when a big earthquake was going to hit, you could secure your belongings and head for safer ground. But you don't. Likewise we never can predict when the market will enter a more serious downturn. (though lots of people seem to have opinions - market action is as difficult to predict as sesmic events. So the next best solution is simply to be prepared. If you want to check up on your "market crash tolerance" - give us a call. We'll be happy to review your situation and recommend changes as appropriate.
Just as a big earth