Can You Afford a 50% Loss?

Global stock markets are selling off, oil is crashing, and the Coronavirus is spreading. Year-to-date, the Dow Jones is down about 15%, and things can get worse before they get better.

No one wants to experience a significant drop in stocks, but they do occur. Over the past fifty years, there have been three periods where stocks fell by 50% or more.[1]

Stocks fell 56% in 1973 and 1974 because of the Arab Oil Embargo.

Stocks fell 49% from 2000 to 2002 during the Tech Wreck.

Stocks fell 53% from October 2007 to March 2009 during the Great Recession.

The worst period for shareholders occurred during the Great Depression, where stocks fell 76%.

How will your life change if stocks fell by 50%? To find out, divide your assets by two and then multiply your answer by 4%. If your current assets are $1,000,000, divide by 2 to get $500,000. Multiply $500,000 by 4% to get $20,000. With assets of $1 million, you can expect an annual income of $40,000. At $500,000, the income declines to $20,000. Will the drop in assets impact your daily living or current activity? If so, consider adjusting your portfolio. But, before you make a major change, let’s look at a few investors – Ginny, Barbara, and Margaret.[2]

Ginny is 100% invested in stocks, so when stocks rise, she’ll benefit, when stocks fall, she’ll suffer. If she invested in the Dimensional Funds Global Equity Index Fund (DGEIX), she would have enjoyed an average annual return of 7.46% for the past 20 years. In 2008, her fund dropped 41.3%. Ginny invested $10,000 in this fund on January 2, 2000; it’s now worth $32,100.

Barbara is more conservative, and she allocates her investments 60% to stocks and 40% to bonds by investing in Dimensional Funds Global Allocation 60/40 Fund (DGSIX). Her fund has produced an average annual return of 6.01% for the past 20 years. Her fund lost 22.7% in 2008, considerably less than Ginny’s account. Barbara invested $10,000 in this fund on January 2, 2000; it’s now worth $25,750.

Margaret is very conservative, so she allocates 25% of her investments to stocks and 75% to bonds by investing in Dimensional Funds Global Allocation 25/75 Fund (DGTSX). Her fund generated an average annual return of 4.26% for the past twenty years. Her fund lost 7.3% in 2008. Margaret invested $10,000 in this fund on January 2, 2000; it’s now worth $19,670. Her fund didn’t lose much money during the Great Recession, but her assets are substantially less than Ginny’s.

To obtain high returns, you need to invest in risk assets, and that means enduring a few years where stocks underperform conservative assets.  If your risk level is high, allocate a significant proportion of your assets in stocks. However, if you’re not ready to lose 50% of your assets, diversify your holdings. A 40% bond allocation reduces risk by 33%, compared to an all-equity portfolio.[3]

A financial plan will help you refine your goals and determine how much money you should allocate to various asset classes. A plan will help you balance your short term needs with your long-term goals. An investor who is too conservative may run out of money when they’re older. Likewise, an investor who is too aggressive may lose their assets during a market downturn. Risk and reward will be forever linked.

Stock market corrections and downturns are normal. Since 1970, the S&P 500 has closed in negative territory ten times or 20% of the time, with an average drop of 14.9%. However, 80% of the time, stocks finished the year in positive territory. A $100,000 investment on January 2, 1970 is now worth $3,196,100.[4]

Here are some suggestions to help you through the market’s turbulence.

  • Don’t panic. Stocks rise and fall every day. If you want to sell, wait for them to rebound. On October 19, 1987, stocks fell 22.6%. In the next two days, the Dow Jones rose by 16%.
  • Diversify your assets. To reduce risk, add bonds and other asset classes to your portfolio. During the decade of the 2000s, The S&P 500 had a negative return, but if you added bonds, international investments, small company stocks, and real estate holdings, your account finished in positive territory.
  • Follow your plan. A financial plan will guide you through a market downturn. It will help you determine how much money you’ll need to fund your goals. It will also quantify your risk level.
  • Examine your risk level. How much risk is embedded in your portfolio? If you’re not sure, give us a call.
  • Look for opportunities. In a crisis, there’s always an opportunity. You’ll probably be early on the purchase, but, over time, your stocks may recover.
  • Don’t time the market. It’s tempting to hunt for bargains, but you’re not going to pick the bottom, so don’t worry about buying at the lowest tick. You’ll know in about five years if you made a wise investment decision or not.
  • Avoid margin. When stocks are falling, avoid margin. A margin balance will magnify losses.
  • Rebalance your account. An annual or quarterly rebalancing will keep your asset allocation and risk level intact.

Today is the eleventh anniversary of the stock market low of March 9, 2009. The S&P 500 closed at 676, and it currently is trading at 2,972 – a gain of 339%.[5] The phenomenal increase follows the bear market loss of 53%. It hardly makes sense to buy during the dark days of a stock market thrashing, but it’s in the depth of despair where you get the best prices. And, to quote my dad, the sun will come up tomorrow.

In the middle of difficulty lies opportunity. ~ Albert Einstein

March 9, 2020

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

 

 

 

 

 

 

[1] Dimensional Funds 2019 Matrix Book

[2] YCharts for the three portfolios – January 2, 2000 to March 9, 2009

[3] RiskAlyze

[4] YCharts

[5] Ibid

There Will be Blood!

There Will be Blood, a 2007 movie starring Daniel Day-Lewis, is based on Upton Sinclair’s book Oil!, published in 1927. Mr. Sinclair’s novel dealt with the struggle of greed and fear that many faced in the early days of the oil industry in Southern California. If Mr. Sinclair were writing his book today, 93 years later, the storyline would probably be similar.

The decline in the price of oil is one of the catalysts for the recent stock sell-off. Below is a look at some of the significant plunges in the price of oil since 1980[1].

