The domestic stock market is at highs; valuations are stretched. It seems as if every day uncertainty surrounding the next trade issue, tariff, currency blowup or tweet is enough to keep even the most conservative investors on their toes. The bull-market is now in its 9th year, while many emerging markets and other asset classes have already slipped into bear market territory.
I’m consistently reading, or being asked, about when it will end, and the irony is that not a single person knows the answer, and attempting to predict it has been an exercise in futility. Rather than prognosticate about the timing of the next correction or economic turn, let us be proactive with what we can control so that we’re not vulnerable; but, rather, can take advantage of the opportunities that present themselves.
Here are some things to consider while times are good.
1.) Pay off Debt – It has been my experience that most stock market anxiety, when corrections set in, is due, in part, to the opportunity cost for that capital. On more than one occasion, I have heard folks say things like, “I should just take out this money and pay off my house, at least I’ll know that’s paid for.” The problem with that statement is that it typically comes at a time when stock prices, and subsequently account values, are down and, therefore, the response is an emotional one correlating with paper losses.
Rather than evaluating this as an either or when times are bad, consider this as something to do when times are good. I am a big believer in having no debt – including your primary mortgage. Yes, I understand the math behind the mortgage interest rate differences and historical stock market returns; however, it is very hard to place a dollar amount on the peace of mind that comes with knowing you owe nothing. Inevitably, at some point, we will go through a correction and when we do, knowing that the house is paid for and there is no debt is a critical component when it comes to sticking it out in the investment world for the long haul. Examine your debt situation today and consider taking aggressive strides towards reducing or eliminating all debt.
2.) Set realistic expectations – Weathering a stock market storm comes down to proper asset allocation. This means not having all of your money exposed to the stock market; and thus, the volatility that ensues when a correction sets in. While most will adhere to an age-based allocation and risk tolerance, meaning that as you get older your stock position is reduced, we tend to get a bit more detailed in our firm. Regardless of your methodology, the basic principle remains the same; as your time period to recover losses gets shorter, your exposure to potential losses must get smaller.
This is fine in principle, but what happens is that, when the market is running as it is now, you will not make as much as the general stock market and you must be OK with that. There is no such thing as a free-lunch, and you cannot expect to reduce your risk to potential loss while still capturing the entire market upside. If you begin to set modest expectations for slow methodical growth in your portfolio over time, your allocation should reflect this and thus your portfolio’s ups and downs, even during a time period of heightened volatility, should be reduced.
3.) Live on a budget, modest income – The wealthiest clients I have are almost all the “Millionaire Next Door.” They drive used, paid for automobiles, live in a modest home, shop at discount stores, clip coupons, eat where dinner specials exist and do not splurge. They have learned that being content trumps competing with the Joneses for the latest gadget or shiny ‘thing.’ Financial sustainability comes down to living within your means and not spending on things that can damage your financial future. If you are in retirement, strive to take no more than 3 or 4% per year out of your investment portfolio in order to live. If you’re not concerned about leaving an estate, you can obviously take more; however, a minimal amount in distribution will again eliminate the stress and anxiety surrounding a market correction or economic downturn. As interest rates increase, it is becoming easier to achieve riskless rates of return which are higher than they have been in years. Qualified dividends remain a solid source of income; however, reaching for anything more than 4% may create some undesirable risk. Remember, not all returns are created equal. The key is to adjust your expenses so that a modest income will easily cover your cost of living; and, therefore, when we see uncertainty you will not fear a change in lifestyle.
4.) Downsize, Simplify – I cannot stress this enough. If you’ve been thinking about selling your home and downsizing, the time to do so is now. Do not wait for that perfect moment when everything is neatly boxed up, all repairs have been made and you’ve identified exactly where you will go. Nope, the real estate market, right now, is quite hot with limited supply hitting the market. I fear that the window of opportunity is closing. I strongly urge folks, who are looking out 3 – 5 years and considering downsizing, to act on this now rather than waiting. The key is to sell when so many others are buying. You may have to get creative with your living arrangements, moving in with a family member or renting an apartment. While an inconvenience, I think this is a far better option than being stuck with an oversized home that just eats into the asset base year after year through maintenance and upkeep. Shed those unwanted pieces of furniture while you’re at it, and simplify your ‘stuff.’ Once you scale back, your expenses will reduce as well. You’ll be one step closer to the modest income needed to meet those expenses and the stress will reduce right along with the tax burden.
5.) Assess Your Risk Tolerance Again – In our firm, we have identified this as the absolute, the most important variable, when it comes to our client relationships. In fact, I believe there is a massive disconnect between what people think they can handle, when it comes to the market, and what they actually can handle. I believe, that when it comes to the market, investors have become so complacent to market returns that any normal and healthy correction will knock most out of the game, and may be the final nail in the coffin for their investing careers. Who can blame them after 2000 and 2008? We’re going a step further by investing heavily in technology and will properly assess this with our clients on a deeper level. I think it’s important for each person to assign a dollar value to potential losses so that you can really internalize your risk tolerance and determine whether or not it is something you can stomach. For example, if you are currently fully invested with a $250,000 portfolio, could you stomach being down $125,000 in 15 months? That is a 50% decline, which we saw from the beginning of 2008 through the first quarter of 2009. If your answer is a resounding, “No Way!”, and yet you’re fully invested, there’s a problem. Keep in mind that the market at that time was staring into the abyss and it was uncertain when and where it would bounce, much less bottom. My guess is that the next great decline, albeit possibly years or decades away, will be as great or worse than the 2008 decline. The key is to make sure your risk is in alignment with your temperament and goals.
6.) What’s the Plan? – Finally, once the debt is gone, you’re on a modest budget and have downsized, if needed, the key is to have a real plan in place to meet objectives with your financial resources. Markets will move up; markets will move down, but knowing what your overall objective is helps to stay on course when uncertainty abounds. If you have never gone through the process of doing a real financial plan, now is the time. Do not wait for a correction or when your asset levels are at lows. Do so now, on your own or with the help of a competent adviser, so that you can properly assess your portfolio, your goals and your objectives by making sure they’re all in alignment and working together. If you don’t have anyone to help you with that, but would like someone, please reach out as we’re happy to help.
On a daily basis, the headlines may tell us just how great things are or how terrible things have become. As someone who finds himself in front of the camera regularly, I can tell you, without a shadow of a doubt, not a single person really knows what the future holds. While the sun is shining and the markets are at highs, it’s time to check under the hood and take some stock of what can be done now so, that when the market does finally turn, you’re not scrambling and are well prepared leaving market anxiety and stress in the past.