A Down-Market Survival Guide for Your 20s, 30s, and 40s

Editor's Note

A version of this article previously published in February 2022.

The first bear market I experienced during my adult life, from 2000-02, seemed particularly violent and frightening. Stocks fell in 2000 and 2001, but the bottom really dropped out in 2002, with the S&P 500 falling 23%.

In hindsight, that period seems like a necessary correction, an almost healthy check on the market’s worst excesses of the late 1990s. And now that I’ve lived through a few like that one, I know that stocks usually recover and beat less volatile assets over time. But at the time, it felt like we were venturing into uncharted territory. It was no fun to watch my stock-heavy portfolio, which I had presided over with pride during the long bull market, drop more than 30% over that stretch in the early 2000s.

That's the odd dynamic in play when you're investing in rough markets in your 20s, 30s, and 40s, before your time horizon shrinks and retirement is close at hand. What's likely to be your main savings goal—retirement—is many years into the future. Based on the facts alone, market volatility shouldn't ruffle you that much because you have more than enough time for your investments to recover before you begin tapping them during retirement. But with less experience as an investor, you may be more likely to get rattled during market swoons than seasoned investors who are closer to retirement.

In other words, when you're in your 20s, 30s, and maybe even 40s, your risk capacity is high, but your risk tolerance may not be.

As with any situation that feels scary and uncertain, it’s wise to focus your energies on what you can control and tune out the rest during volatile markets. After all, you hold no sway over the direction of the economy or the markets; they’re going to do what they’re going to do. But you do exert at least a modicum of influence over your own situation: how much you save versus spend, how you’ve allocated your portfolio, whether you’ve built an adequate cash cushion, and so on.

If you’ve been spooked by recent market volatility and are still fairly early in your accumulation career (that is, you’re likely 15-20 or more years from retirement), here are the key steps to take.

1) Revisit Your Savings Rate

2) Review Your Long-Term Asset Allocation

3) Streamline and Improve Your Investment Choices

4) Assess the Adequacy of Your Safety Net

5) Make Reasonable Investments in Your Human Capital

If you're at a different life stage, you may want to check out the down-market guide for retirees or pre-retirees.

Step 1: Revisit Your Savings Rate

One of the best ways to take back control of your financial plan in uncertain times is to tighten up extra spending and refocus on your savings rate. Look back over the past year and calculate how much of your portfolio you were able to save or invest rather than spend. Many people anchor on saving 10% of their income. But that's apt to be too low a target for many, especially if you're saving for other goals, such as college for your kids, as well as retirement. Rather than relying on rules of thumb for something as crucial as your savings rate, I like the idea of creating a custom savings target based on your own situation.

Once you've set your target savings amount, automating your contributions can help reduce the impediments to getting that money invested. After all, it can be difficult to get motivated to invest more when everything's dropping. If you're contributing to a retirement plan through your workplace, your contributions are already being automatically withdrawn from each paycheck. If you're investing via other retirement savings vehicles, such as an IRA, a health savings account, a 529 plan, or a plain old taxable brokerage account, you may as well put those contributions on autopilot, too. Most investment providers are more than happy to sign you up for automatic monthly contributions that are deducted directly from your bank account.

By putting fixed sums to work at a regular basis, you’re helping to ensure that you’re purchasing merchandise at a variety of price points, including when the market is at a low ebb.

Step 2: Review Your Long-Term Asset Allocation

After you've revisited your savings rate, take a closer look at your actual portfolio, starting with its asset allocation. The portfolio tool in Morningstar Investor or Instant X-Ray can help you see where your portfolio's mix of stocks, bonds, and cash stands today. Are you taking enough risk in stocks, without taking so much risk that you put your plan in peril that you'll sell out of that stock-heavy portfolio at the worst conceivable time?

If you have no idea how to answer that question, there are a few ways to go about gauging the reasonableness of your stock/bond/cash mix. Of course, a financial advisor can help you customize your asset allocation and your portfolio plan based on your own situation. But if you're just seeking a quick check on whether your asset allocation is sane, eyeballing the asset allocations of quality target-date funds (like those from Vanguard and the BlackRock LifePath Index series) can be a start. I also refer frequently to the Morningstar Lifetime Allocation Indexes for a professional take on asset allocation for various life stages and risk tolerances. My model portfolios for retirement savers can also provide some guidance.

