You’ve heard it before:
Defense wins championships. Think about the nicknames that great defenses have gotten in the past: the Steelers’ “Steel Curtain”, the Cowboys’ “Doomsday Defense”. A large part of why the Broncos won Super Bowl 50 was the play of their defense, led by MVP Von Miller.
It’s true that everybody loves to watch great offensive plays – the Home Run Derby, the Slam Dunk Contest, a shoot-out like the Rams vs Chiefs in 2018.
But make no mistake: Defense Wins Championships.
The same is true in your investments. Yes, the market was on an nice run the past decade. It also did that in the ’90s and the mid-2000s. Everybody loves those times (and everybody’s a genius in those times).
But what happened in 2000 and 2008? The market lost 57% of it’s value in the Financial Crisis, and took over 3 years to recover. It lost almost that much during the dot-com crash (the Nasdaq lost over 70%), and that time it took over 4 years to come back.
In fact, from August of 2000 to December of 2010 the market only spent a total of 18 months above its pre-crash high. That’s only 18 months in profitable territory in over 10 years:
Riding out the next grinding down market just to make a decent return is not a plan.
Yes, the market could continue up to new highs from here, and you want to be sure and take advantage of profitable periods, but you also need a plan to miss those massive drops. See, investors often get caught up in big bull markets like we had the last several years. They chase returns and take on way to much risk.
Most institutional portfolios are badly out of balance. The returns of most institutional portfolios are 90+% driven by the return of equities, exposing them to a single adverse event which could last for decades, a poor performing equity market….not balancing the portfolio is so risky as to be imprudent.
–White Paper, “Risk Parity is About Balance”, Bridgewater Associates
Remember, the goal shouldn’t be to beat the market every year or to squeeze the last bit out of an aging bull market. Some better goals are to (1) avoid deep losses (to preserve capital) and the be able to (2) take advantage of opportunities when they present themselves.
None of the traditional investment advice discusses any defense at all – it doesn’t protect your downside. The best it can offer is for you to just lose “a little less” than the market in the next downturn.
To put this into perspective, findings published in U.S. News & World Report found that in 2008, during the Financial Crisis, the average stock fund lost 41%, while “diversified” funds lost 38%. The article actually laughably says,
If your stock fund loss less than 38% in 2008, you’re gold.
(USN&WR, 01/07/09)
I don’t know about you, but someone saying, “Well, the market was down 41%, but you were only down 38%…” is not very comforting when you just lost more than a third of your money.
The point is this: Your investment approach must account for the truth that there are going to be large drops in every market, and that traditional “diversification” alone is not enough.
And as I often say, it’s not about predicting, it’s about preparing.
Here’s three things you should do now to start to prepare:
- Assess your current portfolio. Find out what your invested in now – what fund, asset classes, and percentages. Talk to your advisor (or read up on your robo-advisor’s approach) to see how they plan to prepare for a possible downturn. And then see how your portfolio, and their plan, would have done in previous bear markets. If you’d like more on this, check out my previous post, We Need to Talk: 4 Qs to Ask Your Advisor to be Sure You’re Prepared for the Next Market Downturn.
- Get liquid. Consider lowering leverage, raising cash and taking a look at any investments that are very illiquid (that aren’t very long-term or aren’t designed for volatile, falling markets). Any leverage or margin should be your first target – if you get caught in a down market, a la 2008, that leverage can multiply your losses. Also, be sure you have enough cash so that you don’t have to worry about waiting through the inevitable, eventual downturn.
- Watch your winners. Often, especially late in a bull market, many portfolios become dangerously out of balance. There’s a couple of reasons for this. First, when parts of a portfolio do well – they increase in value – they start to constitute a larger and larger percentage of the overall portfolio. This can increase the risk that an adverse move in just a few securities or investments can cause a large loss to the portfolio as a whole. The second reason portfolios get out of balance is our tendency to fall in love with certain stocks or investments. This might be your employer’s stock (I know a few Amazon employees that this applies to), or one that’s done well and makes you feel pretty damn smart. Regardless of the reason, if you have a position that’s beginning to take up an outsized percentage of your overall portfolio, consider taking some of those profits and reallocating them or keeping the cash for the next opportunity.
And finally, don’t make the mistake of thinking, “Well I’ll think about this when the market starts to turn.” Now is the time to prepare for what could be coming next.
A successful businessman asked to talk because he was thinking about how he could protect himself in case the markets turned. I visited him at his office and we were discussing his concerns about the markets, and I found that he had all of the typical investments through his financial advisor, he had savings, 401k, etc.
We discussed all of this for a bit and maybe you can guess what he said next. “Well,” he said, “when the market starts to turn, then I’ll do something.”
Maybe you’ve thought that yourself. Those are Famous Last Words.
Remember, as we talked about earlier, it’s not about predicting what the market will do, it’s about preparing for it. You don’t run out and buy smoke detectors and a fire extinguisher when your house catches fire. At that point it’s too late.
So take the time to assess your current investments and, if you find them lacking, do the work to make sure your prepared.
If you’re looking for a strategy that is designed for up and down markets, at Taylor Morgan our full, proprietary investment approach does just that:
- We assess 61 assets classes and sub-classes all over the world for the best opportunities.
- Our defensive algorithms monitor every position to protect profits and avoid losses – we are sometimes 100% in cash when conditions warrant.
- Our quantitative futures component can make money in up or down markets.
If you’re interested in the possibility of avoiding the worst of a coming bear market and even the possibility of profiting during challenging times, we’d love discuss our investing approach and see if it’s a fit.
Please leave a comment, question, or get in touch. We’re here to help.