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FOR THOSE WHO KNOW their A.A. Milne, they’ll recall Eeyore as Winnie the Pooh’s perennially gloomy donkey friend. Which brings me to my inner Eeyore—and a thought provoked by the stock market’s astonishing recovery.
Now that the S&P 500 is once again hitting new highs, it’s time to prepare for the next bear market. No, I haven’t reduced my stock holdings as share prices have bounced back and, no, I’m not predicting that another crash is imminent. Like everybody else, I haven’t the slightest clue where stocks are headed next.
Instead, this article is prompted by a different concern. It’s pretty clear many investors were badly shaken by the coronavirus crash and some made panicky investment decisions that they now regret. How can we do better in future? Here are five steps to take now, so you’re prepared for when the economy and the stock market next falter:
1. Ponder your history. The coronavirus crash may have been painful, but it was also instructive: If you didn’t know your risk tolerance before, you do now. During the dark days of mid-March, did you buy stocks, sit tight or sell?
All this happened just a few months ago, but don’t trust your recollection. In an act of self-preservation, we often rewrite our memories with the goal of making our behavior look better. That’s why you should go back and look at your account statements. What did you really do—buy, hold or sell?
If you were among those who sold during the coronavirus crash or came close to it, perhaps you should lower your target allocation for stocks. Even those who are happy with their asset allocation may want to rebalance from stocks to bonds, so they bring their investment mix back into line with their target portfolio percentages. The good news: If you sell part of your stock holdings today, you’ll be lightening up at decent prices, thanks to the market’s remarkable rebound.
2. Get spending money out of stocks. Even if you have nerves of steel, money you’ll need to spend in the next five years should not be invested in stocks. Instead, it should be in low-drama investments like savings accounts, certificates of deposit, money market mutual funds and high-quality short-term bonds.
Imagine the S&P 500 took a 34% nosedive, as it did earlier this year. Think about what that would mean for your teenager’s college fund or the money you have earmarked for a house down payment. Not pretty? That’s why you should get those dollars out of stocks.
3. Invest with conviction. Individual stocks and market sectors often fall by the wayside—and sometimes they never come back. What does the financial future look like for department stores, airlines and cruise ships? It’s anybody’s guess. But even as a huge question mark looms over such companies, we’ve seen the broad global stock market recover. It’s a compelling argument for owning total stock market index funds that give you exposure to the global market.
But total market index funds don’t just deliver broad diversification. They also offer relative predictability. Whatever the market delivers, that’s what fund shareholders get. It’s a quality I find comforting and it gives me greater conviction in my stock market strategy.
By contrast, active fund managers can find themselves badly out of step with the market. Result: Shareholders not only suffer market-lagging returns, but also they may lose faith—potentially bailing out at just the wrong time in the market cycle.
4. Hold your nose and buy Treasurys. It isn’t easy to suggest buying government bonds when 10-year Treasury notes are yielding just 0.6%. But the past two bear markets—this year’s decline and 2007-09—offer an unequivocal lesson: If you want something that’ll prop up your portfolio when share prices are in the dumps, Treasurys are a top choice.
They may offer skimpy yields and you’ll lose money over the long haul, once inflation and taxes are figured in. But you should think of that as the price you pay for portfolio insurance. When the world looks darkest, your Treasurys should shine brightly, offering not only solace, but also something to sell if you need cash from your portfolio.
5. Prepare for rough economic times. Why might you need cash? A stock market relapse would likely be triggered by signs that the economy is slowing again, perhaps heralding the double-dip recession that some pundits have been discussing. I have no idea whether that’ll come to pass.
But I think it’s always important to ponder risk—and, if the economy slows again, the big danger facing many folks will be losing their job. With that in mind, make sure your finances are ready. Pay off credit card debt and pay back 401(k) loans. Set up a home equity line of credit, so you have a backup source of emergency money.
Also add up your fixed monthly costs, so you know how much cash you’ll need to come up with each month, should you find yourself out of work. See if any of these costs can be reduced or eliminated. In addition, build up your regular taxable account and consider funding a Roth IRA. The latter is a low-commitment investment: You can withdraw your Roth contributions at any time with no taxes or penalties owed—provided you don’t touch the account’s investment earnings.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Getting Emotional, Risking My Life and Take the Low Road.
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6. Turn off the TV.
Jonathan, regarding your suggestion to buy treasuries, in the long run interest rates are going to have to move higher, eventually. There’s almost no downside movement left. Your bonds will lose principal on top of lack of yield, taxes, inflation. No thanks. I’d rather own cash.