Now would be a good time to plan for the next bear market and recession.
Before you start to worry, let me add I am not predicting that either a bear market or a recession is drawing near. Indeed, reliable lead indicators of recessions have not issued any warning signs thus far.
The best time to plan for bear markets and recessions is when they don’t seem to be on the horizon.
Most people wait until we’re already in bad periods to consider alternatives. Then, they decide which actions to take under pressure and possibly without enough thought and research.
We haven’t seen a significant market decline since 2009. For that reason, many people likely have forgotten what that was like and they now may be getting complacent.
The major problem with waiting until bad times happen before coming up with a plan is that emotions are likely to rule the decision-making. That’s why too many people sell near the bottoms of bear markets and corrections.
There also is research that concludes during good times that people underestimate their risk aversion. During bull markets when their portfolios are doing well, these people say they’re long-term investors and can ride out significant market declines. They know the markets will bounce back.
But once the same people are experiencing bear markets or corrections, their risk profiles change. Suddenly, portfolio declines can become a big concern. They worry that their investments won’t recover before they need the money.
One good exercise is to look at your current investment balances and mark them down by a certain percentage to account for a correction or bear market. The idea is to see how you would feel if next month the accounts fell 10% or 20%.
Do not simply use percentages to calculate a potential pullback to a given portfolio. Calculate what the losses and the new balances would be in dollars.
Write down the numbers to make them less hypothetical. Would you be willing to give up some potential gains over the next year or so to reduce that potential loss?
Prepare for bad times with risk management and a margin-of-safety approach during good times. Try to avoid holding assets that already have all or most of the good news reflected in their prices. Look for investments with lower valuations.
Right now, it appears to me that U.S. stock prices reflect a lot of good news, while emerging market and European stocks still are priced for poor economic growth.
Also have some balance in your holdings. Don’t set your portfolio based on one economic or investment outlook. You almost always want to own some investments that are going to preserve capital when others drop.
Plus, decide now the data or events that will trigger a change in your portfolio. Don’t let emotions or the latest headlines determine your actions.
You don’t want to act in a panic. Consider the indicators you want to follow and when they’ll tell you to make changes.
Enjoy bull markets and economic growth as long as they last. But remember that preserving your capital and gains is just as important as earning them in the first place.
Until next time,
Robert Carlson is editor of the monthly newsletter, Retirement Watch. In it, he provides independent, objective research covering all the financial issues of retirement and retirement planning. Carlson also is Chairman of the Board of Trustees of the Fairfax County Employees’ Retirement System and the founder of Carlson Wealth Advisors, L.L.C.