Asset allocation is one of the most important decisions an investor needs to make. To determine your mix of domestic stocks, international stocks, and bonds, you need to determine your appetite for risk.

The first step of asset allocation is deciding what percentage of your money to put in stocks versus bonds. People who are more risk-averse should hold more bonds, while people who can tolerate risk and desire higher expected (but not guaranteed) returns should hold more stocks.

I have cautioned many investors, especially young investors, not to put too much money into stocks. There is a trend for younger investors to allocate more and more money into equities as the stock market has risen, and they always say that they can handle the risk. You even see people discussing ways to employ leverage to obtain greater than 100% exposure to stocks. Their reasoning will usually go something like this:

I have a high risk tolerance. Any correction or bear market would be a buying opportunity. I have a long time horizon and I know that stocks generate higher returns than bonds.

Iron Mike’s Words Of Wisdom To Investors

Mike Tyson needs no introduction. Dominating opponents in the late 1980s and early 1990s, he was one of the most feared boxers ever. With a powerful punch and high knockout rates, people would watch his fights with anticipation, knowing that a first-round knockout was always possible when Iron Mike stepped into the ring. With a mean personality, he struck fear into opponents and observers alike. Before one fight, after being told by reporters his opponent’s plans for beating him, Iron Mike delivered the famous quote:

Everybody has a plan until they get punched in the mouth. – Mike Tyson

Part of the reason why Tyson’s quote is so famous is that his words can be applied to many other areas of life, including investing. Everyone thinks they can take a lot of risk until they get hit with a big bear market. It’s hard to know whether you can handle a big bear market until you actually experience one.

Many young physicians have been investing only during this current bull market. They don’t know what it’s like to lose 50% of their portfolio value. Some physicians lost years worth of salary over the course of months during the tech bust and the financial crisis.

The Panic Of A Bear Market

You can read and understand my blog or White Coat Investor or Bogleheads, who will tell you to “stay the course”, but when you’re losing tens of thousands of dollars every day, with no end in sight, it’s hard to stay in the market.

Bear markets are never orderly. A bear market never occurs just because of “profit-taking” after a long bull market. Bear markets are as fierce as a Mike Tyson punch. During the financial crisis of 2008, people really did believe the entire global financial system could collapse and the world would plunge into a second Great Depression, or worse. Bear Stearns and Lehman Brothers, two of the premier investment banks of their time, did not survive the financial crisis.

Even Jim Cramer Panicked During The Financial Crisis

Even seasoned market investors can panic during times of market stress. After a particularly rough week in the markets, Jim Cramer, a market veteran and host of the Mad Money show, went on the Today show in October 2008 and told Ann Curry, along with the rest of America (emphasis mine):

“I thought about this all weekend. I do not want to say these things on TV. Whatever money you may need for the next five years, please take it out of the stock market right now, this week. I do not believe that you should risk those assets in the stock market right now.” – Jim Cramer

To be fair, he did say that for people who had a longer than 5-year time horizon,

“I think what you have to do, if you can withstand it, is just ride it out” – Jim Cramer

You can tell that he didn’t even want to say what he said when he said it. “I do not want to say these things on TV,” he prefaced his quote. But it just goes to show that bear markets are very scary and it’s hard to think clearly in times of stress.

Until You’ve Experienced A Bear Market, Have At Least A Little Bit Of Bonds

Even a 10% allocation in bonds, which I use, will cushion the blow of a bear market. By giving yourself a small cushion in bonds, you can mentally tell yourself that you are not experiencing as many losses as you would have if you held 100% stocks. Psychologically, this can help you weather the storm.

A new investor who has 100% stocks can easily panic during a market crash and quickly become 100% cash. A young investor (such as a new attending physician) may experience losses that cause them to exit the market for years. After the bear market, it will take time, often after the market has recovered much of its losses, before they tread back into the market. This mistake will be magnified year after year for the rest of their lives because of the power of compound interest.

We spend a lot of time quibbling about a basis point (0.01%) here or there, but maintaining your asset allocation during a bear market will be far more critical to your long-term financial success than whether you invest in the S&P 500 or Total Stock Market.

If you make it through the next bear market unscathed, telling all your friends to be “greedy when others are fearful”, then by all means, invest aggressively after you’ve proven yourself. If a big bear market occurs early in your career, remember that the number of dollars at stake is relatively small compared to when you are nearing retirement. A bear market early in your career can be a good test of your resolve and risk tolerance.

Have A Plan, Despite What Mike Tyson Says

This is not to say you shouldn’t have a plan and just roll with the punches. You should have a plan, ideally written down in an investor policy statement, that you can turn to in times of market stress. It will bring mental clarity in troubled times, helping you to make good decisions and stay the course when everyone is exiting the market. Mike Tyson may have said that his opponents throw out their plans when they get punched in the mouth, but fighting Iron Mike without a plan is a sure recipe to get knocked out.

What do you think? How did you react during the tech crash and/or financial crisis? If you’ve never experienced a big bear market, what is your asset allocation?

