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A Checklist for Volatile Markets: Retirement Saver Edition

Running through our six-step checklist can provide peace of mind with your portfolio and plan if volatility persists.

A version of this article previously appeared in April 2020.

The standard "talking head" advice for volatile markets is to do nothing. And it's true that when stocks are gyrating, a policy of benign neglect is invariably going to be better than running around making changes to your portfolio that you'll regret once the dust settles. All too many investors have retreated to cash amid extreme market volatility, only to be left with an equally stressful question once the market begins to improve: Is it time to get back in, or could this be a short respite on the way back down? And if you've gone to the trouble of creating a long-term investment program that syncs up with your goals, that plan should build in the possibility that short-term market drops will happen.

But the advice to "don't just do something, stand there" rests on a big assumption: that your plan was in a good shape at the start of the volatility. Before heeding the generally very sound guidance to tune out what's going on with the markets, run through the following checklist to ensure that your plan is on solid footing. We also have a checklist if you're in or near retirement.

1) Check your safety net.

A key aspect of crafting an investment plan that you can live with during volatile markets is knowing that a short-term financial bind isn't going to force you to raid your long-term accounts when they're down. And it's a fact of life that market volatility often coincides with periods of economic weakness. That accentuates the importance of making sure that your financial plan includes enough buffer assets.

The standard rule of thumb for right-sizing emergency reserves is to stash three to six months' worth of living expenses in cash: bank savings accounts (online account yields are often best), checking accounts, and so on. That three- to six-month threshold might seem daunting, but remember it is 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. Older workers and/or people with more specialized, higher-paying career paths should also build a larger emergency fund than three to six months’ worth, as it may take them longer to replace their jobs if they lose them.

2) Assess next-line reserves.

In addition to checking up on your emergency reserves, think through where you would go for funds if your cash accounts were depleted and you still needed more funds--if a financial crunch like needing to buy a new car coincided with job loss, for example.

Long-term assets in taxable brokerage accounts or withdrawals of Roth IRA assets are worthy next-line reserves if you've depleted your cash but still need additional funds. If you're a homeowner, you may also want to line up a home equity line of credit that you could tap in a pinch; it's easier to secure such a loan when you're employed than when you're not. If you've been using your health savings account as a long-term savings vehicle, paying healthcare expenses out of pocket, remember that those accounts can also be tapped later on, even for nonhealthcare expenses. The key is to have receipts to validate the expenses that you previously covered out of pocket, with non-HSA assets.

3) Reach for a higher contribution rate.

Volatile markets can engender a feeling of helplessness; even if you aim to be hands-off, your investments are like an innocent bystander amid the chaos. One of the best ways to take back control in unsettling times is to increase your savings rate if you can.

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.

4) Review the asset allocation of your long-term portfolio.

Taking a hands-off approach to your portfolio in falling markets is often best, but that's only if your investment mix is reasonably positioned given your proximity to your goals. After you've revisited your savings rate, take a closer look at your allocations to the major asset classes: stocks, bonds, and cash. The X-Ray functionality in Morningstar's Portfolio Manager or Instant X-Ray can help you see where your portfolio's mix of stocks, bonds, and cash stands today.

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 good-quality target-date funds, like those from T. Rowe Price and the BlackRock LifePath Index series, can be a start. (Look for the funds whose asset allocations match your own.) 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, and I like the idea of customizing your allocation based on your human capital characteristics as well as risk tolerance.

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, so it usually makes sense to focus any repositioning efforts there.

5) Check the asset allocation of funds earmarked for short- and intermediate-term goals.

If you're like many investors, you're not just investing for retirement; you may also be investing for short- and intermediate-term goals--a larger home, college for children and grandchildren, and so forth. Any funds for those nearer-term goals should be more conservative than your retirement accounts. Of course, today's very low yields suggest that the return prospects from bonds and cash are meager, 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.

6) Stay alert to tax-saving opportunities.

Finally, market volatility may present some opportunities to improve your tax situation. Tax-loss selling can help you lower your tax bill, this year and in the years ahead. It can be particularly effective if you're using the specific share identification method for tracking your cost basis or if you have narrowly focused investments in your portfolio. With some creative swaps (opting for a value exchange-traded fund in lieu of an actively managed value fund, for example), you can even maintain economic exposure to the very market segments that you've taken a loss on.

Another tax-saving strategy that can make sense in extended down markets is converting traditional IRA assets to Roth. The virtue of doing so after the markets have fallen is that the taxes due will be based on a lower balance. Of course, the market has enjoyed a very long stretch of great returns and balances are still elevated, so it makes sense to get some tax advice before proceeding with a conversion today.

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