Preparing for the Inevitable: A Reminder about Market Cycles

"When is the shoe going to drop?"

It's a question we've heard more frequently over the past year.

Recently, I sat down with a client preparing for retirement. We'll call him Tom.

Tom had spent decades saving and investing and was approaching the transition from earning a paycheck to relying on his portfolio. Thanks in part to several years of strong market returns, he found himself in a stronger financial position than he had expected.

Still, he had a concern. "What happens if the market falls right after I retire?" It's a fair question.

After several years of strong market returns, many investors are understandably surprised that markets have continued to move higher despite concerns surrounding inflation, interest rates, political uncertainty, global conflicts, and economic slowdowns. When headlines seem overwhelmingly negative, it's natural to wonder whether a downturn is overdue.

With midterm elections approaching, investors are once again being reminded of how quickly uncertainty can dominate headlines. Election cycles often generate concerns about taxes, government policy, regulation, and the broader economic landscape. While political developments can certainly influence markets, they also serve as a reminder that uncertainty is always present in some form. The challenge isn't eliminating uncertainty, but building a plan that can withstand it.

From a planning perspective, however, perhaps that's not the most important question. Rather than asking when the next market decline will occur, investors are often better served by asking a different one:

Is my portfolio prepared for the next downturn whenever it arrives?

After all, market declines are a normal part of investing. What often catches investors off guard is how quickly confidence can change and how difficult it can be to stay focused on long-term goals when uncertainty rises.

That's why market cycles matter, and why a disciplined investment plan remains so important even during periods of strong performance.

The Challenge of Strong Markets

After several years of strong returns, it's easy to begin viewing market gains as the norm and volatility as the exception. Over time, investors can become accustomed to positive account statements and start to believe that market setbacks are unlikely or that recoveries will always come quickly.

History reminds us that investing doesn't work that way.

Markets have consistently rewarded patient investors, but not without periods of uncertainty along the way. Successful investing isn’t about avoiding downturns; it's about having a plan that can withstand them.

For Tom, retirement didn't eliminate market risk. Instead, it changed the conversation. Rather than focusing solely on growing assets, the focus shifts toward ensuring those assets can support long-term spending needs through a variety of market environments.

Volatility Is a Feature, Not a Flaw

One way to think about market volatility is to compare it to turbulence during a flight. Few passengers enjoy turbulence. It can be uncomfortable, unsettling, and sometimes intense, but it isn't a sign that the plane is off course. It's simply a normal part of the journey.

Investing works much the same way. Market pullbacks, corrections, and even bear markets can be uncomfortable, but they're also a normal part of long-term investing. They are not evidence that the investment process has failed.

In many ways, volatility is simply the cost of pursuing long-term growth.

Recent years have provided several reminders of this reality. Despite significant volatility related to the pandemic, inflation, and rapidly rising interest rates, markets ultimately recovered and moved forward.

The lesson isn't that every recovery happens quickly. It's that declines rarely unfold the way investors expect, which is one reason attempting to time the market can be so difficult.

Understanding Risk Beyond Market Performance

When we build portfolios, we spend a great deal of time discussing risk. But risk isn't simply about how much a portfolio might fluctuate. We generally think about risk through two lenses: risk tolerance and risk capacity.

Risk tolerance reflects an investor's emotional comfort with market volatility, or put simply, how much uncertainty can be endured before feeling compelled to make changes.

Risk capacity, on the other hand, reflects your financial ability to withstand market declines. Factors such as age, income needs, spending requirements, available assets, and time horizon all influence how much risk may be appropriate.

Tom’s situation illustrates why the distinction matters.

After years of strong market returns, he felt increasingly comfortable with risk. But he was also approaching retirement and expected to begin relying on portfolio withdrawals in the near future. While his tolerance for market volatility may have increased, his capacity for risk was different from that of someone decades away from retirement and still accumulating assets.

The distinction becomes especially important after strong market performance, when rising portfolio values can make investors feel more comfortable with risk than they may be during a downturn.

Why Diversification Still Matters

During periods of strong market performance, it can be tempting to focus on recent winners. The challenge is that market leadership rarely remains constant, and what's popular today may not be what drives returns tomorrow.

That reality is a key reason we continue to believe in diversification across market capitalizations, asset classes, sectors, and investment styles. Diversification isn't designed to maximize returns in every market environment. Rather, its purpose is to help investors avoid becoming overly dependent on any single investment, sector, or market trend.

The same philosophy applies to fixed income.

Bonds aren't expected to outperform stocks over the long term. Their role is different. They can provide an important source of stability, income, and diversification while helping ensure that a market decline early in retirement is less likely to disrupt spending needs.

For many investors, maintaining an appropriate balance between equities and fixed income can help create a smoother investment experience and reduce the likelihood of making emotionally driven decisions during difficult periods.

Preparedness Over Prediction

No one can reliably predict when the next market downturn will occur, what may trigger it, or how quickly markets might recover afterward.

What we can do is prepare.

By the end of our conversation, Tom wasn't asking when the next downturn would occur. Instead, we focused on whether his financial plan had accounted for the possibility.

That's ultimately the goal. We don't build portfolios around predicting corrections; we build them with the expectation that they will occur from time to time. Markets have historically rewarded patient investors over the long run, but never in a straight line. A thoughtful investment plan helps ensure that when uncertainty inevitably arrives, it doesn't force changes to the goals that matter most.

And if your goals, financial circumstances, or comfort with risk have changed, now may be a good time to revisit your investment strategy and ensure your portfolio continues to reflect your long-term objectives.