“The stock market crashed again. It’s the third time this year.” – news reporter on CNBC, May 2016
Some people save more than others, but even those who do are concerned about the possibility of a major stock market crash. I know I am, so to prepare for the worst I’m writing this blog post to help protect my retirement savings from a stock market crash.
While we live in a world where there are no guarantees about the stock market, there are steps you can take to protect yourself from a market crash. Having a good emergency fund is key, as is having a dependable income source in retirement. No matter what your job is, if you’re starting your second or third job, make sure you have at least $1,500 saved in case you lose your first one. Set up automatic transfers so that you can put enough away in your 401-k each month to keep it from being an onerous burden. Figure out how much you can afford to set aside and save from each paycheck, and stick to it.
The Dow Jones index lost 12.9% today. This is what the newspapers said on the 16th. March 2020, the start of the COVID-19 pandemic, reported. My mouth went dry and I was speechless. I’ve had my ups and downs in the stock market. But it was just unprecedented. 12.9% in one day? To put this in perspective: If you had an egg worth a million dollars, you just lost $129,000 – all at once! Any experienced investor knows that when you invest in stocks, you have to be willing to take a certain amount of risk if you want to have a chance of making a profit. But we’re human too, and seeing your savings evaporate before your eyes can be very destabilizing. Therefore, in this article I want to talk about what you can do to protect your retirement savings from a market crash. We’ll look at some steps you can take now to protect yourself, as well as some strategies to help you deal with an accident, should one happen.
What is a stock market crash?
Simply put, a stock market crash is a sudden and unexpected drop in the price of stocks in general. It is perfectly normal for the value of individual companies to fluctuate daily. But when most of the market is falling, it indicates that more may be at stake. In general, stock market crashes are caused by events that affect society as a whole, such as the current state of the economy, politics, wars, natural disasters, … Pandemic! 2020 will be the year when every young investor learns for the first time how quickly a stock market crash can happen. They may also be the result of an economic bubble that eventually collapses. This is the case when many people speculate on the value of something and drive up the price. But if what they have invested in eventually fails, they quickly lose money and take other parts of the economy with them. For example, I was in college when the Internet bubble burst in 2001. It was a stock market crash that happened because investors invested in thousands of Internet startups that were not making a profit and had no idea how to be successful in the long run. The vast majority of them eventually had to file for bankruptcy. A few years later I was already on the job market, and then came the housing crisis of 2008. The situation became difficult when lenders began to provide mortgages to people who could not afford them (known as subprime mortgages), leaving millions of people in default. These subprime mortgages have affected virtually all financial institutions. For example, Lehman Brothers, at the time the fourth largest investment bank in the country, eventually filed for bankruptcy. The effects of the real estate crisis did not immediately spread to other sectors. Big companies like GM and Chrysler have filed for bankruptcy, and the number of unemployed has skyrocketed as employers try to keep their heads above water. This situation lasted for several dark years, later called the Great Recession. Oh, man, my 401k is awesome! It was an anxious time for me, and that’s part of what sparked my interest in financial freedom. It is important to note that a stock market crash is different from a stock market correction. While both can bring the market down, corrections have more to do with a return of valuations to their natural levels than an emotional reaction. For example, if a stock is trading at prices above its fundamentals, investors may begin to hold back, leading to a market correction. These measures are good for the economy because they prevent bubbles from forming (as in the two previous examples).
How will the stock market crash affect my retirement savings?
Unfortunately, a stock market crash is bad for everyone. But especially for retirees or people saving for retirement, the consequences can be immediate. Here’s how:
Reduces overall portfolio balance
The first consequence of a stock market crash is that the balance of your bond portfolio will probably fall. The size will depend on what you invest in (for example, mainly equities) and how those investments react to the market crash that occurs. I remember a story one of my clients told me about a colleague who had saved almost $2 million before the great recession. About a year after the crash, when the S&P 500 was at its lowest point, his roll call dropped to $800,000. He was devastated!
Makes you use up your savings quicker
If you retire a few years before the market crashes, you run the risk that each of your annual withdrawals will result in a larger than expected percentage reduction in your total balance. This phenomenon is called the – risk-return sequence. Here’s a simple example of how it works: Year 1:
- Suppose you start with a $1,000,000 savings and withdraw $50,000 to cover your living expenses. You now have $1,000,000 – $50,000 = $950,000.
- The market is suffering a 20% loss. At the end of the year, you have $950,000 – $190,000 = $760,000.
- You withdraw an additional $50,000 and are left with $760,000 – $50,000 = $710,000.
- The market is still losing 20%. At the end of the year, you have $710,000 – $142,000 = $568,000. In a short period of time, you have already seen your savings fall by 57%. Scary!
For this reason, financial experts often recommend using the 4% rule as a limit for withdrawing savings. The risk of constant returns is one of the main factors that led the financial planner behind this rule, Bill Bengen, to do this research and come up with the 4% rule, which requires you to withdraw only 4% of your retirement savings each year to cover your living expenses.
