Today I woke up to an inch of water on the floor due to a busted pipe from the Austin freeze. We caught it early, shut off the water, and limited the damage. Despite shutting off our water, we're lucky because we have electricity, a backup water supply, and food in the pantry. Others in our city are less fortunate.
Risk happens fast, and fortunes can change quickly. During a raging bull market, investors want to own the story stocks, the high-flyers. When a stock is mentioned on CNBC, Twitter, Reddit, or any social media outlet, investors buy it despite knowing little about the company. As stocks rise, some question the wisdom of diversification or the benefit of owning bonds. At some point, markets correct, and your diversified portfolio will limit your downside.
Stock market corrections are normal. Preparing for a pullback will allow you to take advantage of it and buy the dip. Bonds act as a buffer or a source of funds. They typically rise when stocks fall because investors are looking for a refuge. During the COVID correction, the S&P 500 fell more than 30%, while intermediate bonds dropped about 5%, and short-term bonds rose 2%.
Building an all-weather portfolio is your first line of defense against a risk event. It's impossible to plan for every catastrophe, so don't try. Rather, allocate your assets to stocks, bonds, and cash to minimize risk. Of course, there are trade-offs. If you own a large amount of bonds and cash, it will be safe, but it will mute your growth. If your allocation to stocks is high, you'll experience larger drawdowns, but your long-term growth rates will be higher. Finding a balance between the two is part art and science.
Here are a few suggestions to safeguard your investments.
- Have a financial plan. Before the storm hit, my wife and I had a plan. When disaster struck, we sprung into action. A financial plan allows you to act on facts, not emotion. It will be your financial emergency rescue kit.
- Diversify your investments across size, sector, and class. Invest in a basket of globally diversified funds to give you exposure to multiple asset classes.
- Rebalance your account. An annual rebalance will reduce your risk and maintain your asset allocation.
- Invest in cash if you need the money in one year or less. A cash hoard allows your stocks time to recover. If you have cash on the sidelines, you won't need to sell stocks when they fall.
- Invest in cash and bonds if you're going to buy a home, a car, or pay tuition. If you need money for a large purchase, buy bonds or keep your money in cash so it's safe and secure.
Risk and reward are linked. To capture high long-term growth rates, you need to take risks. The stock market rises about three-quarters of the time, and a quarter of the time, it falls. Welcome the corrections. A declining market allows you to buy quality companies at discounted prices. When the market recovers, you'll be thankful you had the courage to buy when others were selling.
Be safe and happy investing.
"I always tried to turn every disaster into an opportunity." ~ John D. Rockefeller
February 17, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management 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.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor.