Market Volatility: What If You Don’t Have Time to Recover?
- Market volatility can be especially unnerving for investors with short investment time frames, including those in or near retirement.
- Money that you expect to need within the next four years should be in lower-risk, more-liquid investments.
- Retirees’ portfolios should include a mix of investments to support spending in the short, intermediate and longer term.
It's one thing to stick to a long-term investment strategy in a good market—or in a down market, if you have time to recover. But what if you don't? What if your time horizon is short or you have a goal with a series of time frames, like a multi-year retirement?
If you're investing for a long-term goal, a combination of time in the market, consistent contributions and a long-term strategy works. However, if you’re investing for a short time frame, short-term volatility is your enemy. As economist John Maynard Keynes famously said, "Markets can remain irrational longer than you can remain solvent." Don't fall into this trap when creating your investment strategy.
What is a "short" time horizon?
For the average investor, a short time horizon doesn't mean a day or a week. A short time horizon, more realistically, is four years or less. If you expect to need the money within that time frame, you shouldn't be invested aggressively, unless you can afford to lose money and still meet your goals. That's the nature of investing.
Why four years? Since the 1960s, the average time from the peak in an up market to the trough in a down market and back up again has been around three and a half years. Future downturns could be longer or shorter, but a four-year time horizon is a cushion that can help manage risk in most markets.
Average time to recovery for the S&P 500® Index
Source: Schwab Center for Financial Research with data provided by Bloomberg. Chart reflects periods in which the S&P 500 Index fell 20% or more over a period of at least three months. Time to recovery is the length of time it took the S&P 500 to complete its peak-to-trough decline and then rise to its prior peak. Past performance does not guarantee future results.
What model portfolios align with each time horizon?
Your portfolio should be consistent with your time horizon. We often talk about having a long-term strategic asset allocation, but that generally makes sense only if you have a long-term investment objective. If you don't, you should build your asset allocation based on the date you expect to need the money.
The table below shows Schwab model portfolios based on time and risk tolerance. When your time horizon is four years or more, it has made sense, historically, to take greater investment risk. On the other hand, if you have a shorter time horizon, a portfolio weighted toward more-stable assets—such as cash investments, certificates of deposit or U.S. Treasury bills—is usually a good idea.
Assign a target asset allocation to your portfolio
Source: Schwab target asset allocations, non-custom, were developed by the Schwab Center for Financial Research. The historic returns for asset allocation plans are weighted averages of the performances of the indices used to represent each asset class, include the reinvestment of dividends and interest, and are rebalanced annually. Expected returns show Charles Schwab Investment Advisory’s 2015 20-year capital market and return expectations, based on current interest rates and other factors. These capital market expectations are used in Schwab financial planning tools and are below average annual returns historically. For more information see Schwab’s long-term capital return expectations on schwab.com. Please see below for indices used.1
For help with your asset allocation, start by filling out Schwab's Investor Profile Questionnaire for each of your investment accounts and goals. This can help you decide whether one of the model portfolios is right for you.
Which model makes sense for which goals?
Most investors have multiple investment goals. Those financial goals translate into investment plans, which turn into portfolios. If you don’t have a clear list of your goals, start there.
Choose an allocation appropriate for your goal
Source: Schwab Center for Financial Research. For asset classes by allocation, see the tables above.
What if you're approaching retirement or already there?
Thirty years ago, the financial services industry focused mostly on saving and investing for growth. That made sense, as most Americans new to investing were younger and in their prime wealth-accumulation years. Today, retirement is an approaching reality for millions of Baby Boomers.
Portfolios for investors near or in retirement are unique. They have not one, but several time horizons: now (money you'll need in the next year), soon (money you'll need during the next two to four years) and later (money you'll need more than four years from now, for a long, but indefinite, period of time).
Portfolios for people near or in retirement should include a mix of investments to fund spending now, soon and later. Beyond simply being diversified, these portfolios should contain an appropriate combination of higher- and lower-risk investments.
The chart below shows Schwab's model portfolios for retirement, for those who plan to spend from their portfolios. Remember, you're not going to spend it all at once, but over a period that could last 30 years. You should target an allocation that combines low-risk investments for the shorter term and investments with higher return potential for the longer term. Ideally, the lower volatility potential in these portfolios can reduce the risk of your not having money from investments when you need it.
Allocation for your time horizon in retirement
Source: Schwab Center for Financial Research with data provided by Morningstar, Inc. See the chart above for index details.
