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How to Handle Stock Market Shocks (part 1)

After a long period of relative calm in the financial markets, we all experienced the return to volatility earlier this month. The S&P 500 Index (a proxy for the U.S. stock market) dropped 11% from its high on January 26 and to the close on February 8. Of course, since February 9, the S&P 500 Index has increased 7.7% so the total loss for the year is approximately 4.3% — not much of a loss considering the S&P 500 Index is up about 77% since 2008.Year-to-date, the S&P 500 Index is flat. On January 2, this Index was at 2,696 and today it’s at 2,718.

What was frustrating for many investors was that there was no apparent reason for the large drop. It was so random that it caught most of us by surprise. I want to address these recent market swings from the perspective of what it means to you if you are within five years of retirement or are already retired.

First, some background to consider. Because of the shift in retirement savings from employer-sponsored traditional pension plans to employee savings plans like IRA’s, 401(k) and 403(b) plans, you are now mostly responsible for your retirement income security. And keep in mind that Social Security will provide a smaller share of your retirement income in the future due to the increasing rate of Medicare costs. I wrote about this in an earlier blog post. Thus, while in the past someone who received a pension plan could mostly ignore market swings, now up and down markets have a huge impact on you whether you are nearing retirement or in retirement.

So what do you do to handle market shocks like we saw earlier this month? If you are within five years or less of retirement, you need to make sure you have the right portfolio mix in terms of risk for you. If you lost sleep in early February over market activity, sell stocks and buy bonds right now! Don’t wait for the market to come back to any level. Sell right now and move your portfolio to a place where you can sleep at night. Simple, but not easy.

It’s not easy for one primary reason: FOMO (fear-of-missing-out). I could have also said “greed,” but FOMO sounds nicer. When you make the switch in your portfolio from growth to balance or even preservation, you are being smart. Yes, you will lose out on some of the market gains that occur over the next few years, but more importantly, you will miss out on any sharp drops in the stock markets.

Which leads me to the hardest change to make as you near retirement – changing your mindset. After spending years accumulating savings and investing for growth, now you need to change your mindset and investment approach to one of balance or even capital preservation. This is not easy, especially if you have been fully invested since the Great Recession in 2008 and have enjoyed a huge increase in your account balances. But face facts: you are now 10 years closer to retirement then you were then. This amazing fact requires an adjustment in your mind and in your portfolio.

In summary: if you are within five years of retirement and the February market movements made you nervous, change your portfolio and change your mindset.

Next time: How to handle market shocks if you’re already retired