Hi, Everyone. Welcome to the Wiser Financial Advisor with Josh Nelson, where we get real, we get honest, and we get clear about the financial world and your money.
This is Josh Nelson, Certified Financial Planner and founder and CEO of Keystone Financial Services. We love feedback and we’d love it if you would pass it on to me directly: firstname.lastname@example.org . Also please stay plugged in with us, get updates on episodes and help us promote the podcast. You can subscribe to us at Apple Podcasts, Spotify or your favorite podcast service.
Let the financial fun begin!
This is your captain speaking. Sorry for the inconvenience, but we’re experiencing some choppiness.
We are in a stock market correction.
This was a fun week because we got to do our forecast presentation for 2022. Last year we just gave it virtually, so it was fun to be in front of some real live people because these days most of us are on zoom calls, and we thought it was fun to get together in person with some folks. Good to see you! And if you missed it, we’ll be doing a webinar version coming up.
It was interesting talking with a lot of our clients about the stock market correction that we find ourselves in right now. And certainly, our forecast presentation was more interesting than it would have been a few weeks before, because we’ve really had pretty smooth sailing during the last year or so.
A market correction is defined as a 10% or more drop in the stock market. A couple of things about stock market corrections: On average they happen once a year and there’s nothing that we can do about it. Corrections are just part of being an investor, so about once a year we’re going to see a stock market correction, a 10% or more drop.
Now historically, 80% of the time corrections don’t turn into bear markets, which are defined as a 20% or more drop in the stock market. So, only one in five times does a 10% or more drop lead to a 20% or more drop. Meaning that most of the time market drops are just turbulence. That doesn’t mean we just stick our heads in the sand during a market correction. There are things you and I can and should do when the market corrects.
Have you ever flown in an airplane? One of the things you experience is turbulence and sometimes extreme turbulence. I’m sure some of you have had that. I’ve experienced that a couple times where it was actually scary, but planes don’t crash because of turbulence. In fact, my friends who are commercial airline pilots tell me that turbulence really doesn’t bother them a bit. They try to adjust their flight path and altitude to minimize turbulence for the comfort of the passengers, but sometimes it’s unavoidable, and if everybody wants to get to their intended destination, you just kind of have to get through it.
So today we are going to talk about five things to check on during a market correction, because that’s where we are. But first, this episode is brought to you by Keystone Financial Services, a top wealth management firm based in the land of love, Loveland, Colorado. We are here to provide unbiased advice and our goal is to replace uncertainty with confidence and clarity when it comes to planning for your family’s financial future. Take the guesswork out of your financial future today. Schedule a free initial conversation with one of our Certified Financial Planners by visiting www.keystonefinancial.com.
All right, so five things to check during a market correction—
Number one, check your financial foundation. Sometimes people refer to this as having their financial house in order, having themselves really checked up to make sure all the basics are covered. One of those is to make sure all your non-mortgage debt is paid off. And I know some of you might argue with me on this and say, “No, my debt is at a really low interest rate and I can make more in the market.” Trust me, one of the reasons wealthy people are wealthy and have such a good cash flow is because they don’t have any debt, at least non-mortgage debt. Mortgage debt we deal with a little bit differently, but we do want to make sure that all of your other debt is paid off.
We also want to make sure you have three to six months’ worth of living expenses saved in somewhere really safe such as a bank or credit union. That’s probably earning zero percent interest right now, but that’s OK for that three to six months’ worth of living expenses. An emergency fund is needed because of Murphy’s law, which says that if something can go wrong, it will, and at the exact worst time that it possibly can.
Also make sure that you are properly insured at all times, meaning the basics need to be there for health, life, liability, homeowners and car insurance. We also always recommend you carry identity theft protection of the type that has resolution services because sooner or later in this crazy world we live in, somebody is probably going to hack your stuff, and they might do some bad things to your credit.
There are a lot of different services out there. LifeLock is probably the most prevalent as far as brand names, but there are a lot of them out there. Long term care insurance is a maybe. It’s a maybe because it really depends on your situation. In some cases people don’t need it because they’ve got a large enough amount of wealth to self-insure. In other cases it’s wise to look at what options are available. If you’ve had health issues, you might not qualify for long term care insurance. In other cases it’s so darn expensive that it just doesn’t make sense for you and your family. But check out long term care insurance as something that might be part of your financial foundation.
Number two on our list of five things to check during a market correction: Check your financial plan. The big question is, what do you really want? What is your intended outcome with all of this? When people sit down with us for the first time, they might have some vague idea such as, “Well, I want to be able to retire someday.” They might even have an idea of what age they want to retire, but really this is about drilling down and figuring out what is this money intended for and what are we trying to accomplish.
