Preparing for a Stock Market Decline

Jul 2021

It has been years since investors suffered through a prolonged market decline.  The last time markets experienced a long decline was during the Great Financial Crisis of 2008-2009.  The severe and quick market drop we experienced in March 2020 was one for the record books, especially because markets quickly recovered and finished 2020 with a double-digit gain!

But what happens when markets suffer a longer-lasting decline?  How should investors respond?  Investor behavior plays a pivotal role during volatile and downward trending markets.  During turbulent markets, our actions may impact investment performance and our ability to achieve meaningful goals such as retiring comfortably.

Therefore, it would serve investors well to consider the following to better prepare for an eventual market decline:

Know Your History

The stock market has a long history, dating back more than 100 years.  The statistics are vast and compelling, and if interpreted correctly, they can help investors navigate any market environment.  Here are some noteworthy facts:

  • The average bear market lasts only 10 months
  • The average bull market lasts 31 months or nearly three years
  • The market has averaged a double-digit decline every two years since 1950
  • The stock market has gone up about 75% of the time over the past 80 years

Long-term investors should not fear market declines and even bear markets; they should expect them.  Unfortunately, many investors overlook how consistently markets recover after every significant market crash and have gone on to reach new highs!

Tune Out Negativity

We all know about this one.  Everyone becomes a stock market expert when stocks are performing poorly.  From the “I told you to get out a year ago” to “A guest on CNBC said the market was going to crash in a few months”.  The news cycle can make market declines worse because media outlets often focus entirely on the fire and not what extinguishes the fire.  For that reason, it is a good idea to keep your circle of news outlets to a minimum and focus on actual data and analytics.

In addition, if you work with a financial advisor, make sure you talk to them about any concerns you have about the current market environment and how it might impact your investments and goals.  These conversations should happen both when the market is up and when the market is down. At Bloom Advisors, we spend a lot of time educating our clients about market history and making sure they can achieve their dreams regardless of the market environment.

Asset Allocation & Rebalancing:  A Perfect Combo

The split between stocks and bonds is, in my opinion, the most critical portfolio decision.  It will help you sleep better at night, but it won’t entirely protect your portfolio from declining.  It is true that during a significant market decline, most equity asset classes tend to fall in unison.  Historically, the returns of stocks, bonds, and cash haven’t moved in unison.  Market conditions that lead to one asset class outperforming might cause another to underperform.  The result is less volatility for investors on a portfolio level since these movements offset each other.

Asset allocation works well with portfolio rebalancing, which is a process to ensure you stick with your intended investment mix. For example, if you target 70% stocks and 30% bonds, you want to make sure your allocation remains balanced. Investors need to review their portfolio as often as necessary to ensure their allocation stays within their specific risk parameters.  At Bloom Advisors, we review client portfolios at least four times per year to reflect changes to our clients’ needs, investment strategies and market conditions. Engaging in this process of rebalancing will force you to sell high and buy low within your allocation parameters.

Resisting the Urge

The ability to manage investor behavior is crucial, especially when financial markets are in turmoil.  There is a well-known investment expression worth remembering:  “Don’t just do something; stand there”.  It often feels like investors should take action when panic and fear take over.  If you constructed an investment portfolio for your own specific goals, maintaining that portfolio during good and bad times may make perfect sense.

Bottom Line

If you are a long-term investor, it is nearly impossible to avoid stock market declines.  They are going to occur, but how investors respond to them can lead to success or failure.  A successful investor does not let market disruptions dictate their investment allocation, while unsuccessful investors allow fear to take over and guide their decision-making.

Becoming a more successful investor means understanding the risks in a portfolio and aligning the investment allocation to match goals and objectives.  Doing so helps prevent investors from making changes when markets are in turmoil that they will regret later.

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