Financial Planning Fridays #108: Stress Testing Your Portfolio

Hi, Friends. We want to talk with you about stress testing your portfolio. This is a critical exercise to complete while the market is doing well to ensure that you are well prepared for the next temporary downturn and ready to continue holding a portfolio that you are comfortable with for the long-term. Stocks have provided incredible returns over the past 100 years but to get the full return, you had to stick with your portfolio through the many temporary declines we have had along the way. Stress testing your portfolio means knowing how much your portfolio would have been down during previous severe market declines. This is extremely important because it can help you to gauge how you may feel during the next big market decline. If you feel like the temporary loss is just too much and you won’t be able to sleep at night, you should consider changing your financial plan and investment portfolio. The S&P 500 has been down 20% or more 6 times during my lifetime with an average decline of 35%. And the average time to get back to even has been about 2 years and 9 months. These severe market declines came suddenly and without warning. It is very unlikely you would have been able to predict or avoid them. However, if you have a portfolio that you have stress tested and feel comfortable with you could have waited out the decline or even better, been well positioned to take advantage of it and added to your long-term stock investments at the temporarily much lower prices. Let’s look at the biggest decline during my lifetime as an example using a popular 70% stock / 30% bond portfolio. During the Global Financial Crisis, the S&P 500 was down 55% at its low. A 70/30 portfolio was down about 45% at its low. It was a very challenging 18 months from the October 2007 peak until the bottom on March 9, 2009. It then took about 2 years for the 70/30 portfolio to get back to even. Now here is the critical part, to get the full long-term return of your portfolio, you would have needed to stick with your allocation during that very stressful time and tuned out all of the news media, neighbors, and family who were selling their long-time portfolios around you. Or even better, continued to rebalance and add to stock during that huge sale. Your reward for being prepared and holding on? That 70/30 portfolio is now worth more than 5 times its value on March 9, 2009. However, and this is extremely important , if you feel now that there is no way you would accept a 45% temporary loss and you would have sold at some point along the way, then you need to seriously re-evaluate your current portfolio because there is a very good chance that we will experience the same market loss again in our lifetimes. Our clients all have beautiful long-term financial plans that have them on a track to reach their life’s goals- selling out of your portfolio during a severe market decline will likely permanently derail that plan which is why we urge you to complete your own stress test. Thank you and we look forward to talking with you next Friday. Be on the lookout for our next Financial Planning Fridays episode. Subscribe to our Youtube Channel so you never miss an episode. Or contact us directly; schedule your 15-minute call with us today.