Whether this is your first bear market or your fifth (who’s counting?), it can be very stressful to watch your retirement plan balance drop like a rock in a week after months and even years of a steady incline.
Yet bear markets happen. Statistically they last only a few months while bull markets go on for years, but they do happen. And that can affect how we feel about our investments in a drastic way.
When stocks decline in value, however short the drop, it becomes very easy to second-guess what had seemed like a low-risk bet on equities. Even if you’re diversified (good) and pay low fees for your funds (great), it doesn’t take a lot of down to make every choice you made seem like a horrible mistake.
First of all, it’s never a bad choice to buy diversified, low-cost funds. Stocks go up for far longer than then go down and the recoveries after bear markets typically eliminate losses in time.
In fact, while stocks are down you can buy more and lower your cost basis going forward. On the whole that’s a plus, if you have time ahead of you to save and invest.
But declines can be very stressful in the meantime. Nobody wants to have to liquidate a stock or other investment at a low price, yet that’s what sometimes happens when people watch their investments closely in a bear market.
They panic. They presume worse times are ahead. And they take action at the worst moment, selling at the low and locking in permanent losses.
One way to avoid this trap is to balance your portfolio with bonds. It’s okay to own less bonds when you are young and can take the ups and downs. But as you get older and near retirement it’s wise to own more in bonds in order to stabilize your returns.
There’s another way to build a personal shock absorber for bear market times — hold cash.
Having cash on hand relieves you of any pressure to sell an investment because you must pay for something in the short run, such as a mortgage, car payments or health insurance.
How much cash is a function of your needs month to month. It’s good to target three months of spending as an emergency fund, while some financial planners counsel retired couples to keep up to a year’s worth of spending on hand.
It’s important to consider what is likely to happen to your cash if you keep it in, say, a savings account at your bank. It could lose value. Interest rates are incredibly low and could stay that way for some time.
To avoid damage from inflation it can be prudent to seek out a high-yield account and put some of your cash into a diversified, low-cost income fund. Anything you can find that’s liquid or nearly liquid (you can get cash in 48 hours) and pays better than the inflation rate would work, so long as you understand the risk in each product.
Any investment you make brings with it the risk of loss, even investments long considered safe, such as money market funds. Nevertheless, it’s important to balance the potential risk of loss in an investment against the certain risk of lost purchasing power due to inflation.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.