Common things that we hear:
“I want to be able to retire if I want to by the time I’m age 60.”
“I want to be able to spend a certain amount of money per month, and have all my debt paid off, even my mortgage,”
“We want to make sure we’ve got someplace warm in the wintertime, maybe in Phoenix.”
Or maybe someone wants an RV or a condo or something like that.
Whatever it is, we like to attach dollar amounts to all these things to make sure we’re all on the same team and going in the same direction. Because if you and your family don’t have a plan, then it’s going to be difficult to know when you get there. It’s important to have a game plan and have that dialed in.
During a market correction it helps to remember why we’re doing what we’re doing and to ask why the strategy is the way it is. We need to be able to tie it back to what you and your family want to accomplish.
Number three on our list of five is to check your risk number and compare it to the risk number of your actual portfolio. That number will drive your asset allocation, meaning the mix of categories of investments that you own. The most important investment decision is what mix to have of categories of investments, how much is in stocks, bonds, real estate, alternative investments. It isn’t just the things you own, but also what percentages you own them in that yield what rate of return you get over time. All rates of return are potentialities; we can’t guarantee anything, which ties back to that risk number.
To find your risk number, take the risk assessment by going to www.keystonefinancial.com . We’ve got a tool there for free with no obligation. We’re not going to bug you; you can just go and figure out what your risk number is. The tool is about 2/3 of the way down the page where a red box says find out your number. If you’ve taken it before, maybe take it again. It does change over time for some people, because maybe you’re at a different stage in life right now and your risk number has gone up or gone down. If you took it years ago, it could be a good idea to take it again just to make sure you’re in the right place.
A risk number is not gospel, because you can pick any risk number you want. Maybe you take it and it comes out and says you’re a 40 and you say no, you’re a 75. Well, ultimately you get to make that decision because it’s your money. But the test is a good starter as far as asking important questions of yourself. It’s educational because it will show you for different risk numbers how much you can expect to gain or lose during any given time period. This is the most important investment decision because it will dictate what experience you’re going to have, not just in what you can make on your investments, but how rough that ride might be.
Number four on our list of five is to check your diversification. Don’t keep all your eggs in one basket.
Don’t just own one stock, own lots of stocks. Don’t own one property, own lots of properties. Don’t own one bond, own lots of bonds. I can tell you that I’ve experienced this so many times in my 22-year career: I’ve seen people make the mistake of having all their money in one thing. Sooner or later that one thing ends up getting hurt, sometimes permanently hurt. For example, in the late 90s and early 2000s, a lot of people loaded up on tech stocks. Sometimes they got really specific and put everything into one tech stock or all in one category like a dot.com. Well, people who did that experienced an awful lot of pain. In some circumstances, depending on what it was that they owned, they permanently lost money because many of those companies don’t even exist anymore. We saw people taking crazy risks on the order of a risk number of 99 on a scale of 1 to 100. To be so far up there is just dangerous.
Having diversification means that you don’t keep all your eggs in one basket. We’ve seen losses happen even with people who own bonds. Sometimes if you look at a bond, you think, “Well, that’s guaranteed.” Okay, who’s making the guarantee? If it’s a government, is it the US government? Or is it Puerto Rico or maybe Detroit? There have been municipalities that have gone bankrupt and people have lost money. There have certainly been examples of companies that have gone bankrupt. General Motors still exists, but they went through a bankruptcy. United Airlines still exist, but they went through a bankruptcy too. And guess who loses all their money when that happens? It isn’t just the stockholders, but most of the time the bondholders as well. We’ve seen this happen when people worked for a certain company for years and years and thought it was a bulletproof place to put their money. They trusted it because they worked there and put all their money in that one thing. We’ve seen it happen with bonds and with stocks. In some cases people have lost all their money.
We’ve even seen losses happen in the real estate market. Back in the mid-2000s, you might remember that there was some craziness happening with a huge real estate bubble that formed. There was one gentleman in particular I met with who was going to be retiring. We had built a diversified portfolio tied to his risk number and aligned with his goals to produce income for the rest of his life, at least according to the odds. It was just a beautiful plan, but the next time I talked to him he said, “You know what, I’m not going to do that. Instead I’m going to take that money and go buy condos down in Florida. I’m going to flip condos and make a lot more money than I would in a diversified portfolio.” And I didn’t speak with him after that, not because I was mad at him, but we just didn’t connect. But I know what happened to real estate in Florida after that, especially in condos. A lot of those speculative real estate deals lost everything.
