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Protect Your Retirement from the Next Crash

Three recommendations from a noted financial planner

By Ken Moraif | MarketWatch | August 24, 2014

(This article appeared previously on Marketwatch.)

The market has been setting all-time highs — it's up almost 200 percent since the lows of March 2009. Over three quarters of companies (77 percent) have reported earnings that beat estimates. We can look forward to the market rise that historically occurs after midterm elections; I think we're on track to see 18,000 on the Dow Jones Industrial Average.

 
While the market seems to be on a positive track, retirees should be concerned by how similar current circumstances are to what happened during the Great Depression. These similarities could be a harbinger of danger to their retirement plans.

(MORE: Retirement Planning in This Stressful Market)
 
Market Crashes Then and Now
 
Looking back at history, we can see that before the stock market crash of 1929, real estate values were going crazy. Banks were using money from their depositors to finance deals. The same sort of things that caused the 2008 credit crisis triggered the stock market crash of 1929.
 
We had a huge market drop both times. In 2008, the market dropped 57 percent. That's a severe drop, until you consider that the market plunged 92 percent in 1929. And that, of course, was the beginning of the Great Depression.
 
When Franklin Delano Roosevelt became president in 1933, what did he do? He enacted government stimulus programs to help the economy and get us out of the depression. Fast forward to 2008. What did the government do to get us out of the great recession? Massive government stimulus. The U.S. borrowed $3 trillion dollars to pump into the economy. The Federal Reserve is keeping interest rates artificially low. We're setting records in regard to government stimulus.
 
Back in 1933, FDR's government stimulus plan seemed to work. Profits picked up and the economy rebounded. Over the next four years, the market went up 200 percent. Does this sound familiar?

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Today, all of our current government spending, all the cheap money, all the free stuff that helped pull us out of the recession has driven the market up, yes, 200 percent.
 
But if you build a house of cards, it doesn't take much to make it fall. Just a little breeze can make the whole thing come crashing down. That's what happened in 1937. The market went into a tailspin. The government stimulus was just creating a facade and it crumbled: From 1937 through 1939, the stock market went down 42 percent.
 
A Warning for Today?
 
I find the correlations between the Great Depression and the Great Recession very concerning, and I think we're setting up for the same sort of aftershock we saw back then.
 
If we have another recession like the one in 1937, I don't believe the government will be able to get us out of it with another $3 trillion of stimulus. Where will they get the money from? We are already $17 trillion in debt after all.

Retiree investors, while typically having a more conservative investing philosophy, may want to consider implementing certain strategies ahead of time, to shelter their income and investments from any potential aftershock.

(MORE: What to Do When the Market Crashes)

Here are three personal finance tips and investment suggestions you may want to follow: 
 
1. Don't eat your financial "seed corn." Retirees should have at least two years of their cost of living in cash. If they don't have that currently, they need to start now to accumulate it. Cash isn't paying a very high return these days, but retirees need to think of that opportunity cost as an insurance premium. Retirees should think of accumulating the cash for an emergency as insurance for their portfolio that they are buying with lower returns.
 
By having a solid emergency fund, retirees can live on that cash and not draw from their investments at a time when those investments are declining in value. Drawing money from a portfolio of declining investments is what farmers call “eating your seed corn.” If you do that enough, when growing season comes you'll have nothing left to plant.
 
2. Reallocate your portfolio. While I think the Dow will do fairly well over the coming months, I believe that the aftershock could hit in the second half of next year. Until then, retiree investors should bolster their portfolio with a broadly diversified range of stocks, to participate in the potential rally I see coming.
 
For a retiree, diversification is always a good idea. I would recommend using index mutual funds or exchange-traded funds that match broad indexes as the investment vehicle.
 
3. Keep your emotions in check. It's vital that retiree investors remember that their main priority is to protect their principal first and foremost. With this in mind, any hiccup in the market isn’t the time to gamble with your investments and make drastic changes on a whim. Keep your cool, don't panic and work with an adviser who can guide you along in making rational investment decisions, no matter the state of the market.
 
Right now, the stock market has a lot of momentum. Profits are coming in. We're still in an upward phase. I believe investors need to participate in the market when it's going up, whether it's going up for the right reason or not.
 
I also believe that if we don't learn from history, we're doomed to repeat it. I hope the correlations between the Great Depression and the Great Recession don't include an aftershock like the one of 1937. However, with the right strategies and financial game plan, retirees can be prepared to protect their income and maximize their chances of weathering a postrecession aftershock.

Ken Moraif, CFP, is a senior advisor at Money Matters, a Dallas-based wealth management and investment firm. The firm works with pre-retirees and retirees, offering estate and tax planning services, retirement plan consulting, and investment management. He covers retirement trends in his weekly radio show, “Money Matters with Ken Moraif.” You can follow Ken on Twitter: @KenMoraif or Facebook.