We have reached the last step in my series on dealing with volatile equity markets: Evaluate Your Strategy Annually or Earlier if Cash Flow Needs Change.
When I started this series in mid-August, the S&P 500 index had recently hit a low of 1,119. At the time of this writing, it is trading around 1,200. You may not like either of those numbers after reflecting upon the 1,364 point high it reached on April 29, 2011. I don’t, but my point is that if you did not watch the index for the last five weeks, you might think things have actually calmed down, but you would be wrong. Although the S&P 500 index is no worse now than it was five weeks ago, the intervening five weeks have been a wild ride. Did you allow your emotions to go along for the ride?
Let’s take this example a bit further. Just pretend that on September 14, 2010 you vowed to completely isolate yourself from political and economic rhetoric for one year. One year later, you turn on CNBC and you find that the S&P 500 index, which closed at 1,121 on 9/14/10, is now at approximately 1,200. The S&P 500 index had a 7% gain during your year of self-induced media deprivation. Not too bad for twelve months. I am also betting you have fewer gray hairs and worry lines because you avoided all of the intervening angst as the S&P index surged, plummeted, stalled, sank, climbed, reversed, collapsed, recovered….don’t you love the media?
If you were fortunate enough to deprive yourself of all media for that same year, you would also realize that not much has changed in the world either. In the U.S., the economy is still sluggish and very few new jobs have been created, and in Europe, austerity just isn’t fashionable. Greece is still floundering, and China may come to the rescue. Oh, even better though, you missed the whole debt ceiling debate.
No, I am really not saying that you should stick your head in the sand and ignore what is happening in the economy. More importantly, you cannot stick your head in the sand regarding what is happening in your personal life. I believe that my message is better captured by Albert Camus, a French Novelist and a 1957 Nobel Prize winner, who said “in order to understand the world, one has to turn away from it on occasion.”
How can you afford to “turn away … on occasion” from the barrage of market data and, more specifically, the daily equity market volatility? You can if you know where you stand financially (Steps 1 and 2) and you have constructed an investment portfolio that incorporates your stage in life and your cash flow (Step 3). But things do change, so it is vital that you revisit your plan at least annually to determine if you need to make adjustments (Step 4).
Annually, you may simply need to rebalance your portfolio. Consider taking the gains in the asset classes that have done well and reinvesting in those that have not. You may need to refill your cash bucket for another year’s expenses. You may need to reevaluate your cash needs for the next one, three and five years. If you are in the Retirement Red Zone, you should ask yourself how close you are to having the cash and bond buckets filled to meet your allocation goal at retirement. Regardless of how the market has performed during the past year, if your plan was to move from 35% in bonds to 40% due to the approaching retirement date, make the move.
If your personal situation changes during the year, your income decreases for example, it requires you to reevaluate your financial situation and your investment strategy sooner than annually. Before panicking, pull out that worst-case budget that was constructed, and remember that you have already considered the possibility things might take a different turn. In some situations, you may find that the portfolio now has too much equity exposure – so make adjustments based upon the updated plan, not upon today’s market move. Keep in mind also that the emergency fund is there (See Step 2) to give you time to make changes in your strategy over a period of several months instead of several days.
All investment strategies will be tested by disasters and economic events. One of the most important things that the period between October 2008 and March 2009 showed me is that a good strategy, based upon one’s financial situation and cash flow needs, can handle a lot of stress.
This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.