According to the Retirement Risk Readiness Study from Allianz Life, nearly half of Americans (49%) believe a stock market crash is the biggest threat to their retirement income. It's a fair concern. For most of us, a 30% drop in the portfolio balance wipes out years of savings. That can be devastating, particularly if you're behind schedule already, you'd planned to retire within the next few years, or you're already retired. If any of that sounds like you, it's time to play some defense with your finances -- so a future crash won't ruin your retirement.
To be clear, playing defense does not mean selling out and moving your wealth into cash. It does mean adding discipline to your investment approach and how you manage your finances in general. Here are four strategies to do it.
Image source: Getty Images.
1. Check your cash reserves
The more cash you have on hand, the better prepared you'll be to manage through bad times without reaching into your retirement fund. Selling after a crash is not a move you want to make, because it locks in losses and lowers your opportunity to benefit from the recovery that always follows.
Review your finances and decide if you have enough cash on hand to stay out of your retirement account for five years or so. That's most challenging if you are living off your retirement account currently or if you plan to retire soon. In those scenarios, you might have to minimize liquidations rather than eliminate them. An ample cash balance, though, gives you more flexibility to do that. Start adding to your cash savings now.
2. Dollar-cost averaging
Dollar-cost averaging (DCA) is the practice of investing a consistent amount at regular intervals, instead of a larger amount all at once. In practice, this might mean investing $500 monthly rather than $6,000 once a year. If you are participating in a 401(k), you're probably already doing this; your contribution gets deducted from your paycheck regularly and is automatically invested in the securities you've selected.
The key, though, is to leave this process in place before, during, and after a market crash. When the market goes sideways, you might be tempted to stop investing -- we all are -- but resist that urge. DCA proves its worth after a crash, because that's when your consistent contribution buys you more shares at a lower price per share. You can see the end result of this in the table below. Investor 1 invests $500 consistently in the Fidelity 500 Index (FXAIX 1.20%), an S&P 500 index fund, from October 2019 through August 2020. Investor 2 is on the same schedule but gets spooked by the crash in March and pauses the 401(k) contributions and investments temporarily.
|
Date of Trade |
FXAIX Share Price |
Shares Purchased by Investor 1 |
Shares Purchased by Investor 2 |
|---|---|---|---|
|
10/31/19 |
105.66 |
4.73 |
4.73 |
|
11/30/19 |
109.49 |
4.57 |
4.57 |
|
12/31/19 |
112.02 |
4.46 |
4.46 |
|
1/31/20 |
111.98 |
4.47 |
4.47 |
|
2/28/20 |
102.76 |
4.87 |
4.87 |
|
3/31/20 |
90.07 |
5.55 |
0 |
|
4/30/20 |
101.04 |
4.95 |
0 |
|
6/1/20 |
106.25 |
4.71 |
0 |
|
6/30/20 |
107.95 |
4.63 |
0 |
|
7/31/20 |
113.53 |
4.40 |
4.40 |
|
8/31/20 |
121.69 |
4.02 |
4.02 |
|
Total shares owned |
|
51.44 |
31.61 |
|
Average cost per share |
|
$106.92 |
$110.72 |
|
Value at 8/31 |
|
$6,259.73 |
$3,846.63 + $2,000 cash |
Table data source: Yahoo! Finance and author calculations
Investor 1 invests a total of $5,500 over 11 months, while Investor 2 deploys $3,500. At the end of August, Investor 1 has a higher share count and a lower average cost per share. Investor 2 has fewer shares and a higher average cost per share. Investor 2 should have an extra $2,000 in cash available from not investing between March and June. Even so, Investor 2's total portfolio value including that cash is still a few hundred dollars less than Investor 1's portfolio. That's because Investor 1 stuck with the program after the crash and scooped up more shares at lower prices.
3. Invest in high-quality assets
High-quality assets are large, mature companies with experienced leadership teams, solid balance sheets, and strong customer bases. Companies like Walmart, McDonald's, and Procter & Gamble are examples. They've been around the block a few times and have a history of remaining profitable and paying dividends even through downturns. These positions aren't going to show big gains, but they're not going to fall as hard as more speculative options either.
If you are investing only in a 401(k) and have to stick with mutual funds, look for a dividend growth fund or a large-cap fund. Take a peek at the holdings in those funds to ensure you're getting the exposure you want.
4. Pay down debt
You already know high-rate debt is bad for your finances. Step up your repayments now, ahead of a market crash. If you have to choose between debt repayment and increasing your cash savings, know that there's no perfect formula. It often makes sense to save a small emergency fund first and then work on paying down high-rate debt. A small emergency fund is at least enough to cover your car or homeowners insurance deductible.
Stick to your plan
A market crash will affect your retirement plan in some way, but those effects don't have to be permanent or disastrous. Position yourself now to continue on with your monthly investment contributions by adding to your cash savings and paying down high-rate debt. Then, review your portfolio and decide if it makes sense to increase exposure to companies and funds that have proven to be resilient in previous downturns. Take those steps and you'll be well positioned to ride out whatever the market throws your way.
