MCENTIRE JOINT NATIONAL GUARD BASE, S.C. -- The first half of this year has been an interesting one in the financial markets. Stocks rocketed higher in January, only to give it all back and then some in February and March. The markets traded sideways, only crossing to the positive in June. During that time, Facebook has seen their stock implode, recover, only to implode again. Trade wars have been started with friends and adversaries alike and a shooting war was averted with North Korea. Volatility is back. Are we in the last days of a bull market or just taking a healthy breather before resuming the run higher?
What I do know is each trading day that closes, moves us one day further from the last crisis and a day closer to the next. The next financial crisis is coming…that fact is certain. It isn’t something to be feared, but you’d be wise to respect it. We don’t fear the changing of the seasons. These are inevitable changes, but we do prepare for them.
Start by assessing your risk. Look at the big picture of your current asset allocation. Are you 100 percent in the stock market? If you buy mutual funds or ETFs, what is their stock versus bond composition? To keep things simple, we’ll use two simple categories, “risk” assets (no principal protection) and “safe” assets that are principal protected. (It is more correct to say “less risky” versus “safe” because all investments, by definition, have some risk.)
Put all stocks in the risk category and all bonds in the safe category. You can make arguments that a big blue chip common stock is less risky than a high yield or junk bond fund. Those debates are “interesting and irrelevant” to quote Lt. Col. Quaid “Cuew” Quadri. Don’t get too wrapped up in the risk of the company, just divide your investments up by security type. In general, you have less risk of owning a corporation’s bond than you would by holding their stock. If you own mutual funds, they might have bonds in them as well as stocks. Divide mutual fund balances into risk and safe according to their internal mixes. Count your emergency fund, CDs, savings bonds, etc. in the safe category. Express your results as a ratio Risk percent/Safe percent.
What should that ratio be? It depends on your age and personal risk tolerance. If you are younger or don’t mind market fluctuations, put more dollars into stocks. If you are older or just can’t stomach your investments dropping in half from time to time, put more into bonds. A good rule of thumb is to put your age as a percentage in the safe category. According to this rule, a 40-year-old should have 60 percent (100 – current age) at risk and 40 percent safe money. The 60/40 portfolio is the Goldilocks asset mix and almost a cliche. However, over the last 50 years, this rather conservative ratio actually earns 90 percent of the S&P 500 returns while being exposed to only 60 percent of the risk. It is a good starting point if you aren’t sure what else to do.
Finally, adjust your ratio for where you think we are in the market cycle. If you think the good times will continue forever or view yourself as an aggressive risk taker, don’t be greedy, allocate some percentage to safe money. There is a saying on Wall Street, “Bulls make money, bears make money, and pigs get slaughtered.” If you think the correction is imminent, avoid the urge to go to 100 percent cash. Stay invested. You can’t be sure of the timing of the next crisis and the last months of a bull market can be truly spectacular as stocks prices go parabolic. Follow your gut. If you can’t sleep at night, you have too much in the stock market no matter what the age-based rule of thumb says. Make small changes. If you are approaching retirement, you need to give serious thought about dramatically reducing your risk and buying income investments. Don’t assume the market will recover in a few short years. History says we are due for the big one. The next correction could be much deeper and take longer to recover than the last. Now is the time to prepare.