Asset Allocation in the Most Painful Month

Psychology, Featured, Portfolio Talk

As the entire world locks down in reaction to the ongoing coronavirus pandemic, our number one concern as a group is mutual solidarity in saving lives. But the ultimate impact of the tiny COVID-19 virus extends so far beyond the immediate health toll. The disruption to our global economy required to prevent its spread is having profound, deep-scarring effects on the everyday lives we take for granted. Entire industries are closing their doors, countless people are losing their jobs, and any short-term treatment for the disease may simply be a prelude to a much longer financial road to recovery.

So as we shelter in place taking care of our families and waiting for the worst to pass, it’s natural to count not only our stock of food in the pantry but also our collection of stocks in the market. No matter how you invest, I wager it isn’t pretty. It’s not just you. There’s no hiding from the turmoil, and we’re all feeling the pain.

The resulting anxiety prompts normally self-confident investors to suddenly get very curious about how others are doing in the same situation. I get it. So let’s talk real numbers and put the current financial crisis in perspective for different types of portfolios.

A Note on Methodology

Data like this is only as good as the underlying assumptions, so here’s a quick rundown on how everything is calculated.

While Portfolio Charts is built around year-end annual returns and doesn’t normally deal with daily data, I did a bit of extra work to gather recent returns for each asset in order to model the nosedive of each portfolio. I’m going to stick with US-based portfolio data for simplicity, and the timeframe covers the 30 days between the market peak on February 19th and the market close on March 20th. That marks a full month of financial chaos.

All numbers are from ETFreplay, and I collected the returns of representative index funds before calculating the portfolio performance manually assuming they were perfectly balanced at the beginning of the period. Of course that means your own returns may be a little different than what you see for the same portfolio, but it’s a reasonable benchmark for relative comparisons.

Got it? Then let’s jump right in.

Relative Portfolio Losses

Here’s how every portfolio on the site performed over the month immediately following the market peak. As you can see, not every portfolio has been equally affected by the crisis.

There’s no surprise that the worst portfolio of the bunch was the total stock market. Diversifying among thousands of companies may sound impressive, but stocks tend to all fall simultaneously in a crash and the stock market has been brutal the last month. Watching a third of your money evaporate on paper in 30 days is no joke, and I can understand why aggressive stock-heavy investors are on edge.

While no portfolio can claim to post a gain, three do stand out above the rest. The Permanent Portfolio, Larry Portfolio, and All Seasons Portfolio all lost less than 10% even in this extremely difficult timeframe. That’s pretty impressive, especially since stocks have dropped more than 10% per day a few times recently! How did they do it? Notably lower allocations to stocks certainly helped, but specific allocations to things like long term treasuries (+9%), intermediate treasuries (+4%), T-bills (+.6%), and gold (-7.7%) helped offset the losses and even respond positively in the crisis. That’s true diversification at work.

Coming in fourth is my own Golden Butterfly, with a manageable sub-15% loss but a little more than some might have expected for something so similar to the Permanent Portfolio. More stocks than the three leaders along with a healthy allocation to SCV (-42%) nudged the total loss a little closer to the pack, but the overall result is still not bad.

Nobody likes losing money. But while every loss hurts, the pain is relative. Investors in any of these four portfolios probably feel pretty good right now compared to the gnashing of teeth in the financial media over the stock market. They’re less likely to sell at a loss and more likely to stay the course while reaping the benefits of the eventual recovery.

A Familiar Defensive Theme

While that may seem impressive on the surface, it’s fair to ask how this information is actionable. After all, the best portfolios are always obvious in hindsight and for all we know those top portfolios just got lucky based on current circumstances that won’t repeat. Is choosing a portfolio based on one month of data really a good idea?

It’s definitely not! But hear me out.

Long-term readers may recognize that list of four portfolios from another article I wrote last year exploring the concept of recession-proof portfolios (link below). The entire article is especially relevant today, but here’s just one chart that will look very familiar. Rather than looking at only one investing timeframe, this studies all of them and ranks the deepest compounded drawdown for every portfolio since 1970 (using year-end data).

Do you see those best four portfolios at dealing with recessions? They may be in a slightly different order, but they’re the same four portfolios that did the best over the last month. And it’s definitely not a coincidence or a unique phenomenon in the United States. Their strong performance even in the worst times to invest is a direct result of their underlying portfolio philosophies.

