Can You Survive a Market Downturn?

Paul Winkler: And welcome. This is “The Investor Coaching Show,” talking about the world of money and investing and answering questions as well about that particular topic. We ask the question, paulwinkler.com/question.

Is a Market Downturn Coming?

Now I’m hearing an awful lot, of course, as from time to time this happens, you hear people asking about, “Hey, are we concerned about major financial market crashes? Are we concerned that one is going to happen?”

Of course, we’ve had a few of them in recent memory for a lot of people. That memory has been a little bit too recent.

The year 2008 of course was the last really big one; 2002 was no slouch either. The ’02 one was more due to just really a just lack of diversification for most people, and that’s what we’re seeing a lot now.

We’re seeing people not terribly well diversified, and they think they are because they own funds that are called total market funds or target date funds, and they’re supposed to be allocating it for me, and all of that, but not necessarily the case, not necessarily terribly well diversified.

Matter of fact, there was an article about that very topic. It was somebody who was writing about Vanguard actually lowering their fees on target date funds. And so what does that mean for investors?

And all I could think is, “Well, they have a non-diversified portfolio managing the cheapest area of the market to manage. That costs even less than it did before,” and that’s about all it means. 

So it doesn’t mean a whole lot, but that’s the industry for you.

Makes you think you’re really getting something good. But the general issue is people worry about that. Of course, we had 2020, who can forget that? March of last year.

Actually, I was looking at some videos that I had done. Just going through my website and trying to rearrange the website.

And one of the things that I had seen was a video I had done. “Glass Half-Empty or Glass Half-full” was the headline of the video. And I went back to it, saying, “I wonder what I was saying,” because it was literally at the market bottom when the market had just really tanked late March of 2020.

And there I am talking about the various things that could go right. Because nobody was talking about what could go right. All you heard was, “It’s going to be terrible. It’s going to be nasty.”

And I’m talking during this video about various treatments for COVID that were out there, that were possibly out there. I was talking about pricing of stocks as I often do compared to their book values and how in over 30 years of being in this business, I had never seen prices that low.

It was literally these prices in different areas of the market. International stocks I was talking about in the video were at 50 cents to the dollar, on book value, just unbelievably low. So that was at that point in time, though, everybody’s like, “Oh my goodness, we don’t know what to expect.”

And that is, in general, always what you want to think about in terms of stock markets. You don’t know what to expect. Markets will price stuff based on what is expected.

You Need to be Diversified

And somebody was asking me this week, and said, “Are you concerned we might have a major financial crash and lose everything?”

And my general answer to that is if you really diversify properly, when I talk about diversification, I’m talking about you own some of the big companies, the ones that the mutual fund companies are really enamored with, simply big because it’s a cheap area of the market to manage. You do own some of that stuff, but you also want to own some of the value companies whose price is already low compared to their assets.

And therefore, even if you look back through history, it’s really interesting. This surprised me when I actually saw it. It was one of my designations that I had gone through and they talked about this (a wealth management certified professional designation).

And they talked about how value companies, a lot of times during really big market downturns, don’t go down as much—if they go down at all. I mean 2000, they actually went up. In 2001, they actually went up.

And the reason they don’t go down as much is because they don’t have as far to fall, or maybe the economy shifts to where that area of the market—those segments of the market that are represented by those value companies—those areas aren’t going to necessarily be affected by whatever’s happening.

And the thing that happens with those companies, which makes that surprising, is that these companies tend to be distressed companies. 

And you think distressed companies, the economy starts to get a bit soft. Those should fall further, you would think, and not necessarily the case.

So number one, you look at these diversification platforms and the way you actually go and put some of that money into the value companies, some of the money in small companies, some of the money is going into small value. You may look at things that are causing the market downturn.

For example, there may be things that are likely to cause problems in the economy that don’t affect countries equally. So one country may benefit from what’s going on, or several countries may benefit from what’s going on. It may be the drop in the value of your currency, this case, the dollar.

If the dollar drops in value, it takes more dollars because the dollar has dropped in value. It takes more of them to purchase something that is going to be in a different currency. Because when we say the dollar drops in value, we’re talking about it dropping versus another currency out there. So it will take more of our dollars to buy that currency.

And any time you’re buying something outside the country, you’re going to be converting to that country’s currency, whether it be the yen, the euro, or whatever. And if the dollar dropped in value, it takes more of those to buy it.

Well, if you think of it, if it takes more of it, and your investment portfolio is valued in dollars, then that international thing goes up in value relatively, even if it didn’t necessarily go up. It goes up because you’re looking at it in terms of dollars. It appears to go up, you see? Hence, that’s another thing you got going for you there.

Then you get into emerging market countries. You get into different countries that are smaller and maybe they’re more dynamic than the American economy. Maybe they don’t have the demographic issues that we have.

