We’re heading into summertime, which usually includes visions of days when the livin’ is easy. Yet the stock market may have other plans. It often mimics a roller coaster, with many peaks and dips. It can upset our lazy summer days and cause investors to be fearful.
We would all like the stock market to have an easy upward climb, which is what happened from January through April 2019. As of April 30, the S&P 500 index increased 18% year-to-date. Investors can become complacent.
However, we should not forget that during early December (Dec. 1-24) the S&P 500 declined 19%. After Christmas the market rallied, resulting in a decline of 9% for the full month of December and a 4.4% decline for all of 2018.
The market will correct again (see box for stock market corrections during the past century). Since the most recent financial crisis ended in March 2009, the S&P 500 has increased more than 300%. We know a correction is coming, but we do not know when it will occur or how severe it may be. So … what steps can you take now to prepare for the next financial downturn?
1. KNOW YOUR NET WORTH. I recommend that everyone prepare a net worth statement, and update it once each year. (A net worth template is available at thejoyoffinancialsecurity.com/net-worth.pdf.)
2. HAVE AN EMERGENCY FUND that will cover your living expenses for six months. This is to be used if you become ill or lose your job, your house needs a new roof, or your car needs a major repair. Often these crises occur together as in “when it rains, it pours.”
3. CALCULATE HOW MUCH YOU ARE SAVING EACH YEAR, or how much you are withdrawing from your investments if you are retired. If you are not saving the full amount allowed in your employer’s retirement plan, increase the percentage being withheld from your paycheck. If your employer offers a Roth 401(k) or 403(b), contribute to the Roth portion rather than the traditional portion. You will not receive the short-term tax break on Roth contributions, but the long-term tax-free benefit is far more powerful.
4. UNDERSTAND YOUR COMFORT LEVEL FOR RISK. Research has shown that many investors think they are comfortable with a high level of risk, but when a correction occurs they are far less comfortable. There is no reason to lose a large portion of your hard-earned money during a market correction. You want to have an asset allocation (the percentage of equities vs. the percentage of fixed income) that you can live with in good times and in bad times. I recommend selecting an asset allocation that is somewhat conservative, and sticking with it.
5. UNDERSTAND YOUR INVESTMENT PORTFOLIO. If you have a stock broker or financial adviser, ask them to explain the rationale for the investments you own. Does your portfolio primarily contain index funds? Does it contain actively managed funds, or exchange-traded funds, or individual stocks and bonds? Is it diversified between large-cap, mid-cap, small-cap, and international holdings? Is it too heavy in technology stocks? Are the investments aligned with what you want to own?
6. KNOW WHAT FEES YOU ARE PAYING. A stock broker or financial adviser should be able to explain all the fees you are paying. This includes expense ratios for mutual funds, commissions, financial advisory fees, back-end loads, etc. I recommend that you demand transparency when it comes to fees, and you want the fees to be as low as possible.
Once you have completed the steps, your finances will be in good order for the next financial downturn, and you can stop worrying about it. Then you can turn your thoughts to the summer.