With the Dow Jones Industrial Average closing at yet another record high on Tuesday, there are a lot of people wondering when the stock market is going to reverse its upward course.
This is natural given the fact that the closing price of 18,312 represents a gain of over 11,700 points since the March 9, 2009 close of 6,547. The increase of 180% works out to a dizzying average annual gain of 29% over a little more than six years.
Prepare yourself for the next market crash
In Southern California where I live, although we’re unable to predict when they will occur, we know that earthquakes are inevitable. As a result, earthquake preparation kits are a fixture of many households.
Given the fact that stock market crashes, like earthquakes, are part of life, how should you prepare for the next one? I recommend two strategies: Precrash and crash. The first strategy is insurance-based and the second is behavioral.
Precrash strategy: Reduce risk level of your investment portfolio now
If you’re getting jittery, or even if you’re not, this is a good time to reduce the risk level of your investment portfolio. One proven way of doing this is to sell a portion of your stocks and equity exchange-traded funds (ETFs) and transfer the proceeds into one or more immediate or deferred fixed-income annuities.
Immediate annuities are appropriate for retirees and individuals whose retirement is imminent. Deferred fixed-income annuities, which include fixed-index annuities (FIAs) with income riders and deferred income annuities (DIAs), can be purchased beginning 20-plus years leading up to, as well as through the early stages of, retirement.
In addition to elimination of exposure to stock market risk, fixed-income annuities are designed to generate a sustainable lifetime income stream. The dollar amount that you should consider dedicating to this proposed strategy is dependent upon (a) how close you are to retirement, (b) your risk tolerance level, (c) your projected annual after-tax retirement income needs, and (d) your other sources, amounts, and timing of sustainable lifetime income.
Placement of fixed-income annuities is an important consideration. You will have more options if you have nonqualified (nonretirement) and qualified (retirement) investment accounts assuming the latter aren’t limited to active 401(k) plans. While you may be liable for income tax on capital gains if you sell securities in nonretirement accounts, this type of account will minimize income-tax liability when taking immediate annuity and deferred-income annuity distributions.
Crash strategy: Stay the course
Whether or not you implement the proposed precrash strategy, you need to hang tough with your investment portfolio when the stock market endures its inevitable downward spiral if you want to fully participate in the eventual recovery. As anyone who’s been through one or more bear markets knows, this isn’t easy to do, especially if you don’t have a fixed-income portfolio to help you weather the storm.
The evidence speaks for itself. From personal experience, to this day, the historical multiyear returns of clients who chose to sell a portion of their equity holdings and park the proceeds in money-market funds during the last major stock market downturn between October 2007 and March 2009 are noticeably less than those who didn’t pursue this strategy. The more aggressive the portfolio model, the greater the disparity in returns.
You can’t afford to be complacent
When you see the stock market regularly breaking through barriers and hitting new highs, it’s easy to get complacent and forget about the fact that a downturn is unavoidable. While it’s inadvisable to try to time the market, it’s prudent to employ time-tested, conservative strategies that will keep you on track for pursuing your retirement income planning goals. The two discussed in this article will help you do this.
DISCLOSURE: Robert Klein is licensed as a Resident Insurance Producer in California (License #0708321).