My wife told me we needed to have a serious talk…
So I braced myself for what I’d forgotten to do. But luckily, it wasn’t related to house chores.
Instead, she pointed out a string of early morning texts she received from a coworker:
Okay… even in the longest bull market ever, the stock market tanked 800 points twice in a week. Can you ask Grant if I should move my 401(k) into 100% bonds or cash?
Now, if you’re like my wife’s coworker, you’re probably freaking out about all the scary headlines, too: inverted yield curves, trade war tensions, massive protests, geopolitical uncertainty, and more…
So what’s an investor to do?
Well, I told my wife to reply with the following:
If you have a long-term outlook and a diversified portfolio, do nothing. Still, you should stress-test your portfolio to be sure it can withstand market drawdowns.
If you feel like you’re in a similar situation, I’ll share a simple exercise for you to stress-test your retirement portfolio. It’s the same one I sent to my wife’s coworker.
But let me go over why she texted my wife in the first place…
A Sea of Red
The Dow had two big down days in the past two weeks. It fell 767 points on August 5. And it plunged 800 points on August 14. This month, all major U.S. stock indexes are down 3–5%.
Much of the blame fell on the yield curve inversion and rising trade war tensions.
You see, when the yield curve inverts, long-term Treasury yields fall below short-term Treasury yields. And this spooks the markets because inversions have preceded every recession since the 1950s.
Toss in another trade-war Twitter grenade from President Trump… continuing protests in Hong Kong… and Argentina’s market crash… and it’s easy to understand why my wife’s coworker is jittery.
She has reason to be concerned. Her hard-earned savings are at stake.
But a 3–5% move in the market isn’t a lot. Despite all the recent volatility, the Dow is still up more than 12% this year and the S&P 500 is up over 16% (in terms of total return).
That’s why we urge you to look at the big picture—and not to panic on short-term pullbacks.
But if you’re uncomfortable with the volatility, you need to stress-test your portfolio. It’ll help you sleep better at night…
The Stress Test
Since the end of World War II, the S&P 500 has experienced 11 bear markets (declines of at least 20%). The average loss has been 30.4%.
So to stress-test your portfolio, apply a 30% loss to your equity portion.
For example, say you have $100,000 of assets… and you allocate 50% to bonds and 50% to stocks. A 30% tumble in stocks means you’d lose $15,000 of your nest egg.
Or if that’s too hard to imagine, think back to how you fared in the fourth quarter of 2018. U.S. stock markets dropped almost 20% then, just outside of “official” bear market territory.
Now, it’s gut-check time.
Can you withstand a loss like that?
Will you be able to sleep at night?
Do you have time to recoup your losses?
If any of the answers are “no,” then you should revisit your asset allocation… and consider trimming some of your equity positions.
Stick to Your Plan
Volatility will likely continue. The truth is, no one knows where the market is headed in the short term.
That’s why at PBRG, we don’t base our investment strategy off short-term market moves. We use a time-tested asset allocation model. And we stick to our plan.
If we experience an extended downturn, we have a protective policy in place with portfolio diversification, position-sizing, and stop losses. And we can use any pullbacks to add positions on quality companies at cheaper prices.
So when the market bounces back, we’ll have plenty of upside opportunity. (Remember, each of the previous 11 bear markets have been followed by 11 bull markets taking the S&P 500 to new highs.)
Now, if the negative news is keeping you up at night, stress-test your portfolio now.
This way, if a crash hits, you won’t panic. Instead, you’ll be well-prepared to handle it—just like my wife’s coworker is.
Analyst, Palm Beach Daily