by Scott Ronalds
I have no greater insights than you do on what the markets might do over the next several months. But it’s been a while since we’ve had any kind of meaningful pullback in stocks and we’re due at some point. It may not happen next quarter, next year or even this decade. But as I noted in my post yesterday, declines and bear markets are a normal part of investing. Are you prepared?
I find the best way to test yourself is with real money. Let’s say you’re a balanced investor and your portfolio is worth $400,000, all invested in the Founders Fund. A modest decline in the markets might see the fund fall 3-4% over a few months. This doesn’t sound like much. Put it in dollar terms though, and it takes on a different meaning. $12,000 to $16,000 sounds much greater – and feels much worse – than 3-4%. Still, no big deal considering the gains you’ve likely seen over the last few years.
Now assume markets experience a sharper decline and the fund drops 6% over 6 months. Your portfolio is now down $24,000. What would you do?
Let’s turn it up a notch. Investors have soured on stocks and markets are under severe pressure. We’re officially in bear market territory with stocks down over 20% and the fund is hypothetically down 12% over 10 months (the fixed income component is providing ballast). That’s $48,000. The media and financial pundits are calling for further losses. Your neighbour’s bragging about how he moved to cash a year ago and is telling you to get out of the market and buy gold. Again, what do you do?
Keep in mind that our scenarios apply to a balanced portfolio; one tilted more towards stocks would see bigger declines in a bear market.
If you can honestly tell yourself that you would sit tight in each of the above scenarios, you’re in good shape. And if you think that you’d be inclined to add to your portfolio under the more severe scenarios to take advantage of opportunities, you’re in great shape. But if you’re thinking you simply wouldn’t be able to stomach seeing your investments fall by $24,000 or more, we should talk. You may need to dial down the level of risk in your portfolio.
I’m not trying to be an alarmist here. We don’t want to see a sharp decline any more than you do. The thing about bear markets, though, is you never know when they’re going to happen and how they’ll play out. As your investment manager, a key part of our job is preparing you for both the good times and bad.
To finish on a more positive note, it’s important to remember that markets are resilient over the long run, and the steeper the correction, the more pronounced the eventual rebound tends to be.
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