4 Key Steps to Managing Your Portfolio Through a Market Correction in Retirement

In light of the recent market pullback, I thought it’d be beneficial to review how to properly manage your portfolio through a market downturn and avoid making crucial mistakes that can have a lasting impact on your retirement.

Market corrections are a normal, and usually healthy, part of the stock market. It’s often brought on by news or reports that reflect the stock market may have run up a bit too high during a bull run. Markets in the short term tend to be very sensitive to news, headlines, and data reports. Depending on the sentiment of the news and recent economic reports, you may see a positive or negative reaction. The stock market is a “forward looking” marketplace, meaning investors take current news and data, and then project how this will impact individual companies, sectors, and the market as a whole moving forward. For example, inflation in 2023 was 3.4%. Still higher than the Federal Reserve’s target, but significantly lower than the 7% in 2021 and 6.5% in 2022. Because of the encouraging news that inflation was beginning to soften, investors began to feel confident inflation was being tamed and rates cuts could happen in the “future”, leading to the U.S. stock market returning 26%+ in 2023 (as tracked by the Dow Jones US Total Stock Market TR).

When there is encouraging data, you will typically see a rise in stocks. Similarly, if concerning data or reports are brought to light, you may see a sell-off in the stock market. These represent concerns moving forward. And that’s what is happening right now. The most recent jobs report showed significantly less jobs were added last month compared to expectations. This type of data leads investors to have concerns about a recession “moving forward”. Investors begin to think “Maybe the future outlook isn’t as strong as we believed these past 18 months”, and in turn they begin to sell their stocks.

These run-ups and sell-offs will be a constant throughout your investing life. For accumulators (people with more than 5 years till retirement), these sell-offs may not bring much cause for concern, and they may even be welcomed, as they provide attractive buying opportunities. For pre-retirees and retirees, these sell-offs can be a little unsettling, as you may now be in a position where you rely on your portfolio for income to live on.

Successful long-term investing is more about avoiding costly mistakes during these market cycles, as opposed to making great investments. If mistakes are avoided, or minimized, time, patience, and discipline will usually be the key ingredients for successful investing.

Now, this is easier said than done. It’s easy to talk about staying disciplined and patient, and avoiding mistakes, but when your life savings that you live off of decrease 15%+ in a short period of time, it can cause you to ignore these principles and make irrational decisions. So, I want to review 4 Key Principles in navigating a market sell off while in retirement:

1.)     Be Prepared in Advance with Proper Asset Allocation

Of course, if you’re reading this now, during a market sell-off, this may seem like a moot point. But proper asset allocation is the foundation of successful investing in retirement. Proper Asset Allocation will allow you to participate in market appreciation, while having diversifiers that you can rely on when things aren’t going as according to plan in the stocks market. When I say, “Asset Allocation”, I am referring to the mix of Stocks to Bonds to Cash you maintain in your retirement savings. Having an appropriate mix to your financial picture is important, because generally these three asset classes do not correlate with one another. When the stock market appears to be in a sell-off, you can usually (not always, see 2022) rely on your bonds and cash to maintain their value.

Determining an appropriate Asset Allocation is unique to each household. It’s usually dependent upon: 

• Your goals for your portfolio

  • (i.e., appreciation, preservation, or a mix of both)

• Your risk tolerance

  • (how you internally handle swing in your portfolio value)

• Your risk capacity

  • (to what extent do you rely on your portfolio to fund your lifestyle)

Asset allocation is vitally important for retirees, because usually some sort of growth is required to ensure the portfolio lasts throughout your lifetime, but you also need to have conservative assets in place to hedge against market losses in retirement. This is detailed in a previous blog sequence of returns risk.

Having an appropriate asset allocation for your retirement savings should help you feel more at ease during market downturns. This is because a plan is already in place for market downturns. Should stocks begin to dive, you have bonds in place to support withdrawals until the market recovers. Should it be a unique year like 2022, where both stocks and bonds were down 15%+, you have cash in place to support withdrawals until those asset classes recover. A proper asset allocation does not mean avoiding losses. But, it does mean having an appropriate amount of money in various asset classes that do not correlate with one another, so, in the event one asset class runs into trouble, you have other asset classes to rely on during that time.

Again, Asset Allocation is unique to each household’s situation and goals. If you’re unsure of an appropriate asset mix for your retirement picture, I recommend reaching out to a financial planner. I’m happy to help you if needed as well. This is one the major areas we assist our clients. You’re able to schedule an appointment if you’d like to discuss your retirement in more detail.

