It’s been nearly 10 years since the global financial crisis bottomed out. Since then stocks have basically been on an uninterrupted tear, with the TSX doubling in value, and the S&P 500 nearly quadrupling in value. In that time, investors have survived the European debt crisis, Greece’s debt crisis, a Russian financial crisis, the Brexit decision, Trump’s election, and countless other doomsday predictions.

Markets have reached all-time highs so frequently that investors are understandably nervous about an upcoming crash. The problem is, nobody knows when a crash might hit, if ever, or how severe it might be if it does occur. Stocks may continue to go up for a few years, or maybe go sideways for a while, or we might suffer a small correction of 10-15 percent before the next bull market begins.

The tech bubble and financial crisis are still fresh enough in our minds to convince investors that declines of 40-50 percent are normal, when in fact these were major black swan events that perhaps we’ll never see again.

The Crash That Never Came

Investing at all-time highs

Let’s say you’re a nervous investor who decided to get out of the stock market at some point in the last 10 years, whether due to Europe, Brexit, Trump, or simply because the markets were looking “expensive”. What’s the cost of waiting for a correction? It turns out to be quite high.

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch

The Cogent Advisor blog looked at U.S. investment returns over the period 1927 through 2016. That’s 91 years, or 1,092 months. The average monthly return was 0.95 percent. But when they removed the returns from the best performing 91 months, the remaining 1,001 months provided an average return of virtually zero (0.1 percent). In other words, 8.5 percent of the months delivered almost 100 percent of the return.

Their takeaway: Even if you believe the probability of a correction is high, it’s far from certain. And when the correction doesn’t happen, the expected opportunity cost of having waited is much greater than the expected benefit.

The Crash That Never Came

One reader who I’ll call Jason emailed me and confessed that while he used to invest in index funds he got nervous after Trump’s election and moved everything to a full service wealth management firm last year. He didn’t say in the email, but I can imagine he stressed this concern with his new advisor, who placed him into a conservative portfolio aimed to provide downside protection in the event of a crash.

Here’s Jason, one year later:

I just took a look at the past 12 month performance and it was 3 percent vs the market of ~13 percent. I have a sinking feeling I made a mistake and should move it back to self manage using index funds. I sent my advisor a few questions and basically got the answer that they protect the downside, and have a lower risk targeting 4-6 percent average over five years.

I still feel nervous, but at age 42 I think I should be more in the market. We have been at all-time highs for a while so I am torn between a bear market that may start now and the downside protection would be warranted. That said, maybe not.

It’s quite common for investors to act on their fears and make a move like this. Jason got exactly what he asked for from his wealth manager, except for the crash that never came. Now he’s upset that he missed out on last year’s gains, but he can’t have it both ways. If you’re a full participant in the stock market then you take the good with the bad. The idea of stocks for the long run says the good outweighs the bad – that’s why we invest.

Bottom line: Investors need a portfolio that’s built for their risk tolerance and time horizon. If you’re two years away from retirement and worried that a stock market crash will derail your plans then it’s probably not a good idea to have your entire portfolio in equities. On the flip side, if you’re decades away from retirement and don’t plan to access your investments until then, stop trying to guess which way the markets are headed and stick to your long-term plan.

Your investment strategy is only as good as your willingness to stick with it, even in the face of uncertainty. No strategy, not even Warren Buffett’s, is in favour 100 percent of the time. Diversify your investments by owning Canadian, U.S., and International stocks. Instead of market timing, hedge your anxiety with a healthy dose of bonds to smooth out the ride.

As for Jason’s dilemma, I’m tempted to tell him to stick with his wealth manager. To me, that’s a better approach than changing strategies every year. Imagine if he switches to a portfolio of index funds (all equity) and the big crash finally happens next year. He’ll be crushed.

What’s your take? Have you made moves inside your portfolio to ‘protect’ against a crash? How did that work out for you?

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21 Comments

  1. Rummymtg101 on August 17, 2018 at 7:34 am

    Great article Robb and I agree with your conclusion. Jason should stick with the current advisor and instead of drastically switching his strategy; his advisor can modify his tolerance level given Jason’s age and time to retirement. He needs to give minimum of 3-5 years to his new strategy to get a meaningful results.

    • Robb Engen on August 17, 2018 at 3:14 pm

      Thanks! I agree you need time to see how your strategy will play out. The absolute worst approach is to jump around every year chasing last year’s winners.

