The markets will go down, so how should you prepare?
In the last 90 days we have had at least 50 people ask us about an impending recession. Everyone seems to expect that something bad is about to happen in the markets, likely due to the uptick in pessimistic soundbites and clips flooding our senses from various media outlets. Let’s be clear, while we are not predicting a market correction in our imminent future, at some point it will happen BECAUSE IT HAS TO – that’s how market cycles work. But that doesn’t mean we should ignore your feelings. Now is the time to address your concerns and possibly make changes to reflect your current needs and desires.
To start, we believe it’s important to gain a little perspective about recessions and market corrections in general. Let’s begin by defining the terms commonly used to describe the state of declining markets.
This term is used to describe a significant decline in general economic activity as measured primarily by GDP. Typically, a recession is identified by two consecutive quarters of economic decline. Recessions, along with other milestones of the business cycle, are officially declared after the fact by the National Bureau of Economic Research (NBER). It is important to note that a “recession” refers to declining GDP, NOT necessarily market declines. However, as equity prices are essentially aligned with the future earnings potential of companies, it’s only logical to assume that a decline in their earnings potential could lead to a decline in equity values.
This term is used to describe a 5-10% decline in stock prices.
These pull-backs are not only normal, but healthy as they continue to help ensure those in the market are investors, not traders. Pull-backs generally occur about 2-3 times per year.
This term is used to describe a 10-20% decline in stock prices.
There have been more than 100 corrections in the market’s history, and they occur on average once every 12-15 months. In fact, although many seem to have forgotten already, the last correction occurred in December of 2018.
This term is used to describe a 20%+ decline in stock prices.
These periods occur on average once every 7 years. The latest Bear Market ending in 2009 has left a lasting impression on investors as it was the biggest downturn in US history since the Great Depression, with the S&P 500 losing over 50% of its value.
Now let’s review historical market performance as measured by the S&P 500. Remember that past performance is no guarantee of future results, but looking at general trends can help to give us some much-needed perspective.
According to the History of U.S. Bear & Bull Markets by First Trust, since 1926 (that's 93 years)…
• The S&P 500 has experienced 11 Bear Market periods lasting on average 1.3 years with an average cumulative loss of -38%.
• The S&P 500 has experienced 12 Bull Market periods lasting on average 6.6 years with an average cumulative total return of 334%.
• There have been 15 Recession periods, only 6 of which have overlapped with a Bear Market. (Please take note of this!!)
Armed with this data, let’s circle back to our discussion on if YOU are ready for the next imminent recession. Every family we have the privilege to help has their own personalized Investment Strategy as part of their overriding long-term Dashboard plan. When we first design a personalized Investment Strategy and deploy assets into long-term portfolios, we take into consideration all known (and potential unknown) risks that can and DO occur, and then invest assets accordingly. We take many factors into consideration and then build out a portfolio that contains appropriate levels of Cash for short-term needs, U.S. Equities, International Equities, and Fixed Income investments that together are designed to help give our clients a statistical likelihood of creating a lifetime of retirement cashflow with the most appropriate level of risk at that time.
Here’s the reality…you are already prepared for a recession or market decline!
Here’s the reality…as one of our dear clients you are already prepared for a recession or market decline! Let me say that again…you are already prepared for a recession or market decline!
If you cannot accept this as true, and you continue to lose sleep in your anxious state, then let’s discuss what actions you can take to assuage your fears and help prevent you from making a costly, emotionally-charged mistake.
Perform your Self-Affirmations
Read the sentence above and agree/realize that you are already prepared for a recession or market decline because your long-term strategy was designed with recessions in mind. Proactively do nothing different. Keep calm and carry on!
Double your "Cash Zero"
“Cash Zero”, or more commonly referred to as an Emergency Fund, is a threshold we always discuss in our Dashboard Planning conversations. We encourage all clients to keep 6-12 months of spending cash in their checking/savings to create a cushion for any unexpected expenses or life events. By segmenting and maintaining a “Cash Zero”, we are prepared for any short-term surprises that may come our way…we can live our lives as usual without having to tap into our portfolio and interrupting our long-term investment plans.
As mentioned above, the average Bear Market lasts 1.3 years. If you are truly concerned about the impact of another market correction, then we would recommend you consider doubling your “Cash Zero” threshold, which should equal 12-24 months of spending needs. This amount should likely carry you through the majority an average Bear Market period without having to tap your long-term investments and possibly realize a loss.
Isolate planned Capital Expenditures now
If you know that in the next 1-2 years you will have a large expense in excess of your typical spending (large family trips, new windows for the home, new car, basement renovation, education costs, etc.), let’s “spend the money now” by earmarking needed funds and setting them aside. These expenditures are truly short-term in nature and have no business being invested in the equity markets. By carving out these amounts from the portfolio, it often gives us the psychological edge of a longer-term perspective.
Align your investment philosophy with your investment reality
This is the difference between “knowing what you got” and “understanding what you got”. If the sticker shock of a drop in the total value of your portfolio makes you crazy, then maybe we should challenge your overall strategy and investment allocation. It is fairly easy to dial down the risk profile of a portfolio by increasing the allocation to Fixed Income investments, which should help to mitigate overall volatility. However, it is critical that we strive to ensure your future financial independence by maintaining a necessary allocation to Equities to provide long-term growth potential. Always remember, your plan is comprehensive and extends well beyond some arbitrary portfolio balance on any given day.
Don't mistake molehills for mountains
The last time you were on a plane, did you insist the pilot make an emergency landing during a patch of turbulence? The last time you were sitting in gridlock traffic on your way to work and saw a commuter train whiz past you, did you get out of your car, sell it on the spot, and walk to the next train stop? As silly as these examples sound, they aren’t too far off from the behavior of a rattled investor making panicked decisions governed by fear. The next time you feel yourself start to “spin out”, give us a call so we can continue to discuss what your personalized plan looks like, the calculated risks we are taking, and how we should either tweak, hold, or add to the portfolio when appropriate.
We’ve discussed the impact of fear on investing many times over the years because when fear drives our decisions mistakes are made. We believe the best approach to combat fear is open and frequent communication around your personalized strategy and long-term plan. We must always remain steadfastly committed to our long-term goals of building real financial independence and continue to invest into properly risk-aligned portfolios.
As we continue along in our 10th year of this glorious Bull Market, keep in mind that “preparing for the next (inevitable) recession” is best accomplished by simply following the logical (not emotional) steps outlined above.
Raymond James is not affiliated with First Trust Portfolios, LP. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Individual investor's results will vary. Diversification and asset allocation do not ensure a profit or protect against a loss.