I am a firm believer that preparation and planning are the keys to being ready for life’s uncertainties. Athletes train in both good and bad weather. Students getting ready for a test study all the material they might need to know. So what should you do to be ready for the next market downturn?
First of all, you need to acknowledge that it is going to happen. Market ups and downs are part of the economic cycle. If you mentally prepare for what can happen before it does, you might save yourself from making a costly knee-jerk reaction. According to research by Goldman Sachs, 5% corrections typically happen a few times each year. About every 1–2 years a 10–15% correction happens, and a 20%+ decline occurs about every 3.5 years on average.
Next, you need to remember what you are investing for and where you want to end up. For example, maybe you decided years ago on a balanced approach to investing by having 70% in stock mutual funds and 30% in bonds for retirement. Focus on that and ignore the headlines of the day. If it’s been a good year for the market, you may be sitting at 80% stocks or greater, just because they grew faster than bonds. The key point is to consider taking some of those gains off the table while you have them. In this case, you might think about moving 10% out of your equity investments to rebalance your portfolio back to 70% stocks.
Finally, you could consider rebalancing your portfolio anytime it becomes more than 5% off-target. This would occur when your stock percentage reaches 75% (probably an up year) or lowers to 65% (probably a down year). Imagine how easy it could be to make good (and unemotional) decisions if you were forced to buy low and sell high because the portfolio mix said so!