For example, when we look at demographic issues, the aging of the population can have a negative impact on economics and growth and those types of things. And even when you have an aging population, it doesn’t necessarily mean anything; it’s simply you might have fewer people.

But you’re looking at different markets that you can sell things into that don’t necessarily have that. Hence, you’re looking for economies that may not be necessarily negatively impacted by what’s going on in your country.

Bond Portfolios

But the other thing, the big thing is this: the bond portfolios. Now, this is why bonds tend to be so important for the investor.

You want your really short-term bonds; they’re going to be impervious to anything. Doesn’t matter what happens. Doesn’t matter if interest rates fluctuate wildly. Those bonds will be stable in value.

Now you’re going to get some two-year bonds. Two-year bonds are going to be mildly impacted by interest rate swings because the two-year bond is where you lend money for two years. And you think about it, you’re going to get your money back.

The bond maturity is going to be a very short period of time out, and therefore you’re going to get your money back. And when you get your money back, it’s such a short period of time that any interest rate swings. Because you’re going to be reinvesting the money when the bond matures into something else.

So its swing in value due to interest rate changes is very minimal compared to three-year bonds. That’s going to be a little bit more than four-year bonds, and you’ll have some five-year bonds.

Now when you typically put together a portfolio, I tend to focus a little bit less on the really long maturity stuff. Because of the interest rate risk, if interest rates go up, those bonds can go down, and that can also drive the stock market down temporarily. 

Because companies borrow money, the cost of doing business has increased. Possibly people don’t buy as much stuff when interest rates increase because a lot of times, like it or not, people buy things on credit.

So in essence, what we got to do is make sure that we don’t have too much out there in that area. But where they shine is that when you have big market declines, and all of a sudden now there is a drive to lower interest rates around the world, just to try to stimulate the economy, those bonds can actually shoot up in value.

So you want a little bit of both of those types of things. So your bonds are there to move the opposite direction.

Could I Lose Everything?

So I don’t worry about losing everything because if you think about it, for me to lose everything, when I own a company, that company owns real estate. They own equipment, they have inventories, whatever they happen to sell, they’ve got an inventory on whatever they sell.

So in effect for me to lose everything, that would mean that every company around the world that I have in my portfolio, which me personally it’s somewhere in the neighborhood of 15,000 to 20,000 companies, every one of those companies would simultaneously have to go bankrupt and have no value left over. Their land would have to be worth nothing.

So for that to happen, that would be … we probably have bigger problems on our hand if that actually happens.

So we look at that and say, “Okay, big market downturn.” In market downturns, you’ve heard me say this before, possibly, that they don’t typically last all that long in historical terms. Since 1946, the average amount of time before the market recovers back to its previous point was about 111 days.

That means sometimes it’s longer; sometimes it’s shorter. Average, it’s going to be some longer, some shorter, but average about 111 days, not forever.

But how many times do markets go down in a given year? Well, if you look at 5% downturns, it’s about three times a year on average, 5% downturns. 

So you look at that and go, “Wow, that’s a lot.” A lot of times we see downturns that are of that magnitude: 10% downturns once a year. And if you look at 20% downturns, it’s about every six years.

So 20%, I mean if you think about it, you got a $100,000 portfolio, it’s down $20,000. You got a $1 million portfolio, down $200,000 on average every six years, whether you like it or not.

Really, really big downturns, like the Great Depression, and then you got ’73, ’74 and then about every 40 years or something like that. It’s just a huge, huge downturn, but they’re going to happen, and you just don’t know when they’re going to happen.

And what makes them go down is an important thing: this brand-new news. So if you’re saying, “Hey, are we going to have a big downturn?” I don’t know. Nobody really knows.

You have people that act like they know. You have people out there saying, “Oh, I think because of what’s going on in Europe right now and what’s going on with COVID, this is what’s going to happen.”

You’ll have people that have opinions, and they’re throwing junk out there because if they throw something against the wall and it sticks, they’re famous for a long time. 

So it’s worth the risk of being wrong because here’s the thing, the media, and I don’t know if you notice this, but when somebody is wrong, rarely do they ever hold their feet to the fire.

They want the guests to come back and talk about what their next prediction is. Now they may give lip service, “You kinda missed this one a little bit.”

And then the person, “Well, yeah, this happened. Didn’t expect that and blah, blah, blah.”

And they’ll have some reason that they missed and they blew it. But in general, you don’t get a whole lot of pushback when they’re wrong, when it really gets down to it.

So one of the things that you do with your investments is that you really base it on when you’re going to need the money back. Time horizon is a big deal.

And if I’m out there, 20, 30 years, I’m not going to be using this money. I’m not going to be living off of it. Your time horizon is very long—who cares about market downturns?

