The U.S. economy seems to be doing great right now, but for investors planning their retirement savings, it’s still important to watch out for the next downturn.
Recent economic data has been quite positive. America’s real gross domestic product (GDP) increased at an annual rate of 4.1% in the second quarter of 2018, marking its fastest growth in nearly four years. (Source: “National Income and Product Accounts,” Bureau of Economic Analysis, July 27, 2018.)
At the same time, the unemployment rate slipped below four percent again, to 3.9% in the month of July, closer to an 18-year low. (Source: “Employment Situation Summary,” Bureau of Labor Statistics, August 3, 2018.)
However, we have a stock market that grew at a much faster pace than the overall economy. Over the last five years, the S&P 500 Index surged 67.7%, the Dow Jones Industrial Average climbed 65%, and the Nasdaq Composite skyrocketed 113%.
With surging share prices, valuations have become bloated. For instance, historically, the S&P 500 Index had an average price-to-earnings (P/E) multiple of 15.7 times. Today, the P/E ratio for the benchmark index stands at a substantially higher 24.3 times. (Source: “S&P 500 PE Ratio,” Multpl.com, last accessed August 3, 2018.)
In a prolonged bull market where bears have thrown in the towel, most bullish investors have already bought their stocks. That means there are fewer buyers left who can drive stocks higher.
Combine this with the uncertainties we are currently facing (trade wars, higher interest rates) and there is a chance that an unexpected headline could spark panic. And since September, usually the worst month for stocks, is just around the corner, there is definitely a need to protect your portfolio from potential sell-offs.
Are Your Retirement Savings Safe?
This is of particular importance to retirement investors. It takes a long time to build a nest egg. According to the 2018 Market Perceptions Study from Allianz Life Insurance Company of North America, more than one-third of Americans (37%) said that recent market volatility has made them anxious about their retirement savings. (Source: “Though More Comfortable with Volatility Americans Still Lean Toward Protecting Retirement Savings,” Allianz Life Insurance Company of North America, June 5, 2018.)
Furthermore, 38% of Americans said that if the stock market crash is so severe that they lose a lot of money, there is no way they could rebuild their nest egg in time for retirement.
And many Americans are already expecting some sort of a downturn on the horizon. The same study showed that 42% of respondents fear a big market crash, while 44% said they fear a major economic recession.
“Volatility matters, and while we see some increasing comfort with volatility, it is driving a simmering anxiety in many Americans,” said Paul Kelash, Allianz Life’s Vice President of Consumer Insights. “This anxiety about the negative effects volatility can have on their retirement savings is very real and people are still searching for the right solutions.” (Source: Ibid.)
Protecting Your Retirement Savings
So, how can investors protect their retirement savings from potential market downturns?
Well, as cliché as it may sound, don’t put all your eggs in one basket. While I’m a big fan of dividend stocks, having some bonds, cash, real estate, and precious metals could be worthwhile in the long run.
Within your stock portfolio, having a focus on income could help you survive the next market crash. That’s because dividends are always paid in cash. In a market-wide downturn, even the most solid stock portfolio will likely show a loss on paper, but if your portfolio companies can keep paying you dividends, you will still be able to earn an income stream. And keep in mind that even when the bears are dominating the stock market, companies don’t need their approval to mail out dividend checks.
Also, if you are approaching retirement, you might want to focus more on investing rather than speculating. Chasing the hottest tickers may seem like a lucrative business in the short run, but note this: when the market takes a turn south, there’s a tendency for investors to sell the stocks that went up a lot. In other words, you probably don’t want to load up your portfolio with a bunch of hot tickers after a prolonged bull market.
In addition, it would be great for retirement investors to put an emphasis on owning some defensive stocks. These are companies that can generate relatively stable earnings regardless of the state of the overall stock market and the overall economy. This is usually due to the constant demand for their products throughout the business cycle. Examples of defensive industries include utilities, healthcare, and consumer staples.
And because defensive companies can generate stable profits through thick and thin, they can also pay recession-proof dividends. For instance, healthcare company Johnson & Johnson (NYSE:JNJ) and consumer staples company Procter & Gamble Co (NYSE:PG) have both been paying increasing dividends for decades.
Going forward, the stock market will likely continue to fluctuate, and a correction could be on the horizon. But when you have a portfolio of stocks that can provide recession-proof dividends, you don’t have to worry about your retirement dreams turning into retirement nightmares.