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When thousands of people are sick and dying, the stock market isn’t the world’s most pressing problem. It may even be unseemly to worry about it at all.
Yet the market’s steep fall matters, not just for hedge fund investors but for millions of hardworking people who have poured their savings into it, hoping to generate enough for a decent retirement, an education, a house — really, for anything important in life that costs money.
What we’ve just experienced in the market is a big setback. The first three months of the year were the worst for the S&P 500 since 2008, and the worst for the Dow Jones industrial average since 1987.
But what really counts is what you actually held in your portfolio. If you had a well-diversified array of both stocks and bonds, you probably wouldn’t have lost all that much — though you may have already lost more than you feel you can handle.
It’s worth re-examining the classic asset allocation strategies. It’s not too late to adjust course.
How much pain can you take?
“This isn’t a dry run,” David Booth, the co-founder of the firm Dimensional Fund Advisors, told me on the phone this week. “This is real life, unfortunately or not, and I’d tell someone who is seriously stressed out by this that they may need to rethink their strategy, and find something they can relax with.”
In late December, I also chatted with Booth — the benefactor for whom the University of Chicago’s Booth School of Business is named — about his approach to long-term investing. Like Jack Bogle, the founder of Vanguard, he recommended using low-cost index funds.
The key, though, for achieving some degree of personal comfort, is to find an asset allocation that is appropriate for you. How do you accomplish that?
Back in those relatively peaceful days just a few months ago, he suggested imagining a stock market decline of more than 50%, one like the terrible bear market of October 2007 through February 2009.
In such a decline, he asked, what kind of losses could you live with? As it turned out, that wasn’t a theoretical question. This week, he said ruefully, “For a lot of people, that kind of pain’s already here.”
The market dropped more than 33% before action by the Federal Reserve turned stocks around on March 23. I intend to keep buying equities steadily — but with the coronavirus raging, unemployment mounting and the global economy shrinking rapidly, it would not shock me if further declines were to bring the stock market more than 50% from its February peak.
Consider a conservative approach
For someone near retirement or already there, a classic allocation might be 25% stock and 75% bonds, he said. The hefty bond component of such a portfolio is intended to provide a buffer, providing some income while protecting him from losses in the stock market.
At age 73, that’s the recipe he personally favors. “I want to be able to relax, to forget about the market, and sleep at night,” he said. “For me, this kind of portfolio lets me do that.”
How has Booth’s conservative portfolio been working this year? He told me he hasn’t checked. “It will be OK,” he said. “That’s the point — setting up something you don’t need to look at, so you can do other things.”
I checked for him and found that with some important qualifications, it has fared about as well as expected. Dimensional’s Global Allocation fund has that 25/75 stock/bond asset allocation, for example. It has lost money this year, but not nearly as much as the S&P 500.
In the first quarter, the fund declined about 6%, including dividends, compared with a loss, with dividends, of about 20% in the S&P 500, according to FactSet. The Vanguard Target Retirement Income fund, another conservative fund with a fairly similar asset allocation — 30% stock and 70% bonds — also lost about 6%.
That doesn’t strike me as much to worry about, not for a long-term investment.
But for retirees living on such a portfolio, it may be a different matter, because those figures understate the intensity of the downturn at its worst, from Feb. 19 to March 23.
Consider that the DFA fund lost 10.5% in that short period, according to FactSet, and that the Vanguard fund lost 12.5%. That’s much better than the S&P 500’s 34% loss in the same stretch but, still, if you find losses like that too excruciating, you could readjust now by selling stock and holding even more bonds.
Note, however, that even many bonds and bond funds faltered in that period. The S&P Aggregate Bond index, which measures the broad bond market, did not rise, as bonds often do in stock-market downturns. It fell in that brief stretch, albeit by less than 1%. Only Treasury bonds held their own, and, even here, there were problems.
Large exchange-traded bond funds run by BlackRock, State Street and Vanguard all traded at prices lower than those being offered by their underlying bonds. This unusual market distortion would have cost you money if you had tried to sell one of these ETFs at the depth of the market’s troubles, though the situation straightened out after the Fed intervened heavily in the markets.
The lesson from this brief bond glitch is, I think, that you do not want to put yourself in a position in which you must make urgent short-term sales. “Raise cash when things are calm,” Booth said.
Shift enough money into cash — and hold it in a bank or a conservatively run money market fund — so that you can ride out a market storm without having to make sales under duress.
One word: ugly
Younger investors, of course, most likely have far more than 25% of their portfolios allocated to stocks. The Vanguard target-date fund for people planning to retire in 2065, for example, is allocated nearly 90% to equities.
More common stock-bond splits are 70-30 and 60-40. I checked the performance of those kinds of portfolios during the worst of this downturn, from Feb. 19 to March 23. They were, in a word, ugly.
Here are the numbers for a few representative, broadly diversified funds, according to FactSet:
— Dimensional DFA Global Allocation 60/40 Portfolio (60% stocks, 40% bonds and cash): negative 24%.
— Vanguard Balanced (60% stocks, 40% bonds and cash): negative 23%.
— Vanguard LifeStrategy Growth (79% stock, 21% bonds and cash): negative 29%.
I think it’s likely that more aggressive strategies will pay off if you can afford to wait. But as Robert Shiller, the Yale economist, pointed out in The New York Times recently, you might have to wait a long while. We just can’t predict the short-term market.
This isn’t an ideal time to sell stock, because prices have already dropped considerably. But they may well fall further. If you already know, from recent experience, that you couldn’t handle that, Booth said, by all means, sell, and switch to investments that you can live with.
“The textbook answer is to find an asset allocation that you can live with for a long time,” he said. But people in distress don’t care about textbooks. “This isn’t science,” he said. “It’s about human behavior. And if you’re freaking out, the first thing is, you’ve got to find a way to get comfortable.”
Perhaps that means getting out of stocks, he said. Better yet, he added, is to find a way to live with stocks. That may mean that you need a more conservative approach than you had expected just a few months ago.
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