Cut In Half
Please do me a favor. Add up all your financial assets – retirement accounts, investment accounts, checking, savings, etc. After calculating your asset amount, divide it in half. How do you feel? Could you survive financially? Do you need to adjust your lifestyle? The answer to your question will determine how to pursue your future investment strategy.
Since 1930, the Dow Jones Industrial Average has lost half its value on a few occasions, like the Great Depression and the Great Recession. It has declined more than 30% many times, and it appears like it falls at least 10% annually. The average decline since 1930 has been approximately 18.5%, and this year the Dow has dropped 12.5%. Despite the downdrafts, the market has averaged 10% per year since 1926. Unfortunately, we must endure painful down days to reap the rewards from the long-term trend in the stock market.
One client recently said, "If you know the market will drop, why the ***k do we own stocks?" It's a fair question despite the added color. We don't know why or when stocks will recover, but they always have, and if you don't own stocks when they rebound, you'll miss significant returns. After the Dow Jones fell 31% in March 2020 due to COVID, the market soared 55% from March to September. If you panicked and sold, you missed a robust recovery. During the Great Recession, the Dow crashed 53%. If you sold during the onslaught, you missed a 150% return from 2009 to 2013. I've noticed that people who sell stocks when they fall rarely repurchase them when they start to recover.
Let's revisit my original question. How would you feel if you lost half your assets? Of course, you're upset, and you're probably sick to your stomach because no one likes to lose money. However, if a 50% reduction in your assets does not impact your life, a market correction is a mere inconvenience and a buying opportunity.
If the market falls by half and significantly impacts your life, consider changing your investment allocation. Here are a few suggestions:
- Reduce your stock allocation. If a market correction alters your lifestyle, reduce your stock exposure to lower your risk level. Less risk equates to less return and less volatility.
- Buy bonds. Individual bonds are safe and predictable, especially US Treasuries, and they have performed well in previous corrections. During the 2008 correction, long-term US Treasuries climbed 26%. When stocks fell 43% from 2000 to 2003, bonds soared 43%.
- Increase cash. An emergency fund provides liquidity during a market collapse. If you can access some money during a crisis, it will allow your stocks time to recover.
- Reduce spending. If you reduce your spending, then you need fewer assets to live.
The Dow Jones is up 54% over the past five years, and if you've been a long-term investor, you're still making money, but this brings little comfort to new investors or those who bought stocks a few months ago. I know it's a challenging environment, but markets have always recovered. In the meantime, review your asset allocation, expenses, investments, fees, and goals.
If you think of the stock market as a cauldron of minestrone soup that occasionally somebody sticks a ladle in and stirs up, it takes a while before all the vegetables float back to the level that they were at before. ~ Seth Klarman
May 18, 2022
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management, located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
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