Is your portfolio ready for a market downturn?

There are some charts on my instagram and last months market update post showing valuation levels for the US stock market. High valuation levels are usually a warning sign stocks are becoming expensive and their relative return is not as attractive. While it is incredibly difficult to predict market downturns, they are an inevitable certainty.

How often do they occur

If we look at the Dow Jones Industrial Average since 1900 we can see market declines have happened quite frequently. A decline of 10% or more has occurred about once a year on average. A decline of 20% or more has occurred about once every 3.5 years on average.

What can you do to prepare

Using a basic stress scenario will quantify how much money you have at risk. As an example, here is a typical conservative $100K portfolio with 50% Stocks, 40% Bonds, and 10% Commodities (Gold, Oil, etc.) with a basic market stress scenario.

Asset Allocation Market Value ($) Stress Stress Loss ($)
Stock 50% 50,000 -15.00% -7,500
Bond 40% 40,000 -5.00% -2,000
Commodities 10% 10,000 10.00% 1,000
Total 100% 100,000 -8.50% -8,500

The benefit of diversification is apparent. Stocks fell 15% in this scenario yet the overall portfolio is only down 8.5%. The more stocks you own when valuations are high, the more likely you will see larger losses in a downturn. Similarly, rebalancing from bonds to stocks after a market shock will be beneficial when valuations are low.

Conclusions

  • Market declines are unpredictable but are going to happen.
  • Having a plan will help you be ready when they do occur.
  • Rebalancing between stocks and bonds will help to reduce risk and potential losses in a market downturn scenario.

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