  2. Ken on August 17, 2018 at 9:08 am

    I will never forget the costly $35,000 phone call that I made in 2011 to switch my pension out of equity, timing the market because I was expecting a market downturn. It took me 18 months to get the money slowly back to the balanced fund and fortunately I did it then because if I would have buried my head in the sand I would have been stuck in Money market funds, earning very little over the last several years before retirement.

    • Robb Engen on August 17, 2018 at 3:15 pm

      Hi Ken, thanks for sharing. I remember the correction in 2011, which just looks like a small blip on the radar today. Glad you were able to recover and learn a lesson.

  3. James on August 17, 2018 at 10:24 am

    I made a huge change this year due to concern over the markets. I moved 330 k over to GICs as I am retired and that money is my boat money and I did not feel good leaving it in the market while I shopped for a boat which we will buy when my wife retires in the next 2_3 years. I now ride the market with my TFSA, RRSP and RIF, only those funds are expendable or I can wait out a correction as I have a pension that more than covers our bills. I feel good getting 3% on my GICs, I feel good when I see the returns on my registered funds, and I am lucky enough to have earned a DB pension that allows me to do this.. I am not waiting for a crash, I am just not in favour of investing money that I can’t afford to lose, hence moving my retirement boat money out of a very good market( got 13% return last year on it) but now content with a guaranteed 3% as I eagerly shop for a boat to buy. There is no 100% investment solution for all, personal finance is just that, personal.

    • Robb Engen on August 17, 2018 at 3:17 pm

      Hi James, it sounds like you made a good move for your overall retirement plan. It makes sense – move the money you’ll need in the short-term to cash or GICs, and keep a bucket in the markets for the long-term. Well done!

  4. John on August 17, 2018 at 10:32 am

    I believe, for most of us, where we go wrong is allowing our emotions to dictate our reactions. It would seem that fear of loss prompts a greater reaction than watching investments rise in value. There is no simple answer to this since it seems to be hard wired into human behavior.
    I know , personally, that investing when there is obvious value is difficult, but usually successful. The best analogy would be buying food. The lower the sales price, the more likely we are to stock up. So why don’t we do this when stocks or bonds decline ? To do so we must ignore the herd instinct and fear of loss. That is not easy to do,even athough it may be the right move.

    • Robb Engen on August 17, 2018 at 3:19 pm

      Hi John, that’s so true and such an important lesson for investors. It’s difficult to go against your instincts and stick to your plan. That’s why it’s important to write down an investment policy statement. Then, when markets get rough, or you’re thinking about making a drastic move, go back and read it!

      • John on August 17, 2018 at 7:21 pm

        Hi Robb,
        Thanks for your reply. I was a Financial advisor for many years and tried , wherever possible to support my clients objectives, especially when markets became chaotic and returns became negative. There are times when doing nothing is the right course of action.
        Best of luck in your own investing objectives

        John Wilson.

  5. Tricia on August 17, 2018 at 12:48 pm

    I moved a bunch of money from an equity fund to GIC’s after Trump was elected. I was sure a correction was going to come…..but it didn’t. I am angry with myself for doing that, but also glad it I only moved over a small portion of what I originally was planning. This was my emotional self.
    Then I did a portfolio review – of which I haven’t really done in awhile – hitting 50 can do that to a person, and it turns out I needed to re-balance as I was too heavy in equities anyways. So my practical self is happy.

    • Robb Engen on August 17, 2018 at 3:20 pm

      Hi Tricia, thanks for sharing. It sounds like this worked out for you in a roundabout way, so that’s great to hear!

    • Marko Koskenoja on August 21, 2018 at 1:56 pm

      I did the same thing a few months after Trump got elected 🙂

      When there was a dip in equities in February 2018 I bought iShares XDIV, XDG and BMO ZWU, ZDI and ZWC high dividend ETF’s. I currently collect over $3K per month in dividend payments and I no longer worry about the markets.

  6. Bob Lin on August 17, 2018 at 11:43 pm

    The more I’ve learned about the ups and downs of the markets, the more I’ve moved to equities (now 75% of my portfolio}. Having said that, I only felt comfortable doing this when I came up with the plan of building a three-year GIC cash cushion plus $5K emergency fund during my final year and a half of working. If there’s a market crash during my retirement, I won’t need to sell any equities for at least three years, four to five years if I utilize my bonds. Even if there’s a market crash prior to finishing work it doesn’t matter because I’ll have my cash cushion and start my retirement on that.

