Saturday, January 16, 2016

What I Do When the Market Tumbles

When stocks take a dive, investors call their financial advisors and ask them what they should do. I received a few of those calls this week. Most advisors respond with some version of “Don’t panic.”

Here’s what I do when the market crashes: nothing.

To be completely honest, I wasn’t aware that the market had fallen 8% so far in January until my wife told me late this week. I don't watch business news – life is too short. She picked it up on CNN while she was watching election news. (I don’t follow that, either.)

Here’s my theory. If you have such a high allocation to equities that market declines make you anxious, you own too much stock. Find the allocation at which severe bear market losses won’t keep you up at night.

In the 2007-2009 bear market, the S&P 500 fell over 50%. My portfolio fell just 15% because I had a 40% equity allocation. As one of my favorite baristas, Mandy, would say, “It didn’t feel totally awesome.” On the other hand, I didn’t lose sleep.

William Bernstein addressed this in a couple of his early books, including The Four Pillars of Investing (page 268). He suggests that the initial pass at the correct asset allocation for you be based on how much you can tolerate losing in a bear market. He provided the following table:

I can tolerate losing
 this percent
 in a bear market
 Invest this
 much in stocks
 35% 80%
 30% 70%
 25% 60%
 20% 50% 
15%  40%
 10%  30%
 5%  20%
 0%  10%

Every December I evaluate my finances and plan for the coming year. I calculate my desired asset allocation, which might not be the same as last year’s. If my current allocation is within an absolute 5% or so of my desired allocation, I do nothing. Otherwise, I may trade a few funds or ETF’s to implement my new allocation. In reality, this rarely happens because my allocation doesn't often stray very far.

Because I am willing to lose 15% in a severe bear market, I don’t labor over my portfolio value daily. I probably check it four times a year, at most. I retired to enjoy the remainder of my life, not to fret over the stock market.


6 Tips for Investors When the Stock Market Tumbles –NY Times via @Retirement_Cafe
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Here’s some advice from other advisors I trust. Wade Pfau suggests reading this piece in the New York Times entitled, “6 Tips for Investors When the Stock Market Tumbles.” It’s a good one.

Dana Anspach suggests that if you feel that you must do something, instead of selling stocks, enroll in her free online class on retirement – another great idea.

Joe Tomlinson and I provided suggestions in Robert Powell’s USA Today column, “Advice for investors during crazy stock market volatility.”

If you’re retired or plan to be soon, set your asset allocation to a level of equities that you can tolerate. By definition, that means you won’t feel the need to do anything at all when stocks tumble. For young people still accumulating savings for retirement, invest most of your portfolio in stocks and don’t you do anything, either. In fact, do less than nothing. Time will fix this for you. As I recall, the 22% loss on a single day on Black Monday in 1987 didn’t feel totally awesome, either, but now it is barely a blip on the history of the S&P 500.


So, here’s my advice: pick an allocation you can stomach and ignore the noise. If you owned too much equity this time, gradually adjust it downward.

You'll know you're at the right allocation when the market takes a dive and you don't feel a need to call me.

Oh, and don’t panic.




While you're ignoring current market volatility, read about the changing nature of sequence risk as we age in my next post, Death and Ruin. Or, follow me on Twitter by clicking the FOLLOW button on the right side of this page and I'll link you to the best web sources of retirement information. Or, heck, do both!





6 comments:

  1. Sound and timely advice Dirk. I haven't done anything yet, but I am getting close to my 5% buy threshold. I love being able to sleep at night in times like this. Brad

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  2. Equities are on sale? Why didn't anyone tell me?

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    Replies
    1. I know, right?

      They're cheaper than they were two months ago. Whether that is "on sale" remains to be seen!

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  3. Dirk - While I, too, find Bernstein's "how much bear market can you stand" table illuminating and helpful, it implicitly and optimistically assumes a continuation of a reversion to the mean pattern that has characterized the US market for the past century ( i.e. that bulls always follow bears.). What it doesn't model and what worries me the most is a significant drop followed by Japanese-like flat market lasting decades. I'm thinking this would wreck permanent havoc not only on many retiree portfolios, but also on every private and public pension fund. Wondering what your thought is on this this.

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    1. That's my idea of a Black Swan, not the occasional severe market downturn. Bernstein talked about that, too, and suggested that expecting a success rate in retirement of more than about 80% is probably unrealistic.

      As I said above, losing your retirement savings or a big chunk of it, and with it your standard of living, is possible and it doesn't matter if that happens over decades because of sequence risk or in a year due to a spending crisis or over decades due to Japanese-like market returns. You need a plan (I suggest a floor) to deal with the possibility, no matter how unlikely.

      The scenario you suggest would impact far more than your portfolio and you should plan for that, too. I don't worry as much about market volatility as other sources of ruin because I can limit my exposure to the stock market. I can't limit my exposure to spending crises.

      One point I want to emphasize that has come up in several comments on this post. Retirement finance is much more than managing a portfolio of savings, yet researchers, retirees and many of my readers seem singularly focused on market risk.

      We need a broader perspective.

      Yet another excellent question, Barry. Thanks for the discussion!

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