Investors have enjoyed a powerful bull market over the past 8½ years. But they also carry the emotional scars of the steep declines of 2000 and 2008. With stock valuations currently stretched to levels reached only at the end of prior bull-market peaks, many wonder if another steep decline is close at hand.

Here’s how to determine the type of impact a new bear market would have on your ability to meet your long-term financial goals.

It’s an under-appreciated fact that emotions are the primary obstacle to investing success, rather than a lack of knowledge. As Warren Buffett once famously quipped, “If past history was all there was to the game, the richest people would be librarians.” Knowing the right investing things to do is certainly important, but it’s insufficient by itself. The key is to know the right things to do and then to follow through on those decisions, which requires winning the emotional battle.

Over SMI’s 27+ year life, we’ve tried to help our members win this emotional battle by preparing them in advance with knowledge of what to expect, so that when the market’s inevitable winds start howling, they’re prepared. “Praemonitus, praemunitus” — forewarned is forearmed. At least in theory, being warned in advance of what to expect should give a person a tactical advantage in navigating any situation, which includes market events.

This is why SMI starts sounding cautious as bull markets get extended (and why, on the other side of the spectrum, you can count on us providing bullish encouragement in the depths of the next bear market). Part of our role is to act as an emotional counterweight to the prevailing emotion of the moment. Which means that today, with the stock market 8½ years into a bull market which hasn’t experienced even a 15% correction since way back in 2011, we feel the need to remind readers that, as surely as night follows day, every bull market is followed by a bear market.

Granted, the timing of these market shifts is notoriously difficult to pin down. We’ve never found a predictive system that could reliably tell us when a bear market is about to begin, which is why we make no effort to change our portfolios in advance of a market shift from bull to bear. Rather, our strategies take action only in response to market changes that already have occurred, such as when our Dynamic Asset Allocation strategy shifts us out of one asset class and into another in response to market action. With the bull market still intact, our strategies remain fully engaged with stocks.

However, the fact that we don’t take preemptive actions based on predictions of what the market will do next doesn’t mean we aren’t paying attention to changes in market conditions. On the contrary, we monitor the status of many market indicators and signals. And currently, more than a few indicate the conditions for a bear market are either close or already in place. Perhaps most importantly, the Fed has shifted from adding accommodation to the financial markets in recent years to now removing it. While this may be appropriate, it adds a new element of risk to the markets.

These factors don’t mean a bear market will happen soon. It merely means that it could. We have to take that risk seriously, in a way that wasn’t the case a few years ago.

Enter MoneyGuidePro®

In early 2017, SMI premium members gained access to a powerful tool. Our affiliated partners at SMI Advisory Services made personal access to the MoneyGuidePro® financial planning software available for a one-time fee of only $50. This software — ranked the number one financial planning software by advisors the past nine consecutive years — normally costs financial planners $1,295 per year to use. Individuals typically can gain access to it only by working with an advisor, so to have access to it on an individual basis and at a price any SMI member can afford presents a tremendous opportunity.

Not surprisingly, SMI members responded quickly. More than 1,000 have signed up and started using MoneyGuidePro® in the six months since it became available. That’s outstanding! But that means thousands of SMI members have yet to take advantage of this tremendous opportunity. If you’re among those who haven’t signed up for MoneyGuidePro,® we urge you to revisit An Exciting New Opportunity for SMI Members: Personal Financial Planning via MoneyGuidePro® and do so. (Not convinced? Consider Austin's February editorial, Personalized Financial Planning Is Now Within Your Reach.) This is a powerful weapon in waging the emotional war every investor faces!

Modeling the next bear market in MoneyGuidePro®

MoneyGuidePro® does many things, but this month we want to focus on just one: how to use the software to model the impact of the next bear market on your financial plan. It’s our belief that you will derive two tangible benefits from seeing how the next bear market is likely to impact your portfolio and your ability to meet your long-term financial goals.

  • First, it will help reveal if your current portfolio mix is appropriate, or whether you need to make adjustments. Amazingly, many people have no real idea what the impact of a bear market would be on their long-term financial future. This lack of knowledge causes some to plow ahead with investing plans far riskier than they should be. Investors who cavalierly loaded up on technology stocks throughout the dot-com bubble are a good example of this group. They never dreamed the tech-focused Nasdaq index could fall 83% in the ensuing bear market, digging a hole so deep it would require decades to emerge from.
  • Second, it will provide tremendous peace of mind when you have a plan in place that you can trust to weather the next bear market and still hit your goals! It may require some effort to refine your financial plan to the place where you feel comfortable heading into a future bear market. But it’s worth the effort! Having run the numbers and seen the outcome in advance, you will be in the best possible place to withstand the emotional storms ahead. Those emotional winds will drive many investors to make counterproductive, potentially life-altering moves during the next bear market. These misguided decisions to sell near the bear market bottom when they should hold on will cause them to miss the inevitable rebound on the other side. This happens to millions of investors during every bear market. It may have happened to you in 2000 or 2008. There’s no reason it ever needs to happen to you again.

George Santayana is credited with saying, “Those who fail to learn from history are doomed to repeat it.” That’s true, but as we noted earlier, it’s not enough to simply know the history. You need to have the emotional steel to act on it. Seeing your personal plan withstand the ravages of the next bear market in advance and emerge successfully will help provide the mettle you need to make the right decisions in the heat of the bear market cauldron. That’s a worthy goal, and it’s what we’re hoping to achieve as the result of this exercise this month!

Losses during the Great Recession

MoneyGuidePro® has excellent built-in functionality to make modeling the next bear market simple for users. However, due to the specifics of the SMI investing strategies, only some of this functionality will work for SMI members. Some of it will not. We’ll walk through those specifics now.

