Being in the second-longest bull market of all time is making me increasingly nervous. In the current political environment, we might be one ill-timed tweet away from the next bear market. So, what should a prudent investor do?
Remember that the darkest days in stock market history have followed strong bull markets. The Dow lost 90 percent during the Great Depression of 1929-1932. In a single day on Black Monday in October 1987, the Dow dropped 23 percent. During the Tech Wreck Bubble Bust from 2000-2002, we watched the Nasdaq give back 78 percent. And who can forget the depressing depths of the Great Recession from 2007-2009, where we saw the Dow drop a nauseating 54 percent?
How an individual investor reacts to the current market environment is unique to each person’s situation, and decisions should be made with lots of thought and advice specific to individual circumstances. Every investor should be laser-focused on asking two critical questions: How much risk am I now willing to take and how close am I to retirement and needing to access cash in my account? If you work with an adviser, you should be scheduling a meeting to go over your portfolio and compare it to the answers you give to the above questions.
On the issue of risk tolerance, you need to make a hard decision about how much downside risk you are willing to accept for the privilege of staying invested in the stock market as you try to stretch gains. What is your individual downside pain threshold that will start making you eat Tums like leftover Halloween candy? Would you get there if your portfolio dropped 10 percent, 20 percent, 30 percent or more? Communicate this immediately to your financial adviser. You should be able to exit the Wall Street roller coaster whenever your lunch starts to move toward your throat. This is your call.
With respect to your time horizon, give some considerable thought to when you are likely to retire, thereby needing to generate income from your portfolio for living expenses. Those in their 30s and 40s should be many years from retirement, enabling them to be more aggressive and maintain higher percentages of their portfolios in stock. But those in their late 50s and 60s in general shouldn’t be as aggressive in equities. My 30-year-old son should be perfectly comfortable staying with a portfolio where he is 80-90 percent invested in stocks in this current market. However, his 56-year-old father, who might be 10 years or so from retirement, might decide it is time to get more defensive and pare back his concentration in equities to 50-60 percent and take some of his gains off the table. No one ever experiences investment losses by harvesting big gains after an eight-year-plus bull market.
In addition to tinkering with an investor’s asset allocations between equities and fixed income on the front end, investors have a few other options. In consultation with your financial adviser, you can draw some red lines on your portfolio if certain portfolio drops are experienced. For example, if your portfolio drops 10 percent, you could lighten up on equities by some agreed-to percentage, like 15-25 percent. For every additional 10 percent drop, more equities could be swapped out. Whatever your risk tolerance and time horizon, having a plan is important. It will let you order the Buffalo Wings at your next meal out without the need for a side of Alka-Seltzer.•
Maddox, a former Indiana securities commissioner, is managing partner of Maddox Hargett & Caruso.