By, Barbara A. Friedberg
What to do About the Impending Stock Market Decline
We all know the story of Goldilocks and the three bears. Once upon a time, a little girl with blonde hair named Goldilocks went for a stroll in the forest. She strolled into an empty house and sampled 3 bowls of porridge. The first bowl was too hot, the second too cold and the third was just right. In the end, the Bear family came home and scared off Goldilocks.
Recently, the economy and the stock market have been compared to the Goldilocks story (before the bears came home) – not too hot, not too cold – but just right.
If you’ve been investing for the last 8 years, during the recent bull market, you’ve enjoyed delicious stock market gains. The stock market, influenced by a combination of healthy growth and falling interest rates, created a backdrop for stock growth, without the typical stock price volatility. Any negative news hasn’t been enough to rock the stock market rising tide.
But, eventually, this ‘just right’ Goldilocks market is bound to end.
In a recent MarketWatch article, Ryan Vlastelica quoted Goldman Sachs analysts who are predicting higher bond yields and lower equity valuations. That’s stock market speak for a drop in stock prices.
If you’re in your 20’s or 30’s and a new investor, you might mistakenly think that investment market performance is always positive. But just as the economy waxes and wanes, so do stock prices. If the Goldman prognosticators (and others) are right, you need to shore up your investment portfolio for a potential stock market drop.
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Action Steps to Handle a Stock Market Drop
I’ve been investing for decades and seen our family investment portfolio, along with portfolios that I manage, weather several bear markets. Seeing your investment or retirement account drop in value can be upsetting, yet there are ways to protect yourself from doing something stupid and making the impending losses permanent.
- Shore up your asset allocation.
Before the inevitable stock market drop, make sure your asset allocation is set up for the long term. If you’re younger, further from retirement and relatively risk tolerant, you’ll have a greater percent of stock investments and a lesser proportion of fixed holdings.
If you started out with 75% stock investments and 25% bonds and your stock holdings are approaching the 80% or 85% mark, sell some of your stock funds.
- Invest in assets that perform better in a rising interest rate environment.
With interest rates poised to rise you might shift some holdings into international funds, that tend to perform well in this type of environment. Also, consider higher dividend paying stocks along with real estate investment trusts (REITS).
Don’t be afraid of bank CDs or money market mutual funds. Build a CD ladder in a rising interest rate environment and you’ll benefit from rising rates. Buy a CD that matures in 2 years, another that matures in 3 and another that matures in 5 years. As each CD matures, reinvest the proceeds for the same duration at the new, higher interest rate.
- Understand investment history and don’t become a victim of your emotions.
Expect periodic stock market declines. First Trust Advisors, LP reports that in the past the typical Bull Market lasted nine years with an average cumulative total return of 470%. On the other hand, the typical Bear Market lasted 1.4 years with an average cumulative loss of -41%.
Look at this chart showing the price of SPDR S&P 500 ETF (SPY) ETF from 1992 through the present. This fund mirrors the price of the S&P500 stock market index, a proxy for the entire U.S. market.
Notice the two major stock market declines during the last 25 years. The first market drop began in August 2000 during the dot com bubble and ended in March 2003. The next market decline began in September 2007 in response to the mortgage meltdown and sub-prime lending crisis and reversed course in February 2009.
To weather the next bear stock market, don’t have monies in the stock market you’ll need within the next 5 years. Markets are too unpredictable for the home down payment you’ll need next year.
Don’t sell after a stock market drop. Stay with your investment strategy and continue investing through the troughs. And if you don’t want to do all your investing yourself, there are DIY and automated investment managers to help with the heavy lifting. If history is any guide, in the long term, you’ll prosper.
Barbara A. Friedberg, MBA, MS is a former portfolio manager and university finance professor. Her work can be found on various financial websites including Barbara Friedberg Personal Finance.com.