It’s a matter of when, and not if, the economy will sink into recession. I’m not saying that because of some dire economic forecast – it is simply the reality of the economic cycle. We have not had a significant market correction since 08-09, and 7 1/2 years is a pretty long stretch historically. Even as a card-carrying optimist, I have to admit that there is always the possibility that our tepid GDP growth could turn negative in 2017 or in the near future. But market volatility could occur for any number of reasons, recession or not.
It’s vitally important that investors communicate with their advisors during the good times to understand what to expect when the market is down. The longer the current bull market runs, the more we forget how painful volatility can be. Make sure you understand the game plan before there’s a downturn. If you haven’t discussed these five questions with your advisor, it’s time for a meeting.
1) “When there is a downturn, will we change our investment allocation?”
We explain to clients that we do not time the market and that we are long-term, buy and hold investors. They nod in agreement, but then when the market goes down by 10%, I sometimes get calls asking if we should go to cash to avoid further losses. The answer is no, we don’t time the market. In fact, we will rebalance in downturns, buying stocks when everyone else is selling. It’s a discipline that works.
We have ample evidence why we think this approach is best one for investors. When we do have a downturn, emotions tend to take over our decision making process, often leading to sub-optimal results. The best time to have the fire drill is before the fire. Plan what you will do in advance. Make sure you do not turn a temporary decline into a permanent loss of capital by having a knee-jerk reaction when the market dips.
2) “How much risk is in my portfolio? How would it have performed in 2008-2009?”
While there’s no guarantee what will happen in the future, clients should at least understand how they are currently positioned. The best time to reallocate is when the market is up. If your current allocation is more aggressive than your risk tolerance, you should be making changes today to a more conservative strategy.
3) “How can we capitalize on the next downturn?”
You make your money in bear markets; you just don’t know it until later. Ask not only about defense but how we can profit from the inevitable cycles in the economy and markets. What would we like to be able to buy on sale? If we view a market downturn as an opportunity rather than a catastrophe, it will change how we respond. In hindsight, 2008-2009 was a remarkable chance to make the buys of a lifetime. The willingness to buy when everyone else wants to sell takes planning and commitment.
4) “Are there any changes that should be made to my portfolio if there could be a recession in 2017?”
If you are in a 70/30 portfolio, what would happen if you went to a 60/40 portfolio today? Many investors get stuck in thinking that investing should be all-in or all-out. Most of the time, fine tuning and making minor adjustments is a better approach. It’s a good time to revisit your 401(k) and other accounts, as well as to rebalance any equity positions which have run up in recent years.
5) “How could investment performance impact our financial goals?”
If you are close to retirement, the impact could be more significant than for someone in their thirties. Would a recession require that you push back your retirement or other goals? Hopefully your advisor is already considering these factors, but anytime you have a shorter time horizon, it pays to be having these conversations regularly.
I hope this doesn’t sound a pessimistic tone. To be clear, I am not predicting a recession. Pullbacks in the market are completely normal and part of the economic cycle. What no one knows is if we are still in the mid-cycle growth phase of this cycle or at the end-cycle plateau. Economists can only determine this in hindsight. We have a plan in place for each client and want to be sure we talk about volatility before it occurs.