  • April 2011, through the recent low, the price of oil is down 71%.
  • May 1980 to April 1986, the price of oil dropped 77.2%.
  • October 1990 to December 1998, the price of oil dropped 74.4%.
  • July 2008 to February 2009, the price of oil dropped 69.6%.
  • November 2000 to January 2002 the price of oil dropped 43.8%

The price of oil declined by 86% from May 1980 to December 1998, while the S&P 500 climbed 1,005%. The 18-year bull market in stocks averaged 17.6% per year. During this run, there were 2,526 up days and 2,193 down days. One of the down days was October 19, 1987, when stocks fell by 25.7%.

As markets remain volatile, stay diversified, focus on the long-term, and follow your plan. And, as a reminder, the stock market has always recovered.  It might take one week, one month, or one year, but it has always bounced back. If you need proof, please look at the following years: 1907, 1915, 1929, 1930, 1931, 1932, 1934, 1937, 1939, 1940, 1941, 1946, 1953, 1957, 1962, 1966, 1969, 1973, 1974, 1977, 1981, 1990, 2000, 2001, 2002, 2008, and 2018.

There is no free market for oil. ~ T.Boone Pickens

March 8, 2020

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and declines depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor. 

[1] https://www.macrotrends.net/1369/crude-oil-price-history-chart, website accessed March 8, 2020

Certainty

We want certainty in an uncertain world. We want to know the weather report, and what’s for dinner, and where we’ll spend our vacation, and how our stocks will perform. If given a guaranteed chance of receiving $100 or a 50% chance of receiving $200, most of us will opt for the certain payout of $100.[1]

This past Saturday Saudi Arabia’s Abqaiq oil processing facility was attacked. The world’s largest oil field can produce close to 10 million barrels of oil per day, and this attack could knock out 50% of the kingdom’s production.[2] Because of the attack, West Texas intermediate crude oil spiked 14%.[3] How do you plan for a strategic strike on the world’s largest oil exporter? You can’t.

In 2016 Dennis Gartman said oil would not trade above $44 “in my lifetime.”[4] Crude oil closed at $61.56 on Monday. He was certain in his prediction.

Last year, Jamie Dimon, the CEO of JP Morgan Chase & Co, predicted the 10-year U.S. Treasury would hit 5%. It currently yields 1.79%.[5] He’s now preparing for 0% interest rates. Mr. Dimon has his pulse on the economy as the CEO of the world’s second-largest bank, and if he can’t predict the direction of interest rates, let alone the level, who can?

I feel sorry for analyst and experts who are forced to give price targets or predictions because it’s an impossible task. However, investors and the media want answers. If an analyst provides a price target, they must know something we don’t. But they don’t. It’s an educated guess. It gives us a false sense of security because we want the assurance that somebody somewhere knows something.

I worked for Morgan Stanley for several years, and after Dean Witter merged with Morgan Stanley, I was talking to an analyst about stock research reports. He said institutional clients focus on the depth of the research while retail investors look to the price target. Retail investors are looking for certainty.

Certainty is safety. If you bought a U.S. T-Bill and held it to maturity, you would never lose money because they offer a guaranteed return. T-Bills have generated an average annual return of 2.3% for the past 15 years while inflation averaged 2%. Stock market returns are uncertain and not guaranteed. The S&P 500 has returned 6.8% annually for the past 15 years, despite a 56% drop during the Great Recession. Certainty and lower returns are linked.

How can you plan for certainty in an uncertain world? Here are a few suggestions.

  • Financial Plan. Your plan will account for uncertainty, chaos, and disorder. The Monte Carlo simulation outlines several outcomes – some good, some bad. Money Guide Pro financial planning software will run 1,000 different scenarios to provide you with a range of possible results. John Maynard Keynes said, “I would rather be vaguely right than precisely wrong.” A Monte Carlo analysis will give ranges that will be vaguely right.
  • Short-term bonds will give you predictability and liquidity. When the world erupts in bedlam, short-term bonds provide a high degree of safety. Bonds and stocks are inversely correlated, so when one rises, the other falls.
  • A cash reserve will give you access to your money without having to sell your stocks when they are down and out. Cash levels vary depending on your situation. A recommended amount is three to six months’ worth of your household expenses. If you’re about to retire, I suggest holding three years’ worth of cash in a money market fund or investing in short-term bonds.
  • A globally balanced portfolio will give you exposure to thousands of securities scattered around the world.
  • Embrace uncertainty. Chaos and disruption allow you to purchase stocks and other risk assets at deep discounts. Buy low and sell high. When others are panic selling, you can buy great companies that should eventually rebound.

The only certainty is uncertainty.

“What you should learn when you make a mistake because you did not anticipate something is that the world is difficult to anticipate. That’s the correct lesson to learn from surprises: that the world is surprising.” ~ Danny Kahneman, Nobel Laurette – Economic Sciences (2002)

September 18, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

 

 

 

 

 

[1] https://www.gsb.stanford.edu/insights/why-uncertainty-makes-us-less-likely-take-risks, by Dylan Walsh, June 1, 2017

[2] https://www.cnbc.com/2019/09/16/aramco-saudi-arabia-attacks-on-oil-supply-wipes-out-spare-capacity.html, by Huileng Tan, 9/15/2019

[3] https://www.cnbc.com/2019/09/15/dow-set-to-fall-on-fears-spiking-oil-will-slow-the-global-economy.html, By Fred Imbert, 9/15/2019

[4] https://finance.yahoo.com/news/dennis-gartman-best-contrarian-indicator-165610794.html, By Wayne Duggan, June 8, 2016

[5] https://www.marketwatch.com/story/jamie-dimon-warns-of-5-treasury-yields-but-sees-stock-run-lasting-a-few-more-years-2018-08-06, by Rachel Koning Beals