[Note: If you’re new to MoneyGuidePro®, we recommend following the detailed walkthroughs presented in the February and March issues of SMI before reading further here. Those were written specifically as introductory articles for SMI readers.]

Here are links to those articles:

Whether you are just starting with Money-GuidePro® and are using the initial guided-lab experience, or have completed the lab and are working with the full-featured final version of MoneyGuidePro,® the specific processes we will be examining in this article are virtually identical.

The first place the issue of a future bear market arises is on the “Select Your Risk Score” screen (found under the “About You” heading, after selecting the “Risk & Allocation” menu option). As the first screen shot below shows, this page allows you to select a risk score using the slider bar. As you move the slider bar along the risk scale, two things happen.

First, the “appropriate portfolio” for your selected level of risk changes, showing you a suggested mix of SMI strategies. Based on your risk tolerance, as measured by the Great Recession loss shown for the various strategies, you will select a risk score. In our example, Bill has selected a risk score of 62, which results in a 50/40/10 portfolio being displayed. (This means a portfolio comprised of 50% Dynamic Asset Allocation, 40% Upgrading and 10% Sector Rotation, with the Upgrading portion divided 60% to Stock Upgrading and 40% to Bond Upgrading. For more information on blending these strategies, see Higher Returns With Less Risk: The Best Combinations of SMI’s Most Popular Strategies.)

Second, statistics regarding the “Great Recession Loss for this Portfolio” are displayed. In the graphic below, these are on the right of the screen (though they may display at the bottom of the page, depending on your browser and screen settings). MoneyGuidePro® automatically calculates the percentage loss a portfolio like this would have experienced between November 2007-February 2009. The program also translates that loss into dollar terms based on the portfolio specifics you’ve entered into the program. So in our example, MoneyGuidePro® displays that this 50/40/10 portfolio would have lost -39%, which would translate (based on the amount Bill has invested) into a current portfolio loss of -$160,970 were it to happen again today.

(Click Graphic to Enlarge)

Translating SMI strategies to MoneyGuidePro®

Unfortunately, those calculated figures don't accurately reflect the actual performance of the SMI strategies. That’s not the fault of MoneyGuidePro® — it’s simply a limitation of using SMI’s specific strategies within the software. While MoneyGuidePro® has accurate overall performance data for each of the SMI strategies, which allows the software to accurately make future return projections, it doesn’t have the granular historical data on our strategies that it would need to model the past performance between these specific dates. As a result, in this specific “Great Recession Loss” instance, the software has to rely on more generic market index data, which doesn’t correspond at all closely to a 50/40/10 portfolio that includes the distinctly non-index-like Dynamic Asset Allocation (DAA) strategy.

Bottom-line: What this means is simple. If you’re using Just-the-Basics (or indexing in general), these numbers will be fairly accurate. But if you’re using Upgrading, DAA, or Sector Rotation in your portfolio, you should ignore these “Great Recession Loss” figures on this particular screen of MoneyGuidePro®.

What Are You Afraid Of?

Thankfully, MoneyGuidePro® has another feature that makes bear market modeling a breeze. Under the “Results” heading, the last option in the drop-down list is the “What Are You Afraid Of?” screen. This page presents six of the primary fears investors face and allows them to easily model the effects of these six factors on their financial plans.

The first of these fears is labeled “Great Recession Loss” and it looks similar to what we just saw on the “Select Your Risk Score” screen. The difference is that here we get to select the exact level of loss we wish to model using the slider bar at the bottom of the screen.

The key to using this feature correctly is knowing what loss number to enter using the slider bar. To help you determine that, we’ve calculated the actual historical losses that would have been experienced by the various SMI strategies between November 2007-February 2009 and compiled them in the table at right. In our earlier example, we saw that our hypothetical couple was using a 50/40/10 portfolio, with a 60/40 blend of Upgrading. Whereas the Risk Score screen indicated such a portfolio would have experienced a loss of -39%, the table shows that portfolio would actually have lost a much milder -16%.

Using the slider bar to set the loss at -16%, we see that the difference between those two loss levels makes a huge difference in the financial plan outcomes. Whereas a -39% loss would have knocked our couple’s chances of meeting their “Needs Only” down to 26%, a loss of -16% keeps their “Needs Only” probability at 91% and their “Needs & Wants” solidly within the confidence zone at 79% (see graphic below).

(Click Graphic to Enlarge)


Do we know that such a portfolio would only lose -16% again in the next bear market? Of course not. It could lose more, which we can model by sliding the bar further to the right (to say, 20%). But it’s also possible such a portfolio could lose less — after all, the last bear market was unusually severe.

The beauty is MoneyGuidePro® gives you the ability to easily test a range of outcomes. Many people will run through this exercise, see the results, and want to tweak the portfolio mix (or other aspects) of their Recommended Scenario. This is easily done a few screens prior on the “Recommended Scenario” page (see the February and March articles referenced earlier for more details on this process).

The key is that by testing various portfolio combinations, return assumptions, and worst-case scenario “fears,” you’ll hopefully arrive at a combination that instills confidence that you can withstand the next bear market by simply sticking to your plan. Knowing that if you persevere and follow the strategies as they’re laid out, you’re likely to hit your financial goals will change everything regarding bear-market psychology.

Without a plan, you would be tempted to think you need to take action in the midst of the bear market to save your financial future. But with a plan that has already modeled the bear market and survived intact, you can relax knowing that the only steps you need to take are those dictated by the strategies you’ve selected. That’s investing with a Sound Mind!