One fear many investors have is incurring a large drop in the stock market. “Major drawdowns,” as defined by AQR Capital Management, are those where prices drop by at least 20% from peak to trough. The investment firm counts 11 such drops as having occurred in the stock market since 1926, or about one per decade.
Though stock prices have fully recovered within 27 months, on average, according to AQR’s data, realizing the recovery requires an investor to stay fully invested in stocks. This is something that’s much easier said than done. Various studies show a tendency to pull out of stocks when their prices are down. Even if someone sticks with their allocation to stocks, the drops can be painful. Major drawdowns can even be problematic from a timing standpoint, especially for those who had the unfortunate luck of reporting shortly before the drop occurred.
There is a simple solution for cushioning against the blow of such drops: diversify. Holding assets whose returns are affected by different risks than stocks lessens the impact drawdowns have on portfolio wealth. However, diversification can come at the cost of lower long-term returns, as an analysis from AQR shows.
More on AAII.com
- The Importance of Diversification in Retirement Portfolios – Including small-cap stocks and Treasury bills can enable a retiree to take larger withdrawals.
- The Permanent Portfolio: Using Allocation to Build and Protect Wealth – This alternative allocation adds cash and gold to a traditional stock/bond portfolio.
Highlights from this month’s AAII Journal
- Simplified Expectations for Normal Investors – Focusing on four foundational elements—growth, pain, fit and flexibility—can help to establish reasonable expectations about potential outcomes.
- Model Shadow Stock Portfolio: Why Quarterly Reviews Still Make Sense – The higher costs associated with the purchase and sale of less actively traded stocks make it more profitable to transact less frequently.
AAII Sentiment Survey
Optimism rose to an eight-month high, but still remains within its typical range. Plus, this week’s special question asked AAII members for their opinion on the Federal Reserve’s continued raising of interest rates. More about this week’s results.
This week’s results:
- Bullish: 45.7%, up 9.4 points
- Neutral: 29.2%, down 3.5 points
- Bearish: 25.1%, down 6.0 points
- Bullish: 38.5%
- Neutral: 31.0%
- Bearish: 30.5%
Take the Sentiment Survey.
Equity allocations rose to a four-month high but remain within the range we’ve seen throughout 2018. Plus, we asked about what type of impact trade policy has had on portfolio allocations. More about the latest results.
- Stocks and stock funds: 69.9%, down 1.4 percentage points
- Bonds and bond funds: 14.2%, down 0.2 percentage points
- Cash: 16.0%, down 1.1 percentage points
- Stocks: 33.9%, up 3.0 percentage points
- Stock funds: 36.0%, down 1.6 percentage points
- Bonds: 2.7%, down 0.1 percentage points
- Bond funds: 11.4%, down 0.1 percentage points
Take the Asset Allocation Survey.
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The Week Ahead
Monday is Columbus Day, which is a federal holiday. As such, the bond markets will be closed. The U.S. stock exchanges will, however, operate on normal hours.
Third-quarter earnings season will begin in earnest with eight S&P 500 index companies scheduled to report. Included in this group are Dow Jones industrial components Walgreens Boots Alliance Inc. (WBA) and JPMorgan Chase & Co. (JPM), which will report on Thursday and Friday, respectively.
The week’s first economic report will be the September producer price index (PPI) released on Wednesday. Thursday will feature the September consumer price index (CPI). September import and export prices and the University of Michigan’s preliminary October consumer sentiment survey will be released on Friday.
Three Federal Reserve officials will make public appearances: Chicago president Charles Evans on Tuesday, Wednesday and Friday; New York president John Williams on Wednesday; and Atlanta president Raphael Bostic on Wednesday and Friday.
The Treasury Department will auction $36 billion of three-year notes on Wednesday, $23 billion of 10-year notes on Wednesday and $15 billion of 30-year bonds on Thursday.
Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!