How to Prepare and Survive a Market Decline

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Market declines can worry people. When market declines happen, many people wonder how they can survive them, or if they will survive them. It’s important to keep in mind that context matters when the market becomes volatile. It’s not wise to let media headlines worry you when there’s a decline, but rather, to look at the bigger picture. It’s important to look at historical patterns and the “why” behind drops in the market.

The current bull market run has been very steady, but it’s important for people who are investing to keep in mind that a correction can come at any time. This is why it’s important to plan and prepare for a market decline. Positioning portfolios to endure volatile markets is far more effective and beneficial than reacting to market dips.

Market declines happen frequently

There is truth to the saying “what goes up must come down.” It’s important to note that market declines and downturns happen frequently, but they don’t last forever.

Dow Jones Industrial Average 1900-2015

-5% or more -10% or more -15% or more -20% or more
Average Frequency*  About 3 times per year About once a year  About once every 2 years About once every 3.5 years
Average Length**  46 days  115 days 216 days 338 days

*Assumes 50% recovery of lost value
**Measures market high to market low
The Dow Jones Industrial Average is an unmanaged, price-weighted average of 30 actively traded industrial and service-oriented blue chip stocks. Past results are not predictive of results in future periods.

Avoid the urge to time the market

It’s human and a natural instinct to make portfolio adjustments based on what one thinks will happen to the market. Impulse isn’t only confined to periods when stock prices are falling, but also tempting when stocks are rising. Abrupt moves can be costly as research indicates that it’s impossible to predict short-term market moves. In fact, abrupt moves, especially at the wrong time, can significantly damage long-term returns.

Preparing for Market Declines

A good rule of thumb is setting aside one to two years of living expenses in liquid assets. Liquid assets can include high-quality short-term bonds or mutual funds.

This is different and higher than the recommended three to six-month emergency fund. Having one to two years of living expenses in liquid assets meets short-term liabilities and emotional wherewithal to withstand volatility in the market of longer-term investments.

Another way to prepare for market downturns is to diversify portfolios and have the right mix of investment objectives. For people who are especially sensitive to equity declines, a growth-and-income strategy may be appropriate which tends to exhibit less volatility than those focused on capital appreciation.

Disclosure

It’s important to keep in mind that none of this necessarily protects one from a sudden or sharp decline in the market. Shocks from geopolitical events and policy miscues can spark pullbacks. It’s wise to establish a thoughtful portfolio structure to be individualized based on one’s time horizon, risk tolerance, risk capacity and personal financial goals.

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