Preparing For the Drawdowns

Source: NitrogenWealth

When you ask an investor what he would do if the market fell by 20%, his answer will depend almost entirely on whether the stock market has been going up or down.

When the market has been going up—like today—investors happily accept the idea of more risk. When things are going well, the hypothetical scenario of stock prices dropping 20% seems like a happy opportunity to buy shares on sale in a world identical to the one we live in today.

But reality doesn't work that way. When the market is down 20, 30, 40, or 50%, it is generally because something terrible is happening, and the idea of taking any risk suddenly seems irresponsible.

In 2000, it was the dot-com bubble, 9/11, and the fall of Enron. In 2008, housing prices collapsed, unemployment rose, and major banks declared bankruptcy. In 2020, COVID-19 was spreading, people were dying, and the world was shutting down.

Investors in these scenarios didn't see opportunity. They just saw scary things and the potential for them to get even scarier. The world had changed, and they needed to get out.

What is the point?

As much optimism as I have for the long-term success of our country's great businesses and the stock markets we use to invest in them, I'm fully aware that more bad things will happen along the way. I'm also aware that I have no idea what those things will be or when they will happen.

But I do know that when bad things happen, investors will get scared.

History tells me that people who love the S&P 500 today at 6,000 will be anxious to sell if it goes down to 4,000. Investors eager to buy their first Bitcoin at $100,000 will liquidate everything at $20,000. Clients excited about their equity allocation when it was appreciating will wonder why we didn't lock in their gains while we had the chance.

However, like the muster drill on a cruise ship, this is a preemptive reminder that bad things can and will happen...but we are prepared.

When your portfolio goes down, do you have the cash and income to ride it out without selling at a loss? If the answer is no, now is the time to fix that. Does your plan fall apart if the next market decline lasts for five or ten years? If it does, now is the time to fix that.

This isn't to say you should sell everything now and wait on the sidelines for the next big decline. The market could climb another thousand percent before its next thirty percent pullback. This is to say that long-term success is about embracing the stock market's ups and downs. A plan that requires only being in the stock market when it is going up is bound to fail just as badly as a plan that requires moving to the sidelines once things get scary.

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On a personal note, the same day my wife successfully adopted out the previous foster dogs, she took in some new ones. This mama dog had four puppies, and they will all be available for adoption through Jenni’s Rescues Ranch sometime in the next few weeks.