Tuesday, February 6, 2018

Will the Market Go Up or Down from Here?

The answer is yes. It will go up or down from here.

Whenever the market has a large setback (this one is 7% so far, but it happened quickly and may or may not be finished) many of us feel a responsibility to tell our readers not to panic.

So, here's my advice: don't panic. (I hope to provide more useful advice below.)

To the extent that history is a guide, the market will be higher sometime in the future but no one knows when that will be.

It could be Friday.

On the other hand, stocks took 25 years to recover from the Great Depression and 16 years to recover from multiple financial crises beginning in 1963[1]. It took only six years for the market to recover from the 2007 sub-prime mortgage crisis.

When you read how quickly the market recovers from big losses, it's important to note that a retiree's portfolio is not the market index. It probably took longer for a retiree to recover from those losses than it took the market because she was selling stocks to pay bills during that period. At the other extreme, someone in the accumulation phase might have recovered sooner than the market if they were not spending but instead contributing additional savings during those years.

Saving during your working career is like periodically throwing more money into your retirement boat. Spending from that portfolio during retirement is like owning a leaky boat.

Three more pieces of advice.

It is important to ignore the advice of those who say this is the beginning of a much larger market decline because they can't know; they're only guessing.

It is equally important to ignore the advice of those who say this is a great buying opportunity because they're guessing, too.

Ignore those telling you this is the beginning of a crash. They're only guessing. Also, ignore those saying it's a buying opportunity. They're guessing, too.
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You should pay more attention to experts who simply admit that they don't know. Unfortunately, no one is going to interview them because they're boring.

My wife received a text message from a friend last night. "Mary wants to know if they should buy or sell?" she asked from the other room.

Assuming Mary was really asking if the market will go up or down from this point, my initial answer was that they should go to a movie. After a little more thought, I admitted to myself that I know little about their finances and maybe there are good reasons for them to buy or sell, though short-term market volatility wouldn't be a good one.

"How much of their retirement savings have they invested?" I asked.

"She says all of it."

OK, so that gets my attention. That portfolio would have fallen over 50% during the Great Recession. I couldn't tolerate that but maybe they could. I usually recommend 40% to 60% equity for a portfolio from which a retiree is spending. If there are no known liabilities to match (future bills to pay) with that portfolio, I might go with 80%.

"She says they'll be fine — they survived the 9/11 market crash."

So, three important points. First, the market fell about 14% after 9/11. It rebounded 21% in three months. Hardly the Great Recession's 50% loss and not much of a test of one's risk tolerance.

Second, Mary and her husband were working back in 2001 and presumably saving for retirement. As I explained above, there is a world of difference in recovery time between the accumulation phase and the distribution phase.

Third, Mary is trying to time the market and research overwhelmingly shows that no one can time the market and that you will likely lose even more money if you try to.

I promised to provide some more useful advice, so here it is. After you refuse to panic per my previous instruction, reconsider your risk tolerance. It should be lower after retirement because you no longer have a safety net of new savings contributions and no job, for that matter. Retirement is riskier.

If this recent market crash made you feel a need to sell, then it has done you a favor — it's telling you that your equity allocation may be uncomfortably high. After you weather this market volatility, consider lowering your equity exposure.

I like William Bernstein's recommendation to limit your equity exposure in retirement to the maximum loss you could tolerate in a severe bear market. The following table was published before 2007 in The Four Pillars of Investing but I held 40% equity back then and my portfolio fell only 15%, as he predicted.

Be forewarned that if you held an uncomfortable equity allocation before the downturn and lower it before the recovery, that recovery will take longer. If your portfolio fell precipitously because you were holding 90% equities and you lower that to 60%, it won't climb as quickly as it fell.

Should that happen it will be the result of a previous error — overestimating your risk tolerance. That past mistake may cost something but you can fix it going forward.

Your risk tolerance changes over time and is generally much lower during a market decline than you expected it would be during the previous bull market.

So, don't panic. If you don't feel panicked, then your equity allocation may be just fine. If you do feel a bit anxious, wait until the smoke clears and then think about whether you have underestimated your risk tolerance. Adjust your equity exposure then.

The worst thing you can do is panic and sell at a market bottom, though that is exactly what many people do.

In the meantime, ignore the guessers.


[1] The Dow’s tumultuous history, in one chart, MarketWatch.


  1. No one knows what the market will do, if they make predictions they are just guessing. Thanks for telling us this truth.

    No one interviews people who tell the truth because they are much more boring than people who are certain that they somehow have the crystal ball to predict the future.

    Thanks for saying that as well.

    I can't tell you how much I rely on and enjoy your blog!

