Sometimes it is hard to watch what is going on in the market. This is one of those times. It has been a tough week and a tough couple of months. At this writing, the S&P 500 is down about 3-4% for the year. Some of you may be surprised that it isn’t an even greater drop. The news media may have us believing that the sky is falling. We must always remember that news is big business and bad news sells. The concern is: What if the market is on the way down? What if the economy is headed down? What if the gloom and doomers are right?
As you may know, I never make predictions about the future; if I make a prediction, it will be about the past. What I can tell you about the past is that eventually the gloom and doomers will be right. I can also tell you they were wrong last year, and the year before, and the year before that. In fact, the gloomers’ track record is pretty bad, but when they are right we hear about it for decades.
In light of this knowledge, some might be tempted to proceed as if the bad case scenario will never come. In my humble, but accurate opinion, that would be foolish. Bad times will come; we just don’t know when. A more prudent course might be to be prepared for bad economic times even when things look great.
Consider two scenarios: one is a family or individual in the accumulation phase of life, the other in the draw down or withdrawal phase.
The first is accumulating wealth, saving and investing to prepare for the future. How does a downturn in the economy and the investment markets affect this individual? Every time money is invested, shares are purchased. If the shares are low in price, the investor buys more shares. If the markets eventually recover, the investor makes money because the shares are worth more than when they were purchased during the downturn. A perfect scenario for this person would be for the markets to drop severely when they are buying shares and for it not to recover until just before they need the money. The accumulator should cherish severe drops in the market, as long as he or she has the discipline to stay in and keep buying.
The second scenario is the draw down or withdrawal phase. This investor has accumulated wealth and is now using that wealth to meet expense needs. What happens to this person when the markets drop? If the individual is selling market-oriented securities during a downturn, he or she will have to sell more shares at the lower price to provide for their income needs. The deeper the drop the more shares he or she will have to sell. When the markets recover, this investor will have fewer shares at the new higher prices and will have fewer assets to provide for his or her long-term needs. Studies show these individuals are at a high risk of running out of money during their life expectancy.
A better strategy might be to add fixed income investments to withdrawers’ portfolio. These investments tend to add stability as equity markets decline. The withdrawer may want to add enough fixed income investments to his or her portfolio to provide for withdrawal needs during down turns and long enough to wait for recovery. If this investor had enough fixed income to wait 7 years before being forced to sell any equities, it is likely that recovery will have occurred. This would mean that the withdrawer could sell fixed income during down turns and when the market recovers, sell equities to rebuild the fixed side of his or her portfolio. In this case the investor would then have the same number of shares of equities that are now worth more at their recovered prices and never realize the losses of the down market.
We recommend a 7-year liquidity plan to wait out severe drops in market prices. This allows the withdrawer or retired person to sleep as well at night as the accumulator. The accumulator simply says, “I am buying more shares and accumulating wealth.” The withdrawer says, “I have seven years for the market to recover, and I will get my money back.” Both will sleep like babies, not the colicky ones, the regular, tired ones who have been playing all day and are asleep before their heads hit the pillow.
Will the markets go down some more or recover their short-term losses? I don’t know; I hope they come up a lot. Either way, be prepared, and sleep well.