What If the Stock Market Falls 30%?

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Are YOU ready, Doctor?

By Michael Zhuang,

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

Ever since it touched bottom on March 9th, 2009, the market has been going up and up and up with barely any hiccup. That’s dangerous! Because our minds could get complacent. That’s why I want to do a mental exercise with all of you: What would you do if the market falls 30%?

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.

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stock market

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2 Responses

  1. Wealth

    Roughly half of those with $1 million to $5 million are afraid one major setback (such as unemployment or a market crash) would have a significant impact on their lifestyle. Even a third of those with $5 million or more think it can all go away in a flash.

    http://www.msn.com/en-us/money/personalfinance/when-is-dollar5-million-not-enough-personal-wealth/ar-BBkXiEs?ocid=iehp

    That’s especially true for millionaire parents working full-time, 63% of whom feel they can still be clobbered by one major setback.

    Marie

    Like

  2. Greek Exit Could Trigger a Correction, Advisors Say

    http://www.msn.com/en-us/news/world/at-barren-shops-and-closed-banks-greeks-feel-strain-of-%e2%80%98economic-war%e2%80%99/ar-AAckhMj?ocid=iehp

    The Greek debt crisis has come to a head, as the country’s bailout expires and its debt payment to the International Monetary Fund comes due today.

    http://wealthmanagement.com/fixed-income/greek-exit-could-trigger-correction-advisors-say?NL=WM-27&Issue=WM-27_20150630_WM-27_62&sfvc4enews=42&cl=article_1_2&utm_rid=CPG09000002702210&utm_campaign=3088&utm_medium=email&elq2=07836953a5244c91950ecadb5d5b1c47

    The events could lead to a Greek exit from the Eurozone, which some advisors say could trigger a market correction in the U.S. as well as a buying opportunity.

    http://www.msn.com/en-us/money/economy/greece-staggers-into-economic-unknown-with-bailout-set-to-expire/ar-AAcl625?ocid=iehp

    Mikos

    Like

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