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Are YOU ready, Doctor?

By Michael Zhuang,

[Principal of MZ Capital Management – Contributor to Morningstar and Physicians Practice]

First of all, recognize these two important facts:

1.    Market fall of 30% and above happened every ten years or so.

If we use history as a guide, we should expect a 10% odds of that happening over the next 12 months. (So don’t be surprised.)

2.    All market tumbles of that magnitude were recovered within 18 months in the US. (So don’t despair.)

So instead of seeing a 30% fall a bad thing: a horrible hit to your wealth, how about seeing that as a good thing: a deep discount of productive assets on sale that happens only once every decade.

Here is what you should do before, during and after a 30% fall of the market.

1.    Start with having an appropriate asset allocation. Depending on your age and risk tolerance, maybe it’s a 70/30 portfolio, or a 60/40 one, or a 50/50 one.

2.    Stick to it through good market and bad.

3.    Rebalance periodically or opportunistically

Let’s take a 50/50 portfolio for example. After the (stock) market tumble of 30%, the portfolio becomes 35/65. To rebalance back to 50/50, you must sell appreciated bonds and buy discounted stocks.

When you do the above over and over, you create a system of buying low and selling high.

An additional note on rebalance, to keep it simple, you can rebalance every year. The optimal rebalance however, is opportunistic not periodic. The research on that was published in Journal of Financial Analyst and it suggests a rebalance when an asset class has deviated from its target allocation by 20%. When this is done right, you can add about 40 basis points in excess return.