The Investment Scientist

Is A Market Crash Imminent?

Posted on: July 30, 2014

images-75Yesterday I received an email from a doctor client of mine telling me how he had a conversation with some fellow doctors, and all of them are pulling their money out of stocks because they feel that with the market breaking new high after new high, a crash is imminent. He wanted my opinion.

First of all, while all of his doctor friends might feel a market crash is imminent and certain, there is simply no such thing as certainty in the stock market. All we can work with are odds. The following are the odds of market corrections:

Magnitude of market decline Frequency of occurrence (out of 64 years from 1950-2013)
>5% Every year (94%)
>10% Every two years (58%)
>20% Every five years (20%)
>30% Every ten years (10%)
>40% Every fifty years (2%)

My study also shows that the market breaking a new high does not substantially change the odds of returns. In other words, the odds of the market dropping over 20% in the next twelve months are still about one in five; the odds of the market dropping over 30% in the next twelve months are still about one in ten.

Without the ability to tell the future, how do we deal with the odds of market correction? It’s very simple! By having a well balanced portfolio.

For instance, my doctor client has a 60/40 portfolio. If the market were to drop 30% in the next twelve months, it’s likely his portfolio will only drop about 15% since the bond portion will likely gain value.

With rebalancing (selling appreciated bonds to buy depreciated stocks), he will be able to pick up stocks at a 30% discount. Isn’t that great?

Thus, a 30% market crash, provided it even happens, would be an opportunity to relish not a disaster to fear.

The bottom line… whichever way you look at it, there is no reason to pull everything out of stocks right now. That would be a reaction based on an irrational fear.

If you want to find out how I can help you, schedule a Discovery review with me. If you are not ready, you can still get my white paper for free: The Informed Investor: 5 Key Concepts for Financial Success.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

Twitter: @mzhuang

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