Calm for the Storm: Asset Allocation

This article was first published on Sept. 17, 2001. It has been updated.

What gives with this stock market? It keeps bouncing around, but the one thing it seems not to do is to go up with any consistency. According to Yahoo! (Nasdaq: YHOO  ) Quotes, the Standard & Poor's 500 is still down 24% from the high of 1527 it reached on March 23, 2000. When this market will finally recover is anyone's guess. Let's see what history has to say.

Over the last 50 years there have been 10 bear markets counting the one we just had. Indeed, some might argue we're still in it. Regardless, in all those market declines, the longest time from peak to trough to peak was 90 months (from 1973 to 1980). That bear market took 21 months to reach its low, but from that bottom it took another 69 months to regain the previous market high. The chart below shows that the average bear market loss was more than 30% and the average time from peak to peak was 31 months. And, perhaps even more importantly, from the start of a bear market (i.e., at the former peak), five years later the average gain was nearly 12%, but on three occasions there was actually a loss.

Recovery from a bear market

Peak Decline Recovery

Mos. from
peak to peak

Gain/loss 5
years from peak
8/2/56 -21.47% 9/24/58 26 34.85%
12/12/61 -27.97% 8/3/63 21 14.26%
2/9/66 -22.18% 5/4/67 15 3.67%
11/29/68 -35.91% 3/6/72 39 -10.00%
1/11/73 -48.20% 7/17/80 90 -25.37%
9/21/76 -19.41% 8/15/79 35 8.73%
1/6/81 -25.85% 10/20/82 22 52.51%
8/25/87 -33.51% 7/26/89 23 22.22%
7/16/90 -19.92% 2/13/91 7 51.75%
3/24/00 -49.15% n/a n/a -27.77%*
Averages: -30.36% 31 12.49%

Source: Finance Historical Quotes
* Only 55 months; return data still included in averages

These bear market statistics are why we say repeatedly in various places throughout Fooldom that no money you know you will need to take from investments within the next three to seven years should ever be invested in stocks. If you're an aggressive investor, then a three-year reserve should remain out of the stock market. Conversely, if you're a conservative investor, then a seven-year cushion should suffice. I'm partial to a five-year period myself. Once I have set aside a five-year cushion of any cash I must take from savings, my remaining assets are invested in the stock market.

Where does the five-year stash go? Into things such as money market funds, Treasury bills, certificates of deposit, and short- to mid-term bonds, or bond funds where it can still earn interest but avoid most of the volatility found in the stock market. By doing that, I don't need to sell stocks at a low point, which would deplete my lifetime savings far quicker than I desire.

The concept I'm talking about is known as asset allocation. Asset allocation entails investing part of a portfolio into each of the three primary investment markets: stocks, bonds, and cash. In theory, these markets do not move together. As one is at a high, another is at a low, and the third is in between the other two. Having money in all three market areas minimizes downside risk while achieving portfolio growth.

So does this mean you should immediately do the asset shuffle -- sell investments here to buy investments there? Not necessarily. The market remains unsettled, and even the big boys aren't really sure what to do. Unless your analysis reveals that the long-term prospects and fundamentals of your investments have changed, it's probably prudent to simply hold what you have. I suppose you could consider delaying any purchases until the market settles down -- unless, of course, your analysis reveals some true bargains based on your long-term projections and the business' fundamentals.

Some folks may take more risk, and others less. That's an individual choice. The only thing I know for sure is that keeping three to seven years' worth of needed investment withdrawals out of the stock market does much to preclude a nervous stomach when the market inevitably falls, and fall it will. In my opinion, it's an approach that will work reasonably well for any investor, retired or not.

Longtime Fool contributor David Braze is all about retirement. He is thrice retired, but still finds time to answer questions for subscribers to theRule Your Retirement newsletter service. The Motley Fool may be all about investors writing for investors.

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 503310, ~/Articles/ArticleHandler.aspx, 6/25/2017 11:52:34 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 2 days ago Sponsored by:
Change down DOW 21394.8 -2.5 0.0%
Change up S&P 500 2438.3 3.8 0.2%
Change up NASD 6265.2 28.6 0.5%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

12/31/1969 7:00 PM
YHOO $0.00 Down +0.00 +0.00%
Yahoo CAPS Rating: **