Personal Finance

Four Moves to Make Before a Market Downturn

January 13, 2020
Judith Ward, CFP®, Senior Financial Planner
Making large investment changes in response to a market downturn can hurt your portfolio’s performance in the long run. Consider these four ways to be better prepared when market volatility hits.

Key Points

  • Thoughtful planning can help you feel more secure in times of market volatility.
  • You can’t control the market, but you can control how you prepare and react, no matter your current circumstances.
  • Evaluate your options, knowing that you may need to be more flexible about your future plans should the market turn.

Making impulsive investment decisions amid a market downturn is never a recipe for success. Planning ahead, being patient, and considering smaller adjustments along the way can help keep your financial goals on track. During times of market volatility, it's important to focus on the things you can control.

Here are four of them:

1.  Asset Allocation: You may not be able to control the markets, but you can control your asset allocation. Stocks have the most growth potential over the long term, but they are also more affected by short-term volatility. When you’re in your 20s, 30s, or even 40s, you have time on your side, which will allow you to withstand and bounce back from volatility. A portfolio that’s 80% to 100% stocks could be reasonable. As you get closer to retirement, you should start to introduce more bonds into the mix. Bonds provide a buffer to dampen short-term market fluctuations, resulting in a more balanced investment approach.

The key consideration when determining your asset allocation is how your investment mix will impact your lifestyle in the near term. Some people may have enjoyed this bull market and, without rebalancing, might be overemphasizing stocks. Consider, though, in 2008, a portfolio of 100% stocks was down almost 40% for the year. And a portfolio that was 80% stocks and 20% bonds was down about 30% that year.*

Ask yourself: If my portfolio value dropped significantly today, would it impact my lifestyle? The answer to this question can help you put together an appropriate asset allocation for your circumstances. You may find that if you are nearing or in retirement, then you may be investing a little more aggressively than you should be, and you might need to pull back on stocks and add bonds to your portfolio.

2. Saving and Spending: Another factor you can control is how much you’re saving and spending. When you’re in the earlier stages of saving for retirement, a market downturn can be your friend. Continue investing as much as you’re able to—you’re buying shares at lower prices. This may require some discipline and patience, however, as historically it has taken three to five years for stocks to recover from a bear market. Automating contributions can help you keep your savings on track by reducing the likelihood you’ll make sudden changes in response to market conditions.

If you’re planning to retire soon or are already in retirement, your spending is a powerful lever that can help you weather a down market. Small spending adjustments could garner a large payoff. Assess your budget and determine where you might be able to cut expenses or put off larger purchases should the markets misbehave.  

3. Cash Contingency: Another thing you might want to consider is the idea of a contingency—starting to build up some money on the side. For those in the workforce, we typically suggest an amount that’s equal to three to six months of your expenses. Think of it as your personal safety net. Should you lose your job or come upon unbudgeted expenses, you won’t have to raid your retirement savings or rack up credit card debt to make ends meet.

Retirees may view their needs for available cash differently. A cash contingency could be used as an alternative to fund living expenses if there is an extended down market. You can draw from this account instead of having to sell investments at an inopportune time, locking in a loss. Considering that a 60% stock/40% bond portfolio recovered within two years during the last two bear markets, it may be reasonable for retirees to have one to two years of living expenses in a contingent cash account.

4. Flexibility and Preparation: It’s important to consider all your options and think of ways in which you’re willing to be more flexible. Should the market turn, could you continue to work for a couple more years? If newly retired, could you find part-time work to supplement your income? And, if the downturn was strong and sustained, leading to a weak economic environment, would you be prepared if you were to lose your job? For all these reasons, you should keep up with your connections, continue to build a network, and refresh your resume.

While bull markets don’t die of old age, we may get anxious with any bout of market volatility. We might not know when or how long a downturn may persist, but having a plan in place and being willing to make small adjustments can help you maintain control and manage your finances through these periods of uncertainty.

*Stocks are represented by the S&P 500 Index. Bonds are represented by the Bloomberg Barclays U.S. Aggregate Bond Index.

This material has been prepared by T. Rowe Price for general and educational purposes only. This material does not provide fiduciary recommendations concerning investments, nor is it intended to serve as the primary basis for investment decision-making. T. Rowe Price, its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of
(i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this material.

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