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One of the most common questions I get as a Financial Advisor when someone is worried about
how an event will impact the stock market is “What should I do?” People’s first instinct is often to go 100% to cash – just get out of the stock market and everything will be OK, right? Well, that probably isn’t the best solution. In fact, research has shown that missing out on the best days of the stock market, could be just a detrimental to your portfolio as a correction.
Let’s look at a hypothetical:
If you invested $10,000 into the S&P 500 on January 3, 2000 and left it there untouched until December 31, 2019, you would have received an average annual return of just over 6% and your $10,000 would have grown to $32,421.
This 20-year period includes roughly 5,000 days that the stock market was open.
If you missed the 10 best days out of those 5,000, you would have less than half as much money. Missing the 10 best days would have turned your $10,000 into $16,180.
If you missed the 20 best days, your $10,000 would have turned into only $10,176. And if you missed more of the best, you would have ended up losing money.
Missing the 60 best days out of the total 5,000 days would leave you with only $2,331 – an average annual return of negative 7.02%.
So, what should you do? Here are 5 Things to Help You Weather the Storm
Diversify, Diversify, Diversify
This is one of the easiest ways to help mitigate risk in your investment strategy, yet too many people are not properly diversified – and there are two reasons for that. First, most people don’t know what they are doing, they get a form from their employer to select investments for their 401(k) and they focus on what had the highest return last year, or they pick a bunch of investments that have different names and don’t realize they have selected all large cap or all small cap funds, and they are not developing a truly diversified portfolio. The second reason is that to be truly diversified, you have to admit defeat. Diversification means that at any time you will have some investments that do well, and some that don’t – and it can be hard for people to handle the ones that don’t.
Rebalance
Like diversification, this may seem easy but is often overlooked. Let’s look at an example, for simplicity let’s say you have a $100,000 portfolio of 50% stocks and 50% bonds. Now let’s say the stock market has a great year and your stocks are now worth $75,000, and bonds didn’t do much so those are still worth $50,000. Your portfolio has now gone from being a 50/50 portfolio to a 60/40 portfolio and your risk has increased. Rebalancing helps you manage your risk by bringing you back to your original 50/50 portfolio – makes sense, right? Buy low, sell high – it’s the basics of investing. Unfortunately, emotions often get in the way and we don’t want to sell the investments that have been doing well to buy investments that haven’t made any money. If you can, make rebalancing automatic in your investments.
Have an Emergency Fund
Make sure you have enough saved to cover expenses in the event of an emergency without having to dip into your investments or take on debt. If the market goes down, you don’t want to sell off investments if you don’t have to. We recommend that you have 3-6 months of living expenses in your emergency fund to help cover costs should you lose your job or have a major emergency.
Consider a Roth Conversion
If you think a Roth conversion makes sense for you, a market downturn can be a great time to execute it. When you convert your IRA to a Roth IRA, you need to pay taxes on that conversion, so if the market is down, and the value of your IRA is down, it could lower the tax bill on a conversion.
Prepare to invest.
We’ve already talked about Investing 101: Buy Low, Sell High. Too many people get scared by a pullback in the market and want to wait until the market recovers to invest again – which is the exact opposite of what you should do. So, if you have some extra cash on the sideline a market downturn is a can be a great buying opportunity.
The Bottom Line
You can’t predict what the stock market will do. If we look back at history, we will see that the market fluctuates, and we can reasonably conclude that we will continue to have ups and downs in the future. But nobody knows when those ups and downs will happen. As investors, we shouldn’t be trying to time the market, we should be developing a sound investment strategy that helps us build wealth over the long-term.
Important Information
Securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss.