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How to Prepare Your Portfolio For Market Correction

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DeYoung, Gage

Last weekend I watched Business Insider’s “The Bottom Line” June 8, 2017 interview of Jim Rogers by Henry Blodget.

Henry began with an analysis of market valuations projecting dismal returns for the next decade and then introduced Jim Rogers of “Investment Biker” fame. Jim came on to predict a market crash is coming. This was nothing new for Mr. Rogers, he has been forecasting another crash for some time now. But during previous interviews, he humbly admitted he is horrible with market timing and could not say exactly when it would happen. During this interview, Henry asked, “When is this (market collapse/crash) going to happen?” and Jim’s response was, “Later this year (2017) or the next, write it down.”

Given the weight of data, I concur with many current market forecasts of dismal future market returns. In response to these forecasts, for the previous year-and-a-half, I have been helping my clients proactively lower the expenses and fees of their investment portfolios. I believe we will either grow slowly into current market valuations, making low-cost investing a mandate, or we will experience another market correction, resetting current valuations and allowing for the return to a better future return environment. We should be prepared for a market correction to be either swift like 2008 or perhaps drawn out like the one that lasted from 2000 through 2002. (For more from this author, see: Reduce Your Investment Fees to Get Ahead Financially.)

What to Do When Facing a Potential Market Correction

What is an investor to do in this environment?

It is most important to confirm the asset allocation (mix of stocks, bonds and cash) of your portfolio is appropriate for your unique personal financial situation. You should be aware of the potential impact to your portfolio of a significant market correction.

Most of the clients I work with are nearing or in retirement. Depending on the anticipated use of their portfolios and given current high market valuations, I generally prescribe a balanced or conservative asset allocation. A balanced allocation may be appropriate for an investor nearing or recently into retirement with only an anticipated 3%-4% portfolio withdrawal requirement and an average risk tolerance. A conservative allocation may be appropriate for an investor who has a greater withdrawal requirement from their portfolio, an investor age 80+ or an investor with a lower tolerance for risk. This is a general recommendation; however, each client’s situation is unique and could warrant an even higher or lower allocation to stocks.

How Asset Allocation Affects Market Loss

Fidelity Investments’ model balanced asset allocation is built with 50% in stocks, 40% in bonds and 10% in short-term holdings. According to the MoneyGuidePro financial planning software program, a portfolio built in this manner would have lost about 19% of its value during the Great Recession (November 2007 – February 2009). Fidelity Investments’ model conservative asset allocation is built with 20% in stocks, 50% in bonds and 30% in short-term holdings. According to MoneyGuidePro, a portfolio built in this manner would have lost only about 3% of its value during the Great Recession. (For more from this author, see: Why Asset Allocation Is Important in Your Portfolio.)

While it took the S&P 500 four or five years to recover from our previous two market corrections, a balanced allocation, assuming rebalancing and no withdrawals, took only about two years to recover and a conservative allocation, also assuming rebalancing and no withdrawals, took only about one year to recover.

If you are a younger investor with a secure job and are confident you have many years (at least 10) before needing your portfolio, you can most likely afford to ride through a market correction with a much higher allocation to stocks than that of an older investor nearing or in retirement. Indeed, a market correction might be welcomed by a younger investor with a long-term investment timeframe and a dollar-cost averaging investment process in place since it would allow you to purchase stock shares at a much lower cost. When the market returns to current valuations, which it historically always has, you will have taken advantage of the opportunity provided by the correction. Of course, even as a younger investor, you should be sure your portfolio is optimally diversified and not invested in a speculative manner with too much weight in a single sector or individual stock.

Market Timing

Most financial advisors representing financial firms as sales people may not advocate market timing and may tell you “time in the market vs. timing the market” will work out better for you with hopes you will stay the course in your current portfolio. According to Jason Zweig in his 2004 article “Lessons and Ideas from Benjamin Graham,”  Mr. Graham, the “father of value investing,” believed an investor should have up to 75% of their portfolio in stocks when stocks are cheap, but when stocks are expensive, investors should reduce their stock holdings to as low as 25%. For disclosure purposes, I am conservatively positioned with my portfolio and have been for the past two-and-a-half years.

According to Jim Rogers, the anticipated correction he speaks of could be far worse than the Great Recession. Now would be a good time to review your asset allocation.

(For more from this author, see: Building a Balanced, Low-Cost Portfolio.)

Read more: A Big Correction May Be Coming: Now What?

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