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Wednesday, September 2, 2015

Some Market Perspective

The market has been hit hard. A whiff of panic is in the air. China is slowing down big time and  pundits are parading to the financial news networks to offer their disparate views. This is not new. Every correction feels the same. Every correction feels like the end of the world.

So how bad has it been to this point? Well, it depends. It depends on how you are positioned. Back in 2008 when markets were experiencing a much worse environment retirees talked of losing their life savings. This of course got investors who understand asset allocation principles to scratch their heads and wonder how this could be. After all retirees should have a decent representation of bonds in their portfolio and bonds had a positive return of greater than 5%!

I split the investor world simplistically into accumulators and decumulators. Accumulators welcome the current markets because they are building their nest eggs and thereby welcome the opportunity to buy shares at lower prices. The decumulators are primarily retirees drawing down their nest eggs or are close to drawing down their nest eggs. For them market downturns can be traumatic, especially if they don't understand asset allocation.

So, suppose you are a retiree and are decumulating or close to decumulating. Then one asset allocation you could reasonably consider would be basically 40% stocks/60% fixed income and cash. Here is a proposed allocation by Charles Schwab:

Large Cap Stocks          25%
Small Cap Stocks            5%
International Stocks       10%
Fixed Income (Bonds)   50%
Cash                             10%

A quick point on the percentages. Cash at 10% gives the retiree two and one-half years to weather a downturn assuming the usual 4% drawdown rate before even looking to dividend and interest payments.

So how has this allocation fared to date? Here are the numbers through the close of yesterday 9/1/15:

3 months              -3.68%
year-to-date        -1.71%
12 months           -0.90%
3 years               +5.77%
5 years                +7.02%     

The returns for 3 years and 5 years are average annualized returns. These returns on the overall asset allocation can be pretty closely matched using low cost well diversified index funds and avoiding high cost investment advisor services.

I'm not trying to sugar coat the market correction  but clearly anyone who has been in over the long term should see that the situation isn't as bleak as the fear mongers make it out to be. Surely it is worth recognizing that a one million portfolio has seen a $36,800 decrease in value over a short period and that is enough to cause people to lose a little sleep. Another point is that if someone bailed in 2009 and got back in in the last couple of years they must feel snake bitten. But the evidence shows that jumping in and out generally leads to significant under performance.

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