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Making Sense of a Volatile and Down Stock Market

Truly understanding your risk tolerance can help

Bear silhouette market numbers

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What should you do if the bear market returns?

Unlike last year, the stock market is both volatile and down. On February 8, the S&P 500 officially entered correction mode (defined as down by more than 10 percent) less than two weeks after hitting an all-time high. As of April 13, it is down 7.5 percent from the high earlier in the year.

Whether this correction signals an end to the nine-year bull market we’ve enjoyed, the start of a bear market (down 20 percent or more), or neither and the market will quickly recover, is unknown at this point. And there are so many unknowns. Will there be a trade war? A real war? Or will prosperity continue? The questions can’t be answered with any certainty, but there are several things to keep in mind as you ponder the market’s future. I’ll also offer my advice on what you should consider doing with your portfolio now.

First, the stock market has been on a wild ride in the 21st century. Stocks have declined by at least 50 percent or more twice since the year 2000, so a decline of a third is not out of the question. Fasten your emotional seatbelts: When it happens, you will have little to no notice.

Second, understand that we don’t have such an unusual stock market this year. Rather, it was the past nine years of stock gains, especially those last year, that was unusual. According to the financial regulator FINRA, we are in the second longest bull market since the crash of 1929. And not only were stocks up last year, it was also the quietest year in stocks since 1964. We grow accustomed to a stable up market, so naturally it causes more pain when volatility returns.

Third, you are nearly ten years older than you were after the 2008 stock plunge. That means you will have less time to wait for the market to recover, and stocks may not recover as fast as they did during the last big drop.

Fourth, high quality bond funds serve an important role for investors. Though it’s quite possible that Warren Buffett is right that bonds can be riskier than stocks in the very long run, that long run may be longer than your life expectancy. Bonds are the rock-steady part of your portfolio and fund your life.

What to consider doing now

Should you sell stocks now or buy more? Clearly, stocks are a better buy today than they were on February 8. That buying stocks seems like a scarier proposition now is irrational but also very human.

Before clicking the buy or sell button, get in touch with your feelings by truly understanding your willingness to take risk. This is typically measured by a risk profile questionnaire that attempts to gauge your stomach for risk by asking you how much of a loss you could endure. The fatal flaw of risk questionnaires is that we think we can tolerate more risk, but in reality our tolerance generally plummets as fast as the stock market.

A better way to determine your risk tolerance is to go back to your late 2008 and early 2009 account statements to see whether you bought stocks when they were on sale -- or sold them. In my view, past behavior is the best predictor of what you will do during the next plunge, which will almost certainly be different than prior plunges and scarier than any horror flick you’ve ever seen.  

In addition, understand your need to take risk. I’ve never done a financial plan that includes the client being buried with their money. So the closer you are to having enough money to subsidize your lifestyle, the less stock risk you need to take. Even if you possess the readiness and desire to take risk, you may not need to.

My advice

Remember that the purpose of money is to support your life, and you can be rich with less money by adopting a more modest lifestyle. When you have enough funds, take some risk off the table, preferably before a bear market.

If you haven’t met your goals, you probably need higher exposure to stocks -- but only if you are committed to stay the course.  Better yet, buy more stocks to rebalance when the bear finally returns. Simple – yes. Easy – no!