The S&P 500 reached an all-time high on Apr 29 2019. The broad index gained 0.1% to 2,943.03, breaking the previous record high set in September 2018.
This index is having its best start to the year in 32 years. On top of that, it has rallied nearly 18% in the past four months, its best monthly streak since December 2010.
What should I remember when everything is so good?
When markets climb and break records, it often leads to people feeling overconfident. Thus they may be more inclined to over invest in stocks or even to start leveraging your position with borrowed money.
The problem is markets also declines and value, and sometimes sharply. Sometimes painfully through years without apparent end. That’s why I think that diversification is so important. This strategy is meant to protect me when bear markets, declines, and unexpected events happen.
A bear market occurs when stocks, on average, fall at least 20% off their high. Read more about bear markets here (+1000 Views).
Let’s see another recent example of a bear market: Final 4 months of 2018 with US small cap.
As you can see, in less than 4 months US small cap – here represented by Vanguard U.S. Small Cap (VB) – small cap entered in bear market territory with a decline of over 24%.
For an individual with a $100k investment, it would be the equivalent as losing $24k. In less than four months. Harsh.
The stock market and its volatility isn’t for everyone, and things can get bad very fast. When markets are in all-time high, we may forget this. We often do. Belief is the death of reason.
It wasn’t by mistake that I’ve included long-term US government bonds in the simulation above. As you can see the return for those 4 months was a positive +2%, with volatility less than half of the US small stocks.
So if I wanted protection against this fast bear market, what should I have done?
A simpler and more diversified portfolio (across assets) of 60% US small stocks + 40% Long-term US Bonds, would have a far less painful decline: -13.8%. And with nearly half of the volatility: 10.7%.
And what about 2019?
The downside of diversification is that you may enjoy less return when things are great. From Dec 24, 2018 – Apr 30,
But remember diversification is meant to protect you from rainy days. To lock profits by rebalancing your portfolio allocation. It’s a lot easier to endure a bear market when the decline of your investment portfolio is much less sharply when compared with the overall stock market.
And in the end, it’s also diversification that will make volatility your friend, and to enjoy a buying opportunity that
Every adversity, every failure, and every heartache, carries with it the seed of an equivalent or greater benefit.Napoleon Hill