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THE GREAT RECESSION and accompanying stock market plunge didn’t seem so bad to me. At the time, I was a 20-year-old college student with a little money in a Roth IRA that I’d opened and funded since my high school days. Sure, it was no fun losing half my investment account, but it wasn’t a lot of money—at least compared to today.
In the years since, I’ve fallen squarely into the super-saver category, socking away a large portion of my income. That means the 2020 bear market has stung a bit more than 2007-09, even though—so far—the percentage decline has been far smaller.
Of course, that sting is just the emotional response. We should try to view the recent 35% to 40% pullback as a feature of the stock market, not a bug. The fact is, for stock market investors, drawdowns of 50% or more come with the territory. What doesn’t come with the territory: good investor behavior.
How have you fared through this volatility? Maybe I should rephrase that: What actions have you taken—or not taken? If you’re a long-term stock investor, here are four possible approaches:
1. Sit tight. Have you done nothing through this decline? That means your stock allocation is likely down sharply. A 60% stock-40% bond mix would have been more like 50%-50% at the March 23 bottom—though we don’t yet know whether that was the bottom.
2. Rebalance. Did you have the courage to rebalance your 401(k), moving money from bonds to stocks? Rebalancing is rarely a bad thing. It simply resets your portfolio to the risk profile you identified as appropriate during calmer times.
3. Dollar-cost average. If you automatically contribute to your 401(k), you didn’t have to do anything to keep adding to your stock portfolio. But if you have a taxable brokerage account or an IRA where the onus is on you to hit the buy button, adding to your stock holdings takes more grit.
4. Step up your buying. Did you put extra cash to work as share prices slumped? That’s a great way to take advantage of lower prices and speed up your portfolio’s eventual recovery.
Indeed, it’s amazing how periodically investing into a diversified portfolio helps soften the blow of a bear market. Suppose an investor had $100,000 in a 60% stock-40% bond portfolio. He or she rebalanced annually and invested an additional $1,000 a month. Here’s how our hypothetical investor would have fared in the past three bear markets:
Tech wreck. The early 2000s bear market was, in hindsight, no big deal for our hypothetical investor. The account would have grown to $106,000 by the late 2002 stock market low and, indeed, would have been worth $262,000 in October 2007, when the market next peaked.
Great Financial Crisis. What if our investor started with $100,000 in October 2007? He or she would have been in the red by early 2009, with an account value of $80,000, even after figuring in a year and a half of $1,000 monthly additions. Still, from there, the balance would have ballooned to a whopping $503,000 by the bull market’s end in February 2020.
Coronavirus crash. From the end of January 2020, a $100,000 balanced portfolio would have declined 4% in February and another 8% in March, yielding an account balance of just under $90,000 by the end of March. Where does the portfolio go from there? Only time—and investor behavior—will tell.
Still, we can see the benefits of good investor behavior by looking back at earlier market declines. Consider the four strategies described above—and how they would have played out during the Great Financial Crisis. Again, we’re assuming that an investor starts with $100,000 in a balanced portfolio. All four approaches ultimately work out fine for the long-term investor, but as you progress through the four stages, the portfolio recovers ever more quickly.
1. Do nothing. At the worst point, a 60% stock-40% bond mix would have been down 29%. Still, the portfolio would have recovered its losses by December 2010, assuming an investor took no action.
2. Rebalance every six months. The portfolio was back to $100,000 by October 2010. At its low, it was off 31.5%. Why is this short-term loss larger than in the “do nothing” scenario? There’s increased risk when you rebalance during a bear market, because you’re adding to your stock exposure as share prices drop.
3. Invest $1,000 a month, while also rebalancing. The portfolio gets back to even—meaning its value is equal to the $100,000 initial investment, plus all subsequent monthly contributions—as of April 2010. The maximum drawdown was 30%.
4. Invest $2,500 a month, while also rebalancing. Our investor’s portfolio is worth $170,000 as of February 2010, equal to the $100,000 initially invested plus the $70,000 in subsequent contributions. The maximum drawdown was 28%.
I know, I know, that was a lot of numbers. But here’s the point: The key is to keep your cool and stick to your strategy—and a smart strategy is to rebalance occasionally and to continue saving regularly. Find that a struggle? If you don’t want to go it alone, look for a fee-only fiduciary financial advisor to guide you.
Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles include Stepping Up, Where’s My Refund and Scratching That Itch. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.
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Good illustration that many people can benefit from. The key is dealing with the investors (savers) emotional factor.