The stock market had a great run in the 2010s, but 2020 has already reminded us that crashes do happen -- and that they're pretty unpleasant. A sudden 30% drop in the value of your long-term savings can reverse years of contributions and investment growth, putting your retirement timeline on hold indefinitely as you wait for a recovery. It's no wonder 49% of Americans believe a stock market crash is the biggest threat to their retirement income, according a 2020 retirement study by Allianz Life.
You can't prevent a future crash from happening, but you can take steps to protect your retirement plan in spite of a crash. Here are four strategies that will help you do just that.
1. Plan the next five years
A stock market crash hits you the hardest when you need to liquidate your investments at lower-than-normal share prices. That's why experts recommend you don't invest funds you'll need within the next five years. Follow that guideline and, barring any emergencies, you can afford to wait at least five years for a recovery -- without having to sell your positions at a loss.
If your targeted retirement date is more than five years away and you don't plan on tapping those funds for anything else, you are in a good position to ride out a crash. You're in a trickier spot, though, if you do intend to retire before 2026. In that case, it's useful to think through a crash scenario now, while you can evaluate your options with a clear head.
Those two primary options are, delay your retirement or stick to your guns and retire on schedule. Delaying retirement indefinitely probably isn't what you want. But retiring after a crash will having you liquidating more shares at lower per-share prices to fund those early retirement distributions. That's not ideal, because it reduces your earnings power in the future.
There is a middle ground, though. Consider whether you're willing to delay retirement for a fixed amount of time and, if so, for how long. Even a 6- or 12-month delay would help you financially. You could keep making retirement contributions and also build up your cash savings at the same time. The extra contributions after a crash position you nicely to benefit from a recovery. And your cash savings can be your first source of income in retirement, so you don't have to liquidate as much from your portfolio.
2. Invest in high-quality assets
High quality assets are investments that are poised to deliver slow and steady growth over long periods of time. These are usually large companies with experienced management teams, serviceable debt levels, predictable cash flows, and a history of operating efficiency. Often, they're also companies that have paid dividends for years and years. These positions aren't going to make you rich overnight, but they are going to be more resilient in turbulent market conditions.
Mutual funds and index funds can give you quick access to a full portfolio of these large, established companies. Look for funds that track an index like the S&P 500, comprised of the 500 largest publicly traded companies in the U.S. Funds that build their portfolios with premium dividend payers are a good option, too. SPDY S&P Dividend ETF (SDY 2.66%) tracks the S&P High Yield Dividend Aristocrats Index, for example, and Vanguard Dividend Appreciation ETF (VIG 2.54%) tracks the NASDAQ U.S. Dividend Achievers Select Index.
3. Clean up your finances
You can also hedge against a future market crash by tidying up your finances. Pay down high-rate debt and cut out unnecessary expenses. You'll lower your cost of living, which reduces your income needs now and in retirement. That's always a good idea, as it takes some pressure off your retirement savings in terms of how much you'll need to withdraw each year.
4. Commit to keep investing
It may be counter-intuitive, but continuing to invest after a crash will benefit you in the long run. A crash creates a temporary reduction in share prices -- like a sale with an uncertain end date. When your favorite brand of coffee or tea goes on sale at the market, you take advantage of that lower price. Do the same with your investments with money you don't need to use right away. Your investing dollar will buy more, which means you'll increase your share counts at a faster rate. The more shares you own, the more opportunity you have to earn going forward.
You can survive a crash
A crash in the stock market doesn't have to wreck your retirement, as long as you can get by for a few years until a recovery gets underway. Lowering your debt balances and streamlining your living expenses help you in that regard.
You can also proactively manage the volatility in your portfolio by investing in high-quality stocks and funds. Keep on investing in those assets after a crash, and you may come out even stronger on the other side.