Feb 12, 2024 5:08:33 PM •
Lamont Brown MBA, CFP®
Discover effective strategies to prepare your investments for the next downturn
Market Downturns Are Normal and Expected
Market downturns or periods when your portfolio value goes down - are a stressful part of investing. The closer you are to retirement only increases the stress and importance. Avoiding these times of market decline is impossible, but preparing for them is essential to keeping your retirement on track.
Downturns can be challenging to manage because you can't predict when they will start, how long they will go, or how great the loss will be. Sometimes, investors - particularly those who are at or near retirement - may be tempted to change their plans. These feelings are understandable, but they can cause problems in the long run.
Regardless of what kind of financial portfolio you have, there are ways you can structure your portfolio to minimize the loss and keep you on track for a secure retirement.
Remember: Downturns are Temporary
I've survived the last few market downturns and become wiser each time. Most importantly, every downturn has reminded me that all downturns are temporary. This is the first step to being prepared.
The stress caused by a declining portfolio should not take you off track from achieving your goals. If you've done the planning and developed a long-term financial plan. Your focus should be on taking advantage of this time and not panicking.
Remembering the next downturn will be temporary is essential as you prepare, and this will allow you to understand better how not to panic.
Know Your Needs
Understanding your cash requirements is the first step to preparing for the next downturn. Knowing specifically, how much you’ll need to support your lifestyle helps you to be prepared. By knowing how much you need to have to maintain your lifestyle, you can better understand where to start your preparation.
Have A Buffer
Build your "Sleep at Night" fund. Your “Sleep at Night” fund is there to be the buffer between you and the market downturn and is meant to reduce your stress. This fund is not your emergency fund. An emergency fund protects against emergencies like a leaky roof, or unexpected car repairs.A cash buffer is designed to pay living expenses during a downturn. The buffer should support you for at least two years and not be at risk during the market downturn. Having this cash buffer is critical if you are nearing retirement or in retirement.
There are several considerations you need to understand when building a cash buffer. First, understand what income you’ll need to replace during a downturn. Having these savings will allow you to maintain your lifestyle and protect the longevity of your investment portfolio.
The longer the downturn, the more stress you add to the portfolio, thus increasing the chances of you running out of money later. This financial reality helps explain why building a cash buffer is so important: It allows you to avoid changing your portfolio which may hurt you later in retirement.
Diversify, Diversify, Diversify
Imagine this scenario: You invest your entire retirement savings in one company, and that company goes bankrupt. In that case, you may find yourself completely out of any retirement savings. While this is an extreme example, it does illustrate the importance of diversification.
Diversification is a technique where you add investments in different markets to reduce the impact of a downturn. Diversification can occur in many ways. Diversification is simply adding more investments in different markets because no investment responds the same to a market downturn.
Simply put, don't put all of your eggs in one basket.
If done right, diversification means a downturn will only impact a smaller part of your portfolio. For example, if bonds go down, only that slice of your portfolio will go down. Remember that there are two sides to most market downturns: Winners and losers. Your financial goal is to minimize the impact the losers will have and take advantage of the winners.
Rebalancing your investment portfolio is an essential step in preparing for the next downturn. Over time, your portfolio risk will change. As markets perform well, your growth-focused investments will grow faster than your stability-focused investments. These gains will change your portfolio's risk level. This could increase the impact of a potential downturn. So, taking time to rebalance or return your portfolio to your risk level is part of your preparation.
The difficulty in predicting a downturn makes it even more important that you regularly rebalance your portfolio. After all, you can rarely know when a downturn is occurring. Regular rebalancing can help minimize your portfolio's risk exposure.
Stay The Course
The most challenging component to managing any downturn is this simple truth: Downturns are an expected part of investing. However, knowing this does not remove the stress especially when retirement is near. Taking the following five steps will help you to be prepared for the next downturn:
Remember: Downtowns are Temporary.
Know Your Needs
Have a Buffer
Diversify, Diversify, Diversify
Each step is an important part of being prepared for the next downturn and is meant to help you stay the course. After all, staying the course and not panicking will keep you on track to a secure retirement on your schedule.