June 2015 – Take Our 1-Question Downside Risk Quiz

How would you answer the following? You are 55 years old and have managed to accumulate $337,400 in your retirement savings account. During the next market correction, how much of that balance are you willing to lose?

• $0
• $25,440
• $37,400
• $67,480
• $158,900

The last significant bear market is US stocks occurred during the period from October 31, 2007 to February 28, 2009. The S&P 500 lost over 50% of its value during this period. Keep that in mind as you review our comments on the choices in our quiz:

If your answer is $0:

It is unrealistic to assume that you would lose no money during a period when all asset classes except cash fell in value. A cash or stable value fund in your plan would have achieved this result, but you will have little chance achieving your investment goals over the long run by using nothing but cash or stable value funds in your account in every market condition.

If your answer is $25,440:

A moderately conservative portfolio fell by about 7.5% during the sixteen month decline ending in early 2009. What do we mean my moderately conservative? Well, about 20% of your total portfolio would have been in the stock market, with the balance in bond and cash funds. Many investors think holding only 20% in stock funds means you cannot reach your investment goals, but protecting from significant market declines when risks are extremely high can often help over the long haul.

If your answer is $37,400:

Some investors feel a psychological benefit in not having your portfolio fall from the $300,000 range to the $200,000 range, so this is a rational reaction. Recognize, however, that this is only an 11% decline during a market environment where stock lost half of their value, or more, so you would have needed to position your portfolio very conservatively to limit your losses to this amount.

If your answer is $67,480:

A bear market is generally defined as one in which stocks fall by 20% or more. A decline of this amount represents the decline you would have suffered were you invested entirely in stocks during a typical bear market decline. If you are comfortable with losses of this magnitude, you can consider yourself an aggressive investor.

If your answer is $158,900:

Almost no one chooses this answer, that’s a huge decline! Guess what – that is the amount of money you would have lost from October, 2007 through February, 2009 if you were invested in any of the 13 largest target date funds with a 2030 target date (the date closest to your retirement age if you are 55). Those funds lost 47% during that period, a loss that will be difficult to overcome should your retirement date be something closer than 2030.

We are reminded of commentary from Ed Easterling of Crestmont Research delivered over ten years ago ⁽¹⁾:

Risk can be friend or foe, and as an investor you will succeed or fail depending on how you deal with it. Risk is an inherent condition of all investments and should be respected, assessed, managed, and prudently controlled.

You may have heard, “If you want greater returns, you have to take more risk.” The implication is that risk creates returns—as though risk represents an element that mixes with investment capital to morph into returns. In reality, risk represents a condition that drives investors to demand compensation and protection.

The first step toward making money is not losing it.

⁽¹⁾    Excerpted from Chapter 5 of Just One Thing: Twelve of the World's Best Investors Reveal the One Strategy You Can't Overlook (John Wiley & Sons: 2005; John Mauldin, Editor