Retiree Portfolio Calm for the Storm: Asset Allocation

When the stock market goes into a prolonged decline, investors ask, "How long will this last?" Our only (albeit imperfect) instructor is history. There have been nine bear markets in the last 50 years. In the worst, it took 90 months, or 7 1/2 years, to go from the market peak to the bear's trough and back to the former peak. What's an investor to do? Allocate your assets.

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By David Braze (TMF Pixy)
September 17, 2001

With the Dow trading at 1998 levels, it seems we're in the midst of a bear market, i.e., a prolonged market decline of 20% or more.

According to Yahoo! Quotes, the Standard & Poor's 500 is down 31.9% from the high it reached on March 23, 2000 (1527 then versus 1040 as of this writing). When this bear market will end is anyone's guess. Let's see what history has to say.

Over the last 50 years there have been nine bear markets.

The longest time from peak to trough to peak was 90 months (from 1973 to 1980). The bear market itself lasted 21 months, but from that bottom it took another 69 months to regain previous market value. Note that the average loss was more than 28% 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 17%, but twice (due to the nasty '70s) there was actually a loss.

Recovery From a Bear Market

Mos. from Gain/loss peak to 5 years Peak Decline Recovery peak 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%
Averages: -28.27% 31 16.96%
Source: Yahoo.com Finance Historical Quotes
The investor's salve: asset allocation
These bear market statistics are why we say repeatedly in various places throughout Fooldom that no money you know you will need to spend 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 a five-year cushion of any needed income from savings set aside, my remaining assets are invested in the stock market.

Where does the five-year stash go? Into things like money market funds, Treasury bills, certificates of deposit, and short- to mid-term bonds 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 cash in stocks at a low point, which would deplete my lifetime savings far quicker than I desire. (For more information on where to put your non-stock money, check out our Where to Stash Your Cash Crash Course and the Short-Term Savings Center.)

It should be apparent that what I'm talking about is asset allocation. Asset allocation entails the investment of 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 somewhere between the other two. Having money in all three areas minimizes downside risk while achieving portfolio growth. (Feel like you need objective, personal feedback on your own asset allocation? Check out TMF Money Advisor.)

What now?
So does this mean you should immediately do the asset shuffle -- selling investments here, buying investments there? Probably not.

The market is unsettled right now, and even the big boys aren't sure what to do -- except that many seem to be selling today. That may work for them, but it's probably downright (f)oolish. Unless your analysis reveals that the long-term prospects and fundamentals of your investments have changed, it seems prudent to simply hold what you have. Additionally, you might consider delaying purchases for a while until the market settles down -- unless, of course, your analysis again reveals some true bargains based on your long-term projections and the business' fundamentals.

Have questions? We have answers -- on the Retired Fools and Retirement Investing discussion boards.

Best to all... Pixy

Dave Braze has neither sold nor bought shares during the past three months. He probably won't buy or sell anything for the next three days, either. The Motley Fool is all about investors writing for investors.