It’s easy to make money when the market is just going up. But when things get choppy like they are right now, it’s super important to remember that diversification is key. Make sure you’ve got your assets spread out, not just as far as asset allocation and different categories of investments, but also spread things out in those different categories themselves. Let’s say that you own Apple as one of maybe 500 stocks. Maybe it’s in the form of mutual funds. Often that’s what we invest in, right? And that one stock probably won’t be on your radar even if Apple were to go broke (and they probably won’t anytime soon) but if they did, it would just be a little blip on your portfolio, nothing you would probably even notice because of diversification.
Diversification is free; it doesn’t cost anything, and it will never hurt you. And though by under-diversifying you might get a moon shot; you might get one stock that turns into a rocket ship, you can also get completely killed and lose all your money based on that one thing.
Number five on our list is to check your withdrawal percentage. Here I’m speaking to people who are retired right now. They’re not working, and so they’re drawing out of their portfolio. If you’re a client, we’re probably sending you that money every month. It’s important to look at what percentage you’re taking out on an annual basis. We like the 4% rule. Sometimes people say it should be 3% or 5% or some other percentage. We like the 4% rule because we’ve looked at a lot of research that shows we’ve got really high odds of not running out of money at that percentage. It depends on your portfolio, but the odds are good as long as we stick to that 4%.
Why is that? Well, when we build a diversified portfolio, if it’s balanced, we’re probably going to be somewhere in the range of 6 or 7 or 8 percent per year as our assumption for your long term rate of return. Now, of course, it depends on your risk number. If the risk number of your portfolio is too low, then you probably won’t be getting those returns, so probably less than that. And who knows, if you have a high risk number it could be larger returns. But we use 6, 7, 8 percent as our benchmark rate of return, depending on your investments. So knowing that, let’s say we take 4%, but we’re earning 6, 7 or 8% per year. That means your earnings per year, on average over time, should be more than what you’re pulling out. And the difference in between is key, because that’s your cost of living adjustment. In other words, your portfolio on average should be going up as a trend over time, so that the money you take out should not be exhausting the capital. Your capital should be going up over time, which means you should be able to give yourself a raise.
Of course the stock market is not guaranteed. We can’t guarantee anything when it comes to investment returns. We’re just talking about experience and what’s worked for clients historically, so keep that in mind with the 4% rule. You might think about it as a fixed amount, but it’s really not. 4% needs to be fixed to whatever your value is in any given year. If you start with $1,000,000 and now that $1,000,000 has gone down to $800,000, how much should we take out? Should we take 4% of a million or 4% of $800,000? The conservative option would be 4% of $800,000 which gets back to my original point of number one: check your foundation. That’s why we want to get all your debt paid off. People in that position are in a pretty good spot to be able to weather all kinds of financial storms. Because they don’t have any debt, their fixed expenses tend to be pretty darn low, meaning that when there are recessions or pull-backs, they are in a position to be able to pull back their personal spending, at least temporarily. If you’re taking out a percentage and adjusting it over time, now you’ve got really high odds of never running out of money—as long as your portfolio is dialed in the correct way.
Sometimes people ask, “Well, Josh, how much could I really take out before you guys would start getting nervous?” So, our warning bells at Keystone Financial start going off when someone takes out more than 5% in a year. That starts to make us nervous, because we really plan on people being around for a long time. Our clients are on average age 58. That means we’ve got a lot of younger people too, but many of our people are relatively young retirees; they might be in their 50s or 60s when they retire. I consider that a young retiree because the odds are that if you take care of yourself, you probably have a good 20-30 years to make that money last for you. Therefore, it’s really important that we adjust for inflation by taking out 4 percent of your portfolio per year, maybe 5 percent if you really want to push it.
Then adjust as the market adjusts, which means it can work in your favor too, right?
Let’s say your $1,000,000 now goes up to $1.2 million. Well, can you take 4% of $1.2 million? Well yeah, that’s the idea, that as your capital goes up over time, you’ve got more money you can take out. So again, our warning bells start going off at 5%. More than that, based on the research we’ve seen, means the odds start going up of having a problem down the road, especially if you are younger and trying to live off this for multiple decades.
To sum up, those are the five things to check on now that we are in a market correction. As we’ve seen, maybe by the time you hear this, we’ll be out of the market correction. It often happens that the market pulls back sometimes for a very short amount of time. The nice thing about market corrections and even bear markets is there’s never been a market correction or a bear market that wasn’t eventually followed by a bull market.
