Worried about a market crash? Here's how to make smart investment decisions.
If you check the financial news every once in a while, you may inevitably see headlines like these: “Financial experts warn of imminent market crash…” “Indicators lined up for bubble burst…”, “If you have any money in the markets, read this!” While these headlines can be intriguing, most of the articles provide very little substance. However, it is important for investors to be conscious of risks and to evaluate how volatility in the markets will specifically affect their financial goals. In this post, we explore some actions that you can take to understand how market movements may affect you.
Grabbing your attention
If you look again at the headline examples above, you will notice some similarities. They are all very general and they are playing on fear. Since there is always an element of risk when we invest our money, we retain some measure of a fear of loss in our minds associated with our investment. The experts of marketing are well aware of this and they use our fear constantly to vie for our attention and our clicks. Please check out this post from last year for more information to help protect yourself from misguided headlines: Expert Advice or Total Scam?
Defining the risk
Every day we are faced with risk. Some is measurable, some is not. As investors, it is important for us to be aware of what risks we face and to evaluate if they are high probability or low probability. The media and headlines tend to focus on low probability risk because that is what we fear the most. Major political changes, extreme global events, or fundamental changes to our way of life are frightening, however, they don’t happen often and they tend not to drive long-term market results.
At Centered Financial, one of our mottos is “Invest with Purpose”. At the core, this means to understand why you own what you own and to make your investments intentional. When it comes to risk, this means that we need to understand how our investments may be impacted in different scenarios.
What is happening now
A helpful thing to remember when it comes to evaluating risk is to ask, “What is the market saying?” as opposed to “What do I think the market should do?” As investors, we often are looking at present conditions with the thought that markets should react a certain way. However, many of the movements in the market are evaluating expectations for six months or more in the future.
As I discussed in our 2nd quarter market outlook, there are a lot of positive signs of economic recovery at the moment. We have fully moved out of last year’s recession and our business cycle is in an early recovery phase. Consumer demand is increasing and a comfort level of moving beyond the pandemic is starting to set in. .For example, this week Southwest Airlines said that airfare prices are approaching 2019 levels as leisure travel is continually increasing[1].
While we are seeing positive signals, there are also some concerns to be aware of. Last week, we received a jobs report that was poorer than expected[2]. This may be an indicator that unemployment is leveling off which would leave us under capacity. In addition, the economy is still dependent on extremely accommodating monetary policy. This means that the Fed is putting a lot of money in our economic system to help things out and many are worried about how the market will react if the Fed changes their course.
Consider the image below:
This chart shows the S&P 500 price performance currently (black line) compared to the price performance during the recovery from the Great Financial Crisis (pink line). The graph below the two lines shows a comparison of earnings growth. The message is that there was a point in our recovery from the 2008 crisis where things were going well and then the Fed changed their policy. This resulted in a 3-month 15% correction. At the time, that was very frustrating, but as you can see in the graph, things got back on track quickly and the market marched upward. What is interesting is that we are now facing a very similar situation. The market has recovered strongly, our economy is showing improvement and many wonder if the Fed will act similarly to how they did back then. If so, we may be facing a similar market downturn while expectations are reset. For the time being, the Fed has communicated that they have learned from the past and that there are several indicators including unemployment levels that are not warranting a change in their current policy.
The other concern is inflation. We are already seeing some healthy increases in inflation levels. If the Fed continues their current policy for too long, we may run the risk of inflation running too high. Higher inflation tends to affect stock prices. Historically it also has influenced bonds which makes assets like cash and gold attractive as hedges if inflation runs too high.
So, what should we do now?
As I have shown in the chart above, we are not dealing with anything new. While the past is no indicator of future results, it helps to keep in mind that history has taught us many lessons and despite market fluctuations, stocks have consistently been an asset class that has outpaced inflation and provided long-term positive returns to help us reach financial goals.
We also know that it is extremely difficult to time any market changes. The old mantra, Time in the market is better that timing the market, is good advice. As you can see in the image below, over the long-term it helps to stay put and ride through market corrections.
Two smart moves to make if you are worried about volatility
Ask the right questions
If you are concerned about what is happening right now, it is important to evaluate your feelings and put them in context with how you might be affected by any risks. Here are some important questions to ask before you make any investment changes:
1. Will a crash affect my income?
If you are actively taking income from an investment portfolio or you plan to take income soon, a sudden drop in the market can be a major concern. Investment losses are sometimes increased if we are actively withdrawing money and do not give it the opportunity to grow back. You should take steps to make sure you protect the income that you need from unnecessary volatility.
2. Do I have time for my money to grow back?
If you are saving for a specific event like retirement or a major purchase, it is important to be conscious of the time it will take for markets to recover from a downturn. Consider the chart below that shows an average correction results in a loss of 13.7% and takes 4 months to recover from. As a general rule of thumb, we recommend that any money needed within 18 months should be held in cash. Money needed within 2 – 5 years should be allocated to bonds, and money that is needed beyond 5 years should be allocated to stocks.
[3]
3. What are my expectations?
As I mentioned before, many headlines try to play on our fears. We are often more susceptible to a fear of loss because we have not set the right expectations. Consider the chart below. The red numbers are the maximum percent decline of the market during the year, and the bars show the actual end of the year performance. As you can see, the average for an intra-year drop is about 14%, however the market has finished positive 75% of the time. If we invest with the expectation that the market will experience corrections regularly, we will gain more confidence in our ability to handle bad news.
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4. How exposed am I to a loss?
Remember that the market news that you typically read does not reflect your actual portfolio. This is because you can’t actually invest in a market index. We can mimic indexes, but a well-diversified portfolio is going to have exposure to a variety of asset classes. Below is a comparison of a moderate portfolio to some common risks. If you have questions about how your portfolio is exposed to a market loss, make sure to reach out to us!
Evaluate your investment mix annually
Each investor should make decisions based on their own tolerance for risk. When we initially invest, we typically pick an investment mix that matches our tolerance and at Centered Financial, we always focus on choosing an investment mix that is appropriate for a financial plan. However, over time as asset values change, our investment mix changes. We may find ourselves with a much more aggressive allocation than we had intended.
I recommend evaluating your asset allocation at least annually. Keep in mind some of the general rules of thumb that I have mentioned before. If you need to withdraw money within the next 12-18 months, keep that money in very low-risk assets. However, money that needs to grow to meet a long-term goal should be allocated to risk assets that can outpace the growth of inflation. The portfolio risk spectrum below can be a helpful guide.
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We hope that this discussion on market risk is helpful as you navigate the current investing environment. We are here to help, so please reach out to us with any questions or concerns about the markets and we would be happy to discuss your needs.
Also, if you are close to retirement, we have a helpful e-book to help you navigate important decisions. Download your eBook here.
[1] https://www.cnbc.com/2021/05/19/covid-travel-southwest-says-leisure-airfares-near-pre-pandemic-levels-but-jet-fuel-prices-rise.html There are a lot of constructive things happening in our economy and the market has responded with a strong start to the year.
[2] https://www.cnbc.com/2021/05/07/jobs-report-april-2021.html
[3] Image Source
[4] https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/
Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.
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