Second in a series of posts about protecting your portfolio from the next bear market.
Part one Protecting Your Portfolio From a Bear Market provided context on market declines and what protecting yourself from them means. It recommended positioning your portfolio so that when a bear market occurs you’re not forced to sell stocks before they can recover.
No one is going to ring a bell right before the bull market ends warning you to get out.
Part two of this framework elaborates on proper portfolio positioning so you can ride out a bear market and get the eventual recovery we have historically seen after financial crises. Don’t Fear the Bear
Investors who stay the course see their portfolios recover and make money. Investors who sell turn short-term temporary losses into permanent ones.
“We don’t have to be smarter than the rest; we have to be more disciplined than the rest.”
In my experience, there are two main reasons why investors sell investments during a downturn. The first – and the focus here – is because they needed money to cover expenses or emergencies. The second – which we’ll address in Part 3 – is not being able to stomach market volatility.
Your Portfolio Should Not Be Invested in a Vacuum
Whether or not you go all out and build a financial plan before investing, it’s important to know your investment time horizon – both when you might need to withdraw from your portfolio and how much you’ll be withdrawing. The goal is to invest in a way that’s appropriate for your time horizon so that you are not forced to sell stocks and other volatile investments at a loss. A good wealth manager will be able to build a financial plan for you and match your asset allocation to your expected cash-flow needs (Let’s Make a Plan With a CFP® Professional). If you are a do-it-yourselfer consider the following guidelines.
Short-term is money you’ll need in the next three years, and it should be in cash. Cash is the only fully liquid guaranteed investment. CDs are guaranteed, but not liquid. Bonds are liquid, but not guaranteed. Find a high-yield savings account (a money market fund with a decent yield), set it aside, and call it a day.
Long-term is money you don’t need for over 15 years. This is longer than you might think, but according to price history on the S&P 500, a broad stock market index that tracks the performance of large US company stocks, in order to be certain that you won’t experience a market loss during your holding period (again, assuming history repeats itself which is obviously not guaranteed), you should only have a 100% stock portfolio if your holding period is 16 years.
You can fairly consider this 16-year guideline as too conservative. For one, it’s the time period that has guaranteed you no losses. For an overwhelming majority of the time, 10 years is plenty. Secondarily, it was calculated by using only one group of stocks, albeit a broad one: US large company stocks. Including smaller company and foreign stocks should not require you to wait this long. However, international stocks don’t have as long a data set. If you want to use 10 years as your definition of long-term, I won’t argue, but I think prudence dictates the extra years.
By extension, intermediate is money you’re going to need in the next 4–15 years. When during that span you will need it and how much of it you’ll need will determine your allocation. These variables mean it won’t be as straightforward or precise. You’re going to invest in stocks and bonds, not more than 80% stocks or less than 20%. Anything over 80% will be too close to the volatility of an all-stock portfolio, and a portfolio with no stocks can be riskier than one with even a token amount.
I see two major scenarios for how and when you might need this money: You’ll need all of it at some point or you’ll need a certain percentage of it per year.
If you’re going to be cashing out the entire portfolio, I’d stick to the following ranges based on when you’ll need it:
- 4–5 years: 20%–35% stocks and 65%–80% bonds
- 6–8 years: 35%–50% stocks and 50%–65% bonds
- 8–15 years: 50%–65% stocks and 35%–50% bonds
If you’re going to have a steady withdrawal, I’d target the following asset allocation ranges for stocks with the rest being in bonds.
- Less than 4%: 65%–80% stocks
- 4%–5%: 50%–65% stocks
- 6%–7%: 35%–50% stocks
- Over 7%: 20%–35% stocks
Click here for Part Three