1) When we start with Asset Allocation, actually we are already underweight equities (less than 100%) based on the % of temporary falls we can tolerate.
2) This default underweight does not require identifying 'when' the market will crash. But should be based on expectation (derived from history) i.e 10-20% temporary decline almost every year and 50-60% temporary fall once every 7-10 years in equities.
3) If markets happen to crash suddenly, our default underweight position (called asset allocation) will reduce the impact and debt allocation can be used to buy at lower levels
A superb recent performance may sometimes mask dangerous risk-taking. A dismal recent performance may sometimes mask a solid investment process and good long term track record. Differentiating both is unfortunately more art than science.
A thread on how to address this...
1) Consider full market cycle performance from peak to peak or bottom to bottom.
2) Check how did the performance occur - huge sector calls, concentration, mid & small cap exposure etc
3) Check downside capture ratio and declines vs benchmark in all major falls
4) Do you understand the process?
5) Do you have a rough quantitative/qualitative check for the process by looking at portfolios?
6) Will you be able to tell if the process is followed especially when a fund is underperforming?
1) What took three years and seven months in the Great Depression took one year and six months in 2008, and only one month in the current crisis!
2) In the Great Depression, it took 3 years 7 months from Black Thursday before President Roosevelt broke the peg to gold, allowing the Fed to print enough to stop the free fall in equities and the economy, and the reflation continued for 4 more years before the next downturn.
1) Handling bear markets finally boils down to psychology 2) Having a pre-defined what if things go wrong plan (when to invest + how much to invest + where to invest) creates the much needed 'feeling of control'
3) Having some debt allocation which can be moved to equities partially at lower levels - can help you change your frame of reference - you are suddenly waiting for the markets to fall to your pre determined levels 4) This is illogical as your remaining amount is down but works!
5) Inherent conviction on entrepreneurship (read as equities) to create long term wealth is a must 6) As things get bad and after each fall, the lure to predict exponentially increases - you utter the most dangerous words "the markets will fall further let me wait for clarity"