Four Fortifications for Your Retirement in a Volatile Stock Market
In 2022, the U.S. stock market was lower for the year when the halfway point rolled around. This is relatively rare, occurring only twice since the financial crisis, in 2010 and 2020. The broad-based Standard & Poor’s (S&P) 500 index fell more than 20% in the first six months of 2022, placing it in what is called “bear market territory”.
Stocks are volatile investments whose value always fluctuates on a day-to-day basis. The periodic occurrence of bear markets is part of being a stock market investor. That does not change the fact that your retirement funds may have taken a hit during this year—and that’s not an easy experience!
We believe that it’s perfectly natural to want to “fortify” your retirement against stock market volatility. Much of what is written in the popular press can be very short-term in its orientation and possibly ill-advised. Over the past 50 years of helping families plan for and live through retirement, we would like to share some potential ways to fortify your long-run portfolio positioning intelligently.
This article shares tips, including:
1. How sensible diversifying of your portfolio can help protect your equity
2. What should trigger a review of your asset allocation
3. Why discipline is an essential aspect of investing
4. Devising a long-term financial plan to guide your portfolio
1. What is sensible diversification of your retirement portfolio
The old adage, “Don’t put all your eggs in one basket,” certainly can be applied to the stock market. If your retirement portfolio represents the substantial majority of your available investment assets, you might be prudent to start with the assumption that you don’t want your retirement portfolio to be solely invested in stocks. (If you are very young, with many years to retirement, and depending on other unique circumstances, you might be an exception to this guideline.) For most people, diversification (investing in different asset types) is potentially a safer and more stable approach.
This means that, when the stock market drops, you also have money in other types of investments, which may not take a similar hit in the short-term. Typically, the other asset classes in retirement portfolios are bonds and cash.
Bonds provide more principal stability than stocks, although the principal can still fluctuate a bit (generally inversely with the movement of interest rates). Bonds also provide cash returns from interest payments. Allocating some percentage of your retirement assets to Cash aims to provide a stable way to maintain your principal, but you may not earn much interest or experience any capital appreciation.
Some retirement portfolios are also invested in alternative investments, such as real estate, precious metals, or even hard assets such as commodities. You may want to reach out to your Atlanta financial advisor to discuss how your asset allocation could potentially be structured to provide protection against stock market risk. Getting the allocation right should be based on a good long-run plan (see #5 below).
2. Reviewing Your Asset Allocation
It’s important to review your asset allocation periodically, at least once a year. However, even two or three times annually may be advisable. Why? The first answer is that it may be appropriate to “rebalance” your portfolio to keep in aligned with your allocation plan. A simple example will show why this is so.
Assume you started the year with a retirement portfolio of $500,000 and your diversified asset allocation guideline was 50% stocks ($250,000), 40% bonds ($200,000), and 10% cash ($50,000). As of mid-year, your stocks might have declined 20% from $250,000 down to $200,000. With interest rates having risen, your bonds might be down 5% as well, from $200,000 to $190,000. Your 10% in cash, or $50,000, was likely unchanged. Diversification meant your total retirement portfolio was down 12% to $440,000. But your stocks are no longer 50%. Because they declined the most, they are down to around 45% of the total “pie”. Rebalancing would mean you sell enough of your bonds and cash investments to add to your stocks and bring them back up to 50% of the lower amount, or $220,000 of the $440,000. This rebalancing is a “Sell High – Buy Low” discipline that means you’ve added to your stock investments when they were lower in price.
Secondly, your risk tolerance may change. Risk tolerance is defined as “the degree of risk that an investor is willing to endure given the volatility” in the investment. This is unlikely to happen 2 or 3 times a year, but over the course of your investing lifetime, your risk tolerance may indeed shift.
Yours can change with varying factors. One of them is your age. If you are 64, and set to retire next year, your risk tolerance for stock market volatility is likely to be lower than if you are 25 and just began investing. At 25, you likely have decades to reap the benefits of stock market appreciation, even given periodic bear markets. At 64, you are preparing to begin living off of your assets in the near future.
