The world has become disruptive in the past couple of years. Rampant inflation in the economy and rising interest rates are causing many Americans to wonder if retirement is in their future.
One rule I live by is “never make lifetime decisions based on short-term factors.” Let us assume you are 60 years of age and wanting to retire at age 67. Your career is going well and your savings for retirement has been maximized for the past 30 years. Based on these simple facts, you surmise that retirement would be sustainable for the remainder of your life. Then the pandemic strikes! The economy contracts! You are now feeling less confident in your plans.
A market correction is defined as a 10% or more decline in major market indexes. Based on that definition, the U.S. experiences a correction approximately every two years (consider recently the Covid Correction). There have been twenty-eight corrections in the S&P 500 since World War II. The average market decline during this period was 14%. One of the most important key facts to remember is that the index recovered and returned to new all-time highs within a few months to a few years.
Typically, emotional investors create their own problems by over-correcting their portfolios. Wayne Gretsky, the Hall of Fame Hockey Player, remarked to a sports reporter asking his secret to holding the title in the National Hockey League for the most points in a season, “I skate to where the puck is going to be, not where it has been.” In a similar approach, you should not become so emotional during market corrections that you leave the market and realize losses when patience may return your investment positions to a greater value than when the negative market change occurred.
One method of removing the emotion from your investment portfolio management is to rebalance to maintain the appropriate risk balance you desire. There are two methods of rebalancing: time and threshold. Based on our research, either method will provide comparable results which is keeping your desired risk at a certain range or level.
Rebalancing using a time approach is simply setting a periodic date to rebalance your portfolio by selling the necessary asset classes to maintain the appropriate mix for your risk tolerance. For example, on the first business day of every fourth month you will rebalance your portfolio. Simple to remember and takes a little trading to sell and buy the various securities.
Alternatively, you can rebalance using the threshold method. When a portfolio is designed based on your time horizon, risk tolerance, and cash flow objectives, you may arrive at a portfolio with 50% in equities and 50% in fixed income investments. Over time the portfolio will experience changes based on market conditions. Should the equities allocation increase to 60%, the impact will be a reduction in fixed income investments to a 40% allocation. To maintain your proper risk level in the portfolio, you might wish to sell some of your equity investments and buy fixed income investments until you arrive at the desired 50/50 allocation.
During market turmoil, it is critical to your long-term success to manage risk. If you want a portfolio analysis of your retirement assets, contact a CERTIFIED FINANCIAL PLANNERTM professional. It is always better to know where you will land before jumping!