The S&P 500 finally broke its streak of positive annual returns in 2018, missing out on a 10th consecutive year without a decline.

S&P 500 Index Annual Returns (2008 to 2018)

Annual Return
2008 -37.0%
2009 26.5%
2010 15.1%
2011 2.1%
2012 16.0%
2013 32.4%
2014 13.7%
2015 1.4%
2016 12.0%
2017 21.8%
2018 -4.4%

As you can see in the chart above, prior to 2018 the last time we ended the year worse than we started it was 2008, when the market dropped -37.0% in the midst of the financial crisis.

In fact, the run from 2009 through 2017 matches the nine year economic boom of the 1990s and the two stretches are the longest of their kind dating back to 1926.

During a period of record growth, it’s easy to forget that stocks can, and do, go down. Often, the market moves with astonishing velocity, catching the vast majority of investors by surprise (like it did in the fourth quarter of last year when the S&P 500 index dipped -13.5%).

It’s for this very reason that the single most important decision we make as investors is our asset allocation (i.e. the ratio of stocks vs bonds). More than anything else, this decision is the best way to align our risk profile with the potential for decline in our portfolio.

However, even for the few of investors who get this right, a bear market can still be an extremely challenging time.

And since we don’t know in advance when volatility may come knocking, it’s a good idea to be prepared well before the next market decline takes hold.

To help bring this point home, let’s look at the three general phases that individual investors go through on their path to, and through, retirement and how best to respond:

Accumulators (Young and Mid-Career Investors)

How to Respond

  • Ignore the headlines proclaiming the world is ending
  • Avoid the temptation to sell. Remain invested. Rebalance and tax loss harvest according to your plan.
  • Keep saving. Increase your contributions if you can.

Here’s a simple fact: A bad bear market when you’re a young investor is essentially meaningless in the grand scheme of things.

It probably won’t feel like this when it happens, but a 30%, 40%, or even 50% decline when you’ve got $25,000 invested will be nothing more than a blip on the radar by the time you retire.

In reality, lower stock prices are actually a very good thing if you’re actively contributing to your investment accounts.

Lower prices mean that you get to buy more shares for the same dollar investment than you could before. In turn, owning more shares means that your portfolio will compound even faster in dollar terms as the market recovers.

Ultimately, if you’re a freshly minted college graduate or you’ve only been in the workforce for a few years, the amount you contribute matters far more than short-term performance.

For folks in their 30s and 40s, the middle of your career means higher earnings and an even greater ability to save. By this time the hope is that you can consistently put away a large percentage of your income every year, while also satisfying your short-term goals.

Accordingly, your bear market mindset should also be centered around the opportunity to acquire even more ownership in the world’s companies and to do so at a bargain, sometimes even fire sale, prices.

The reality that a bad stock market is actually good for accumulation-phase investors is one of the greatest ironies in all of personal finance. When you find yourself in the middle of this kind of opportunity, don’t let it pass you by.

Near- and Semi-Retirees (Protectors)

How to Respond

  • Regularly review and update your financial plan
  • Ensure your asset allocation is aligned with your plan and risk profile
  • If necessary, implement a pre-determined alternative to get back on track

If you’ve got five years or less to retirement, you’ve probably already done the bulk of your savings. Certainly the hope would be to continue contributing according to your plan, but now the focus really changes.

Whereas early in your career the amount you put away typically far outpaced how much your portfolio grew in any given year, now the reverse is often true.

For example, even a modest 4% return produces an $80,000 gain for an investor with $2 million saved. That’s more than four times the maximum 401(k) contribution for 2019 of $19,000.

There’s simply more dollars at work.

This fact pattern means that it’s critically important to review your financial plan, ideally well in advance of a market decline.

The primary goal should be to refine your retirement projections and revise your asset allocation so that you’re only taking as much risk as is absolutely necessary for your plan to succeed.

Simply put, while a stock-heavy portfolio might be appropriate for some investors during this stage, most of us are not in a position to handle a 50% decline with retirement just a few years away.

It’s also important to discuss the “what-ifs” and to stress test your plan using scenario-analysis and Monte Carlo simulation.

Having a good plan in place before market disruption means you’ll be well-positioned to handle all but the most extreme sequence of events without forgoing your opportunity to retire.

Accordingly, the primary response to a bear market in this phase is to review and update your plan to determine whether any changes are required. If you need to work a little longer or consider trimming your vacation budget a bit, now is the time to figure that out.

Don’t put yourself in the position of quitting your job without a proper plan even if you have a seven figure portfolio. $1 million doesn’t go nearly as far as some investors would like to think.

Retirees (Distributors)

How to Respond

  • Review your withdrawal rate and your retirement plan at least annually
  • If your plan requires it, temporarily reduce your withdrawals until the market recovers
  • Defer large expenditures that would require an outsized distribution from your portfolio

By the time you’ve reached retirement, the game plan is usually pretty clear: don’t run out of money.

Hopefully you’ve saved enough that your asset allocation only requires a modest weighting in stocks in order to satisfy your goals.

You’ve also lived through numerous business and market cycles so you’ve seen stocks go up and down countless times.

Thus, you might assume that even a bad couple of years isn’t the end of the world and you can just to “sit tight” like you have before.

While avoiding the temptation to get out of the market is generally good advice, retirees face an acute risk that other investors do not as a result of the following realities:

  • Since you’re not working, you may be heavily (or entirely) dependent on your portfolio for income.
  • Taking large withdrawals during a bear market can mean that you’re forced to sell investments at depressed prices.
  • While eliminating stock market risk might sound appealing, doing so can actually have a devastating effect on your portfolio’s ability to survive your lifetime.

The above fact pattern means that retirees need to be particularly careful in the years immediately before, during, and after their retirement date.

The combination of discontinued employment, a severe market decline, and withdrawals that exacerbate the decline of your portfolio is what is known as “the perfect storm of retirement”

When all of these factors hit at once, the storm can sometimes be bad enough to capsize your “retirement boat” unless you take immediate corrective action.

Often this means temporarily reducing your portfolio withdrawals or deferring things like home improvements or vacations. For some retirees it means that part-time work may need to become a part of the conversation.

Whatever the case is, it’s far better to attack a situation like this head on, rather than burying your head in the sand. The facts are the facts regardless of when you decide to assess the damage.

Hopefully, with a sound plan and the right stock/bond mix, you’ll be in better shape than you thought. However, even the best plans are rarely “set it and forget it.” To be successful, you still might need to make some adjustments to confidently stay on track.

Closing Thoughts

As a financial planner, one of the things I focus on with clients is making sure they have the proper expectations for risk and return in their portfolio.

Part of that responsibility means constantly reminding folks about the other side of the investment coin. In other words, when markets are down, we stress the importance of sticking to our plan and prioritizing what we can control.

Conversely, when markets are good, like they are now, I probably sound like a Debbie Downer. Markets are hitting new record highs nearly every day and I’m talking about how to handle the next 2008.

Sadly, most investors won’t plan ahead and will find themselves in the middle of a bear market without any clue as to how to respond. If you’re reading this in 2019, hopefully you’ll take action so you can be the exception to that rule.

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