So, a bear market can potentially disrupt your retirement plans if you’re in your mid-60s or older. It’s usually appropriate to be more balanced in your asset allocation than might have been the case when you were 25. Other factors that can affect your risk tolerance are your job status, income, family structure, marriage, the birth of a child, a divorce, outside asset and income sources, et cetera. Any other factor that affects your income, expenses, and overall life situation can be a factor.
Your goals also have a major bearing on your asset allocation. Time horizon is probably the most important variable. If you want to retire in 30 years, your asset allocation will most likely be different from someone whose goal is to retire in five. The nature of your planned retirement is also important. Suppose your goal in retirement is to downsize and move to an area where the cost of living is much lower than where you currently live. Your need to withdraw heavily from the portfolio would likely be less in comparison to someone who plans to travel and spend extensively. “Withdrawal rate” affects asset allocation.
Our Approach Isn’t Just Numbers—It’s About the Financial Life You Want
3. A Disciplined Approach is Essential in Investing
Discussing your goals and portfolio planning with a fiduciary investment manager in Atlanta could be a prudent step. But once you’ve discussed your objectives (and periodically reviewed them), the best planning in the world will not help you unless you stay disciplined over both the short and the long-term. It’s generally not advisable to suddenly decide to sell because you look at your statements and see less in the funds than last month. As our firm’s Chief Investment Officer, Ryan Patterson, CFP®, CFA, likes to say, “Panic is not a strategy!”
If you’ve committed to a long-term holding strategy as part of your plan, stay with it. This is a basic tenet of portfolio management. We believe that one of the worst investment decisions you can make is to panic and sell into a stock market decline. Historically, the U.S. stock market has bounced back from every bear market in the last century—and then continued upward. By the time you feel like you need to sell, it is likely that most of the damage to your portfolio has already occurred.
If you panic-sell, you’ve eliminated your ability to benefit from the potential upward rebound. Remember: losses only exist on paper until you sell. When you sell, you’re locking a loss in, ensuring the loss of equity by falling prey to fear.
4. Long-term Retirement Planning
For retirement or any other goal, stock market investing is not a short-term game. As a matter of fact, for short-term goals, other asset classes (like cash and bonds) might be the investments you look to. Despite attractive advertising claims, no one can time the market, so while the stock normally recovers, given time, no investor should assume that it will go up over the short-term.
The good news is that over the long-term, it does typically rise. The S&P 500 index has returned about10% annually for the past 100 years (even when you factor in periodic market dips). Overall, that exceeds the returns on bonds and cash.
Historically, inflation has run at roughly 2-3% annually (although it’s currently higher). The interest earned on U.S. bonds and cash, once adjusted for income tax impact, has been under the inflation rate for the past decade. So, over the long term, the stock market has been the most likely asset class to deliver returns ahead of inflation.
Consult with a Fiduciary Financial Planner
So, what is there to do now? When it comes to protecting your retirement savings, your optimal action may simply be consulting with an Atlanta fiduciary advisor. A wealth advisor can develop an individualized plan for you that may even lower your tax liability long-term (among other things).
An individualized strategy takes into account your goals, your current age, the age at which you plan to retire, your risk tolerance, your projected retirement income (such as a pension or annuity), and more. At Linscomb & Williams, we even work with your present cash flow to maximize what you can currently contribute to your retirement and other goals.
Find out how meeting with experienced financial planners in Atlanta could help you strengthen your retirement equation. Contact us today to discuss your current situation and long-term plans.
Linscomb & Williams
For over 50 years, Linscomb & Williams has aimed to help people like you mitigate financial risks and grow your wealth, so that you can live life on your terms and define your own unique future. As a fiduciary, our aim is to deliver the best advice to you so you can achieve your financial goal, for one single fee.Read other posts