Are You Trading One Risk for Another?

In a recent survey of over 18,000 individual investors conducted by Dimensional, (Dimensional 2017 Investor Feedback Survey), 31% of the respondents said their greatest fear was “experiencing a significant investment loss in a market downturn.” The largest group, 37%, said their greatest fear was “not having enough to live comfortably in retirement.” The juxtaposition of these two fears being at the top of the list is very telling.

The essence of the work that we do everyday involves helping clients better understand and accept that without volatility, without market downturns, many of them will run out of money in retirement. The premium (above inflation) long-term returns provided historically by the global markets allow for lifestyles to be maintained throughout retirement. Without these returns, you are simply exchanging one risk, (volatility), for another (loss of purchasing power). So part of the answer is to have the proper portfolio, but the other part of the answer is to have the discipline to maintain that portfolio in stormy times. One of the two won’t do, you need both.

Most mornings while I am dressing for work, I have Bloomberg TV running mainly as background noise. I never cease to be amazed at how, day after day, the commentators over analyze every data point in hopes of uncovering what these might mean for future market returns.

While we can’t predict the future, we can establish reasonable expectations and design a portfolio that matches these expectations. The chart below details the Hypothetical Growth of $1 Invested at the Market High during the Past Six Market Declines of at least 20% (1973-Present). This chart depicts in a simple format, the downdraft possibility as well as the recovery timeframe for a 100% Stock Portfolio (70% U.S. and 30% non-U.S.) and 60% Stocks/40% Bonds. Downturns of this magnitude have historically occurred every half dozen years or so, with the most recent time in 2011.

As it is quickly apparent, the addition of bonds to the portfolio helps soften the downturns relative to the 100% stocks option. The 100% Stock Portfolio is back to even ($1.00) after Five Years in the worst timeframe (2007-2009), while the 60% Stocks/40% Bonds Portfolio is back in positive territory somewhat more quickly ($1.10 after five years using the same 2007-2009 period). The tradeoff, however, accrues during the longer 10-year timeframes. During each of the periods reflected on the chart, the 100% Stock Portfolio produces stronger growth. These results conform to our overall expectations. Bonds help you stay invested during downturns, while a larger allocation to stocks usually provides more return…in the long term.

Helping clients understand tradeoffs and uncertainty is what we do. Trying to avoid uncertainty isn’t the answer. Ready for a real conversation?

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