This is an excerpt from "Bat Socks, Vegas and Conservative Investing," by Dave Vick. Edited by your's truly, Tom Vick. I'm sure we have had a great run the last decade. Only I can't help, but wonder what if a bear market did happen again? I know what would happen for my clients, to the best of my abilities, but for many that don't have a financial plan or retirement income plan...they might be left wondering. Enjoy this excerpt!
What if the worst bear market in history happened again?
I know what you are thinking, “Man, this guys a real pessimist!” I got it. Yet, those who know me know I am a very real optimist and rarely believe the worst is going to happen. But, what if it did? What would the worst bear market in history do to your portfolio, which carries with it your lifestyle in retirement?
What was the worst bear market in history you ask? Most would argue the worst bear market started with the Crash of 1929 and didn’t recover from its market high, until the fall of 1954 a 25-year bear. Okay, that’s negative!
Generally speaking, a bear market is a 20% drop in the broad market indexes such as the Dow Jones Industrial Average or the S&P 500 over a two month period. Bear markets are a time of deep pessimism, falling stock prices and usually high volatility. A bear is not to be confused with a correction. The correction is usually a short period of time, something less than two months, while a bear market is two months or longer. (1)
There were two very large and very long bear markets in the twentieth century. As I previously mentioned the 1929 crash which lasted to 1954, and then the 1965-1982 bear market. Most seniors remember both and boomers definitely remember the gas lines of the 70’s bear market. Russell Napier in his book “The Anatomy of a Bear” says on average every three years there’s a bear market, every eight years there’s a stinker of a bear market, and big bears last an average of 17 years. Napier also says the bear market that started in 2000 wouldn’t end until 2011-2014, probably closer to the latter, with the Dow at less than 5000.(2) Now that’s negative!
Everyone knows the old investing axiom, “Buy Low, Sell High”. Find the bottom of the Bear and invest. Then sell at the height of the Bull run, maximizing your gains. If you can do this you can retire wealthy beyond imagination. Sounds easy, but is incredibly difficult. In fact, Napier’s book is all about trying to find the historical commonalities that run through bear markets so you would be able to estimate when the bottom of the next bear is and invest.
John D. Rockefeller is reported to have said, “The way to make money is to buy when blood is running in the streets.” (3) I believe this means you ought to buy when everyone else is selling and sell when everyone else is buying. Warren Buffett says, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” (4) Again, sounds like good advice, but how does the average investor know when everyone else is selling or buying. Isn’t that just a guess anyway?
I believe this is where the ABC Model of Investing shines its brightest, because investing in the three categories will almost always increase opportunities for success in a long hard bear market. In fact, when others have lost money in a buy and hold mentality believing the market will recover over an extended period of time, those who have diversified in the ABC Model have made money.
Using the ten years of the market from 2000 through 2009 as an example let’s see how the ABC’s would have performed. If Russell Napier and other economists are right, the bear started with the tech-bubble bursting in 2000, this would be a good ten years to view. (5)
The illustration above shows the S&P 500 returns (6) for the years 2000 through 2009 on the left. The investible assets are $500,000. This example shows a typical investor who has about 10% in cash earning an average of 3% and 90% allocated to the market represented by the S&P 500. We use the broad market index to approximate what investing in the market in general was like over that period of time. Certainly an investor could have been in more or less risk than illustrated here. Yet, the illustration shows in general terms how the market performed from 2000-2009. Notice, there are no monies allocated to Column B, which are Index Annuities.
The chart shows at the end of the ten-year period this investor would have lost over $100,000. I don’t know about you, but a 20% loss in the market is devastating when it comes to retirement!* Imagine if you were 52 years old in 2000 and planning to retire when most people retire at age 62. Would you do what many have had to do, which is work another 3-5 years in hopes of recovering those assets needed to retire?
And what if it happens again? What if the next ten years aren’t any better than the last ten years? Can you afford to lose another 20% or possibly more? Can you continue to push off your retirement indefinitely?
When I show this graph to clients they tell me, “Yep, that’s about what happened to us.” Yet, the same clients will surprisingly stay in this broken down Wall Street model attempting to recover with a hope and a prayer.
There has to be a better way, and I believe there is. Look at the graph below.
Using the same $500,000 over the identical ten years (7), let’s allocate 60% to short term laddered maturities in indexed annuities. Assuming an average index Cap of 7% we begin to see how the ABC Model is a great model to use for bear markets. This time period was a bear market and yet the allocation made $96,869 over the same time period while the first example lost $101,786. That’s a difference of $198,655 over a really nasty decade. It’s probably the difference between you retiring when you want to or not!
“The first rule is not to lose.
The second rule is not to forget the first rule.”
Warren Buffett (8)
Mr. Buffet helps us to understand why the ABC Model works so well. The key is simply to protect your principal and retain your gains. Remember Green Money Rules #1 and #2? That’s right. Green Money Rule #1 is the same as the first rule for Warren Buffet. Don’t lose! Look at the Red Column C in the years 2000 through 2002. You started with $150,000 in 2000 and ended with $89,000. Remember the “Tech-Bubble”? If you were invested in tech-stocks in those years you took a much greater beating. Now look at the same years in the Green Column B. You started with $300,000 and ended with $300,000. Are you happy? Darn right! You didn’t gain anything, but you didn’t LOSE anything. Zero is your Hero!
Look down the Red Money Column at the ninth year, 2008, and the loss of 38%. It took you five years to just about get back to where started in 2000 and then the bottom dropped out. You lost $55,796 and only had $92,203 left of your Red Risk money. Yet, peer into the ninth year of the Green Money Column and notice you didn’t lose a dime and have $391,901* which is more money than you started with in the year 2000. Can’t say the same for the Red Risk Column can you?
I’m not saying that you shouldn’t invest in the market, but I am saying you can diversify with Fixed Principal Assets like laddered maturities of Fixed Indexed Annuities and the decade wouldn’t have been the abysmal lost decade of 2000 through 2009.
The decade from 2010 and forward doesn’t look any better either. With government bailouts, increasing mortgage defaults, escalating taxes, a new government controlled health care system, and a thirteen trillion dollar deficit; something is going to get ugly. I hate to think it’s your retirement account in the market that gets devastated.
I know. It’s negative. But what if it happened again?
