The scariest part about a drop in your portfolio isn’t the amount that it’s gone down. It’s wondering how much further it could go.
There are several important things to understand about a decline in your diversified stock portfolio:
✔️ how often it’s happened
✔️ how big the declines have been
✔️ how long it’s taken to recover
Knowledge of these things—realizing declines are common and relatively short-lived while rebounds are inevitable and last much longer—can help set your mind at ease. It can keep you from making a rash decision to bail out, which could feel good in the moment, but wind up badly burning you in the long run. Want to learn more about these aspects of investing, or just refresh your memory? I just covered them last week in this article.
But all of that analysis is general. And it’s backward looking. It doesn’t tell you anything about the future or what we are living through today. That a -10% decline, let’s say, is not likely to turn into -20% (or -20% isn’t likely to turn into -30%), doesn’t change the fact that it could, and this time (like all times), feels different.
To overcome this dread, you need one more piece of the puzzle. Brace yourself, because what I’m about to say is going to sound crazy.
You need to understand that the amount of the actual decline DOES NOT MATTER.
How can that be? How can I be so cold and callous? Because of this simple fact: the more a diversified stock portfolio goes down, the more it tends to bounce back. You tend to get to the same place regardless.
This isn't just a hunch. I looked at all temporary declines on an all-stock asset class portfolio of at least -5% from 1995-2024. There were 17 in total that we have sufficient data to measure multi-year recoveries.
- SIX times we saw losses of-10% or less, the next 12 months averaged +11.1% gains and the next 3 years averaged +13.1%/yr gains.
- SEVEN times we saw losses of between-10% and -20%. The next 12 months averaged +23.7% gains and the next 3 years averaged +16.5%/yr gains.
- FOUR times we saw losses of greater than-20%. The next 12 months averaged +51.6% gains and the next 3 years averaged +25.3%/yr gains.
Catch that? The worse the decline, the bigger the bounce back. It’s the rubber band effect.
In fact, looking at every decline (each of a different duration) and then adding three years, we find the annualized return an investor earned was +8.7% per year gains during all of these periods, and +7.6% gains during just the worst four declines. That’s right—gains, despite the bad start. And average annualized gains that look virtually the same no matter how bad the start was.
Try to relax, and avoid watching the financial (or any) news and obsessively checking your portfolio balance. I never advise clients to look at anything but their quarterly snapshot. I know that might not be realistic but try for something closer to that than daily. We simply can’t know how long or how far this decline will last. And that’s no different from past declines. But we can be confident that if we hold tight we will recover, the magnitude of the gains should be proportional (a better term, in my opinion, than reciprocal) to the decline.
As long time clients have experienced countless times, and newer clients are on the path to learning, "This too shall pass" is still undefeated.
Please don't hesitate to reach out if there is anything you'd like to talk about. You know I'm here...
______________________
All-Stock Asset Class Portfolio = 21% DFA US High Profitability fund (DFA US Large Company fund prior to 7/2017), 21% DFA US Large Value fund, 28% DFA US Small Value fund, 18% DFA Int’l Value fund, 12% DFA Int’l Small Value fund, rebalanced annually.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.