After an eight-year bull market, many investors are afraid the other shoe is about to drop. Indeed, in a survey commissioned by the Global Atlantic Financial Group, 74% of respondents were worried about a stock market correction. What's more disturbing is that 59% of the survey respondents said that if a correction were to occur, they might not be able to retire when they planned to.
If a bear market really is on the way, now is a good time to do what you can to protect your retirement investments so that you won't be in the same situation.
How to protect your portfolio
When the stock market is going strong, it's tempting to fill your portfolio with stocks. After all, when you see average stocks producing double-digit returns year after year, the natural reaction is to go all in. The problem with this approach is that when the market drops (which it will, sooner or later), a portfolio composed entirely of stocks will take a much bigger hit than a portfolio with a mix of investment types.
That's why diversification is such a powerful way to protect your portfolio from corrections. By spreading your money out over several different assets, you can practically guarantee that no matter what happens to the market or the economy, something in your portfolio will flourish.
Retirement investments and diversification
When you're still decades from retirement, your retirement savings accounts have a huge advantage: During your working years, you aren't drawing on those investments, so there's no immediate impact if the market goes into free fall -- and your portfolio has plenty of time to recover from even the most horrendous crash. However, as you approach your planned retirement date, you gradually lose this advantage. By the time you're about five years from retirement, a severe market correction could leave your portfolio unable to produce sufficient retirement income.
That's why most financial advisors recommend that you shift more of your portfolio from stocks to bonds with each year that passes. Splitting your money between stocks and bonds is a simple but effective way to diversify your retirement investments and protect yourself from bear markets. You can diversify more broadly by picking up a few alternative investments as well, but it's best to keep at least 90% of your retirement money in stocks and bonds. And by buying shares of an index fund with your stock money, you can take an additional step to reduce your risk of losses.
Retirement asset allocation
The way you split your money between stocks and bonds is also known as asset allocation. A simple way to figure out where your retirement money should go is to subtract your age from 110 and put that percentage of your money in stocks, with the remainder in bonds. This allows you to benefit from the high average returns stocks produce for as long as possible, yet have a cushion of bonds to shield you from the swoons of the stock market as you approach retirement.
For example, when you're 30 years old, this formula would tell you to keep 80% of your retirement investments in stocks and the other 20% in bonds. Once you reach 60 and are getting near retirement, the formula would tell you to have a 50-50 split between stocks and bonds.
Because the years immediately before and immediately following your retirement date are the most vulnerable period for your retirement portfolio, you might want to shift your balances a bit further toward bonds during those years. For example, if you plan to retire at age 62, you might change your asset allocation to 60% bonds and 40% stocks instead of having that 50-50 balance at age 60. You could then hold that 60-40 balance until your 70s, which would get you well clear of the riskiest years.
Restricting your stock purchases may cause you some pain when you see the market churning out high returns, but it will significantly reduce your pain when the inevitable correction wreaks havoc on your stock holdings. And if said correction arrives when you're on the verge of retirement, your ample bond holdings may well produce enough income to help you retire on schedule anyway.