When the stock market drops or crashes, have you ever had this thought:
My portfolio is down $100,000…$200,000…$1 million! How will I ever recover what I’ve lost?
This is an important question to consider…your retirement life depends on it! It’s common to wonder how you’ll ever regain the value in your portfolio. It feels like someone came into your account and took that money out. You might even worry that you’ll run out money and end up back at work in retirement to make ends meet.
Though market downturns are always uncomfortable, they are common, so it’s critical to understand that a $1 million drop in your portfolio due to a market decline isn’t the same as a $1 million withdrawal. Why? What’s the difference if your statement shows $1 million less than you had last quarter?
Let’s think of your portfolio like your home.
Square feet in your home and shares in your portfolio
Take a look at your home value online. Are you surprised to see that the value changes all the time? If your neighborhood got a new shopping center, your price jumped up. When mortgage rates spiked, your price dropped. Now look around…did you home grow or shrink during that time? Unless you built an addition to your home, you’ve had the same number of square feet the entire time. You didn’t gain or lose any square feet; you would simply have received more or less money for the home if you chose to sell, based on the circumstances. As the housing market recovers, your home will increase in value.
Now think about your portfolio. If you invested $300,000 in Microsoft at $300 per share, you just bought 1,000 shares. If the price declined to $200 per share, your statement would now show $200,000 – a $100,000 drop in value! But look a little closer…did you lose any shares? Unless you sold shares and spent the money during that time, you still have 1,000 shares. You would simply receive less money for them if you sold right now…just like the square footage in your home. If the price bounces back to $300 per share, you’re back to your original investment.
How volatility can work for you
During that market downturn, what if Microsoft paid you a dividend and you reinvested it while the price was down. You just bought more shares at a discount…like getting a deal on building an addition to your home. It’s also why systematically rebalancing your portfolio is so important: it sells some of your winners for a gain and buys shares of investments that have declined in value at a discount.
When do you need your money?
This brings us to the most important question: when do you need your money? As we discuss in Understanding Retirement Income, your time horizon is one of the most important factors in ensuring that market ups and downs don’t disturb your retirement paycheck. As we learned above, you’re only giving up assets when you sell and spend, not when share prices decline. In retirement, we want to carefully assign roles to your investments.
- Safety. These funds are your rainy-day reserve, kept in cash or high-interest savings, and intended to provide a secure backstop when the unexpected arises.
- Income. This provides your monthly paycheck, invested in dividend and interest-generating assets that can deliver steady income.
- Growth. This bucket grows the funds you won’t need for multiple years, invested to grow your portfolio and refill your safety and income buckets over time, and enable you to ride out the ups and downs of the market.
Whenever possible, we want to avoid short-term spending from your long-term growth bucket, especially in a downturn, as this would mean selling funds and locking in those losses.
When the market drops, look around your home
How does this help? The next time we’re in the middle of a market decline and you see a drop in value on your statement, look around your home as a reminder. Unless you’ve spent from your account during that time, your home can serve as a reminder that you haven’t lost shares, just like you haven’t lost square feet. Talk with your advising team to make sure your strategy still fits your needs and, if so, you can take reassurance from the knowledge that as the market rebounds, your nest egg will, too!
The “Alterra” name was coined by joining the Latin roots “alter”, the origin of the word “altruism” with “terra” meaning earth or land. This name reflects the company philosophy of “clients before profits” and providing firmly grounded advice.