By Ben Carlson
A 30% drawdown can be tough to swallow with a 60/40 portfolio but that’s what happens when stocks fall 55% or so. Now look at the Millennial and Gen X portfolios: not really that much carnage because (a) their smaller initial investments and (b) monthly contributions made up for some of the volatility.
You can also see from the ending balances that a combination of disciplined investing, market gains and regular contributions would have led to some nice asset growth in each of these portfolios even with a huge market crash at the outset.
With these ending values in mind, I wanted to see how each of these three would fare during the next bear market. No one can predict the magnitude or length of a bear market because they’re driven purely by emotion so let’s use the averages since World War II.
The average bear market since 1945 has seen losses of roughly 30%, lasting 16 months from peak to trough. Using these numbers and assuming our uber-disciplined investors continue to make monthly contributions, here’s how things would shake out:
The percentage declines wouldn’t be as bad this time around, but the real focus here should be on the fact that the dollar declines are magnitudes worse in each scenario.
I’m stating the obvious here that larger balances will lead to more dollars lost, but it’s important for investors to remind themselves how difficult it can be to sit tight when more money is at stake.
Investors often use historical returns when performing backtests or scenario analysis without thinking through how the value of their portfolio will impact their actions. Even a smaller percentage drawdown will feel much different from a higher market value.
Jason Zweig shared an interesting study in “ Your Money and Your Brain ” that looked at investor perception of gains and losses under similar scenarios. In the study, the investors who focused on changes in price levels earned between five and 10 times more profit than those who focused on price changes in percentage terms.
If you’ve been fortunate enough to make some good money over the past decade or so, it can help to reassess where you stand now versus where you were during the last big market downturn.
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Your perception of risk is constantly changing, whether you know it’s happening or not. The current market value of your portfolio can play a large part in how you view risk at any given moment.
I have a feeling many investors will be caught off-guard when the next bear market hits and their portfolios look different than they did heading into the last one. It’s impossible to avoid anchoring to the highest market value you’ve seen.
No matter where you are in your investing life cycle or how far stocks fall from here, the next bear will likely feel more painful than the last.
Prepare yourself now before it hits.
Vanguard Total Stock Market Index /zigman2/quotes/202876707/realtime VTSMX -1.07% , Vanguard Total Bond Market Index /zigman2/quotes/206402661/realtime VBMFX +0.70% and Vanguard Total International Stock Index /zigman2/quotes/210096929/realtime VGTSX -0.84% mutual funds were used for all portfolios
Millennial portfolio: 50% U.S., 20% bond, 30% international
Gen X portfolio: 45% U.S., 30% bond, 25% international
Baby Boomer portfolio: 40% U.S., 40% bond, 20% international
Portfolios are rebalanced annually
All contributions made on a monthly basis
In the 30% bear-market scenario, I’m assuming bonds will provide no returns to be conservative
The performance numbers here are peak-to-trough market values, not time-weighted returns to keep things simple