The big idea and why it matters: While experiencing volatility in our investment portfolios should make us less concerned about future volatility (antifragility), it’s often not the case. Investors should understandably fear the inability of their portfolio to recover from drawdowns (permanent impairment of their nest egg), which is why we focus significant attention on increasing portfolio robustness.
“Most of the policies that support robust economic growth in the long run are outside the province of the central bank.” -Ben Bernanke
It’s fascinating that a quote like this is on record from Mr. Bernanke, given the very involved role that the Federal Reserve has played over the past few decades. I was going to point out that Ben Bernanke was Fed Chair from 2006-2014 (notably during the entire Global Financial Crisis), but it’s almost unimaginable that someone reading this blog doesn’t know who he is already.
Bernanke’s quote implies that the Fed knows its limitations but attempts to intervene heavily in the economic picture anyway. Regardless, he’s spot on: the Fed cannot create a robust economy for us, nor can it create a robust portfolio for you.
However, today, we’ll continue exploring how to take it upon ourselves to increase our portfolio robustness. Our goal is to find a portfolio in which we can have greater confidence, regardless of what markets throw our way. Spoiler alert: it won’t involve buying index funds and praying for Fed intervention during times of distress. Here we go!
Investing is not like the rest
While investing should be like everything else in our lives, it simply is not. We love sales at stores, but we hate it when our stocks go on sale. We constantly learn from life’s experiences and become stronger because of them (antifragility), but extreme market events have the opposite effect for many investors. I still have clients who are emotionally scarred from the Dot-com bust and even more so from the 2008 Financial Crisis market selloffs. For those of us who managed money through that latter period, it still feels like yesterday, but we’re now 17 years past the 2007 market peak and only days past the 16th anniversary of the collapse of Lehman Brothers. Understandably, it can still feel like a fresh wound for some investors. I sometimes find it challenging to convince my brain it has been that long, though I know the math is correct. It’s time to move on.
The healthy perspective – one of antifragility – is that equity markets have not only survived such moments but have generally thrived since the March 2009 lows. That’s not to say it’s been an easy ride. There has been some volatility and many unsettling items along the way (the Flash Crash, debt crises, wars, wild levels of government spending, more bank failures, etc.). Those seeking reasons for concern can easily find them daily, but there is great power (and wealth to be generated) in knowing that the issue du jour will pass, just as the most dire circumstances – the GFC – did.
Important disclaimer
A vital caveat to the simplistic view that “markets eventually recover” (which is true) is that it is NOT the same as saying “portfolios eventually recover.” Thus, I don’t want the above to imply that I’m dismissive of investors’ genuine concerns regarding market volatility. Depending on one’s spending requirements and the construction of a particular portfolio, the ability to recover after a market downturn can be significantly reduced. And THAT (“permanent impairment of capital” – h/t to David Bahnsen for the phrase) is what we deem the real risk to worry about – not market volatility itself.
Since the significantly positive year of 2023 (S&P 500 up 26.29%) and higher-than-average year-to-date market performance of 2024 (S&P 500 up 21.02%), it feels like the 2022 downturn is far in the rearview mirror. But would you believe that a standard 50/50 portfolio (50% S&P 500 / 50% Barclays Agg Bond) has annualized returns of only 3.37% over the past three years? It has been even more challenging with a global portfolio, as returns have been annualizing at (negative!) -3.36%. Now, imagine an investor with one of those portfolios has a spending requirement of 4% each year. Basic math tells us that their portfolio hasn’t yet fully recovered to where it was three years ago. That’s not fun.
You might say, “But, Steve, I have more than 50% equities or don’t even own bonds, so I’ve done just fine.” That would be true, as the S&P 500 has now returned 29.57% cumulatively (9.24% annualized) over the past three years (and, if you like those numbers, you should ask me what Dividend Growth has done!). For those who felt more exposure to the “tech trade” was a good idea, the Nasdaq is up less than half as much – at 12.74% (4.18% annualized). I’d also bring to your attention the countless people I’ve been in touch with who have been holding inappropriately high levels of cash for years (who have missed out on such returns). In reality, most portfolios will fall somewhere between the various benchmarks above.
But none of that is the point because returns don’t matter in and of themselves. What’s important is why someone owns a given portfolio, what goals it is funding (or failing to fund), and whether it allows them to sleep well at night. We’ll cover all of that next time. Sorry to leave you in suspense, but we still have a lot to get to, and this current edition is getting long enough already (becoming too robust, perhaps? 😊).
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
[Source: Tamarac AdvisorView, data thru 9/19/24; US 50/50 is comprised of 50% S&P500 / 50% Barclays Aggregate Bond; Global 50/50 is comprised of 50% MSCI ACWI ex-US / 50% Barclays Global Agg ex-US. All indices are total return]
