4 Ways to Prepare for a Market Meltdown
I heard a market pundit say today that Greece might be a "Lehman moment" for the markets (referring to the failure of Lehman Brothers that helped bring on the 2007-08 market crisis). If it is, that means the canary has died and we better get the heck out before the market caves in on us.
We Live in a "What if" World
It's easy to take a stressful event and reason to an extreme outcome. The news media are masters of it. They take bad world events, extrapolate them to their worst possible outcomes then talk endlessly about it. This "what if" game can be very intoxicating.
"What if" Greece defaults and it's a "Lehman moment" for the markets (aka 2009)?
"What if" Y2K shuts down the world computers?
"What if" Bush wins the White House?
"What if" Obama wins the White House?
"What if" we've reached peak oil?
"What if" China stops buying U.S. Treasuries?
"What if" we have another terrorist attack?
"What if" interest rates rise?
It is human nature to worry about things and take them to unreasonable conclusions. We do it about the news and about our own lives as well. Heck, just last night I couldn't sleep because I took a small insecurity of mine (not getting enough done) to the extreme of being a lazy bum. The current "what if" regarding the crisis in Greece, is the same thing multiplied by group dynamics and then taken to the nth power by the media.
The fact is, most worries in life and in the world simply don't happen. They just don't. Trends reverse themselves. Innovation solves a problem. The situation changes. The worry was unfounded. The threads of our lives and the world are complex beyond our comprehension and we simply muddle through.
Spending time on "what ifs" stop us from focusing on the truly important things in our lives. "What ifs" entertain us, but do little to help us make smarter financial decisions.
4 Ways to Prepare for a Market Meltdown
Sorry, nothing sexy here. No "sure fire" strategies or the "one" asset you must own now to avoid a possible market meltdown.
You work too hard for your money and the reasons you invest are too important to make investment decisions on:
Intuitions
Predictions
Market calls
Speculations
Feelings
Hunches
Beliefs
If you're truly worried about a market meltdown, it is better to turn off the television, call your advisor or hold a family meeting and work through these 4 steps to help you prepare your investment portfolio for ANY scenario.
Keep Enough Cash Reserves. Most people simply don't keep enough cash reserves. I'll admit, I struggle with this as well. It's hard to justify having cash sitting in a savings account when it's earning almost no interest and it can be allocated to lifestyle, debt reduction, gifting or investing. The opportunity cost of these other choices is too much for most of us to bear. The real return of cash reserves comes from the flexibility it gives you. We've all seen or heard of households crumbling financially when the unexpected happens and they have no funds to weather the storm.
Only Invest for the Long Term. One of the biggest factors in investing success is time. The objective of investing is to participate in the long-term growth of the world economy. This takes time. Time to ride out the inevitable cycles of economies and markets. How much time? I don't suggest someone invest in equity markets if their time horizon is less than 5 years.
Stay Broadly Diversified. This is said so often that most people don't listen, especially now, when the markets have been good for a few years. Diversification sucks right now. Being diversified means you've probably underperformed most equity markets. That can get frustrating and cause you to move assets to "better" performing investments. This is a recipe for disaster that is baked time and time again. Investors (and advisors eager to please) get less and less diversified during strong markets and then get slammed when there is a correction. Stay diversified and positioned to participate in the entire world economy. Oh yeah, make sure you rebalance to your target allocation annually.
Know the Risk in Your Investment. I find most people don't appreciate or know the amount of risk they take in their portfolio. If you understand the possible volatility you may experience during a 1, 3 and 5 year period you'll be better prepared to handle periods of market disruption. There is ample data showing the historical returns of assets classes and allocations. I suggest you review these annually to reconfirm your comfort with the risk you're taking. I've found understanding this to be vitally important to the success of an investment plan.