You can read in depth about how these portfolios work here:

The Top-4 Portfolios to Recession-Proof Your Investments

The short story is that they are specifically designed to handle any situation, and each author attacks the problem of minimizing downside risk in their own unique way. Harry Browne wrote about fail-safe investing, Larry Swedroe talks about reducing the risk of black swans, Ray Dalio is an industry leader in investing for all seasons, and while I’m not in the same stratosphere I spend a lot of time trying to educate people on things like noise-cancelling portfolios. It’s a very different mindset compared to your old-school stock/bond/glidepath crowd and incorporates simple but sophisticated modern risk-management techniques that can help investors of all types.

By the way, I had no idea the rankings would shake out like this before I ran the numbers. But the results don’t surprise me. While no portfolio is perfectly predictable, some portfolios really are more trustworthy than others. Anyone looking for ways to minimize volatility over both short and long timeframes can learn a lot by studying the thought leaders in that area.

What’s Your Real Risk Tolerance?

You’re a clever bunch, and I already know what a few of you are thinking. How does the recent drop compare to the worst drawdowns of all time? Combining the two previous charts looks like this:

Now before I get to the analysis, I think it’s important to point out a shortcoming of the data. The deepest drawdown is calculated using annual year-end returns, while the 1-month data is calculated from a daily high. Comparing annual data to daily data is not really a fair comparison, as annual sampling masks temporary drops that recover by the end of the year. So investors whose current losses are near or beyond previous deepest drawdowns should definitely keep that data caveat in mind before jumping to conclusions. But I do think it’s helpful for evaluating realistic expectations in context of current events.

How stressed out are you about your portfolio right now? Be honest. Do you watch the markets constantly? Are you having a tough time sleeping because you’re worried about your financial plans going up in smoke? Have you been tempted to sell everything and stuff cash under the mattress until things blow over?

Look again at the above chart. Yes, the current market drop has been frighteningly swift and we may even end up setting new all-time lows before it’s all said and done. But historically speaking there’s still a long ways to go.

Nervous investors can interpret that information in two ways:

  • If you’re already freaking out, there’s a good chance you either didn’t understand what you were signing up for or overestimated your willingness and ability to deal with the very real downside risk associated with your portfolio choice. As Mike Tyson famously said, “everybody has a plan until they get punched in the mouth.” Well the market just landed a haymaker, and I understand why you’re woozy. Changing portfolios when you’re emotional is usually a very bad idea, but once things calm down it might be a good opportunity to reevaluate how ready you are to hold the same portfolio through the next inevitable crisis.
  • But on a more positive note, as bad as things feel right now they’ve been even worse in the past. So as you study the historical data, losses even deeper than you see today are already baked into the numbers. The average return includes some really bad years similar to what we’re currently dealing with and markets eventually recovered. And yes, retirees experienced even deeper drawdowns than you are now and still survived just fine — that’s exactly how safe withdrawal rates work! So while the economy does look pretty dire right now, it’s not the end of the world. Be patient, and in time this will eventually be just one more red square on the Heat Map to be studied but not feared.

Fight Fear With Knowledge

That idea of studying bad times in order to prepare yourself to not fear them is actually quite empowering once it sinks in. Times are tough for everyone right now. But from an education perspective it presents a unique opportunity to witness first-hand how certain asset allocation concepts work through adversity, and it’s also a good time to use history as a guide to put current events in the proper perspective. To summarize:

  • Well-diversified portfolios are handling the market downturn significantly better than you’d think by only reading the stock headlines.
  • Several of these portfolios have demonstrated this ability time and time again, and are worth learning about to see if you can apply the same concepts to your own portfolio.
  • The current downturn is certainly alarming, but it is still nowhere near the worst drawdowns real people experienced before you started paying attention.
  • Very poor returns are already baked into the historical data, so as long as you’re doing your homework without cherry-picking timeframes you should be well-prepared.
  • And for each of those points, Portfolio Charts is here to help. From the variety of portfolio options to the best historical data I can muster to put everything in proper context, I’ve got your back.

So if I have one suggestion for investors as they shelter in place over the next many weeks, it’s to take a break from the reactive financial news and take the opportunity to be proactive in your search for investing knowledge. I’ve intentionally seeded this article with lots of links to get you started, and you can find many more resources in the Research Topics section on the front page. Things may even get a lot worse before they get better, but proper asset allocation with a true sense of history can be a great tool in building a sense of educated calm that we can all use right now. Seek it out!

Take care of your families and neighbors, wash your hands, and keep your head up.

We’re in this together.

Are you surprised by how some portfolios are doing right now?