How would you feel if your retirement savings dropped by 10% tomorrow or 30% over the next two months? What would you do about it?
When you begin to lose your hard earned money, the inevitable feelings of fear, anxiety, and worry are natural. Of course, as we all know, making decisions when you are feeling fearful or worried will not result in optimal choices.
In the event that you do lose a chunk of your retirement savings when the market unavoidably turns negative I want to give you a couple tools to mitigate the investment errors that can come from these feelings of fear and anxiety. Due to the political and economic instability in the world, I believe there could be a large market event in the near future and if a market crash were to occur, the likelihood of an ensuing bear market is also a very real possibility.
Over the past 30 years, there have been similar stock market events such as the bursting of the dot-com bubble in 2000 or the housing market crises in 2008 followed by the Great Recession. These events were massive and catastrophic to entire industries as well as the global economy.
Looking back, I was aware of those events when they occurred and have since read a lot about them but I did not experience them first hand. If you’re like me and graduated college around 2008 you really don’t know what it’s like to watch your savings drop by 30%, and because of that I hope you use this article to help you prepare. For those of you that have been through that experience, this will be a great reminder to ensure that this time your investments are in order.
Now what do we do?
We make preperations before a major market event occurs and we can do this in two ways:
- Apply the proper asset allocation and appropriate level of risk to your portfolio based on your savings and retirement goals.
- Learn and understand how you will react in different scenarios when you are losing money. You must have an understanding of what your emotional relationship is with money.
Before I dive into the details, I want to note that everyone has different goals and objectives when it comes to savings and investing. I don’t have specific recommendations or investment advice for you, but I will detail these two important topics so you can discuss them with your investment professional and hopefully help yourself weather the next economic storm.
For those of you in the investment industry don’t bypass these topics as rudimentary. Take the time and apply them to what you usually do with your own portfolio. Are you really prepared for the worst case scenario?
Asset Allocation and Risk Mitigation
As an investment professional you learn early on that asset allocation is an important aspect when constructing a portfolio. For example, it can be as simple as 60% stocks and 40% bonds but for retirement savings it’s usually a factor of age. By preselecting an asset allocation model and sticking with it through the rough times you will gain confidence in your portfolio will keep it together no matter the economic circumstances.
I recently read the book Pioneering Portfolio Management, by David Swenson, the Chief Investment Officer of the Yale Endowment and discovered just how important asset allocation is. He manages a portfolio of over $25 billion and states that one of the largest predicting factors in investment success over long periods of time is the asset allocation of the portfolio. Even though he manages much more money than the rest of us and has different objectives we can take that lesson from him and make asset allocation a top priority.
The other choice that needs to be made while constructing a portfolio is the level of risk tolerance that you are willing to accept. You need to understand how much you are willing to lose in any given market scenario. If the portfolio is constructed correctly over time it will achieve your investment goals while not losing more than you’re comfortable with in the event of a negative market event.
One of the more impactful things you can do right now is to understand these two tools and make sure they are properly reflected in the construction of your investment portfolio and how they can protect you when things go the market turns against you. With this understanding you become more comfortable with your choices and can attain peace of mind during even the worst of times.
Understanding Our Emotional Relationship with Money
Understanding your own personal behaviors and feelings regarding money allows you to pick an appropriate asset allocation mix and level of risk tolerance while constructing your investment portfolio. To accurately determine these factors we must understand how you will react specifically to material financial losses.
We want to do our best to protect our capital from our unreliable emotions and by incorporating them into our decisions we will be ahead of the game.
Then you have to understand your emotional connection with money or the psychology of investing in how you react when the market is moving against you. Understanding the emotions that you may experience could protect you from some very impulsive and expensive mistakes.
To this point, we’ve done the best we can to predict how we will react and prepare our portfolio for the downturn of the market. But even with those preparations, what will you do if you had a mutual fund investment in your 401(k) that is falling 2%-3% each day and after two months is down more than 65%? Do you sell? Do you hold on expecting it to rebound?
I’m not here to tell you what to do but I want you to think about what it might feel like if you were in that situation. For me, simply writing “down 65%” makes me nervous and I can’t imagine the feelings that would run through a person’s head if that were to actually happen.
Preparation is intended to take a majority of the choices out of your hands if a stock market crash were to happen. Money makes people emotional and when people are emotional they can be very irrational. Understanding our own behaviors and why we do what we do in the face of adversity allows us to ride out the rough patch. Understanding what situations trigger your stress will also allow you to stay away from making those poor investment decisions at the worst possible times.
I don’t write this because I have all the answers but rather because I don’t and think there are many others in my same shoes. I want to make sure people are considering what could happen and attempt to find their own answers. I can’t be certain but I believe you will be thanking yourself in 30 years because of the time you put into thoughtfully preparing yourself to stay calm during the worst of times.
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