24 COMMENTS

  1. I enjoyed this post. A few things I agree with and a few things I don’t. I personally don’t think a traditional stock:bond allocation will provide complete protection for a possible correction given that much of this excessive overvaluation is driven by a bubble in interest rates. Also, (this is not intended to be offensive), I don’t think this blog (or some other listed) can claim that “(they) will tell you to “stay the course” [during a crash]” given these sites were not around during previous market events. Even the “ultimate” bogleheads panicked in ’07-’09, which is truly epic because it was 3 months before the bottom after already losing ~40% nominally and ~80% through the actual correction (https://www.bogleheads.org/forum/viewtopic.php?t=30085&mrr=1230673467). IMHO, given the current structure of this market, I would not be surprised if over a weekend, the market decides to really tank, people cannot access many of their accounts (even their bank accounts) and well… OTOH, I would not be surprised if the market doesn’t crash and goes to the moon in nominal terms but with a significant loss in real wealth. What I am certain of is that the current conditions are not sustainable, significant volatility is coming (either right or left tail risk) and, to paraphrase a Chinese proverb, we are/will be living in interesting times.

    • Excellent comments as usual, thevaluedoc. Hopefully, I will be accountable for all of my many previous posts to “stay the course” when the next bear market hits! Please link to them if I ever write a post that says otherwise!

  2. I watched a reel last week of Mike’s knockouts…it was incredible. He was so strong.

    I am still at 100% stocks and figured when I hit $500k in assets I will start allocating into bond. Before then I still have a way to go until retirement and can ride out a storm.

  3. Great post. I am afraid many investors think that the next market crash will be similar to the last one. The market tanked in the fall of 2008, but that was followed by one of the best recoveries that started in March of 2009. The next market correction might have 3-4 years of negative returns like from 2000-2003. Nobody knows what will happen, but is better to have a plan that you can live with when the market goes tanks.

    • I agree. The course of every bear market is a little different from previous ones, but they do follow general themes. Often, people will rationalize a decision that deviates from their plan by saying “This time is different…”

  4. I take a set it and forget it approach for the most part. Occasionally I re-balance but I agree with you that its all talk until you go through a bear market. Most people panic and end up selling, making the bear market even worse for them since they often get back in after the market has been on an uptrend for some time.

  5. I was just starting a few years into my residency retirement matching account when 08-09 hit. I watched the assets go from like 35K down to 20K or so. I had a target fund. As the absolute amount was so small, it didn’t bother me at all.
    Now I’ve got real money and loathe to see it dwindle in the next downturn. I’ve been increasing my bonds to 20%. I try to mentally simulate a crash sometimes (yeah I don’t know how), just to avoid freaking out a being miserable. I think I’ll be ok, but I think it’s like saying I’ll be ok if I don’t get that big promotion….. It’ll hurt either way. Loss aversion is a real B, but hedonic adaptation works in the bad news direction too, so I figure I’ll adapt a bit to the loss before the market rebounds.

    Btw, these bear doomsdays posts are proliferating.

  6. I’ve been through two bear markets since starting to invest over 20 years ago, and thanks to the wisdom of my Dad, who was a financial planner, I was able to hold steady through them. But that was when my total investments were in the low- to mid-five figure range. Now that I’ve hit the six-figure investment mark, I suspect the next bear market will hurt a lot more! I’m really hoping it happens soon, when I’m still early in my life as a physician, so that the loss will not be as great and I will have lots of opportunity to benefit from it. We shall see…

  7. We didn’t make any changes during the dot com crash or the housing meltdown. We were 100% stocks and continued invested each and every month.

    Now though, we’re (early) retired so things are different. We’ve recently moved into some bonds to help us deal with sequence of returns risk since we’re in the drawdown phase.

  8. I used to think I was pretty tough and could handle a big punch. Now, as my net worth increases I’ve backed off to around 70% stocks. I’m willing to tolerate a 25% drop in net worth but not a 50% drop.

  9. Having lived through a few Bear Markets, I know I will just ride it out. I watch the news for a day or two and then tune it out. I usually look up how much I’ve lost, have a laugh, keep on with my life and my investment plan. I remember how my co-workers were reacting in 2008 and I especially remember the one that was 1 year away from retirement. She panicked, moved her TSP funds and then had to work an additional 2+ years past her original retirement date to have enough money to barely squeak into retirement. Come up with a solid plan, keep your head down and one has to turn off the news for their job is to hook you with sensationalism.

    For me, Bear Markets are always a Fire Sale. Only wished I had spare money to dump into my VTSAX at times like those.

    • Needless to say, this article does not apply to you 🙂 You have proven yourself by staying strong through multiple bear markets. Unfortunately, not everyone has nerves of steel, and those people should hold more bonds until they know they can handle a bear market.

  10. I generally believe young investors should have aggresssive portfolios. I do think they should have at least 10% bonds to instill the discipline of rebalancing. 90% stocks v. 100% stocks is no different with regard to bear market pain, but the behavioral education derived from sticking to a plan and executing disciplined rebalancing into a bear will pay off for the remainder of investing career.

    Dave

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