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Know your tolerance for a market downturn and stay calm when it hits: experts

The Financial Post with Lisa Kramer 13 September 2018

Nobody can predict with accuracy when stock markets will end their record-setting bull run, but the best way for investors to deal with the next downturn is to remain calm and stick to a well-crafted plan.

The current U.S. bull market became the longest on record as of Aug. 22, 2018, prompting many market observers to wonder when the party will come to an end.

“The very nature of these downturns is that they happen by surprise, so you really can’t anticipate when they’ll happen or why they’re going to happen,” says Lisa Kramer, a finance professor at the University of Toronto’s Rotman business school.

As a result, Kramer says it’s important to know your own ability to tolerate a potential loss within a specific time period.

One strategy is to imagine having your stock portfolio drop by a specific number of dollars — such as $3,000, or $30,000 or $300,000 — within the coming year.

“To think about their portfolio minus that big number is pretty visceral as exercises go,” Kramer says.

She advises speaking with a good financial adviser who can explore the possible range of investments that fits best with your individual circumstances.

“A really diligent adviser will go a step beyond that . . . and help the client understand themselves.”

Among the key factors to consider: when the money will be needed (known as an investment horizon), your age, occupation and experience as an investor.

Moshe Milevsky, a professor of finance at York University’s Schulich business school, says an understanding of the individual’s investment horizon is an essential first step in determining how to prepare for a stock market downturn.

“If you’re concerned now about where the (stock) market is, maybe tilt your asset allocation slightly — and I mean slightly — towards fixed-income (interest-bearing investments such as bonds).”

He adds that occupation is another important consideration, because some people have steady income that will likely carry them through a downturn while others have more erratic pay or a type of work that would suffer in a recession.

What’s not helpful: predictions about what’s to come.

“Market timing could be very costly,” says Ari Pandes, an associate professor of finance at the University of Calgary’s Haskayne business school.

“Left to our own devices, there is that bias that you push the panic button and end up selling at the wrong time because you think the world is falling apart.”

The last time the stock world “fell apart” was a decade ago, starting a few weeks after New York-based Lehman Brothers filed for bankruptcy on Sept. 15, 2008.

Although it wasn’t known at the time, the three major U.S. stock indexes were about to embark on a six-month freefall that would eventually wipe out more than 40 per cent of their value by mid-March 2009.

Other markets, including Canada’s, shared the pain. The S&P/TSX composite index dropped 38 per cent by March 9, 2009. Since then, Canada’s main stock benchmark has recovered, moving nine per cent past its pre-crisis high.

Dave Nugent, head of investments for Toronto-based Wealthsimple, says investors shouldn’t be spooked by historical facts like the fall of Lehman Brothers because they don’t predict the future.

“Yeah, we’re heading into the 10th anniversary but there’s been talk about a correction for the last couple of years and (the market) keeps going higher.”

As a result, Nugent says, one of the biggest services provided by Wealthsimple — a robo-adviser with about 100,000 clients — is to help them remain disciplined investors through good times and bad.

“It’s sometimes hard to take some money off the table when markets are higher and allocate it to more conservative investments,” Nugent says.

“On the flip side, it’s very difficult to pull the trigger and add to stocks when the markets are in free fall.”

Neville Joanes, chief investment officer for WealthBar, says the Vancouver-based robo-adviser also helps clients develop an in-depth financial plan and uses various means to keep them aware of what its portfolio managers are doing.

“Where there may be a market correction, or there may be some additional volatility, the goal is to get their mind away from what’s happening right now and to have them focus on what they’re trying to achieve long-term.”