This article was contributed to us by Charles Schwab Singapore.
Nine years into a bull market, the stress of an upcoming market downturn is likely top of investors’ minds amid rising concerns around global growth, trade tensions and Fed tightening.
No bull market runs forever, so what do you do when the bull stops running?
While we do not think that a recession is imminent, one big lesson from 2008 is that it can’t hurt to prepare an emergency bear market kit for your portfolio, and the current market volatility can be a timely reminder for a portfolio check-up.
Here are seven steps you can take now to prepare your portfolio for a potential bear marketand stay on track for the long-term.
# 1 Keep Your Portfolio Diversified
The old adage “don’t put all your eggs in one basket” is especially important for investors. Being well diversified can help cushion against losses, and that’s a preventive measure one can take anytime.
A globally diversified portfolio — one that is diversified both within and across asset classes — tends to be better positioned to weather market swings and provide a more stable set of returns over time. Since a diversified portfolio is invested in many asset classes, it can benefit from owning top performers without bearing the full effect of owning the worst performers.
# 2 Rebalance Your Portfolio Regularly
It’s natural to want to stay on the market train and tap every last bit of return from a bull market. After riding investments up, investors have a tendency, we’ve seen, to not harvest gains.You’ll need to keep some growth investments, but don’t be afraid to tap gains and rebalancing is the traditional approach to do so.
Rebalancing involves selling investments in your portfolio that have risen in value and shifting that money into other areas and investments in your portfolio that haven’t. It is a way of adjusting your portfolio to keep risk in line with your objectives, as market changes can skew your allocation from its original target. Over time, assets that have gained in value will account for more of your portfolio, while those that have declined will account for less. It is therefore important to rebalance your portfolio periodically andwe recommend rebalancing every 6 or 12 months.
You can also rebalance into investments that have held their value and are likely to do so in the future too, such as cash and short-term investments.
# 3 Set Aside Cash
Instead of boosting your allocation to investments that have fallen in value, consider shifting some money into investments that have held their value, and likely will continue to do so in a bear market. Cash and short-term investments fit this bill.
Cash has the long-term potential of being an agent of diversification in your portfolio as it has a very low correlation to other asset classes, so it offers protection against volatility.
Another advantage of cash is that it can come in handy in down markets. With cash reserves, you can buy in when prices are attractively low without having to sell securities at a loss, if they are also at a low point.
In summary, cash can provide your portfolio with some stability (low correlation, low volatility), flexibility and liquidity (to buy new assets without selling old ones cheap).
# 4 Know That You Have The Resources To Weather A Crisis
One of the things that make people panic in a bear market is when they simply don’t know whether they’ll have enough cash to handle near-term goals. Ideally, you won’t have to face this question in a crisis — because you should know the answer.
The answer may vary depending on the life stage of the investor; for instance, if you’re retired, knowing that you have the next couple years’ worth of living expenses in a bank account — and several more years in bonds that mature when you need the money — can help keep you calm and clear-headed. You’re going to react a lot differently than someone who gets blindsided and has never laid that groundwork.
If you’re a younger or mid-career investor saving for a goal that is still 15 or more years away, such as retirement, you should take advantage of your relatively long investment horizon. As you have time to recover, you would generally do better to focus on your long-term goals rather than panicking about short-term market movements.
At the end of the day, remember it’s not just about your risk tolerance but your financial capacity to handle risk. You might feelrisk tolerant, but if you haven’t structured your investments to handle a sharp drop, your financial capacity to handle risk may not match your attitude.
# 5 Match Your Portfolio To Your Goals And Investing Timeframe
Map out a plan that takes into account what you’re saving for, whether near-term expenses or future financial goals like your children’s college tuition or retirement. While it is not an absolute or certainty, a good plan is a roadmap that will keep you on track; a written financial plan can help you craft an appropriately balanced portfolio, and it can also calm your nerves and make it easier to stay the course when markets get bumpy.
Market corrections can be especially upsetting if you don’t have time to recover or you’re not sure you’ll have enough financial resources to handle near-term goals. However, you can structure your portfolio to take some of the worry out of watching the markets.
Money you expect to need within the next two years, or that you can’t afford to lose, should be in relatively stable short-term investments like bank savings accounts, certificates of deposit or Treasury bills. Money for long-term goals can be invested in potentially higher-growth, higher-risk assets like stocks, because you will have more time to recover from a downturn.
# 6 Remember: Downturns Don’t Last
While they can be scary, bear markets are a part of long-term investing and can be expected to occur periodically throughout every investor’s lifetime.
However, it’s important to keep them in perspective. No bull market endures forever and neither does a bear. Historically, the market’s upward movement has prevailed over the declines, and since 1966, the average bear market has lasted just under 17 months, which is far shorter than the average bull market.
In addition, bear markets often end as abruptly as they began, with a quick rebound that is very difficult to predict. This is why long-term investors are usually better off staying the course and not pulling money out of the market.
Past Bear Markets Have Tended To Be Shorter Than Bull Markets
Source: Schwab Center for Financial Research with data provided by Bloomberg. A bear market is usually defined as a decline of 20% or greater. Duration is measured as the number of days from the previous peak close to the lowest close reached after it has fallen at least 20%, and uses a 30/360 date conversion (30 days a month/300 days a year). The market is represented by the S&P 500 index. Past performance is no guarantee of future results.
# 7 Find An Expert You Can Count On
Finally, if you don’t want to go at it alone, your bear market kit could benefit from having a financial professional you trust to collaborate with you to help structure your portfolio, especially if you think you’d be tempted to do something rash in a market slide. This partner can walk you through a complete portfolio review and help prepare you and your portfolio for times when the market gets tough.
Ultimately, worrying excessively about a bear market is counterproductive — you’re better off being prepared for one. It’s nearly impossible to time the market and it’s generally healthier for your portfolio if you resist the urge to sell based solely on recent market movements.
If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the noise and focus on your long-term goals. Market volatility is unnerving, but it’s a normal — and typically short-lived — part of investing.
Investment involves risk. Past performance is no indication of future results, and values fluctuate. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.
Past performance is no guarantee of future results. Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.