2.)     Stay disciplined and patient

Assuming Key Principle #1 is set up, the next thing to do during a market downturn is to stay disciplined. The stock market has a history of rewarding the patient. I love this chart from J.P. Morgan:

This chart illustrates the S&P 500’s (an index that tracks the performance of the 500 largest public companies in the United States) returns each calendar year, while also showing its lowest % loss at one point throughout that calendar year. The gray bars represent the overall return for that given year. The red dots represent the lowest % loss at one point during that year. For example, in 2021, the S&P 500 at one point was at a -5% return YTD. It then proceeded to end the year up 27%. We all know what happened in 2020 with COVID. At its worst point in 2020, the S&P 500 was down 34%. By 12/31/2020, the S&P 500 had returned 16% for the year. Two years before that, in 2018, the S&P 500 was down 20% at its lowest. It still ended up losing value on the year, but it ended at -6%. A significant recovery from being down 20% earlier in the year. 

The chart speaks for itself, but the lesson to take from this is to not overreact during a market sell-off. Another lesson that is easier said than done. When the market is down 25% like it was at one point in 2022, your mind is more likely thinking, “This is bad. How much worse is it going to get. We need to get out now.”. And each time the market is down by these large percentages, it’s usually something different. The mind in these moments will be saying, “I know what the charts say. I should stay invested. But this time is different. It may not recover this time.” It’s that sort of thinking that can cause the costly mistakes we want to avoid. 

Of course, we would all like to be able to time the market. We would love to sell at the tops of these gray bars, then buy back in at the bottom of these red dots. As they say, hindsight is 20/20. No one knows when the market will peak or bottom out. That is why you are usually best off remaining disciplined, finding comfort in your asset allocation and financial plan, and patiently waiting for the market to rebound.

3.)     Rebalance

As we just discussed, inaction can be an investor’s best friend when it comes to market selloffs. If you are going to take action, one of the key action items I look to perform for the client portfolios I manage is rebalancing. Having a rebalancing strategy can help you “sell high, and buy low”, while also maintaining the risk associated with your portfolio.

Rebalancing is the act of selling overweight positions and reallocating them into underweight positions, bringing your portfolio back to its target asset mix. This goes in line with the first key principle.

For example, hypothetically speaking, let’s say you’ve determined an appropriate mix for your retirement portfolio is 60% Stocks / 35% Bonds / 5% Cash.

Then let’s say the stock market goes into a downturn and loses significant value. You may check back in on your asset allocation and see that now your retirement savings are allocated as 53% Stocks / 40% Bonds / 7% Cash.

To get back to your target, or rebalance, you would sell 5% in Bonds, 2% in Cash, and allocate that 7% into your stocks. What you’d be doing is selling the part of your portfolio that has maintained its value, and using those proceeds to buy into the asset class that has lost significant value. It may seem counterintuitive at the time. “Why would I want to sell my assets that are doing well and use them to buy an asset that is losing money?”. But this allows you to buy stocks at a potentially discounted price. Buying more shares at a lower value may allow you to recover much quicker should stocks rebound.

There are various rebalancing strategies to conduct. Most commonly used rebalancing strategies are either:

• Tolerance Band Rebalancing: This means you set +/- parameters to your portfolio and you rebalance any time those parameters are breached. For example, I commonly use a 10% upside threshold for stocks and a 5% downside threshold. Meaning, if the target mix I’m managing is 60% Stocks / 40% Bonds, should their portfolio ever get to a point where the stocks are now at 55% or lower, that would trigger a rebalance. On the other hand, if stocks increase significantly, and now their portfolio is running at 71% Stocks / 29% Bonds, that will trigger a sale of their stocks.

• Calendar Based Rebalancing: This means you’d rebalance your portfolio on a set calendar schedule. Whether that be quarterly, semi-annually, annually, etc. Regardless of how far off target you are, when you reach your next scheduled rebalance, you rebalance back to your target asset allocation.

I personally manage my client’s portfolio using a tolerance band rebalancing strategy. But regardless of which one you choose; the key part of a rebalancing strategy is the ability to stick to it.

4.)     Reassess your risk tolerance moving forward

Lastly, after the sell-off has settled down, take time to reflect on your comfort level with what just occurred. If you found yourself unsettled, anxious, losing sleep, etc., that may be cause to adjust your portfolio. It’s possible your portfolio is too aggressive for your comfort.

You’ll also want to reflect on how your portfolio withstood the market sell-off. Did it react as intended? Did your conservative assets maintain their value as you anticipated? Were there economic factors that you didn’t consider and negatively impacted your portfolio? Use these downturns as a learning lesson to improve your portfolio moving forward and close any gaps you may have within your investments or your retirement plan. Doing this may help the next market sell-off be a little less tumultuous on your savings and on your peace of mind. 

These are 4 Key Principles I maintain when managing retirees’ portfolios through a market selloff. Again, the big takeaways would be to have a plan ahead of time and stay disciplined and patient.

Thank you for taking the time to read. I hope this was beneficial for you. If you, or someone you know, would benefit from an investment review, please feel free to reach out and schedule a brief introductory appointment. I’m always happy to discuss your situation and see how we can help.

Thank you,

Drew Schaffer, CFP®

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