When we think of risk when investing, short-term volatility is typically the risk we mean. When we think of risk in retirement, a better definition is: not having enough money when you need it. In building a retirement portfolio, you should target the appropriate amount of risk in different buckets to meet your "now," "soon" and "later" needs.
How can I review my portfolios and goals in volatile markets?
- Start with a list: What are your goals? Assign each a priority and time horizon.
- Next, develop a diversified allocation for each. Use the Investment Profile Questionnaire to help guide your choices. The questionnaire is particularly useful in a down market, as we tend to answer questions like "how much risk can you take" differently in bull and bear markets. Beware "recency bias," however. Investors tend to answer questions differently when thinking about short-term performance—don’t do this when creating a long-term plan.
- Write down your allocation, based on time horizon, and stick to it until your personal circumstances change.
How can I decide if my allocation is on track for retirement?
Remember, you have multiple time horizons. Few investors cash out their entire retirement portfolio all at once. In a retirement portfolio, you want to create the right mix of investments with low return/low risk combined with higher potential return/higher risk to meet your "now" (less than one year), "soon" (two to four years) and "later" (four years or more) needs.
The best way to do this is to start with a budget. Do you know how much money you may need this year? During the next two to four years? If you know this, it makes investing for four years and longer easier. The portfolios above are a place to start, based on generally sustainable spending rates—also shown in the table—depending on your stage in retirement.
How do I invest for income?
Don't fall into the trap of investing solely for income in retirement. This leaves you vulnerable on two fronts: you may lose money if you're forced to sell investments during a down market to fund "now" spending, and you may miss out on potential growth that could help fund your "later" spending. With a balanced portfolio, you will likely be in a better position to benefit from both income and growth opportunities. Also, a narrow focus on income can lead to a greater concentration in certain investments or sectors than most investors should take.
Should I change my allocation in response to changing market conditions?
It's important to start with a preselected target allocation for each goal. Then you can use changing market views for guidance as you "shade" the allocation of investments in your portfolio, rather than going all or nothing into one investment or other.
What can I do now?
After reviewing each of the points above, you may want to talk with a Schwab Financial Consultant for advice that takes into account your specific circumstances and goals. This should help you feel more comfortable investing in both good and bad markets, no matter what your time horizon may be.
1 The indices representing each class are: S&P 500 for large-cap stocks; Russell 2000® Index for small cap stocks (1970-1978: CRSP 6-8 Total Return Index); MSCI EAFE (net of taxes) for international stocks; Barclays U.S. Aggregate Index (1970-1975: Ibbotson US Intermediate Term Government Bonds Total Return Index) and the Citigroup 3-Month U.S. Treasury Bill Index for cash investments (1970-1977: Ibbotson US 30-Day T-Bill Total Return Index).
Talk to Us
To discuss how this article might affect your investment decisions:
- Call Schwab anytime at 877-338-0192.
- Talk to a Schwab Financial Consultant at your local branch.
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 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.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Diversification strategies do not ensure a profit and do not protect against losses in declining markets.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
Charles Schwab Investment Advisory, Inc. ("CSIA") is an affiliate of Charles Schwab & Co., Inc. ("Schwab").
The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.
CRSP Indexes are a monthly series based on portfolios that are rebalanced quarterly. Individual decile portfolios are created for each exchange group, the largest being in decile 1 and the smallest in decile 10. In addition to each decile portfolio, returns are calculated for the following: CRSP 1-2, CRSP 3-5, CRSP 6-8, CRSP 9-10, CRSP 6-10 and CRSP 1-10. The returns of the combined portfolios are the value-weighted returns of the relevant deciles. Index levels are calculated based on an initial value of one dollar on December 31, 1925.
The MSCI EAFE Index (Europe, Australasia and the Far East) comprises the MSCI country indexes capturing large and mid-cap equities across developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of the following 21 developed-market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.
The Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency).
The Ibbotson U.S. Intermediate-Term Corporate Bond Index is a market value-weighted index which measures the performance of intermediate-term maturity U.S. corporate bonds.
The Citigroup 3-Month U.S. Treasury Bill Index is an unmanaged index representing monthly return equivalents of yield averages of the last 3-month Treasury bill issues.
The Ibbotson U.S. 30 Day Treasury Bill Index is an unweighted index that measures the performance of one-month maturity U.S. Treasury Bills.