Protect yourself in inevitable market dips

With the U.S. stock market surging to all-time highs, do you know how often it has registered a steep decline? Every 20 years? Every 10?

The answer will probably surprise you: On average, about every seven years.
That’s right. Since 1890, bear market declines of 20 percent or more have occurred on average every seven years. That’s something to be aware of now that more money is flowing into the market, chasing higher prices. And, with market measures including the S&P 500 at all-time highs, it’s worth noting that it has been more than four years since we’ve experienced any significant declines.
Yet what goes up must come down — temporarily. There have been five periods when the market has fallen 50 percent or more in real economic terms (after inflation): in 1911, 1929, 1937, 1972 and 2000, a decline that finally reached its trough in February 2009 after about a 54 percent decline.
And there have been 12 other periods with drops of more than 20 percent since 1890, bringing the total number of steep drops or bear markets to 17.
Significant declines in foreign markets are also more common than you probably think. Since 1900, the U.K. market has experienced nine declines of more than 20 percent, including one whopping drop of 74 percent (April 1972–November 1974). And since 1957, Japan’s market has declined more than 20 percent six times, including a plummet of 72 percent between December 1989 and March 2003. That’s a lot of market pain for one of the world’s largest economies.
Thus, you can’t escape normal, inevitable and regular declines regardless of what markets you invest in. So what should you do? Put your money in your mattress? The problem there is that you’ll get eaten up by inflation over time. Instead, you should prudently invest in global markets with full awareness that declines will randomly occur.
This is somewhat akin to making sure the foundation of your house has proper grading so you’re prepared to weather inevitable rainstorms. Unless you live in a desert, storms occur regularly; the only question is when.
To be prepared for market declines, you should:
• Expect such declines so that when — not if — they occur, you don’t fall victim to fear that can prompt rash behavior.
• Have a detailed, comprehensive financial plan that anticipates market declines. You just can’t throw money into the markets, taking the invest-and-hope approach. You need a comprehensive plan prepared around your personal goals, incorporating financial science, just as you need a blueprint to build a house. Without a solid plan, your nest egg is more likely to experience a structural failure. To develop this plan, consider seeking the guidance of an experienced financial adviser. Insist on getting in writing an agreement that clearly states that the adviser will be serving you as a fiduciary — a legal/regulatory status meaning they must always put clients’ interests first. This is critical.
• Make sure your plan provides significant diversification among numerous asset classes and is globally diversified. In your stock holdings, you want numerous types and sizes of companies. And you want to have investments outside the stock market, chiefly in investment grade bonds, which historically have usually — but not always — moved in different directions than stocks.
• Hiding is no way to achieve future financial security. Use financial history — evidence instead of emotion — to prudently plan your investments.
Although no one knows when market declines will come, I’ve learned in my many years as an adviser that those who have plans that anticipate declines can not only remain calm when the market starts to fall but also can often turn declines into opportunities. If you have in place a disciplined process that monitors all of your investments, you can take advantage of the buying opportunities that sharp declines create.
Market declines are normal, yet temporary. And, if you’ve planned for them, you can remain calm and confident, while those around you succumb to fear and end up becoming victims of their own behavior.

Tim Decker, a fee-only financial planner, is president of ISI Financial Group in Lancaster. He is the author of “The Sleep-Well-At-Night Investor” and host of the radio program “Financial Freedom,” which airs at noon Saturdays on WHP-AM 580. Contact him at www.isifinancialgroup.com.
This content is based upon information believed to be accurate by ISI Financial Group Inc. However, it should not be relied upon for legal or accounting purposes. Past performance is not indicative of future performance. Investments involve risk, including the possible loss of principal. Always seek professional advice before making any financial or legal decisions.

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