We had an excellent question come in via the MoneyGuidePro® section of the SMI Forums recently, and I wanted to address it here to put it in front of a wider audience. It's central to effectively following the instructions in the September feature article, Facing Your Fears: Modeling the Impact of a Significant Bear Market on Your Financial Plan, so hopefully addressing it here will help other people wondering about the same issue.
Here's the question:
I am currently using Fund Upgrading, DAA, Bond Upgrading, and Sector Rotation in our portfolio, and I am working with the full-featured final version of MGP. I went to the “What Are You Afraid of?” screen, selected “Great Recession Loss”, and that’s where my question arose. You wrote that “the key to using this feature correctly is knowing what loss number to enter using the slider bar”, and also that “The hypothetical couple was using a 50/40/10 portfolio, with a 60/40 blend of Upgrading.” Setting the slider at 16 produced for them a much more optimistic outcome. And it was somewhat cut and dried, since they were using only one of the several SMI strategies.
My question: How do I know or calculate what number to set the slider on if my portfolio assets are being managed under multiple SMI strategies? I know I need to make some adjustments, and I am confident that MGP is an excellent tool to use in the process. But I am stuck until I get this one question answered. I know I must be missing something.
The key information we need to answer this question comes from the "Facing Your Fears" article linked to above. In the article, we included an "SMI Strategies Loss Table" that broke down the returns of each SMI strategy during the Great Recession time period. I've included that table here at right. We can use that information to calculate the correct loss number to enter using the slider bar in the "What are you afraid of?" section of the software.
Here's an example of how that might look using the strategies you mentioned. You'll need to substitute your own percentages to reflect the amount you allocate to each strategy, but hopefully, this will help you figure out an appropriate loss to enter.
If you are using DAA, Upgrading, SR in a roughly 50/40/10 ratio, we've already done the work for you and listed those results in the table.
If you're using some combination other than 50/40/10, here's how to run your own numbers.
Let's say a person's portfolio is weighted as follows:
30% Stock Upgrading
5% Sector Rotation
25% Bond Upgrading
They would look at the loss table and find the corresponding results for each strategy:
Stock Upgrading -50%
Sector Rotation -39%
Bond Upgrading +5%
Multiplying each strategy result by that strategy's weighting within your portfolio will provide us with a weighted average for the portfolio as a whole. (First, convert each portfolio allocation to a decimal: i.e., 40% becomes 0.4.)
The calculations for our example look like this:
DAA: 0.4 x -1 = -0.4
Stock Upgrading: 0.3 x -50 = -15
Sector Rotation: .05 x -39 = -1.95
Bond Upgrading: .25 x +5 = +1.25
When we add up those results, we find that this portfolio would have lost -16.1% between Nov 2007-Feb 2009. So you'd enter -16% as the portfolio loss using the slider bar.
As we noted in the article, it would be worthwhile to go back to this input at some point to test it with a slightly worse result, like -20%. There's no guarantee the next bear market will look exactly like the last one, so testing your plan with a range of outcomes makes sense.
If you have a cash allocation in your portfolio, you can probably safely assume a zero return on that portion of the portfolio. That means you can ignore it for the purposes of this calculation. While cash did earn a positive return back in 2007-2009, it's likely that the Fed would drop interest rates quickly back toward zero if another bear market were to take hold.
Gold and other precious metals are trickier. During the Nov 2007-Feb 2009 period that we're modeling, GLD (the main gold ETF) was up 17.9%. However this masks some pretty serious movement in both directions — for example, GLD was down -16.1% in October 2008 alone. So it wasn't as clear-cut as "gold did well when the stock market fell" (although that was the ultimate result). The other thing that makes this a tough call is that this performance occurred within the context of a much longer bull market for gold that ended in 2011. But gold has declined from those 2011 highs considerably. So it's probably an open question whether gold would perform similarly the next time around when it isn't in the midst of decade-long bull market of its own.
If your gold holdings aren't particularly sizeable relative to the rest of your portfolio, you could probably leave them out and not have it impact the result much. Otherwise, gold can be added as another "strategy" and calculated the same way we did the others, using either the historical return (+17.9%) or some other more modest figure.
Hopefully, this helps clarify how to use the Loss Table in the article and how to arrive at a custom "Great Recession" loss number to use in your personal plan.