Don’t let fears of a big stock market decline derail your investments

There’s widespread fear right now about a big stock market decline, fears that can cause even the most experienced investors to feel panicky. Given the incredible stock market run and concerns about a potential artificial intelligence bubble, these fears are understandable.

But forecasts of a pending market calamity and the damage it will do to your financial future threaten to undermine your carefully constructed investment plan. Hear this: A good investment plan accounts for market declines, so don’t let fear interfere with that.

Every smart investor needs to set out their asset allocation, whether that’s on their own as a do-it-yourself investor, with their financial adviser or with the help of a financial planner.

Your split between stocks, bonds and cash has a direct influence on whether you will have enough money to do the things you want to do, whether that’s buying a house, paying for your kids’ education or retiring comfortably. Your rate of return is one factor, but there are other things to consider, too, including how much money you need for your short and medium-term needs.

This kind of thoughtful asset allocation plan means that a market decline – or the fear of one – does not require adjusting your exposure to stocks. In fact, it would be damaging to do so because you’d be straying from your optimal asset mix and potentially selling your stocks at the wrong time.

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Time horizon is a big driver of your asset mix. If you have a long time horizon – seven years or more – then a portfolio heavily invested in equities can be appropriate, even for retirees. While traditional advice says that older people need a lot of safety in their investments, that’s not always true.

A 70-year-old doesn’t necessarily need a high allocation to fixed income; at that age, they could still have 20 years (or more) in retirement. Or they might not need all of their money, and have plans to leave it in their estate to beneficiaries who might have an even longer time horizon.

In fact, there’s a strong argument for retirees to have a high allocation to stocks in their portfolio. A 2023 analysis by three finance professors at American universities showed that a portfolio made up of a mix of domestic and international stocks resulted in the best outcome – measured using four metrics – as compared to a mix of stocks and bonds, regardless of age. Of course, the investor needs to be able to emotionally handle the volatility that comes with an all-stock portfolio.

For those who will need to take money from their investment accounts every year, holding some cash is prudent. A retiree who has enough cash-equivalent investments to fund their income needs over a two- to three-year period should not be concerned about a decline in the rest of their portfolio.

That’s because stock markets tend to recover from downturns within a median of about two and a half years, according to data from financial consulting firm Yardeni Research. So, relying on cash and bonds for your withdrawals means you can leave your stock investments to recover.

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If you have medium-term spending needs between three and seven years, you should hold some bonds or GICs. This is what a bear-market-proof asset allocation plan looks like.

Everyone who reads investing-related information has heard the buy-and-hold story: Stock markets rise and fall, but over long time periods, they have always gone up. This gives investors the confidence to choose the right asset allocation and stay invested through market turmoil.

Your asset allocation should be adjusted only if your financial or personal situation changed. A serious illness that can shorten your time horizon, a disability that increases your spending needs and the purchase of a property are some examples.

It’s easy to be swayed by the opinions of market watchers, especially now after a long and strong bull market, and concerns over the high allocation to technology in the U.S. stock market. But predicting a stock market crash is nothing new – and history has shown that investors who can wait out a decline end up better off than those who tried to time a decline and recovery.

So don’t panic. Choose the right asset allocation and stick with it.

Anita Bruinsma is a Toronto-based certified financial planner at Clarity Personal Finance.