The market tends to pull back for a little while—maybe it’s for days, maybe it’s weeks. Maybe it’s even months or in some cases years. That’s not particularly fun but we’ve seen that happen and when it does, it takes several years for it to come back. But that is one of the risks. That’s why we get returns—because we’re taking risks. We’ve got uncertainty within our portfolios and because of that, we get the better returns over time in things like stocks and real estate, things that are not guaranteed. Historically, that’s where people have seen more returns because they’ve been willing to absorb that risk.
So five things to check during a market correction:
Number one, check your foundation. Make sure you get all of your non-mortgage debt paid off. Use the debt snowball that we’ve talked about in previous episodes. Go back and listen to that if you’re not sure what I’m talking about. Get three to six months’ worth of living expenses saved. Make sure you are properly insured. One asterisk on that is homeowners insurance. Check how much protection you’ve got on your home, because for a lot of us, home values have gone way up and we want to make sure you’ve got enough protection in case something crazy happens. For example, not long ago in Colorado, a whole neighborhood burned down from a grass fire. These were nice homes that weren’t in the mountains or anything like that. So be sure your homeowners insurance is adjusted for whatever the current value of your home is.
Two, check into the big picture for you and your family. What is the result or outcome you’re after?
Are you really clear on it, and is your Certified Financial Planner really clear on it? You want to be on the same page.
Three is to check your risk number compared to the risk number of your portfolio. We have tools to figure that out. It’s important to use those tools because as financial planners, that’s a really common mistake we see: people come to us and have no clue how much risk they’re taking in their portfolio. It might be a default option their employer gave them in their 401 K. Find your risk number and align it with your plan.
Four is to check your diversification. Don’t keep all your eggs in one basket. Use the free option of diversification. I’m begging you, if you have a big concentration of one thing, even if it’s one really nice property or one really nice stock, please diversify into more eggs.
Five is to check your withdrawal percentage. We like the 4% rule and certainly no more than five in any 12 month period.
My last thing is to offer some encouragement to those of you who are still working or saving. Here’s the thing: right now the market is on sale! It’s a great buying opportunity. When things get cheaper, you can buy them cheaper. If you have money to invest, see it as a buying opportunity because history has shown that there’s never been a market correction or a bear market that wasn’t eventually followed by a bull market. That’s the story of human history, and innovation is the key. That’s why all these companies, whether tech companies or healthcare companies, continue to make more profits over time as a general rule. There are certain companies that don’t, but the overall market is made up of a bunch of businesses that are trying to make things better and because of that, they earn better profits over time. That’s why things go up. It’s the story of human innovation that we continue to grow as an economy.
So, certainly this is something to consider as an opportunity. Even if it’s just your normal 401K contributions going in, know that you’re buying more shares of investments. They’ve gone down in value, but you’re putting in the same dollars which means you’re buying more shares. And if we think those shares are going to go up in value over time, at least consider that they’re on sale right now. Keep in mind that when you hit markets like this, they’re not permanent. Planes don’t crash because of turbulence. They might be uncomfortable, but that doesn’t mean things will end up bad in the end.
One other statistic I saw from Fisher Investments this week, is that if you look at five year rolling periods over the last 100 years or so, back to 1928, then 87% of the time the market was positive during any five year period. So, if you’re in a market correction right now and thinking about what to do, know that almost always you’ll be back up and probably higher by the end of any given five year period.
Fisher Investments also looked at 10 year returns. And in any given 10 year period, 94.1% of the time you would have been positive. Over any 20 year period, the S&P 500—which is the broad stock market, not specific investments—was positive 100% of the time. So wherever you’re sitting today, if you’re nervous about something going on in the world or the markets, or you’re checking accounts too often, remember that market corrections are just part of the experience. It’s that turbulence factor—not real comfortable, but an unavoidable part of being an investor.
Trust your pilots. Trust that we are here to get you to your destination as comfortably as possible. We do want to get you there, so I encourage you to reach out to us. If you have questions, if you’re getting some anxiety, one of the best things you can do is just reach out to us. Sometimes it’s just a five or ten minute conversation with one of your planners here to talk about whatever your concerns are. We can go back and look at your plan, look at your risk number and these things we’ve been talking about checking. We do this for our clients. If you’re not a client right now, maybe you should be. Check us out at www.keystonefinancial.com We have a free conversation available to you. We can jump on the phone, jump on a zoom call, and look at whatever your financial needs are that need to be met.
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Thank you for listening today. I hope you have a great week and God bless.
This episode has been prepared for informational purposes only and is not intended to provide and should not be relied upon for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors. Investment advisory services offered through Keystone Financial Services, an SEC registered investment advisor.