Tries to make irrational decisions
Emotional investing is one of the surest ways to make bad decisions and lose a lot of money. And when there is a stock market crash, people tend to become very anxious and take hasty action. I remember during the great recession, one of the administrative assistants I worked with told me she was so afraid of what would happen that she had withdrawn her entire 401k and transferred it to her savings account. She concluded that it was better to stay with half of what she had than to lose everything. Unfortunately, that was probably one of the worst ways to handle the situation. The old saying in investing is: Buy low, sell high. So if you’re pulling your money out during a market crash, you’re doing the exact opposite by buying high and selling low. It’s also important to keep things in perspective and realize that stock market crashes don’t last forever. About 3 years after the start of the Great Recession, the stock market recovered its previous value. All those who did nothing and just let the crisis pass by saw their investments eventually regain their pre-crisis value.
How do you prepare for a market crash?
I have been through two major stock market crashes with our savings and I can say that I have learned some pitfalls to avoid and techniques to limit your losses. Here are some smart preventative measures you can take to prepare for the next market crash.
When I help my friends estimate how much they will need for retirement, I like to add about 20%. For example, if someone thinks they need to save $1 million, I suggest setting the end goal at $1.2 million. Why? After all, additional funds can be used as a safety reserve. In the same example, suppose you retire with $1.2 million and the market drops 20% in the first year. In this case, you will be much more confident in your egg, knowing that you only need a million dollars to get started.
Ensure low extraction rate
Another reason to consider increasing your capital is that you can expect a lower withdrawal rate when you retire. The same study by Bill Bengen that established the 4% rule also found that uptake rates of 3.0-3.5% have a 100% survival rate over 50 years. However, if you want to make sure your savings can withstand all the stock market crashes and economic recessions we’ve seen in the last century, then a lower withdrawal rate is for you. Just as you can increase the value of your savings with the 4% rule, you can do the same with lower withdrawal rates. For example,
- If you want your apple to yield $40,000, you need to set aside $40,000 / .04 = $1,000,000 using the 4% rule.
- However, if you want to be super safe and get $40,000 with a 3.5% withdrawal rate, you need to accumulate $40,000 / .035 = $1,142,857.
In a nutshell: The more security you want, the more space you should leave.
Not to invest on a speculative basis
If you associate your retirement dreams with cryptocurrencies or the latest stock market memes, I have bad news for you. When the market crashes, speculative investments (based on media hype rather than proven, real fundamentals) are usually the first to go. It happened during the dot-com crash in 2001, and history is still repeating itself. Instead, stick with funds that have had reasonable returns in the past. I usually use boring but reliable index funds for this purpose, such as. For example, replicate the S&P 500.
Diversify your assets
If you are just starting out, you can invest heavily in stocks because you have plenty of time to weather a downturn and get your money back. Since the beginning of the great recession, my stock funds have quadrupled in value. However, as you get closer to your expected retirement age, it makes sense to become more conservative by diversifying into stocks, bonds and other asset classes (real estate, gold, etc.). The strategy is for these other assets to absorb or perhaps offset some of the losses when stocks fall. Classic rule: Take 110, subtract your age from that, and allocate that percentage of your portfolio to stocks. For example, let’s say you’re 50 years old. According to this rule, you should invest 110 – 50 = 60% of your money in stocks and the remaining 40% in bonds. So if the market collapses, only 60% of your portfolio will be affected, and the other 40% will likely suffer relatively smaller losses. This will give you much more confidence than before that your money will stay with you for the rest of your life.
Rebuild your portfolio every year
One of the best ways to ensure that your asset allocation remains proportionate is to perform a rebalance once a year. Rebalancing involves selling some of the securities in which your portfolio is overweight and buying securities in which you are slightly underweight. For example, suppose you prefer an asset allocation of 80% stocks / 20% bonds. If you do nothing, the stock market could appreciate and your actual allocation could go to 90% stocks/10% bonds. In this scenario, when the market finally crashes, you will lose more money than you expected because you were too excited about the stock. By regularly selling a portion of these returns, you keep your portfolio balanced with the right mix for you. Moreover, rebalancing brings us back to the mantra buy low, sell high. By forcing you to sell some of the winning funds and buy more of the underperforming funds, you are effectively locking in your profits. I simplify the rebalancing process by setting it up automatically in my financial settings. Since everything is managed digitally, almost all investment service providers make this easy – you just need to check a box somewhere in your account settings.
How to preserve your capital during a market crash
It’s one thing to do everything you can to protect your money before the market crashes. But when it finally comes, it only takes one major misstep to get you in trouble and cut your portfolio in half. The next time you find yourself in the middle of a stock market crash, here are some smart tips to keep your head above water and your money out of danger.
