Fear a Bear Market

10/28/2020 10:00 am EST

Focus: MARKETS

Landon Whaley

Editor, Gravitational Edge

Headline risks are everywhere, much like bloated credit card statements in January after a holiday spending spree, says Landon Whaley of Whaley Global Research.

This week’s “Headline Risk” comes courtesy of yet another person perpetuating the “it always comes back” belief about the U.S. stock market and telling investors not to worry about a bear market.

Columnist Mark Hulbert quotes stats from an Allianz Life survey that found people are more scared of running out of money in retirement than they are of dying.

Hulbert acknowledges that “Retirement planning projections made at the end of the third quarter [2018], right as the stock market was registering its all-time highs, now need to be revised.” But he goes on to say that you needn’t worry because, “Believe it or not, the average recovery time was ‘just’ 3.2 years.”

Where do we even begin to unpack this sack of garbage?!

Let’s use this article as the jumping-off point for a two-year case study to debunk the idea that retirees shouldn’t fear a bear market.

Most of the people we know with accounts at the old institution lost an average of -10% during the final quarter of 2018. To keep things simple, let’s say your retirement nest egg entering Q4 2018 was a cool $1,000,000 and that your portfolio strategy takes the same 3.2 years to regain the high watermark it reached before the -10% decline in Q4 2018.

At the start of January 2019, you had $900,000, and it was time to withdraw the 3% you rely on from this account to live during the year. And for the sake of this illustration, your advisor takes his fee upfront, which is another 1%.

You’re now starting 2019 with $864,000, which is down -14.6% from your September 30, 2018, statement. During 2019, you earn a +3.6% gain, which is one-third of the 10% loss you experienced (remember that compounding means you need to gain +11.1% to recoup a -10% loss), and you end the year with $895,104.00

For the next two years, you get the same gains (and you take identical distributions, and the advisor gets the same fee), and as Mr. Hulbert predicts, at the end of 2021, your strategy is back where it started, but your account value to start 2022 is only $849,976.09.

Even though your portfolio strategy has clawed back its -10% loss, you’re getting further and further away from your $1,000,000 high-water mark!

Folks, the math is simple, and it highlights a very real market fact that the old institution would rather you not know drawdowns kill portfolios.

Even a -10% drawdown can have long-ranging consequences, and in this example, I used conservative numbers for investor withdrawals and advisor fees. Imagine the hole someone would dig if they were withdrawing more than 3% each year or paying their advisor more than 1%!

Beyond that, a vital and often overlooked aspect of any drawdown is the recovery period following the decline. As Mr. Hulbert says, the average recovery time is “just 3.2 years.”

I don’t care if you’re a 26-year old millennial who thinks you’re going to live forever, a 45-year old going through a midlife crisis, or a 99-year old hoping the next trip to the mailbox won’t be your last, getting zero return on your money for 36 months is a non-starter!

Remember, every day your account spends in a drawdown is a day that you are neutralizing the most powerful concept in all of finance, the power of compounding.

I’m on the record stating that the decade of the 2020s will look like the 2000s, which saw the US stock market go nowhere on a cumulative basis, and the economy experiences two separate recessions. For investors, this 2000s redux means higher volatility over the next ten years than the previous ten. A higher vol environment also means that the likelihood of retirement-impacting stock market drawdowns will be as high as Cheech and Chong.

The “headline risk” bottom line is that you should not only fear bear markets; you should fear drawdowns in excess of single digits regardless of the overall market environment. You don’t need a full-fledged bear market in US equities to put your portfolio in a retirement bind. Believing “the stock market always comes back” is the quickest way to transform your retirement from pottery classes and golf to “Hi, welcome to Walmart.”

To learn more about Landon Whaley, please visit WhaleyGlobalResearch.com.

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