It’s the stuff of nightmares for near-retirees: A sudden, dramatic plunge in the stock market, just months away from your last day at work.
That happened to a lot of people in 2008 and 2009, folks who diligently saved and prepared to leave their working life on good terms, only to be forced to wait five years more for their portfolios to recover.
The important point is that they did recover. All it took was time and patience. But how could they have avoided the declines in the first place?
The concept financial advisors use to talk about this problem is “time horizon,” that is, the point in time at which you need your savings to begin to work for you as income in retirement.
Setting that date is important. Even if you change your mind and move it forward or backward a few years, having a clear target is the first step in building a legitimate, effective retirement portfolio that will work hard for you and not let you down at the last minute.
Here are the three key ideas to understand when it comes to avoiding big market declines:
1. Nobody promised you a rose garden
Volatility is normal in any investment. A small business will have good months and bad months, and any stock investment will do the same. After all, it’s a market like any other. However, over long periods you should expect total return to smooth out the jagged periods, while compounding helps you build wealth.
2. What goes up eventually comes down
Advisors often refer to “reversion to the mean” to describe how high-flying stocks can be pulled back to earth in time. That’s why rebalancing is so important. Selling a portion of your gainers gives you a chance to realize some of the upside while it exists.
3. What comes down eventually goes up
Same effect, different direction. People can panic out of stocks at or near their low point. If you can stomach holding on to a declining stock, it often will recover and even go on to new highs. That’s a great time to use your rebalancing gains to buy in, while prices are lower.
Of course, the trick to all of this is not to attempt to market time or pick stocks but to use very cheap index funds and index ETFs to buy and hold entire asset classes. A well-designed portfolio will slowly dial down your risk as your retirement age nears, greatly reducing the effects of a market crackup when it matters most.