The worst thing you can do at a time when the market is losing value is to get out of yourself. Letting your emotions run wild and making rash decisions is a recipe for absolute disaster. Remember: Market cycles are perfectly normal, even if they are unpleasant. But they don’t last forever. I was certain that when the COVID-19 pandemic began and the markets went into free fall, with the Dow Jones index losing 37% in the first month of , we were heading for a possible second Great Depression. But fortunately for the economy, it wasn’t as bad as it could have been, and stocks have since hit new highs.
Don’t stop saving for retirement
Another mistake people often make during a stock market crash is to stop making contributions to their retirement plan. Unfortunately, you are beginning to follow a false logic: Why should I invest in something that will lose its value? You really did make that mistake… In the years before the great recession, I had the good habit of using my profit sharing check to fund my Roth IRA. But that year I was wary of what was happening in the stock market, so I stayed on the sidelines. As a result, I missed out on some big wins when things went back to the way they were. The problem with this logic is that you should be investing precisely when markets are falling – when prices are at potentially low levels. While this can be frightening, most stocks trade at a discount to their true value and are likely to rebound once things stabilize. The best way to put it is to quote an investment industry legend, Warren Buffett, the Oracle of Omaha: Be afraid when others are greedy, and be greedy when others are afraid.
If you are already retired and the market has collapsed, another strategy is to adapt to the situation and tighten your belt for a few months. For example, if you normally spend $40,000 on living expenses, you can try to make ends meet on $35,000 for a year. Nowhere does it say that because you are retired, you must follow the 4% rule to the letter and always take the maximum amount you are entitled to. An easy way to keep costs down is to temporarily not adjust for inflation and keep your deductions at the same level as the previous year. Another solution could be to look for a part-time or half-time job. By taking a second job, you can make up for the amount you took out, even if it’s only temporary.
Stock market crashes are inevitable. Humans are emotional creatures, and when something happens in our economy or society, our reaction can cause stock prices to fall. Since most people’s retirement savings are in equity funds, this will have a profound impact. You will likely see your retirement savings shrink, as will the amount of money they provide to cover your living expenses. Whether you are saving for retirement or are already retired, there are a few steps you can take to minimize your losses. Strategies such as exceeding your goal, diversifying your assets and planning for a lower withdrawal rate are very effective in ensuring the longevity of your money. Other smart tactics, such as remaining flexible and continuing to contribute to your retirement savings, will help you limit your losses. Above all, remember not to make any rash decisions. You’ve come this far with your money, and if you stay the course, you can weather the storm and come out the other side in one piece.
There are many ways to protect yourself from those who would try to take your hard-earned retirement savings. Do you have investments in a 401k or IRA? Do you put money in a CD? Are you in a Roth IRA? If you have 401k or a Roth IRA, be aware that there are rules that protect your money.. Read more about how to protect 401k from stock market crash 2021 and let us know what you think.
Frequently Asked Questions
How can you protect retirement savings from the stock market crash?
The stock market isn’t always a place of safety. If you’re like most people, you’re probably counting on the stock market to help you pay for the things you want out of life. If you’re like most people, you’re probably counting on the stock market to help you pay for the things you want out of life. For many, this isn’t a problem. They have enough money in the bank to make up for any losses, and they have enough invested in stocks to make up for any gains. But what if you don’t? If your retirement savings are in the stock market, you can lose it all in a matter of days. In other words, having your retirement money invested in the stock market is like leaving a burning The stock market is volatile. While the years ahead look promising, the past has shown us how quickly those years can change. In just a few years, the market could have a serious correction because of changing economic trends, and the result could be a sharp decline in the market. The good news is there are a few simple steps you can take to protect these funds.
What happens to my savings if the stock market crashes?
The stock market is one of the biggest factors in the smooth functioning of our economy. Most people invest their money in the stock market because they hope to make money, but they also invest because they need investments that will provide income for the long haul. Understanding how stocks work will help you make better decisions when you invest in the stock market. Stock market crashes are scary, especially our own. Over the past few years, we have experienced a huge increase in volatility in the market, with values dropping even lower than they were during the Great Depression. But you’re not alone. Many people have been affected by these drops. Many have lost their jobs, and some have even lost their houses. These happen more often than you may think.
Where should I put my money before the market crashes?
The stock market is a fickle beast – at any given time it can seem like one thing and then the next it’s another, and it’s usually a lot of both. It’s like the rest of the economy in that respect, though. Right now, the money markets are in a place where they’re probably not the best place for long-term savings, and some of the worst if you’re looking to put money aside for retirement or other goals. When you hear the media talking about the stock market, you’d think the economy is doing great and everything’s going to be okay. We live in uncertain times. The markets are going nuts, people are losing their jobs and the economy is slowing down. The other day, I was checking out the performance of some of the funds that I’m invested in, and it seems like the market is going to crash any day now. I’m really nervous about this. What’s going to happen?
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