Adam Levy, The Motley Fool
5 min read
The last few years have been absolutely fantastic for stock investors. The bull market of the last four years has pushed the S&P 500 (SNPINDEX: ^GSPC) 116% higher while the tech-heavy Nasdaq Composite (NASDAQINDEX: ^IXIC) is up an even more impressive 156%.
While the bull market has been strong and supported by stellar earnings growth and improving outlooks, many investors can’t help but notice that stock market valuations are particularly high. That’s not a sustainable position for stocks: Either earnings have to grow fast enough to bring valuations lower, or stock prices have to come down.
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In fact, it’s a practical inevitability that stock prices crash 20% or more in the future. The markets move in cycles, and eventually, some event will trigger a big sell-off in the stock market. If you want to position your portfolio to recover in less than half the time it takes for others, here’s exactly what you should do.
The best portfolio for a market crash
It doesn’t take any groundbreaking portfolio strategy to produce rapid recoveries in the event of a stock market crash. Investors can hold a simple 60/40 stock/bond portfolio with periodic rebalancing and achieve superior results in maintaining portfolio stability.
Since 1988, the 60/40 portfolio has recovered from drawdowns of 20% or more in just 11 months on average, according to data compiled by J.P. Morgan analysts. Meanwhile, the S&P 500 took an average of 24 months to recover, even with dividends reinvested.
It’s worth noting that the 60/40 portfolio only stands out against an all-stock portfolio in terms of recovery when the portfolio drops at least 20%. Smaller drops don’t exhibit much difference in how long it takes the portfolio to recover. That said, that’s exactly the kind of protection an investor should hope for from bonds: a stabilizing force amid big long drops without providing too much drag amid shorter pullbacks.
The stability of the 60/40 portfolio is further evidenced by the likelihood that it will produce a positive return over any given five- or 10-year period. Since 1989, the 60/40 portfolio has produced a positive return 99% of the time over any five-year period and 100% of the time over 10 years. The S&P 500 alone only achieves positive returns 87% of the time over five years and 93% of the time over 10 years.
