Will You Have Time To Recover?

worst case scenario

In case you missed it, you can watch an “At a Glance” summary of this week’s blog posting here.

When Your Investment Strategy Fails Will You Have Time To Recover?

Just because you are prepared (or preparing) doesn’t mean you have to go through it. Hope and plan for the best but prepare for the worst – isn’t that what a great investment approach is suppose to provide?

the complete worst-case scenario survival handbook

Why 2017 isn’t 1987

Last week I talked about why 1987 doesn’t matter anymore, I wanted to make something really clear. The reason why 1987 doesn’t matter in 2017 is because the world had already voted and was continuing to vote between the 4 major asset classes, and the election results kept coming back with the same candidate winning time after time (stocks).

Stocks won for the first time in 1982 after losing the vote for 17 years. And stocks continued to win for the next 18 years. When the winning asset (candidate) goes through a price correction but the world doesn’t change their vote on that winning asset then there’s nothing you need to do.  Really. I know this might sound bad or wrong but it’s true. Sometimes doing nothing IS the right answer.

Please note, the 2000 and the 2008 falls in the stock market happened because the world started voting for a new candidate (bonds). And that is why 2000 and 2008 were so painful.

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By the way, this election between the core asset classes is happening every trading day of the year.

The world had already said that stocks were the place to be in 1987. And the world kept voting this way until the beginning of 2000. And then their votes started changing to Bonds, Cash and Gold.

A Price Correction Doesn’t Mean A Behavioral Correction

When there’s a price correction in the leading asset. But the future’s stability is never questioned then bonds/cash/commodities/real estate don’t start leading.  All the contenders stay in their place. This is what happened in 1987. Stocks kept winning, including in 1987 when stocks rose 5% for the year.

When stocks beat bonds/cash = future stability.

When bonds/cash beat stock’s = future instability.

When commodities/gold beat stocks and bonds = future inflation & instability

Though Real Estate is a key asset class, since it takes months to sell/buy (read: very illiquid), there rarely is a “tell” when real estate is beating the other four.

Nuance is King

Knowing the nuanced differences between between a price correction in a leading asset and a price correction with a new leader is important.

Remember you (and the world) are only voting between 5 assets (stocks, bonds, cash, commodities, real estate)… and really the vote is between stocks and bonds 95% of the time.

IF you keep the relationship between the five main assets as your true north then you are able to keep your approach powerfully simple.

Easy to say but not easy to implement. Though we at Fearless Wealth Research make it easier to implement than anyone else.

Are You Prepared for Your Worst Case Scenario?

I want you to look at your investment approaches worst case scenario. I want you to look at when your approach wasn’t working. Or when it was failing or appeared broken.

If you have a big box advisor there’s only two approaches they’re going to do for you. They’ll either put you in a stock long-only never get out approach. Or they’ll put you in a 60/40 stock/bond split and rebalance it twice a year. Are there variations between these two, of course there are but not much. The core of the big-box investment approach is clear, never get out. Allocate to age and self describe risk tolerance and take the full hit of every fall.

Worst Case For Long-Only Stock Portfolios…

Below is a price chart of the S&P500 index. When you include inflation (US Government inflation) the investor would have needed 16 years to break even. And that is if they stayed the course. But let’s say they did. 16 years to break even is a lifetime for many people. Especially if that person is 60 and their life expectancy is 80.

A 16 year get-back-to-even is 75% of that person’s remaining life. That’s an expensive worse case scenario.

If you would have been investing a consistent monthly amount of money into the market during this 16-year time period. You would have shortened your time to breakeven. And if you would have reinvested ALL dividends back into the market then you would have also shortened your time to breakeven.

long only all stock takes 16 years to breakeven

The stock market goes up 78% of the time. But what about the 22% of the time it falls? The above price chart is a good example of how that 22% of the time can take 16 years to get back to break even. And again, the above price chart is the S&P 500 inflation adjusted by the Bureau of Labor Statistics (BLS.Gov) measurement of inflation. Which for reference is at 2.5% today.

If you have medical bills or college bills or live on the coast of the United States then you know your local inflation rate is noticeably higher than 2.5%, but that’s a topic for another post.

The point: having a falling stock market 22% of time does NOT equate to only needing 22% of tie to break even. Time is allusive and something very few people look at. Short time period with a 49% fall (dot com) and 58% fall (Global Financial Crises) can take an emotional life time if not an actual lifetime to get back to break even.

Worst Case For The 60/40 Portfolio…

The 60/40 Portfolio “only” took its followers 12 years to break even from the 2000 dot com fall. But, and this is an important but,  the likelihood of an older investor being in this fund is likely. It’s likely the average age of an investor in this style portfolio is in their 70s. Why? Because this “balanced” approach is sold almost exclusively to people over the age of 60.

The older age means relatively these investors have less time. And a 12-year recovery can literally be a  lifetime. This relative time to recover difference and the fact that their earnings runway has ended is one of the reason’s why older investors are feeling more uncertain about what the future holds.

Plan for the worst, prepare for the worst so you can enjoy the best.

The relationship between the core asset classes is more important than a person’s age or self-described risk tolerance.

The take away: the time to recover is what looking at the worst case scenario is about. What’s the key? Not losing 50% of your money. If you only lose 11% or 12% then the time to recovery can be cut significantly.

This is one of the keys of finding a powerful system that really works for people.

In Your Corner,

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RC Peck, CFP




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