Scary Times for Investors

Source: Globe and Mail

Waking up and hearing all kinds of horrendous reports on the nuclear plant developments in Japan is obviously scary. The bad news continues to cascade. Two parts of the brain are firing on all cylinders: one is the concern with the plight of the Japanese as pictures and horrific videos circulate online, and the second is the  impact on the global economy and investment markets as markets around the world fall.

The videos get us to wonder how in the world  we would cope if similar events happened here. Seeing videos of people scouring  lists to see if their loved ones have been located  brings back memories of 9/11. Walls of water washing away homes and automobiles as if they were toys leaves one gasping.

On the investment front, emotions are running high. It is easy to feel like that squirrel in the road darting back and forth as the automobile approaches. Just as the squirrel isn't sure which way to go, investors, on one hand, see opportunity to buy in cheaper - the downturn everyone was waiting for - and on the other hand are wondering whether a bigger downturn is ahead and, thus, whether getting out is the right move.
Like the nervous squirrel, make a wrong move and it is easy to get squashed in a market like this.

As indicated in a previous pos,t it is a time to get our bearing. It is times like this when people learn their real risk tolerance. Risk tolerance quizzes get crumpled up and pitched into the trash can in light of real world events.

Let's start with our asset allocation. It was structured on a number of important factors:  risk tolerance (as best it could be measured), when you will start drawing on assets, ability to take risk, age, and  past experience in the market.

Whether you are an accumulator or decumulator is important. Accumulators are building the nest egg. If you are more than 5 years away from drawing on your nest egg, the economic downturn can be seen as an opportunity as long as you can stand the volatility. If you can increase contributions, reallocate to stocks as markets drop, and lessen your exposure to bonds.   As bond prices rise, this is the time to consider these moves. You are looking ahead to where markets will be 15 to 20 years from now.

The decumulator faces a different situation. He or she is drawing on the nest egg. In times like this, the decumulator needs to have a plan. Just drawing the monthly paycheck by selling a fixed amount across funds can result in reverse dollar-cost averaging which, in turn, can do severe damage to a portfolio. Before the market downturn started, at least nine months' worth of payments should have been in a short-term fund and the portfolio structured so that at least 60% of income needs were being generated by dividends and interest. These income flows should be used, as they are received, to replenish the short-term fund at this point.

Typically, a 65-year-old will have 60% or more of assets in fixed income. These assets are providing a valuable cushion in this environment. Bond prices, for example, are up sharply this morning. From an overall perspective, decumulators, as a first step, may want to raise their bond allocation by 5% - DIY Investor uses a 5% band in structuring asset allocation. Decumulators also need to keep in mind that a portion of their assets are for the longer term. In other words, a portion of their assets have a 15 - 25 (or longer) year investment horizon.

As always, the ability to sleep at night is paramount. If you are tossing and turning and wondering whether this market downturn will wreck your retirement, you may need to reconsider your allocation.

The important point to remember is that panicking gets investors in trouble and is one of the biggest sources of under performance.

Disclosure: This post is intended for educational purposes only. Investors should do their own research and consult an investment professional before making investment decisions.