In the wake of the Covid-19 outbreak and the significant decline for stocks in the first quarter, many investors took dramatic steps by selling out. Others held on to their investments but stopped contributing future savings. Neither is ideal. If we use past declines as our guide, there are a few proactive steps that you can take to lessen your portfolio pain and be better prepared for the future.
First, rebalancing some of your portfolio from bonds to stocks can help you recover more quickly when bear markets subside. If you don’t own bonds, but have idle cash that you won’t be spending in the next year or two, adding that to your stock portfolio can also help. At the very least, staying invested in the stocks you own is far better than bailing out.
Second, staying balanced and sticking with a globally diversified, small cap and value "tilted" portfolio, despite its recently disappointing results, can increase your expected returns and help you recover lost ground more quickly when compared to shifting more to US large cap growth stocks that have held up better recently.
Let’s look at the worst bear markets in the last several decades to see how these steps would have helped.
From January 1973 through September 1974, the S&P 500 Index experienced its largest decline since the 1930s, losing -43%. As the bear market looked like it would extend into a third year, investors no doubt found the safety of bonds more appealing--the One-Year Treasury Note Index had gained +12% over the same period.
But the next five years saw a dramatic recovery for stocks with minimal gains from bonds. Rebalancing some of your bond allocation back into stocks in 1974 would have helped you recover lost ground more quickly. While the One-Year Treasury Note Index gained only +41, the S&P 500 gained +117% from October 1974 through September 1979, and every $1 invested grew to $2.17 vs. just $1.41 for bonds.
A globally diversified stock index recovered even quicker. The Dimensional Equity Balanced Strategy Index, which includes small cap, value, and international (small cap and value) stocks gained more than twice as much. Over the same period, it returned +260%, and every $1 invested grew to $3.60. Staying diversified was the most successful strategy of all.
From April 2000 through September 2002, the S&P 500 Index experienced a bear market almost identical to 1973-1974, losing -44%%. Bonds held up much better as interest rates were significantly higher back then--the One-Year Treasury Note Index gained +17% over the same period. The urge to sell stocks and shift to safety was overwhelming.
But the next five years once again saw a dramatic recovery for stocks with minimal gains from bonds. Rebalancing some of your bond allocation back into stocks in 2002 would have helped you recover lost ground more quickly. While One-Year Treasury Notes earned just +15%, the S&P 500 gained +105% from October 2002 through September 2007, and every $1 invested in stocks grew to $2.05 compared to $1.15 in bonds.
Once again, a globally diversified stock index recovered even quicker. The Dimensional Equity Balanced Strategy Index gained almost twice as much as the S&P 500. Over the same period, its return was +198%, and every $1 invested grew to $2.98. Not bailing out of small cap, value, and international stocks despite the 2000-2002 bear market losses, as well as a dramatic five-year period of underperformance in the 1995-1999 bull market, proved to be quite prescient.
Most of us remember 2008--the worst stock market loss since The Great Depression. From November 2007 through February 2009, the S&P 500 Index declined -51%. In just 16 months, every $1 invested in stocks was more than cut in half. Bonds once again held up--the One-Year Treasury Note Index managed a gain of +3%. Nobody wanted anything to do with stocks by the end of this bear market; even lower-quality corporate bonds were seen as too risky after double-digit losses.
But the next five years once again saw a dramatic recovery for stocks with minimal gains from bonds. Rebalancing some of your bond allocation back into stocks in 2008 and early 2009 would have helped you recover lost ground more quickly. While One-Year Treasury Notes earned just +6%, the S&P 500 gained +182% from March 2009 through February 2014, and every $1 invested in stocks grew to $2.82 compared to $1.03 in bonds. This despite the fact that we experienced another steep decline in 2011, with the S&P 500 falling -16% from May through September 2011.
And once again, a globally diversified stock index recovered the fastest. The Dimensional Equity Balanced Strategy Index gained noticeably more than the S&P 500. Over the same period, the Dimensional Index returned +224%, and every $1 invested grew to $3.24. Staying committed to a broadly diversified portfolio with increased exposure to small cap and value stocks globally, despite a greater decline in 2008 (-59%) and a bigger set back in 2011 (-22%), was unquestionably the smartest move.
During extreme market moves and worrisome headlines, many investors want to make changes so they feel better about "doing something" or avoiding potential future losses. But there's never a more important time than today to stick with core investment principles like rebalancing, dollar-cost-averaging, and broad diversification. Owning too many bonds during a recovery can inhibit your ability to regain lost ground. Buying more stocks from the partial sale of bonds or from additional cash reserves is the easiest way to eventually get ahead. Staying diversified across global stock markets and including small cap and value stocks is equally important. They've fallen farther in this bear market but usually, the asset classes that get hit the hardest are the ones that recover most quickly. After all, the best defense is a good offense.
Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.