20 Mar

The Case for Strategic Allocation

March 20, 2020

In these uncertain times, markets have dropped at record-breaking speed. What is an investor to do? Building and sticking to a plan may sound trite, but it’s a solid strategy that is backed by historical data.


Strategic AllocationMarket events of the past five weeks have left many feeling stunned and confused. Markets have dropped faster than at any point since the Great Depression – largely due to a rapidly evolving global health issue that has resulted in societal measures used to stem the tide that have not been seen in a lifetime, for many. In the midst of this massive shift in investor sentiment, stories are trickling out of a brother-in-law or an aunt or a one-time college roommate on Facebook who saw this was coming and moved their portfolio to cash in January. Many investors are now questioning why they – or their professional advisors on their behalf – did not make a similar move.

There are many answers to that question. For individuals (or some advisors), it may have simply been paralysis by the magnitude of the shift – the daily market movements of 4-10%, up and down. But for some, the decision has been a strategic and informed decision. I would like to outline a few of those rational reasons:

  • Timing of Goals – For goals that are greater than five years away, there are few historic timeframes where equities did not have corresponding five-year positive returns. Even when the first year of retirement is next year, the majority of retirement expenses are well above five years away. Strategic allocation involves matching your investment decisions to your goals. Nothing about the current environment changes that approach. Near-term distributions can come from cash reserves and non-stock portions of the portfolio, which have NOT retreated like stocks. If the portfolio is designed properly, that practice can continue for years.
  • The Bottom Is Not Knowable – Anyone who says they were, due to their knowledge or intuition, able to identify the top of the market is mistaking skill for luck. They have probably fooled themselves into believing they will be able to predict the bottom as well. There have been numerous up days and down days throughout the past month. All headlines have been negative, but markets have not responded to them all the same way. The bottom of this particular downtrend will likely be the day before a positive news announcement (like a definitively successful treatment or a downtrend in the virus created by warmer air or a successful vaccine or some other positive news). Of course, it will not be recognized at the time as “the bottom” because it will at first look like a positive just like all the false positives before it. This time, it will be real – but not seen as such until much later. I don’t know whether that will be this year, next year, or longer, but it will happen.
  • A History Lesson – In 2008, there were rises in the S&P 500 of 12% in March/April, 6% in July, 15% in October, and 26% in December. Those were sandwiched in the middle of large decreases, of course. The actual bottom was not reached until March 2009, after which markets rallied by 70% from the first week of March 2009 to the last week of December 2009. The first 43% took place in the first three months of that rally. There were drops along the way of 9% in June, 5% in September, and 6% in October. At each of those highs and lows throughout those two years, people were convinced they knew what would happen next. Many spent the next 11 years picking when the next bear market would come. Some of those who “correctly” predicted the current bear were wrong on many predictions in between.
  • Evidence-based Investing versus Unknowns – When portfolios are built for the long term, rational return and risk forecasts are able to be constructed to match up with goals. When human guessing is introduced to the process, those long-term return and risk forecasts become irrelevant. Projections of whether a client portfolio has a high probability of successfully accomplishing a goal cannot properly be constructed on human decisions of untimed moves into and out of cash.
  • Buying Low, Selling High – For those who sold before some portion of the down trend, in order for their portfolio to benefit cumulatively, they will need to reinvest their portfolio at a lower place than where they sold. Otherwise, the move to cash will end up costing them real money – not saving them anything. Two decisions need to be made: a sale at a high AND a buy at a lower price.

So what is to be done in line with principles of strategic allocation?

  • Over time, rebalancing portfolios can help when allocations stray from their strategic percentages. That maneuver involves discipline in selling assets that are high (the asset classes that have not gone down significantly) and buying the asset classes that have gone down in value.
  • For portfolios with taxable investments, losses can be harvested to save on taxes for years to come in the future.
  • Contributing cash on the sidelines at current depressed values is a great practice to ultimately improve long-term performance and take advantage of the drops along the way. However, if cash on hand is either needed for goals in the next three years or is what helps an investor hold steady with the rest of the portfolio, there is nothing wrong with maintaining that position!

Markets have recovered from a huge variety of worries and disasters over time, including the Great Depression, World War I and II, Korea and Vietnam, the Oil Crisis of the 1970s, 18% interest rates in the early 1980s, Black Monday in 1987, the Tech Bubble bursting compounded by the September 11 terrorist attacks, the global debt crisis in 2008, and countless others. I spoke with a client this morning who remembered feeling very similar to today during the Cuban Missile Crisis: the world had permanently changed. At each one of those times, most people wondered, “Will it ever recover?”

Of course, throughout that same time period, markets have risen a massive amount in the big picture. It feels like there will never be new highs, but there is yet to be a 12-year timeframe in which markets were not positive over the past 120 years. (For the most recent context, markets returned to their previous high of November 2007 in March 2012 – less than five years.)

Do not let fear or greed dictate portfolio decisions. This is difficult to do in the middle of a crisis when our lives are thrown into upheaval – jobs potentially in jeopardy, trips cancelled, students home, group events of all kinds suspended. These are real changes, but they do not necessarily indicate a portfolio change – unless the timing of long-term goals has changed (like the potential need for funds to weather a period of unemployment).

I went back to a journal entry I wrote in November 2009: “If we had said in November 2008 that equities would be up 16% 12 months from now, who would have believed it? But it happened. ‘Don’t trust your gut.’” This time is different, but each downturn throughout the past century has been different. But people were driving Model T’s in the 1920s and self-driven electric vehicles today. Flight began in the early 1900s, and we are now considering manned trips to Mars. Optimism has seldom been en vogue, but it has been the long-term reality. If you have a plan with articulated goals, timeframes, and portfolio allocation to match, your response can be strategic as well.

Meet the Author: Joel Cundick

0 Comments | Leave A Comment