  2. "I like William Bernstein's recommendation to limit your equity exposure in retirement to the maximum loss you could tolerate in a severe bear market." I personally like Bernstein's suggestion that if you have won the game (near or in retirement), stop playing. If you are not playing, it seems to me you are a lot less likely to panic in a bear or very volatile (and headline-grabbing) market. If I am not mistaken, he recommends 25% equities in retirement, for potential use in discretionary spending.

    1. Rob, I like both of those strategies, as well. I don't recall reading a Bernstein recommendation regarding a 25% equity allocation in retirement, though. If you can find that reference please share.


    2. Hey Dirk-I ran across it here when I was looking for the quote. Its possible I took it out of context and admittedly I did no reference checking and have not read Mr. Bernstein's books, so if the link isn't correct or good for sharing, that's fine, I'll stand corrected. What I also like was the quote about how to gradually move from 75% equities to 25% starting in mid career-taking money off the table when there was a bull market and standing pat when there was a bear market.

    3. Rob, thanks for sending the link. I've read a lot of Bernstein over the years and I do think you're misinterpreting it. (I had read that CNN interview.)

      First, the 25% is a quote from the blog writer, not from Bernstein, and I believe it is meant as an example and not a recommendation. I don't recall ever reading a Bernstein recommendation for a 25% equity allocation other than the table I referenced in which he recommends 30% equity for extremely risk-averse investors who could tolerate no more than a 10% bear market loss or 20% for a 5% loss.

      He recommends taking money off the table before retirement when "[In the middle of your career] you need to start bailing out of risky assets as you get closer to achieving that liability-matching portfolio—when you can “win the game” without taking so much risk." That means taking money off the table as you approach retirement if and when you have already saved nearly 20-25 times the amount you need to spend.

      Since most households never save that much, most households won't reach the "take money off the table" trigger. That's far different than a recommendation to reduce equity exposure to 25% in mid-career. I believe that little equity exposure that early would doom most savings plans.

      I do believe, however, that equity exposure should be reduced in late career to mitigate the risk of a huge market loss just before retirement.

      Following his advice to put 20-25 times required spending in a floor portfolio would also result in a tiny or non-existent upside portfolio for most households but that ignores Social Security or pensions. I also note that his recommendation for assets in the floor portfolio (TIPS, SPIAs and short-term bonds) is consistent with my recent recommendations, though I believe he once again ignores Social Security benefits.

      If someone in the grocery store checkout line asked me how to allocate their portfolio before and after retirement and I had to give a quick answer, I'd say 80% equities before retiring, drifting down to 40% to 60% over the last ten years before retirement.

      I agree with Bernstien (I can't really remember a time when I haven't) that if a worker were fortunate enough to reach her savings goals by mid-career that she should take some money off the table. But, realistically, how often is that going to happen?

      Thanks for the discussion!

    4. I have found Kitces article on using a "Bond Tent" near retirement very interesting. The early years of retirement are where money would be getting used to replace Social Security if that is being postponed, so locking in those "fixed income" replacements would be critical with safe assets. https://www.kitces.com/blog/managing-portfolio-size-effect-with-bond-tent-in-retirement-red-zone/

      Presumably then the equity percentage after about age 70 or so would be largely a function of how much risk you can tolerate and if you can easily meet your financial income goals with a typical potential range of 20% to 70% equities to select from.

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  4. Excellent post, Dirk. I love the "How Much Can You Lose" chart, just inserted it into a post I'm publishing next Tuesday, with a backlink to this post. Excellent resource, I love your stuff!

  5. Great article Dirk. I’m in complete agreement and if anything, I’m a wee bit more conservative currently in my equity allocation. You may want to check out my recent postings (on asset allocations) over at my Fire Checklist blog: https://firechecklist.net

    1. Thanks. I also agree with your urgency to get rid of debt, by the way.

  6. In his book, The Future for Investors, Jeremy Siegel references the 25 year recovery period after the 29 crash.
    He observes that the long term investor who took no action saw the indexes return to their 1929 levels 25 years later in 1954.
    He observes however that due to the effect of reinvested dividends, by 1944 he has seen his portfolio return to its pre-crash level. By 1954 his portfolio was quadrupled with a CAGR of over 6%.
    Check it out. Pages 139-140.

  7. Keep in mind that there is a world of difference between the recovery of a portfolio from which one is spending to pay retirement expenses and a portfolio with periodic savings and no spending.

    Also, keep in mind that the experience of that investor you mention is not guaranteed to be repeated for you. For example, you are unlikely to experience that post-WWII boom in the U.S. "Past performance is no guarantee of future success."

    And lastly, the investor referred to in that story, Hoyaray, isn't you. You're that investor's grandfather. That investor had decades of a working career to recover. His grandfather retired in 1929. How well do you imagine that he recovered? If you were early in your working career, you'd have a really good chance to recover before retiring, too.