For most of the past decade, stock investors benefited from a long bull market that made making money seem easy and natural.
Then, near the end of February, all hell broke loose. The market seemed to be in free fall one day, soaring the next, and plunging again — with no end in sight.
As you know, the turmoil was caused by a noneconomic force that appeared suddenly: a frightening virus spreading rapidly around the world. Investors had no way to know this was coming. Still, experienced investors had every reason to expect that something would eventually shatter a decade of stock-market nirvana.
“When we get scared, we forget that it’s normal to be ready for bad things to happen,” wrote author Annalee Newitz in the New York Times. “It’s not overreacting; it’s just how we get through life.”
Two challenges investors face
Right now, investors face two challenges. The first is navigating the current crisis. The second is preparing for the next one — because there will be a next one.
The first challenge is tough. When you’re strapped into a roller coaster that suddenly feels overwhelming, you can’t just jump off.
When your investments appear to threaten your financial future, it may seem tempting to bail out. But history shows that panic selling is one of the surest ways to sabotage long-term success.
Whether you’re on a wild roller coaster or riding a chaotic stock market, the best response is the same: hang on, think about something else, and remember that you will get through it.
Preparing for the next crisis
The second challenge is preparing your portfolio — and your emotions — for the next severe setback. That means confronting the tug-of-war between greed and fear.
For many U.S. investors, greed has dominated since around 2010. As markets rose year after year, fear was pushed aside.
The long stretch of easy gains may have done a disservice to a generation of new investors. It’s easy to forget past pain when everything seems to be going well.
The best way to prepare is to learn from history.
Losses are normal
Stock-market losses are normal and inevitable. I often tell investors I can guarantee they will lose money in equities at some point.
The equally important truth is that, over the past 90 years or so, the market has always recovered.
The emotional lesson is simple: bad things happen. That’s just part of investing.
The good news is that you can fine-tune your portfolio so it’s prepared for rough times.
Risk, return, and asset allocation
Investing in equities means accepting risk. The trade-off is unavoidable: higher long-term returns require higher risk; lower risk means lower expected returns.
The most effective way to control risk is to adjust the balance between stocks and bonds.
Below are results from the past 50 years. Stocks are represented by the S&P 500 index. Bonds are represented by a mix of short- and intermediate-term government bonds and TIPS.
Three choices: bonds vs. equities (1970–2019)
| Percent in S&P 500 | Compound Return | Standard Deviation | Worst 12 Months | Worst Drawdown |
|---|---|---|---|---|
| 20% | 7.8% | 4.3% | -8.6% | -8.9% |
| 50% | 9.0% | 8.1% | -23.2% | -25.9% |
| 100% | 10.6% | 15.0% | -43.4% | -50.9% |
Choosing what’s right for you
I’ve long believed that a moderate allocation — about 50% in equities — may be appropriate for many investors, including retirees. That’s how I invest my own money.
Younger investors who are still accumulating assets can afford to take more risk. Investors who are especially uncomfortable with market swings may prefer 20% or 30% in equities.
The key is understanding what you must endure to earn a given return. If you study the worst periods — from months to several years — you’ll gain clarity about what staying the course really means.
It meant enduring losses exceeding 50% in 1973–74, 2000–2002, and again in 2008 — not to mention a single-day drop of more than 22% in October 1987.
I can’t promise an end to wild market rides. But I am confident that choosing the right balance of stocks and bonds will make those rides much easier to endure.
I’ve also studied variations that include international stocks and value stocks. For more details, check out my podcast “Fine Tuning Your Asset Allocation.”
Richard Buck contributed to this article.