What could happen to my passive online smart allocation during a bear market?
Let’s assume you are ten years from retirement and you go to an online advisor and answer some questions about your goals, risk tolerance, age, etc. The online service, based on sound historical data, recommends an allocation that comprised of 80% stocks and 20% bonds. That allocation is prudent based on the average expected market outcomes over the next ten years. Since below average or low probability outcomes occur in the financial markets, it is prudent to understand how the allocation performed in a real-world bear market. Therefore, we reviewed the bear market performance of an 80%-20% stock-bond portfolio comprised of the following commonly used low-cost, index ETFs and mutual funds:
HOW WELL WOULD YOU SLEEP AT NIGHT?
The chart below shows the performance of the allocation above based on adjusted daily closing prices between October 9, 2007 and March 9, 2009. If you were ten years away from retirement, "sticking with the program" would have meant enduring a portfolio drawdown of 48.35%. If you had $1,000,000 invested during the financial crisis bear market, the gut-wrenching and sleepless nights loss would have come to $483,494.
LOW FEES ARE ONLY PART OF THE INVESTMENT EQUATION
A loss of $483,494 puts some perspective around the importance of principal preservation relative to focusing exclusively on low fees and tax efficiency. The chart below shows the performance of the individual ETFs and mutual funds over the same period.
It is interesting to note despite the appearance of "it should help me in a bear market" diversification, nine of the ten investments lost money. The false diversification FAQ provides another example of asset correlation in a bear market.
BUT, THE FINANCIAL CRISIS WAS UNIQUE, RIGHT?
As demonstrated in the cost justify fees FAQ, similar drawdowns occurred in the dot-com bust bear market. If your current advisor has no exit strategy, you have to wonder what would happen if another 1929 event occurred. Horrible bear markets have happened in the past and they will occur again sometime in the future. It is not a question of if, but only when.