    My cash cushion and emergency fund form part of my 25% Fixed Income. I only have 14% to 15% of my portfolio in bonds.

    • Robb Engen on August 19, 2018 at 8:50 am

      Hi Bob, it sounds like you have a great plan to manage your investments in retirement. I plan to take a very similar approach, with a bucket of cash (1-year), a bucket of fixed income (3-5 years), and a large bucket of equities (long-term). Well done!

  7. Jim on August 18, 2018 at 2:46 am

    The Trump Non-Crash of 2016:
    ———————————

    My portfolio in 2016 was quite defensive. April 2015 thru January 2016 was not good by any means for the Canadian market. April 2015: 8.8% cash balance – by May 2016 I had a cash position in the RRSP greater than 25%. Things were uncertain to say the least in America and Canada was getting beat up in oil and anything related to it. Canada was starting to rebound a bit.

    By the time the US election was a month away, I had grown my cash position to nearly 33%. The markets were certain that the election was uncertain. The TSX had rallied from the 12,000 range all the way almost to 15,000.

    Then the election came and the immediate reaction was fear and disappointment. Gold reacted big time. The markets looked to be going down a big amount (500 pts or 1000 pts on Dow Jones?)

    In the day, days and week or so after, sentiment was different. Nobody really believed Trump would win, but now had – and the analysts and talking heads were pricing in a Trump tax cut, looser banking and business restrictions – I had reduced my cash position that was once almost 33% to 11% then 0% less than a month later in mid December.

    Sentiment had changed, and I decided to follow through with it. And here we are today.

  8. Dale Roberts on August 18, 2018 at 4:33 am

    Great post Robb. It’s a common story. We should always invest within our risk tolerance level. We should always be prepared for the next correction, the correction that we know nothing about – because we haven’t met that correction yet. We don’t know when it’s coming, we don’t know how angry Mr. Correction will be.

    Great advice. But perhaps the reader could still self direct but within the right risk level?

  9. CJ on August 18, 2018 at 1:38 pm

    i read an interesting article recently that suggested that if your paying a mortgage then you should consider that as an equivalent to bonds in your total portfolio. Home prices on average increase at the rate of inflation. As a result you should therefore be 100% in equities, I think this makes sense. in other words why have 30% allocation of bonds and have a house that appreciates at the rate of inflation, if your lucky. Calgary has had zero increase in home prices in over a decade. I also wonder what the logic is in paying off a mortgage quickly? your mortgage rate is 2-3% and returns in the stock market are 5+%

    • Robb Engen on August 18, 2018 at 2:23 pm

      Hi CJ, I’ve read something similar and my takeaway from it was if you have a mortgage alongside your investments then you are essentially borrowing to invest. Your expected returns will be higher if more of your investments are tilted towards equities. That makes sense, and it’s one of the reasons why I don’t hold bonds in my portfolio.

      As far as paying off the mortgage, while I’m not in a hurry to do so right now I will start to pay it down more aggressively once our RRSPs and TFSAs are caught up and maxed out. It comes down to what else you can do with that extra cash flow that’s more productive, and as rates tick up a bit higher I’ll take that guaranteed return and get rid of the mortgage.

    • Bob Lin on August 18, 2018 at 11:35 pm

      We paid our mortgage off about 8 years early. On paper the math suggested that investing would or should have made more sense, but when we paid it off it felt great. Two years later my wife was laid off. Having no mortgage made dealing with that much more easy. We have no regrets and knowing what we know now, we’d do the same again.

  10. Ian MacDonald on October 3, 2018 at 7:05 am

    If you carefully choose financially solid stocks that pay “good” dividends year in year out, you don’t really care too much about the actual stock price. However, the interesting thing is that dividend stock prices do increase, sometimes doubling or more. In a down turn like 2008 on paper you may loose half the value of what your stocks were at their peak but they come back eventually and surpass the old peak. The trick is to live on your dividends, be patient and stick with your solid portfolio.

    • Marko Koskenoja on October 3, 2018 at 9:41 am

      Great post Ian – I agree 100%. I did just that in Feb 2018 and now no longer worry about the market news and dips.

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