Retirement Planning….Market Volatility What to Do?
Late last year the equity markets experienced much volatility causing a lot of angst among investors, especially retirement investors. It is during uneasy times like this that many people start to have feelings of panic and forget the basics of investing. So, I thought I would use this post to remind investors about a couple of concepts that I have covered many times before but some may have forgotten.
First of all, I do believe that, at some point, the nearly 10-year bull market we have been enjoying (until recently) will end and we will suffer a major market meltdown. But I do not believe we are there yet. I think the recent market drop is just a long overdue market correction and we are still some time away from the beginning of a bear market. Of course, no one knows when the next bear market will begin. However, because we have had several years of very good stock market returns, I think now is a good time to re-assess your portfolio and consider making it more conservative. How does one do that? I cannot tell anyone what they should do. I can only tell you what I have done.
Snorkeling off the Boat at Guana Cay
The first step I did was to re-assess my equity allocation (that is, what percentage of my total financial assets I want invested in equities). Last summer my equity allocation was about 40%-42%. This allocation was reasonable and appropriate based on my current age of 64. Because stock market valuations have been much higher than average, I was feeling the long bull market was likely nearing its end. So, I wanted to lower my equity allocation to about 30%
Typical Bahamas Sunset
At the same time, because of my feelings about the market, last fall we decided to sell a rental property we had owned for 20 years. This was a very tough decision as this property had been an “income-generating machine” the last 20 years. At the end it was yielding over 24% on our original investment in addition to providing tax benefits. Frankly, the property was better as an income investment rather than having the cash in hand to invest. But the opportunity to sell came along so we decided to take it.
The cash proceeds from this sale (in addition to the market correction) lowered my equity allocation from about 42% to about 28%. So just adding the property sale proceeds to our financial holdings lowered our equity allocation close to where I wanted to be. Now that I have my desired equity allocation, I am in the process of reassessing all my equity positions.
Had I not decided to sell the rental property, this is what I would have done to get to my 30% target equity allocation. First, I would have assessed each of my individual equity holding’s level of risk (i.e., its volatility) and pared back or eliminated my riskiest positions. Second, where I own Exchange-Traded Funds (ETFs) for exposure to a certain market segment such as large-cap, small-cap, and emerging market funds, I would reassess how much exposure I want from each market segment and make changes to the percentages of each, likely paring back small-cap and emerging market funds and adding to funds that are more recession resistant, such as a consumer staples fund.
A final thought…..What should drive your preferred equity allocation? I have noted in the past the conventional age-based formula of:
Equity Allocation = 100 – Your Age.
However, this is just a general guideline as everyone’s situation is different. For example, a big consideration is how much guaranteed annuity income you have (such as social security benefits and/or an employee pension). If you have enough annuity-type income that you can fund your basic living expenses, then you can take on more risk in your portfolio with a higher equity allocation.
Christmas from our boat in Hope Town
In my opinion, your target equity allocation should be one that will allow you to remain calm if we experience another market meltdown like we did in 2008. For us, since we are not collecting any annuity-type income at this time, that figure is 30%. If the stock market drops 50% or more later this year, I will not sell any of our stocks or stock funds. I will ride the market down and wait for the next recovery. Our 70% fixed-income allocation allows for enough funds for us to live on for over 12 years and, additionally, allows us to set aside cash to buy more equities if the market does crash.
The reason I use this approach is that it is well documented that retail investors are not good at getting out of markets near the top (think 1999 and 2007) and then having the courage to buy back into the market near the bottom (think 2002 and 2009). For most people, it is best to periodically “re-balance” your portfolio back to your target equity allocation to reflect your current risk tolerance and not try to time market tops and bottoms.
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