At times like these investors are paying closer attention to their 401(k)’s and other investments. Many of you are opening your statements and seeing the change in the balance from last month and feel like you have to do something.
There are a large number people that have never been through a stock market downturn. Or maybe they just forgot that the stock market can go down. It has been awhile. The stock market has been going up for almost 10 years, ever since March 9th, 2009. That day the Dow Jones Industrial Average (DJIA) bottomed out at 6547. It hit an all time high of 26,828 on October 3, 2018. As of this writing stocks are about even for the year but have retreated about 9% from that all time high.
Unfortunately, many people go with their gut and anytime the market goes down more than a few points they sell. Market downturns cause them severe mental anguish because their mindset is “I’m losing money”! And if they don’t do something they will lose more – or maybe even lose it all so they take some or all of their money out of stocks. Yet every time the market has gone down it has come back and after it does those people that sold will get back in. Buying high and selling low is a great recipe for investing disaster. No wonder people get scared and confused. If only they could look at the market as a long term investment instead of a casino. Historically the market returns have averaged 9 to 10% per year. That is not every year, it’s just the average.
If you stay in the stock market long term and don’t get scared out when things look bad you may get those returns. But you will be tested. From mid October 2007 to the low in March 2009 the DJIA dropped 54% a total of 7,600 points. Is that kind of drop ever going to happen again? I guarantee it will! So how do you get market returns without panicking?
Reduce your risk. To reduce your risk only put money into stocks that you won’t need for at least 7-10 years. And only put an amount in stocks that isn’t going to make you panic when the market goes down. This is money you are going to designate for growth.
You have to look at all of your investments together. Let’s say your investments including retirement accounts and other money equals $100,000. Pick an amount you are going to invest long term. For some investors it might be $10,000 and for others it might be the whole $100,000. Whatever that amount is put it in a diversified portfolio of stocks. The other part put in safe fixed income investments that fluctuate very little in value.
Systematically Rebalance. Using the above example, let’s say you determined you can invest $40,000 of the $100,000 for the long term. The other $60,000 will go into safe investments like CD’s or maybe bond funds. That means $40,000 is 40% of your total investments. If the market goes up and your 40% becomes 45% sell the amount of stocks that will bring you back to 40%. If the market goes down and your 40% becomes 35% of your total investments then buy 5% in stocks. Always shoot for your target.
Instead of letting your gut and the scary news lead you to do the wrong thing at the wrong time by rebalancing you are buying stocks when they are low and selling when they are high.
Some investors do everything I have talked about but then forget to rebalance, or they get greedy, and their percentage of stocks gets far too high. Then when the market has a correction and they lose a lot more money than they are comfortable with and they panic. For example, if you reduced your risk to 40% stocks back in 2009 but neglected to rebalance at all for ten years, the stock portion of your investments may be around 70% of your investments now because of the increase in the market. Any market correction would cause your investments to go down much more than they would have ten years ago.
Choose Your Comfort Zone. Balance your need for growth with the risk you are willing to take. No matter what your age or the size of your investment this method of choosing a target and rebalancing will control your risk by reducing your overall volatility. Using the above example if you have 100% of your investments in stocks and the market drops 20% your $100,000 would become $80,000. If you have 20% of your investments in stocks with the same 20% market drop your $100,000 only drops to $96,000. Choose your comfort zone and once you know your downside you won’t be surprised during market corrections.
Bill Oldfather is a fee-only financial planner and investment advisor. Oldfather Financial Services is an SEC Registered Investment Advisor based in Kearney NE. Email to [email protected]