While no one can fully predict a market crash—or 100% “crash-proof” their investments, for that matter—investors can take steps to prevent their retirement portfolios from bearing the brunt of a sudden downturn.
Some market volatility is an expected part of investing, especially if you're in the market for decades at a time. But the specter of a market crash shouldn’t send you and your retirement savings out of the game entirely. Instead, by making smart moves now and keeping the long-term goal in mind, you can protect your nest egg from a downturn—and ensure that you’re ready to benefit from the recovery.
Here are five ways to protect your retirement savings from a market crash:
1. Stay Diversified
You never want to have all of your eggs in one basket, and that’s especially true if you’re aiming to shore your portfolio up against a downturn. A mix of stocks, bonds, and cash is the first step toward ensuring that you’re not overexposed to any one asset class. Of course, within each asset, you want to diversify as well.
Your equity mix, for example, should include small-cap, mid-cap, and large-cap stocks as well as investments in various regions, including emerging markets. Your fixed-income portfolio may also include various types of bonds, with different yields and terms. The right allocations should reflect your age, risk tolerance, and time frame to retirement.
2. Reduce Your Risk as You Near Retirement
While diversification remains key, reducing the risk in your portfolio as you near retirement is equally as important. That’s because near-term retirees have much less time to recover from a sudden and significant market downturn than those who are decades away from retirement.
Conventional wisdom has long suggested that investors subtract their age from 100 and the remainder is the percentage of their portfolio they should have in stocks. So a 40-year-old investor would have 60% of her retirement assets invested in stocks and 40% in bonds. However, more recently advisors suggest that 110 or 120 is a better number than 100. That’s because people are retiring later and may benefit from the added growth a larger equity position can provide.
If you’re within five years of retirement, your investment portfolio should be mostly fixed income. Ensuring that your risk decreases as you age will prevent you from losing big if the market drops in the latter stages of your saving years.
3. Have a Plan and Stress Test It
It’s easy to make quick, reactive decisions when the markets are rapidly declining. But those decisions—which often lean toward pulling your money from the market—are often not in the best interest of your retirement savings. Having a long-term plan is the best way to combat emotional investing in the event of a market crash. Work with a financial advisor to determine your strategy for contributing and investing in your retirement.
Then have your advisor stress test your plan against multiple scenarios to determine how effective it will be over the long-term. What happens if the market does better than you’re expecting? What happens if it does worse? How long could a downturn last? This type of planning can’t prevent a market crash, but it can help you create a plan that's designed to weather some volatility.
4. Maintain Emergency Cash
If you suspect a crash is approaching, check on your cash reserves—and build it up if possible. All investors should have at least three-to-six months of expenses in cash or cash-equivalent savings vehicles such as short-term bonds or CDs.
However, retirees within five years of retirement may have up to three years of expenses saved in cash. In volatile times, this cash is vital. You can draw on it to sustain your living expenses, instead of tapping into your retirement savings in the event that the market downturn also impacts your job or income. For those close to retirement, a cash buffer can provide support for living expenses so investments impacted by a downturn have time to recover.
5. Keep Contributing
If you can manage, maintain your retirement contributions through a volatile market, even if a crash seems imminent. A down market is a great time to be contributing to your retirement savings—you have the ability to buy low and take advantage of stocks that may be relatively “on sale.”
Maintaining your contributions allows you to benefit from the market recovery, if and when that occurs. You can recoup losses that your portfolio suffered and perhaps make some new gains on individual equities or sector investments that were hit and then bounced back.
Market downturns and even crashes happen, as we've recently witnessed. Take these steps to prepare yourself and protect your retirement savings, and you can limit the damage and come out the other side ready for what's next.
Looking for additional guidance on how to protect your retirement savings? Connect with a Fifth Third financial advisor today.