The stock market is always susceptible to ups and downs, but this year has been a wild rollercoaster ride. Back in February, the S&P 500 reached its highest point since 2009. Fast-forward to March, and the index closed out its worst quarter since 2008. Then on August 18th, it reached another record high.
These dramatic highs and lows can be worrisome to investors. Even though the stock market is soaring right now, there's no telling if another downturn is around the corner.
Those who are nearing retirement may be especially concerned about this level of volatility. In fact, 72% of Americans are worried that a recession or economic downturn will wipe out their retirement savings, a survey from AARP found. While there's no way to predict whether another market crash is looming, there are ways to protect your savings as much as possible.
Will a recession trigger a market crash?
First, it's important to note that recessions don't always equate to market downturns. They often go hand-in-hand, but the economy and the stock market are independent of each other and don't always align. Case in point: The U.S. officially entered a recession back in February, despite the fact that the stock market has been surging and reaching record highs as of late.
In other words, a recession alone doesn't necessarily spell trouble for your retirement savings. However, if the pandemic worsens and businesses close their doors once again, another round of mass layoffs could potentially trigger another stock market downturn.
There's nothing you can do to prevent a stock market crash, so if a downturn is around the corner, you'll have no choice but to face it. However, there are a few things you can do to ensure it doesn't wipe out your life savings.
How to protect your retirement savings
One of the best ways to safeguard your savings against market volatility is to ensure your asset allocation is aligned with your risk tolerance.
Asset allocation is simply how your investments are divvied up within your portfolio. Younger investors are typically advised to invest more aggressively, allocating the majority of their portfolio toward stocks. Older investors nearing retirement should aim to invest more conservatively, allocating more money toward safer investments such as bonds.
If you're close to retirement age, you'll want to avoid investing too heavily in stocks, especially if another market crash could be on the way. One rule of thumb to determine how much you should be investing in stocks versus bonds is to subtract your age from 110, and the result is the percentage of your portfolio that should be allocated to stocks. So, for example, if you're 65 years old, your portfolio should be comprised of 45% stocks and 55% bonds.
By investing more heavily in bonds, you won't see as much growth because bonds typically have lower rates of return than stocks. However, they're also less risky because they're not as susceptible as stocks to the wild ups and downs of the market.
The risk of playing it too safe
If you're an extremely risk-averse person, you may be tempted to throw all your savings into bonds and quit investing in stocks entirely. Or you may choose to allocate the majority of your portfolio to bonds even if you have decades until retirement. Those may seem like good ideas on the surface, but playing it too safe can actually be dangerous.
Because bonds have lower rates of returns than stocks, it will be harder to reach your savings goals if you're primarily investing in bonds. That means you'll need to do more of the heavy lifting, saving more in your retirement fund, since your investments won't grow as much as they would if you had invested more in stocks.
Although stocks are inherently riskier, the stock market has always bounced back from its crashes. In fact, the S&P 500 has seen historic returns of around 10% per year, on average. In other words, despite short-term volatility, the stock market does see positive returns over the long term. By investing too conservatively, you're missing out on those gains.
Even if you're close to retirement, it's still wise to allocate at least a small portion of your portfolio to stocks. You'll want your investments to continue growing even after you retire, and investing in stocks will help your money grow faster.
When saving for retirement, it's important to strike a balance between risk and reward. Investing too aggressively could be dangerous if you're nearing retirement, but playing it too safe has its risks as well. By finding the right balance between stocks and bonds, you can maximize your savings while limiting your risk.