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Preparing for the Next Market Downturn

by Larry Gray

US Capital Wealth Management provides some interesting insights in its May 5, 2017, Market Insights. The issue focused on preparing for retirement and preparing for the next stock market downturn.

The firm conducted a survey of its readership to determine the probability of a major bear market — greater than 30 percent market decline — occurring in the next five years and how investors are preparing to handle this potential challenge.

Roughly 70 percent of the respondents indicated the chance of a major market decline in the next five years is 70 percent or greater. The most popular choice for how to prepare for the next bear market was to hold cash, which received 40 percent of the vote.

The email newsletter went on to present several retirement funding scenarios that included holding cash, a portfolio that generated a 5 percent average annual return and a portfolio that earned a 7 percent return. Through their examples based on a $500,000 portfolio, they showed that the all-cash option would fund 10 years of retirement, the 5 percent portfolio would provide 20 years of fully funded retirement, and the 7 percent portfolio would fund 40 years of retirement.

The question is then asked: Is a 7 percent return from investing in equities a realistic assumption? Imagine that it is 2007 and you decide to put all of your money ($500,000) into the S&P 500 and reinvest dividends. In 2008, the market lost 37 percent of its value. What was your average annual return over the next 10 years?

Even if you had invested your portfolio at almost exactly the wrong time (a year before the Great Recession), you still would have made a 7 percent average annual return.  Since 1928 when the S&P 500 index began, the average annual return is approximately 9.5 percent.

The bottom line conclusion: Holding cash is not the answer.

The firm did recommend 1) establishing a system of rules-based investing to set a non-emotional sell threshold and minimize losses; 2) investing in alternative assets that are not correlated to the stock market and have an acceptable risk-return profile.

 

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