Conversely, we can conclude that, even though risk is high, the time frame for that risk is unclear. It could be 1999 all over again. It could also be 1997, in which case we have a couple of years before the trouble hits. Or it could even be 1995—or maybe 2000. High risk is not the same as immediate risk.
Fortunately, we know how to tell when high risk is turning into immediate risk. The 200-day moving average is a good time to start paying attention, and the 400-day moving average is a good time to start worrying. But what should we do besides worry?
Well, as always, it depends. But I can give you some ways to think about the problem that will help you decide what is best for you.
Deciding what is best for you depends on a few key variables:
How much time you have to invest. For younger investors, say in their 20s up to their early 40s, their long time horizon to retirement means they can, if they wish, essentially ignore any pullbacks in the market. They have time to recover from what, after all, is a normal process. Their horizon is long enough that long-term returns are actually likely to play out. Plus, they will continue to invest during the downturn, so they will be able to buy low and harvest appreciation during the recovery.
The shorter your time horizon, which is to say the older you are, the more you might want to take action. With less time to recover losses, and with less time to keep investing at lower prices and harvest the appreciation, a more cautious stance might be appropriate. Dialing down your risk, either by increasing your cash allocation or by decreasing your stock exposure, might make sense in that case.
Overall, the sooner you need to access your savings, the more concerned you should be by any drawdown.
Your risk tolerance. How willing and able are you to ride out any pullback? This is often phrased in percentage terms. For example, could you handle a 20-percent drawdown? A better way to look at this, though, is in dollar terms. Although 20 percent might seem doable at first, could you stand to lose $100,000 on a $500,000 portfolio? The results are the same, but one might sound much worse than the other. The less willing or able you are to lose money, the more you should consider taking action to avoid such a loss, again either by raising cash or by reducing stock exposure.
Your willingness to actively manage your investments. When those alarm bells go off, and you need to limit your exposure, are you willing—and able—to make the necessary trades? For investors who work with financial advisors, this is an easier question. For everyone else, it can be difficult to execute on a trading decision. Selling is hard, and buying back in is even harder. If you need to actively manage your investments, you might want to consider getting a financial advisor to help.
In the end, you can also choose to do nothing, no matter your age or risk tolerance. Riding things out is not necessarily a bad decision. I compare the kind of analysis I’ve done here to weather forecasting and a stock market pullback to a hurricane. If you retired to Florida, you know a hurricane will hit at some point. When one shows up, are you going to sell out and move back north? Probably not. That doesn’t mean, however, that you shouldn’t pay attention to the weather forecasts. Even though you will stay put, you need to know what’s coming so you can prepare to ride it out with a minimum of risk and damage.
Right now, it looks like it might be time to start keeping an eye out for storms. There’s no need to panic, but there is a need to starting thinking about what you’ll do when the storm hits. The time to make those plans is now.