- Long bull markets in stocks can make investors overconfident and lead them to underestimate risks.
- Trade wars, the flattening of the yield curve in bonds, and major averages testing all-time highs are all reasons to be concerned.
- Market conditions were good in late 1999 and late 2007; both times were preceded by their own walls of worry for investors to climb.
- There are a set of simple steps to follow that can help prepare a personal investment portfolio for a market correction.
The stock market is invincible. So it seems, anyway. I won’t rehash the litany of hurdles that stocks have had to clear since March 2009, the market bottom set during the last bear market.
Suffice it to say that the latest bout of market worries — trade battles with all of our major trading partners and the flattening of the yield curve — hasn’t been a problem for U.S. stocks, considering that the major averages continue to test all-time highs. It’s almost to the point where we can’t conjure up new things to worry about, so why even bother worrying at all about a future market downturn?
Things were pretty good for investors in late 1999 and late 2007 also; both times were preceded by their own walls of worry for investors to climb. Yet both times investors squandered years of gains, many of whom never regained enough confidence to ride out those bears or get back into the stock market. You may have heard the expression after both market declines, “My 401(k) turned into a 201(k),” meaning people’s retirement accounts took 50 percent haircuts.
Is it fair for me to connect today’s stock market to those two past stock market eras? I think it is. It is my job to prepare clients for possibilities that their own risk tolerance can’t accept. History repeats itself, and it’s high time to make sure you’re not suckered by the next bear market.
The most important thing for you to know about the next market downturn is not what you’d expect. The yield curve, Federal Reserve Bank interest-rate policy, trade tariffs and stock buybacks are all very important to investors. But there is something else that supersedes those topics, and it's personal. I'm talking about investor complacency — your potential complacency.
Being a complacent investor is not the same thing as being an aggressive or conservative investor. It means you have not taken basic steps to understand how much risk you're taking in an investment portfolio. Do you expect stocks to rise over the next 10 years as much as in the last 10 years? If the answer is yes and you're an aggressive investor and you lose a lot of money in a bear market, then fine, you've accepted that risk. My concern is for the investor who is not aggressive but is not fully aware of how risky their portfolio has become because of the rising stock market since the Great Recession.
Preparing for a bear market is not about an all-or-nothing decision. It's about making sure you are investing within your risk tolerance so that you will be able to ride it out without acting emotionally.
History doesn't repeat itself nearly as identically as people repeat history. And few people wake up in the middle of the night screaming, "I have to rebalance my accounts as soon as the sun comes up!"
If you're an investor 55 years of age and over and you plan on retiring within the next 10 years, you are the one this applies to the most. If you're in your first five years of retirement, then this applies equally to you. If your investment portfolio takes a big hit early in your distribution years or a few years before that, it could have a lasting negative effect on your potential to fund your later retirement years. That's because you'll have to sell more shares of stocks or funds to maintain your distribution amounts while having fewer shares working for you during the next rally.
For many investors still in the accumulation phase of wealth building, a down market actually is a friend. But no one can afford to be complacent. The right investment portfolio, the one you can live with, isn't necessarily the same as the one that is currently generating what seems to be endless returns.
I've developed a rapid complacency test — sort of like the rapid flu test. It's only four straightforward questions. Don't be afraid to take it. Not taking it and avoiding the truth will result in a far scarier situation.
— By Mitch Goldberg, president of investment advisory firm ClientFirst Strategy