A Trip Down Memory Lane

You've likely heard on the news and elsewhere that this month is recognized as the ten year anniversary of the stock market collapse and the start of the Great Recession. While anniversaries normally entail celebrations to remember happy times, this one has tended to give me the chills. It was, after all, ten years ago this past week when Lehman Brothers was allowed to fail and the global economy felt like it was unravelling faster every day.

Having been in the business at the time I can tell you that September 2008 was a wild and uncertain month. Market and economic news seemed to worsen by the hour and people were scared. There were many phone calls with folks asking questions like, "Are we going to be okay?" and, "Is this the end of the financial system?" and even, "How quickly can we sell everything and find a mattress, or maybe jars to bury cash in the yard instead?".

While there are many takeaways from that period, for regulators, investors, and yes, also for advisors, a primary lesson should be something that we often discuss: When it comes to investing, focus intently on what can be controlled and try not to worry too much about the rest, even though it can be gutwrenching sometimes.

Quality, cost, allocation, and rebalancing are critical to investing successfully over a long period of time. Let's look at the latter two and how they would have helped us get through 2008 in one piece.

Here's a series of charts showing how an investor would have fared if they had stayed the course with their allocation and rebalanced during the Great Recession, instead of heading to the mattress store.

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The example below shows an investor with a moderate portfolio allocation of 60% in stocks and 40% in bonds (represented by SPY and AGG, funds that track the S&P 500 and Barclays Aggregate Bond Index, respectively).

Assuming the investor (the green line) held their investments through 2008 and rebalanced their portfolio quarterly, they would have done better than the U.S. stock market (the S&P 500, the blue line) during all the craziness of September.

moderate model - sept 08

You can see this outperformance in the chart. When the market dropped precipitously the investor's portfolio declined, but not by as much as the stock market. The loss was roughly in proportion to the amount of stock market risk the investor was taking.

The other 40% of the investor's portfolio was in so-called core bonds, mostly Treasuries but also high quality corporate bonds. The latter declined in September too, but not as deeply as the stock market. Treasury bonds held their value during this period, which helped buoy the investor's portfolio.

We can see in the next chart how bonds (the green line this time) fared versus the stock market during September. You can get an idea of how mixing the two amounts together in different proportions would mitigate risk. This process of asset allocation saved many investors during the dark times, so long as they stuck with it.

stocks vs bonds - sept 08

How long would it have taken this hypothetical investor to recover, assuming they stayed the course and rebalanced? We see in the chart below that it would have taken about two years.

moderate model - financial crisis

How long did it take the stock market? About four years! For the Great Recession as a whole, it took about five years for the market to fully recover from it's highs in October 2007. Why? Because the market had a deeper hole to dig itself out of.

Since then, however, we see the tradeoff when using bonds to mitigate stock market risk. Stocks continued to rise (the blue line in the chart below) and that same hypothetical 60/40 portfolio (the green line), while doing quite well, hasn't kept pace with pure unadulterated exposure to stocks. A more moderate portfolio doesn't go down as much, but it doesn't go up as much either. That's the tradeoff.

60 40 vs stocks long term

So, we each get to decide which is most important to us, growth at all costs, or if we're willing to give up some growth potential for a smoother ride during tumultuous times.

The answer to that question is something to remind ourselves of when (not if) we enter the next market crisis. And here's a trick question to close with. How long would it have taken an investor to recover if they sold their investments in September 2008?

Answer: Maybe forever.

Have questions? Ask me. I can help.

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