Investors might have gotten used to a nearly decade-long bull market, and they may not know how to handle anything else. That will likely change soon.
The stock market has seen record gains since the Great Recession in 2008, but many believe a downturn is looming. The Dow Jones Industrial Average DJIA, +4.98% and S&P 500 SPX, +4.96% two indices that measure U.S. equities, are experiencing their worst years since 2008. As such, investors may soon be in for a bumpy ride.
Downturns usually have investors panicking about losing all of their money, and that fear can drive them to sell their investments and wait until the market trajectory has reversed. That’s not necessarily a move that most advisers would endorse.
“Most investors buy high and sell low — exactly the opposite of what you want to do to make money in the markets,” said Scott Bishop, partner and executive vice president of financial planning at STA Wealth Management in Houston.
More than three-quarters (77%) of advisers expect a market downturn sometime in the next two years, according to a survey by Oaks, Pa.-based financial services firm SEI Investments Company. One-third predict it will happen in 2019.
Advisers say they are already fielding questions about a potential downturn. Here’s what they’re saying:
’I hear the market is going to crash — what should we do?‘
Many advisers tell their clients not to panic and “do nothing” because market timing — when investors try to buy or sell investments based on what they think will happen in the markets — is hard, and should generally be avoided. But market volatility, which many investors have been experiencing this last quarter, is also normal, said Eric Roberge, a financial adviser and founder of advisory firm Beyond Your Hammock in Boston.
“Our investment strategy is built to handle that,” he said. “What it is not built to do is have clients tinker with portfolios based on their emotions and how they feel in the moment.” Of course, it’s still important to talk out concerns and find ways to ease them, he said.
Instead of reacting to the market, investors should plan for the good and the bad — and try to remind themselves of these strategies when they become uncomfortable with the market’s turns. “Hearing it before is not the same as living it,” said Theodore Haley, president of Advanced Wealth Management in Portland, Ore. “It’s normal to be concerned but it doesn’t mean you should act on it.”
There are some investors who may need to adjust their portfolios if a downturn persists, however. Near-retirees and current retirees’ face the most risk because they need those assets sooner than their younger counterparts. The first few years of retirement can be risky during a downturn, when portfolios might see low, no or even negative returns, because those retirees may then be withdrawing from the principle of their portfolios (thus lessening their potential returns in the future).
’Will I still be able to retire?’
Advisers usually walk their clients through simulations to show them how their money will look under various scenarios. Bishop said he uses financial planning software to share updates about how potential events could affect their portfolios with his clients, who can see their strategies at work. “Many times, if they see that there is no material impact to their retirement plans, they feel better about staying the course,” he said.
When clients are still worried, he uses “Monte Carlo” analyses, which show the impact of changing investment allocations to be more conservative or aggressive. These analyses include calculating minimum required returns to have assets last through retirement and simulating random market conditions.
Investors can do a few more things to ensure a smooth retirement, even in the midst of a downturn: They should check that they’re properly diversified and rebalance their portfolios if they aren’t, try to withdraw as little as possible in the first year or two of retirement, pay off debts and maximize Social Security. In some cases, near-retirees may want to delay retirement so they can continue earning an income, instead of relying on passive income from investments.
’Why is my portfolio doing one thing when the market is another?’
Before advisers answer this question, they ask their clients what they mean by “the market.” Usually, it’s the Dow Jones Industrial Average, which is an index of 30 large, publicly-owned companies, or the S&P 500, another market index of 500 large companies.
“Neither of those markets are necessarily representative of the client’s portfolio, since those holdings are so focused on large cap U.S. companies.” Many clients’ portfolios are more diversified, which means they include other asset classes, such as bonds and cash. They may also be invested in international funds or alternatives. “So, in reality, by looking at the S&P 500, you’re only looking at a tiny portion of a fully diversified portfolio,” Roberge said.
Benchmarks can be helpful, but not always, Haley said. “Nobody’s goal is to beat the market, or it shouldn’t be,” he said. “It should be to fund your lifestyle and to retire at a comfortable age and achieve goals in life.”
’How long will this downturn last?’
Economists, advisers and researchers disagree on the answer to this question. “It could be a downturn like February, or it could be a bear market that lasts a decade,” Haley said. “The point is nobody knows.” Market corrections, bear markets and bull markets vary each time, as do their impacts.
The good news: This market volatility has helped people gauge how comfortable they really are with risk, before it gets any worse, said Ken Nuttall, director of financial planning at BlackDiamond Wealth in New York City.
Risk-tolerance questionnaires, which investors typically get when setting up a portfolio, can only do so much to estimate how much money investors are really willing to lose. Because investors don’t actually feel or see the loss when asked questions, they may feel more confident in their ability to stomach it. Now that the market isn’t shooting straight up like it has the last eight or nine years, some clients are saying, “Okay, I don’t have the risk appetite that I had before,” Nuttall said.