What do you do when a bull stops running?
Investors concerned about the prospects for the current rally might be wondering. The S&P 500® Index almost tripled in value from the start of the bull market in March 2009 through early October 2015. While that is obviously a pretty good run, we don’t expect this bull to become a bear any time soon.
That said, one big lesson from 2008 is that it can’t hurt to prepare an emergency kit for your portfolio. Here are seven things to think about as you put together your kit:
1) Know that you have the resources to weather a crisis
“We think one of the things that make people panic in a bear market is that they simply don’t know whether they’ll have enough cash to handle near-term goals,” says Mark Riepe, Senior Vice President at the Schwab Center for Financial Research. Ideally, you won’t have to face this question in a crisis—because you should know the answer.
If you’re retired, knowing that you have the next couple years’ worth of living expenses in a bank account—and several more years in bonds that mature when you need the money—can help keep you calm and clear-headed, Mark says. “You’re going to react a lot differently than someone who gets blindsided and has never laid that groundwork.
“It’s not just about your risk tolerance,” he adds. “It’s about your financial capacity to handle risk.” You might feel risk tolerant, but if you haven’t structured your investments to handle a sharp drop, your financial capacity to handle risk may not match your attitude.
2) Match your money to your goals
Map out a plan that takes into account what you’re saving for, whether near-term expenses or future financial goals like college tuition or retirement. Structure your portfolio to match those goals.
Money that you’ll need in the short term or that you can’t afford to lose—the down payment on a home, for example—is best invested in relatively stable assets, such as money market funds, certificates of deposit (CDs) or Treasury bills. Goals that need funding in three to five years should be addressed with a mixture of investment-grade bonds and CDs. For money you won’t need for five or more years, consider assets with the potential to grow, such as stocks, which are more volatile. (Of course, your allocation should also account for your time horizon and risk tolerance. If you’re retiring in six years, you probably don’t want to invest solely in stocks.)
3) Remember: Downturns don’t last
The Schwab Center for Financial Research looked at both bull and bear markets in the S&P 500 going back to the late ’60s and found that the average bull ran for more than four years, delivering an average return of nearly 140%. The average bear market lasted a little longer than a year, delivering an average loss of 34.7%. The longest of the bears was a little more than two years—and was followed by a nearly five-year bull run.
How does this impact your bear market kit? Even if you find yourself headed into the second year of a bear market, remember that it won’t last. No bull market endures forever, neither does a bear. And historically the market’s upward movement has prevailed over the declines.
4) Keep your portfolio diversified
Let’s say there is a slump—is there a remedy to help your portfolio get back on its feet? Being well diversified can help cushion against losses, and that’s a preventive measure you can take now. Consider the assets you’ve set aside for medium-term needs or goals. Being diversified means you have a wide variety of investment grade bonds—corporate, municipals, Treasuries and possibly foreign issues. And they should have varying maturity dates, from short-term to mid-term, so you always have some bonds maturing and providing you with either income or money to reinvest.
Your long-term assets should be divvied up among a wide array of domestic stocks—big and small, fast-growing and dividend-paying—as well as international stocks, real estate investment trusts (REITs) and commodities, says Mark. That mix gives you exposure to asset classes that tend to move at different times and speeds, he says.
5) Don’t miss out on market rebounds
“It’s easy to say that you’re risk tolerant when the markets are near all-time highs,” says Mark. “A better indicator is what you did in the last downturn.”
Many investors sold at the bottom of the market in March 2009, turning temporary paper losses into real, wealth-crushing losses. Mutual fund outflows were about $21.6 billion that month, according to the Investment Company Institute. And many of those same investors failed to get back in the market during one of the strongest bull markets in history.
To get a sense of what’s at stake when you pull out of the market, even temporarily, during a bear market, the Schwab Center for Financial Research compared the returns from four hypothetical portfolios:
- One that remained 100%-invested in stocks as the market touched its bear-market low and then rebounded.
- One that was diverted to short-term T-bills for a month after the market bottomed before returning to a 100% stock allocation.
- One that was diverted to T-bills for three months after the market bottomed before returning to a 100% stock allocation.
- One that was diverted to T-bills for six months after the market bottomed before returning to a 100% stock allocation.
As you can see in the table below, the all-stock portfolio was the best performer and was still delivering higher returns than the other portfolios three years after the market bottomed.
Timing the market is very difficult—no one knows for sure when the bottom will come—so if you can tolerate it, riding out a bear market may be worth it.
6) Include cash in your kit
Cash has its short-term uses, true, but don’t let that blind you to its long-term potential as an agent of diversification in your portfolio. Cash has a very low correlation to other asset classes, so it offers protection against volatility. Another advantage: Cash reserves can come in handy in down markets. With cash you can buy in when prices are attractively low—without having to sell securities at a loss, if they are also at a low point. So cash can provide your portfolio with some stability (low correlation, low volatility) and flexibility (to buy new assets without selling old ones cheap).
7) Find an expert you can count on
Finally, your bear market kit could benefit from having a built-in buddy system, so to speak. Meaning, if you’re not sure how to structure your portfolio correctly, or you think you’d be tempted to do something rash in a market slide, you should find a financial professional you trust to collaborate with you. That person can walk you through a complete portfolio review and help prepare you and your portfolio for times when the market gets tough.