1

Failing to have a plan

Investing without a plan is an error that invites other errors, such as chasing performance, market-timing, or reacting to market “noise.” Such temptations multiply during downturns, as investors looking to protect their portfolios seek quick fixes.

Developing an investment plan doesn’t need to be hard. You can start by answering a few key questions. If you’re not inclined to make your own plan, a financial advisor can help.

2

Fixating on “losses”

Let’s say you have a plan, and your portfolio is balanced across asset classes and diversified within them, but your portfolio’s value drops significantly in a market swoon. Don’t despair. Stock downturns are normal, and most investors will endure many of them.

Between 1980 and 2019, for example, there were 8 bear markets in stocks (declines of 20% or more, lasting at least 2 months) and 13 corrections (declines of at least 10%).* Unless you sell, the number of shares you own won’t fall during a downturn. In fact, the number will grow if you reinvest your funds’ income and capital gains distributions. And any market recovery should revive your portfolio too.

Still stressed? You may need to reconsider the amount of risk in your portfolio. As shown in the chart below, stock-heavy portfolios have historically delivered higher returns, but capturing them has required greater tolerance for wide price swings. 

The mix of assets defines the spectrum of returns

Expected long-term returns rise with higher stock allocations, but so does risk.


The ranges of an investor’s returns tend to widen as more stocks are added to a portfolio. We examined the calendar-year returns between 1926 and 2019 for 11 hypothetical portfolios--book-ended by a 100-percent investment-grade bond portfolio and a 100-percent large-cap U.S. stock portfolio and including in between nine mixes of stocks and bonds, with each mix varying by 10 percentage points of stocks and bonds. The results include notably narrower bands of returns and fewer negative returns for bond-heavy portfolios but also smaller average returns.

Notes: Stocks are represented by the Standard & Poor’s 90 Index from 1926 through March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Dow Jones Wilshire 5000 Index from 1975 through April 22, 2005; the MSCI US Broad Market Index from April 23, 2005, through June 2, 2013; and the CRSP US Total Market Index thereafter. Bonds are represented by the S&P High Grade Corporate Index from 1926 through 1968; the Citigroup High Grade Index from 1969 through 1972; the Bloomberg Barclays U.S. Long Credit AA Index from 1973 through 1975; and the Bloomberg Barclays U.S. Aggregate Bond Index thereafter. Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Vanguard Investment Strategy Group. Data are as of December 31, 2019. 

3

Overreacting or missing an opportunity

In times of falling asset prices, some investors overreact by selling riskier assets and moving to government securities or cash equivalents. Or they may embrace the familiar, perhaps moving from international to domestic markets, in a display of “home bias.”

It does sometimes take a market shock to alert investors to the risk in their allocations. For example, you may let your portfolio drift in rising markets, perhaps not realizing that you’re taking on more and more risk over time. But it’s a mistake to sell risky assets amid market volatility in the belief that you’ll know when to move your money back to those assets. That’s called market-timing, and the chart below shows one reason why it’s a bad idea.

The futility of timing the stock market

Its best and worst days happen close together.

 During the past 40 years, thirteen of the 20 strongest daily gains for stocks, as measured by the Standard and Poor’s 500 Index, occurred in years that ended with negative total returns. And nine of the 20 biggest daily declines in stocks occurred in years that ended with positive total returns. Extreme market movements, up and down, often occurred in close proximity to one another.

Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Vanguard.

*Source: Vanguard calculations, based on the performance of the MSCI World Index from January 1, 1980, through December 31, 1987, and the MSCI AC World Index thereafter. Both indexes are denominated in U.S. dollars. Our count of corrections excludes those that turned into bear markets. We count corrections that occur after a bear market has recovered from its trough, even if stock prices haven’t yet reached their previous peak.

Notes:

All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Diversification does not ensure a profit or guarantee against a loss.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. 

The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

The Vanguard Capital Markets Model is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.