Market corrections are extremely painful, there’s no sugar coating it. But there’s no need to make matters worse by turning an uncomfortable season into something that has a permanently negative impact on your future.
Trying to keep yourself focused on why you’ve entered the financial markets in the first place is easier said than done. The purpose for your investments is almost certainly to help assure your assets keep pace with inflation and to position yourself as well as possible to reach future goals either for capital expenditures, a secure future income stream, or for a legacy to leave your loved ones.
To help achieve these worthy goals, there are a few useful steps to surviving market corrections and ultimately thriving in their recoveries.
A first step is to fortify your foundation.
For those nearer to or in retirement, this foundation equates to a set of extremely high quality assets or other perhaps guaranteed sources of income that assure your recurring expenses for your desired lifestyle are met. For some this is a pension. For others it might be social security or annuities. Some might be comfortable enough with high quality bonds; unlikely to default even though they aren’t guaranteed as the other income sources are. For many, it’s a reasonable combination of all of the above.
So the first step is to take a deep breath, step back, and take a look at your collective portfolio and the income it is positioned to provide on a guaranteed basis. If that review creates more anxiety than relief, we should plan to chat about whether or not you might benefit from some changes to your total plan.
For those with plenty of years before retirement, this foundation is more about the fundamental habit of saving and investing. And it doesn’t stop in downturns. Instead, it takes full advantage of them since you’re able to buy more assets for the same contribution as things get cheaper. For younger investors, their first step is to remember that successful investing can be boiled down to the behavior of doing the right things long enough; which simply means to live within your means and continue to save and invest without regard to the current news cycle.
Once the foundation is fortified, the rest is all about building wealth by growing the portfolio that is supported by your foundation.
From a mental perspective, this wealth building segment of your portfolio needs to be separate from your savings or your ‘emergency fund’ of typically 3 to 6 months of expenses safely stuffed in a bank account. Remember that the only money you should have in the financial markets is your investment capital. This is money with at least a couple years to work before it needs to be used. All money that is potentially spent in the next 12 months (and 24 if you’re particularly conservative) should be in your local bank, not an investment account.
A common and critical mistake made by many people is to confuse or comingle their savings money and their investment capital. When you mistakenly have your short term savings in the market it is nearly impossible to keep proper perspective when markets experience their inevitable rough patches. The wild mood swings of the market are far more likely to lead to your own mood swings if you see things dip and you immediately equate that to some short term goal or obligation being jeopardized. When you have a mental earmarking on your investment capital, it allows you to reduce emotional reactions to the market’s jagged movements. This positions you very well for long term investment success. On the other hand, if you have short term money at risk, you set yourself up for failure due to the natural frailty of our human emotions.
Next, to best build wealth within the investment portfolio, avoid “all-or-none” type thinking. Stick with discipline and you’ll fare better over time. Recognize and accept that nothing works all the time or in real time. There is no perfect strategy or allocation that will propel a portfolio on a linear pattern upward without fail. Some years the ‘exceptions’ outweigh the ‘rules’. One simple example from this current market phase is that both stocks and bonds of all types are in the red. This is highly unusual and it is also fairly meaningless if you are focused on the future state, not just the current state, of your wealth. In fact, to generalize things a bit, essentially all ‘growth’ assets and ‘safety’ assets are down at the same time currently. In other words, investors doing the right things by diversifying across various sectors like bonds, real estate, metals and others in the effort to add a margin of safety to their portfolios are uniquely discouraged by how this backfired in 2018. Does this mean it was a mistake? Does this mean diversification is dead? Does this mean continuing to depend on investing as the best way to outpace inflation and reach future goals is foolish? Absolutely not. It means 2018 was a bad year in the financial markets. Does it mean 2019 and 2020 will also be bad years? Looking back at history, there’s no reason to believe that.
I’ve often said that “all anything is all wrong”. I stand by that statement. Of course, from one quarter to the next, this stance can be wrong. Sometimes it is clearly better to be 100% in technology stocks or 100% in cash. But common sense couples with history to say this is a recipe for long term failure, not long term success.
In these dreary days of the financial markets, it makes the most sense to stick with discipline and diversification. Sometimes it takes a few days more than normal for the right medicine to kick in and cure what ails us. Discipline and diversification, like medicine and rest, will ultimately show their healing powers.
The takeaways:
- If you’re nearing the distribution phase of your portfolio, take a clear headed look at what exactly is being relied upon to create the bulk of your income. Are those sources guaranteed? If not outright guaranteed, how comfortable are you with their ability to pay you as long as you live regardless of prevailing market conditions? Hopefully this exercise gives you reassurance through the market storm. If it doesn’t, let’s talk about ways to increase that sense of security.
- Don’t abandon discipline of any sort. Continue contributing to your portfolio if you have a multi-year time horizon, and don’t abandon your disciplines of diversification and exit strategies at any time.
- It is imperative to be honest with yourself about the level of volatility you can withstand in your portfolio. Volatility in and of itself isn’t risk. Risk is better expressed by how you react to volatility. Your investments should provide peace of mind, not stress. That said, stress is always an unavoidable component of the investing process. Your time horizon is the key to how much stress you are likely to feel. With a multi-year time horizon, stress should be minimal. If distributions are near, you should be realigning your portfolio to reflect those income streams, which should also result in a much more manageable stress level.
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