For 111 days, even if it’s three years for the market to recover from the downturn, or five years or six years, you look back at the Depression, you had 1929 and took you to 1938 for it to actually completely come back. And then World War II and all of that, you had a little bit of a dip, and then it came back up.

You look at that and go, “Ah, you know what? Big deal. I’ve got a long time. I don’t worry about that.”

And if you’re older, you’re getting closer. You’re starting to add those bonds in because they tend to mitigate some of that risk. And you’re adding some of that back in so that you don’t have the full weight of the market downturn on your shoulders. 

And then when you’re right at retirement, you might have 40–50% of your portfolio sitting in bonds. That’s someplace you can pull money from, you can pull income from, to buy you time for the stock market to come back.

And you look at it, and you say, “Wow, I don’t know what’s going to happen next,” and I always say that you never know what’s going to happen next.

Brand-New News

It’s always brand-new news.

Stock prices are reflected in, if you actually look at how they’re set, it’s the present value of all the future earnings of the company. So you have quite a job on your hands trying to figure out what all those profit streams are going to be for the company going forward out in the future.

So you’re looking at this terrible task that investors have to figure out what proper pricing is, and nobody really knows, but everybody votes as to what they think is going to happen next. And that’s what pricing comes in at.

And there’s new news coming out every single day that is setting that price. Now, when the news comes out, it may be something terrible. And then two weeks later you go, “Oh, it’s not nearly as bad as we thought it was going to be.”

And if you’re one of those people who sold out, you’re sunk. You’re sunk because you sold out; you sold to somebody else that took the risk off of your hands.

And that is why so many times we see, and we look at investor returns and the results that they get with their investments, and they’re so visibly poor. And it’s because the investment advisors, the investment community, get fooled by it as well.

It’s very easy because you’re worried about losing a client to go and say, “Oh, don’t worry, Mrs. Jones. I’ll go and put more of your money in this over here. And we’ve done that.”

And you don’t realize that they went and sold after the fact, after it went down, and then they bought the bonds, and then the stocks came back, and then you’re sunk. You lost it. You missed out on the upturn.

And as I’ve often said, if you look back through history again, 2.2 days since the 1960s, 1963, to be exact, till now, 2.2 days out of every year, give us 100% of the return of stocks, historically. It’s just unreal.

So market downturn, big crashes, and those types of things, I have no idea. Now on the other hand, for those who are sitting around waiting for a market crash to go and invest, you don’t want to do that either.

Studies show that people lose more money waiting for a downturn where they can rebuy at a lower price, than they ever would if they just went in and took some of the market downturns in stride. So you don’t want to do that either.

Literally both of those things are called tactical asset allocation, which is a form of market timing, and it doesn’t work.

We know why? Because investors are stupid? No, it’s because they’re so well informed, generally investors are so well informed, the people that are buying and selling your stocks on a day-to-day basis, they do nothing but trade in that particular company.

If they’re a market maker for Coca-Cola, that’s what they do all day long. They buy Coca-Cola and they don’t want to buy and sell it. They don’t want to pay too much for it when they buy it; they don’t want to sell it for too little.

So perish the thought of trying to get some inkling as to when markets are going to go down. Just make sure your asset mix and your time rise, and if you’re in retirement, you might be 50–60% stocks, and that’s it. And then the rest of it is fixed income.

You don’t try to be a hero. You make sure the time horizon matches what your time horizon is for taking an income and your portfolio mix matches that. And that’s the idea, that’s the best you can do.

But try to figure it out? Yeah, you can’t. Because the reality of it is, it’ll be something totally out of the blue that causes markets to go down. That’s the way they work.

It’s usually not, you’re sitting there looking at one thing and going, “Boy, I’m really watching interest rates,” or, “I’m really watching the inflation rate to see how that’s going to affect stocks and what’s going to happen.”

And then all of a sudden it’s COVID that knocks the stock market down. No way to know. No way to know. And the reality of it is, we can’t know because it’s based on unpredictable and unknowable news. 

So one of my most popular videos out there, we were looking at this week, is on Facebook. We actually had this video, and it was on … I’m too old for this. It was people worrying about anticipating stock market downturns.

And it was a video I did a while back, a little while back, and it had 54,000 views. So a lot of people do worry: “As I get older, I can’t, I don’t have time for this. I don’t have time to recover from a market downturn.” And I walk through every market downturn through history and how long it took to recover and what actually caused the downturn and how different the things were, how different the events were.

And that’s something you can go out on the internet and check out. I think it’s even on my website, paulwinkler.com. So anyway, thanks for the question. And if you’ve got a question, paulwinkler.com/question, that’s how you ask questions for the radio show.

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