We have arrived at mid-2019 to find the world in a place that is a little less certain than it was even a year ago. Many economic indicators are signaling a global economy that could be slowing down and consumers and governments, with their sky-high debt loads, seem poorly prepared for what may eventually come next. The word ‘recession’ is being bandied about even in respectable, serious publications, and there is a lot of speculation around “when?” and “how bad?”
When the economic storm clouds roll across the sky during an otherwise clear day the natural tendency is to start thinking about what you need to do to prepare. It’s very logical to feel like a significant change in external factors requires a response on our part. For folks whose primary issues are job security and debt, I have already made suggestions on how to protect yourself. But what if you are in the position where you have been working hard to build net worth and passive income through your investments? What steps should you take then?
(Note that this information is oriented to traditional buy-and-hold long-term investors with well-diversified portfolios).
Protecting Your Hard-Earned Investments
The first recommendation I would make is to re-evaluate your emergency fund. Your emergency fund is really the buffer between your regular cash flow and your investments. In other words, if your income unexpectedly falls or your expenses rise, your emergency fund is there to ensure you do not need to liquidate your investments that have a longer-term focus (your retirement accounts, etc.) in order to meet short-term needs.
When challenging times start to shake your confidence, boosting the size of your emergency fund is a great tonic. Add and extra 10%, 20%, or whatever amount works for you. This way, if you have a recession-related interruption in your income or your business activities, you will have more room to deal with it without withdrawing investments at a time when markets are weak.
Review Your Asset Allocation
Before markets roll over into losses, it’s a good time to review your investment asset allocation. This should be a regular habit (at least yearly) anyway, but if you are feeling nervous it’s an especially good time.
Most long-term investment portfolios are allocated between two primary asset classes: bonds, which are less volatile (less risky) and lower yielding, and stocks which are more volatile and higher yielding. Generally speaking, the ratio of stocks versus bonds determines the risk and expected long-term return on a portfolio.
When your portfolio was set up, the ratio of stocks versus bonds should have been assigned based on your tolerance for risk first and your return expectations second. If this was done well, there should be no need to make adjustments despite what is going on in the economy. A well-considered asset allocation would have taken into consideration the potential market declines that are tolerable for you in a worst-case scenario (such as a 2008-style correction). The best advice is to ride out the storm, confident that better days are ahead and in relatively short order there will be a recovery and a return to growth.
In this case, the most brilliant thing you can do is add more money if you see the value of your portfolio drop significantly. This basically means the securities in your portfolio are selling cheap, and when things are cheap it’s a good time to buy more.
But I Have To Do Something!
If you really feel like you can’t stay the course, like you have to do something, I would suggest that perhaps your existing asset allocation is not a fit for your risk tolerance. I am a firm believer in the idea that your investments should never keep you up at night. So here’s what you should do: move a third (or so) of your stock holdings to bonds. It’s that simple.
For instance, if your portfolio is 75% stock now, take it to 50%. If it’s 50%, take it to 35%. Why do I recommend this?
First: never try to time the market. This move should not be made because you think the market will decline soon. You really have no idea, and neither do I nor does anyone else. This is solely a tactic to get the volatility of your holdings down so that you have the confidence to keep the rest invested. Moving a third of your stocks to bonds will significantly lower volatility (risk) and reduce any temporary losses suffered from market pullbacks.
Second: making really big moves in and out of stocks (such as taking stock holdings to zero) virtually guarantees your portfolio will underperform compared to people who stay the course. This has been proven time and again in serious studies and is reflected in the chart below. Missing just a few good days out of several decades can drastically reduce your returns.
Third: there’s a really good chance you are wrong. Time and again people get very worried about the economy (etc.) only to see it and the stock markets continue to grow, in some cases for years. By taking risk off the table but staying invested you will still see some market-based returns even if your instincts are completely off base. You won’t miss out entirely.
Fourth: if you are right and the stock markets swoon, you can muster up the courage to move some or all of those reallocated funds back to stocks when prices are lower. This would have the added benefit of essentially buying stocks on the cheap, without having to come up with any additional cash.
After The Storm Passes
Once the perceived crisis has settled, your nerves have calmed down and you can reflect on the situation, re-evaluate what your long-term asset allocation should be. What you will likely decide is that you are a more cautious investor than you thought and you will maintain a new balance of stocks and bonds that better reflects this reality.
Important Disclaimer: the information above is for general informational purposes only and does not in any way constitute an offer for the purchase or sale of any security and is not intended to be considered comprehensive or personalized financial or investment advice. themoneygeek.info assumes no responsibility for the use or application of this information. Always consult a tax, investment, or other appropriate professional before adopting any new financial strategies.
I am an accredited Financial Planner with 23 years of experience in the financial services industry. During the course of my career I completed hundreds of financial plans and recommended and sold hundreds of millions of dollars of investment products. I believe that financial independence is a goal anyone can aspire to and I am passionate about helping others to live life on their own terms.