I believe that the next market downturn will wipe out several years’ worth of gains.
The chart below shows the S&P 500 price assuming hypothetical declines ranging from 10% to 60%. I also included the date of the first day the S&P 500 ever closed at or higher than yesterday’s closing price, days since that date, and approximate years since.
Yet, many investors have been chasing stocks higher over the last several years so they now sit with too much risk exposure. Many others have been adding stocks aggressively even since the November Presidential election in “fear of missing out” as the market has set record highs.
For what? To eek out a little extra return? What are they potentially gaining by adding that extra stock exposure and what are they potentially risking? Current market valuations suggest they’re gaining relatively little upside while taking on tremendous downside potential. After all, just a mild 10% correction wipes out all the gains going back over two years (not including dividends).
We really do have short-term memories, don’t we? When the market starts to slide, it will likely be quick. And while many think they’re comfortable with that volatility, we often find that’s not the case once a quarter or more of the portfolio is wiped out in a relatively short period. But the future is very bright for those of us who can remember the past and avoid temptations of thinking this “time is different.”
The key is to use an informed, disciplined approach. So what I have done for clients is employed sophisticated financial modeling to first identify the most appropriate long-term strategy. I refer to this long-term strategy as “neutral,” which serves as our long-term target. But, throughout the market cycle, I use market valuation and economic data to inform tactical decisions making the portfolio either more aggressive or more conservative over time, within limits, as warranted by the data.
Right now, as you can guess, my clients’ portfolios are positioned more conservatively than they would be if we were in a fairly-valued market and economic fundamentals looked sound. The goal is to make the portfolio more conservative near the top but get more aggressive near the bottom.
Getting more conservative at the top helps to preserve some dry powder that we can then deploy near the bottom when assets are much cheaper. After all, the truly great investment opportunities present themselves at the bottom in the depths of despair, but you need to have the resources available (along with patience and discipline) when everyone else is forced to sell.
As I often quote Warren Buffett, “Be fearful when others are greedy and greedy when others are fearful.”
Even if it takes two years for that downturn to materialize (I heavily doubt it will take that long), the few extra percent you could potentially make from that marginal exposure may be wiped out in a single day. It’s okay to be a little early. Patience and discipline are a prerequisite for successful investing.
Your nest egg is not a gambling bankroll. It’s the means to your financial wellness and freedom. If you have too much exposure, no one can help you after the downturn hits. The key is to be positioned appropriately before it hits. So, at the very least, let me run financial projections for you to help determine if changes are needed. The cost is very low.
Also, a quick reminder I’m offering free portfolio reviews through the end of March so just about a week left to take me up on that offer!
