Any way you slice it, 2019 was a fruitful year for the investor class. In what was nearly a mirror image to 2018, virtually every asset class had positive returns last year, including double-digit returns for US, international developed and emerging market stocks. Real estate investments (REITs) were one of the best performers last year, returning nearly 29% in 2019, and a broad decline in interest rates provided a tailwind for solid bond returns as well. Even gold and other commodities were up sharply last year.

As we [rightfully] celebrate these returns, we should also note that last year was atypical, and few calendar years produce such uniformly positive results. As evidence-based investors, we know that all investing involves risk and that financial markets will move up and down over time. Equity markets are particularly volatile, and are frequently punctuated by ‘corrections’ (declines) of 5%, 10% or more. (According to InvesTech Research, the S&P 500 index has experienced a 5% drawdown about every 7 months on average, and a 10% decline about every 26 months since 1932.) It is interesting that these corrections are both entirely expected but completely unpredictable at the same time. While we can’t control what the markets will do, we can control our reaction to market movements.

Although it’s been more than a decade since the last major US market decline, investors should always be prepared mentally and financially for a market draw-down of more than 20%, with or without an associated recession. Below are some questions to ask yourself now as 2020 begins-

 

  • What proportion of your overall portfolio is invested in riskier assets (stocks, real estate, low-credit quality bonds) and which portion is in safer investments (cash, Treasury bills/bonds, high-quality short-term corporate bonds)? Does this match your tolerance for risk?
  • Have the strong gains in the stock portion of your portfolio, particularly in US large companies, caused your portfolio allocation to drift far enough that an adjustment is necessary?
  • Is your portfolio well-diversified at the security and country level, with exposure to several different asset classes that are not highly correlated with one another?
  • How would you react to an equity market decline of 30%, 40% or more? Would you be able to sleep at night? Do you have a sound financial plan that you could stick to?
  • Would your lifestyle be affected by such a decline? Would you need to delay retirement or another important financial goal? Do you have enough cash in the bank or in other low-risk, liquid investments that you could draw upon without being forced to sell in a declining market?
  • Do you view market downturns with dread or as an opportunity to rebalance your portfolio and to lower taxes by harvesting losses in taxable investment accounts?

 

Hopefully by pondering these questions now, with many financial markets near all-time highs, investors can ensure they still have the right portfolio and the right plan for whatever the markets may have in store for us in 2020 and beyond.