Liquid Strategies Insights & Commentary

Find the Time – Asset Allocation Strategies To Manage Volatile Markets

Author: Justin Boller

 

Since 1976, there have been 3 periods where a balanced portfolio (60% stocks / 40% bonds) have experienced drawdowns of greater than 10% - after the 1987 crash, the recession in the early 2000’s and the financial crisis in 2007-2008. While each of these are unique in their own way, they do have one thing in common, we recovered.

TIME PERIOD

MAX DRAWDOWN NUMBER OF MONTHS TO MAX DRAWDOWN NUMBER MONTHS OF RECOVERY TOTAL MONTH BELOW PRINCIPAL VALUE
9/30/1987 – 12/31/1988 -17.42% 3 13 16
9/30/2000 – 9/30/2004 -22.82% 25 24 49
11/30/2007 – 11/30/2010 -32.51% 16 21 37
Average -24.25% 14.7 19.3 34

*Returns shown represent a constant blend of 60% S&P 500 Total Return Index and 40% Bloomberg Barclays US Aggregate Bond Total Return Index.

Today’s coronavirus fueled market has taken a balanced portfolio once more across the -10% threshold. The good news is that this too shall pass and we (and our portfolios) will recover.

The key to a recovery is time. We’ve all heard that for most investors the best strategy is to buy and hold. Essentially, give it time to work. However, in an environment like today, our emotions cloud this sound advice and we are tempted to make changes to our portfolio. This often causes us to sell at the wrong time.

So, what is the best way to prepare a portfolio for the unknowns that are around the corner? The best piece of advice I would offer is to intentionally buy time in your portfolio. Based on what we know about past major declines, a full recovery of a balanced portfolio averages a little less than 3 years. If we insulate 3 years of distribution needs in a portfolio (i.e. keep in cash), then we psychologically know we have bought enough time to allow for a recovery within the rest of our portfolio and will not be forced sellers at the wrong time to meet our cash needs.

I’m a big fan of breaking down a portfolio not by asset class, but by time buckets.  Here’s an idea of how this approach could work. Some portfolios may need more buckets, some less, so customization to an individual’s needs is still paramount. The cash bucket represents 3 years of estimated distributions from the portfolio. The 3-5 year bucket is still highly conservative, but offers some income with more aggressive income strategies in the 5-10 year buckets. Ideally, the income from these strategies can waterfall back down to replenish the cash bucket as distributions occur. That allows for the growth bucket (10+ years) to remain untouched regardless of how crazy the market might get.

What I have found is that the ending asset allocation tends to be very similar when using the time bucketing method as it does to a pure asset allocation method, but there are clearer objectives around each asset. When faced with a challenging environment like today, instead of being frustrated because your portfolio is down x%, you can easily look into the portfolio and see that it is the 5-10 year and 10+ segments of the portfolio that are contributing the most to the drawdown. With the understanding that time is on our side in these buckets, we can better process the market turmoil and better rationalize weathering the storm rather than panic selling.

Time does heal all wounds, but that can only be realized by intentionally making time part of a well-balanced portfolio.

 


 

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The assertions and statements in this blog post are based on the opinions of the author and Liquid Strategies. The examples cited in this paper are based on hypothetical situations and should only be considered as examples of potential trading strategies. They do not take into consideration the impact that certain economic or market factors have on the decision making process. Past performance is no indication of future results. Inherent in any investment is the potential for loss. 

Topics: Overlay

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