As you survey these allocations, you’ll see that the equity weightings are generally pretty high for people in their 20s and 30s, and remain so through the 40s and even beyond. For example, the equity allocation in the moderate version of the Morningstar Lifetime Allocation Index for people retiring in 2035—people in their 50s, most likely—who have moderate risk tolerances is just under 70% of assets. The thinking is that younger investors should generally take as much equity risk as they can tolerate and hold that allocation steady throughout the accumulation period. After all, at that life stage, not amassing enough in retirement savings is a bigger risk factor than having to put up with short-term volatility. The allocations to equities step down gradually as retirement approaches.

Yet before you run with one of these off-the-shelf allocations, there are a few other swing factors to consider. One is what you do for a living. If your earnings tend to be volatile and lumpy (for example, most real estate agents and commission-based salespeople), that argues for a milder overall asset allocation than would make sense for someone with very stable human capital. Also consider your own behavior: If the market volatility scares you so much that you might sell everything in a panic, you need to address that with a milder asset allocation. Just be sure to understand the trade-off between low volatility and returns. More volatile assets like stocks tend to have higher long-term returns than cash and bonds, so if you want to limit equity risk, you’ll need to make it up through saving more or longer.

Finally, consider whether you're investing for short- and intermediate-term goals rather than retirement alone. If you're investing for shorter-term goals—such as a home down payment, you probably don't want to have much, if anything, in stocks. Yes, the returns from bonds and cash are lower, but they're also much less likely to encounter big swings to the downside. My model portfolios feature guidance for investors with short- and intermediate-term goals who are saving outside of a retirement plan.

If it turns out changes are in order, be sure to bear tax considerations in mind. Making changes in your tax-sheltered accounts won't trigger a tax bill, especially considering that stock performance was strong until quite recently. That's why it usually makes sense to focus any repositioning efforts there.

Step 3: Streamline and Improve Your Investment Choices

A volatile market environment can also provide an opportunity to play cleanup with your portfolio, streamlining your accounts and holdings and tightening your focus on those investments that are truly best of breed.

Streamlining your accounts—and the holdings within them—will make it easier to keep track of your plan. Start at the account level, consolidating all like accounts together. Tax-deferred account stragglers—rollover IRAs and former 401(k)s, for example—can be consolidated into a single rollover IRA, while all taxable accounts can be merged together, too, as long as the ownership remains the same. Multiple Roth IRA accounts can be consolidated as well.

Next, take a look at streamlining within the accounts. Look for duplicate holdings within a given category—for example, multiple large-cap blend funds. Morningstar Medalist ratings for mutual funds and exchange-traded funds can help you identify investments that are tops in their categories. Individual stocks can be a fit for many investors, but if you don't have the time to devote to overseeing individual equities, this is another area to consider streamlining.

As with making changes to your asset allocation, be sure to bear in mind the tax consequences of selling individual holdings. You won’t face tax costs to reposition within your tax-sheltered accounts, but rejiggering your taxable holdings—especially long-held positions—may trigger capital gains tax. Get some tax advice and move deliberately when making changes there.

Step 4: Assess the Adequacy of Your Safety Net

Market corrections often occur during periods of economic stress. That means that in addition to boosting savings and assessing whether any long-term portfolio tweaks are in order, it’s also important to play defense on your total financial plan during down markets.

Start by assessing your insurance coverage. A good rule of thumb is to insure against risks that would cause extreme financial hardship and to skip insurance for items that would not. Homeowner’s (or renter’s), health, disability, and auto insurance are musts, as is life insurance if you have minor children; on the flip side, you can say no to the extended warranty for your laptop or washing machine.

Because market dips often coincide with periods of economic weakness, it's also essential to maintain—and possibly even add to—emergency reserves. In case of surprise expenses (unreimbursed healthcare expenses, big vet bills, or emergency car or home repairs, to name some of the biggies) or job loss, having a cash cushion on hand can keep you from having to resort to unattractive forms of financing like credit cards or raiding your 401(k). While the rule of thumb of stashing three to six months' worth of living expenses in cash might seem daunting, remember it's three to six months' worth of essential living expenses, not income. Gig economy workers, because their paydays can be lumpy and may be even lumpier in a period of economic weakness, will want to run with an even larger cash cushion amounting to one year's worth (or more) of living expenses.

Step 5: Make Reasonable Investments in Your Human Capital

Speaking of “investments” in the broadest possible sense, a volatile market can be a good time to invest in yourself, to improve your earnings power and your marketability in the hiring marketplace. Such investments in human capital are particularly justifiable in the strong job market that prevails today. That means obtaining additional training, staying current on new products and technologies, or possibly even pursuing an advanced degree. Not all outlays for education and training will pay off financially, but it’s wise to consider them earlier in your career rather than later on, when you have less time to recoup your costs.