Can You Afford a 50% Loss?
Global stock markets are selling off, oil is crashing, and the Coronavirus is spreading. Year-to-date, the Dow Jones is down about 15%, and things can get worse before they get better.
No one wants to experience a significant drop in stocks, but they do occur. Over the past fifty years, there have been three periods where stocks fell by 50% or more.
Stocks fell 56% in 1973 and 1974 because of the Arab Oil Embargo.
Stocks fell 49% from 2000 to 2002 during the Tech Wreck.
Stocks fell 53% from October 2007 to March 2009 during the Great Recession.
The worst period for shareholders occurred during the Great Depression, where stocks fell 76%.
How will your life change if stocks fell by 50%? To find out, divide your assets by two and then multiply your answer by 4%. If your current assets are $1,000,000, divide by 2 to get $500,000. Multiply $500,000 by 4% to get $20,000. With assets of $1 million, you can expect an annual income of $40,000. At $500,000, the income declines to $20,000. Will the drop in assets impact your daily living or current activity? If so, consider adjusting your portfolio. But, before you make a major change, let’s look at a few investors – Ginny, Barbara, and Margaret.
Ginny is 100% invested in stocks, so when stocks rise, she’ll benefit, when stocks fall, she’ll suffer. If she invested in the Dimensional Funds Global Equity Index Fund (DGEIX), she would have enjoyed an average annual return of 7.46% for the past 20 years. In 2008, her fund dropped 41.3%. Ginny invested $10,000 in this fund on January 2, 2000; it’s now worth $32,100.
Barbara is more conservative, and she allocates her investments 60% to stocks and 40% to bonds by investing in Dimensional Funds Global Allocation 60/40 Fund (DGSIX). Her fund has produced an average annual return of 6.01% for the past 20 years. Her fund lost 22.7% in 2008, considerably less than Ginny’s account. Barbara invested $10,000 in this fund on January 2, 2000; it’s now worth $25,750.
Margaret is very conservative, so she allocates 25% of her investments to stocks and 75% to bonds by investing in Dimensional Funds Global Allocation 25/75 Fund (DGTSX). Her fund generated an average annual return of 4.26% for the past twenty years. Her fund lost 7.3% in 2008. Margaret invested $10,000 in this fund on January 2, 2000; it’s now worth $19,670. Her fund didn’t lose much money during the Great Recession, but her assets are substantially less than Ginny’s.
To obtain high returns, you need to invest in risk assets, and that means enduring a few years where stocks underperform conservative assets. If your risk level is high, allocate a significant proportion of your assets in stocks. However, if you’re not ready to lose 50% of your assets, diversify your holdings. A 40% bond allocation reduces risk by 33%, compared to an all-equity portfolio.
A financial plan will help you refine your goals and determine how much money you should allocate to various asset classes. A plan will help you balance your short term needs with your long-term goals. An investor who is too conservative may run out of money when they’re older. Likewise, an investor who is too aggressive may lose their assets during a market downturn. Risk and reward will be forever linked.
Stock market corrections and downturns are normal. Since 1970, the S&P 500 has closed in negative territory ten times or 20% of the time, with an average drop of 14.9%. However, 80% of the time, stocks finished the year in positive territory. A $100,000 investment on January 2, 1970 is now worth $3,196,100.
Here are some suggestions to help you through the market’s turbulence.
- Don’t panic. Stocks rise and fall every day. If you want to sell, wait for them to rebound. On October 19, 1987, stocks fell 22.6%. In the next two days, the Dow Jones rose by 16%.
- Diversify your assets. To reduce risk, add bonds and other asset classes to your portfolio. During the decade of the 2000s, The S&P 500 had a negative return, but if you added bonds, international investments, small company stocks, and real estate holdings, your account finished in positive territory.
- Follow your plan. A financial plan will guide you through a market downturn. It will help you determine how much money you’ll need to fund your goals. It will also quantify your risk level.
- Examine your risk level. How much risk is embedded in your portfolio? If you’re not sure, give us a call.
- Look for opportunities. In a crisis, there’s always an opportunity. You’ll probably be early on the purchase, but, over time, your stocks may recover.
- Don’t time the market. It’s tempting to hunt for bargains, but you’re not going to pick the bottom, so don’t worry about buying at the lowest tick. You’ll know in about five years if you made a wise investment decision or not.
- Avoid margin. When stocks are falling, avoid margin. A margin balance will magnify losses.
- Rebalance your account. An annual or quarterly rebalancing will keep your asset allocation and risk level intact.
Today is the eleventh anniversary of the stock market low of March 9, 2009. The S&P 500 closed at 676, and it currently is trading at 2,972 – a gain of 339%. The phenomenal increase follows the bear market loss of 53%. It hardly makes sense to buy during the dark days of a stock market thrashing, but it’s in the depth of despair where you get the best prices. And, to quote my dad, the sun will come up tomorrow.
In the middle of difficulty lies opportunity. ~ Albert Einstein
March 9, 2020
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.