HOW TO AVOID THE DANGER

The previous pages illustrate the danger of conventional methods for investing in stocks during a secular bear market. The solution to the problem of avoiding the lurking danger and protecting one's retirement plans consists of two main actions:

  1. Appropriate Asset Allocation: What is best for each investor depends on his or her specific financial situation, anticipated income, time until planned retirement and desired lifestyle and activities during retirement. There may be other important factors to consider. Virtually all investors will want to incorporate stocks and bonds into their portfolios, and other asset classes such as money market funds, real estate related, and possibly precious metals and other commodities related may be included. As a rule, the closer one is to retirement or if one has already retired, the more conservative the asset allocation should be. That means a smaller percentage in stocks, and more in bonds and money market funds that are less volatile and will produce higher levels of income.

  2. Tactical Risk Reduction Models: As the previous pages showed, buying and holding stocks during a secular bear market is an extremely poor approach. That does not mean avoiding them altogether. Even during a secular bear market, there are periods when the risks of investing in stocks are reasonable and can be consistent with portfolio objectives. However, it is critical to avoid owning stocks when the risks are too high and the danger of substantial losses in equity values is to be avoided. Bonds are less volatile than stocks, but there are also periods when the risks of owning bonds are too high for the purposes of their presence in the portfolio. The key is identifying when owning stocks, bond, or other asset classes is too risky. MDP Associates uses simple, thoroughly tested, quantitative formulas to make those decisions, which are risk reduction models to be used in conjunction with the target asset allocation.

The pages that follow discuss these steps in more detail. In particular, there are some simple sample asset allocations to which the risk control models are applied over a long (more than 40 years) historical period. Seeing what would have happened over the last complete secular bear market (1966-81) shows how the combination of an apporpriate asset allocation and the tactical models reduces the risk substantially. In the most conservative example allocation, there is only one small losing year in the 49 year period, 1963-2011. The more aggessive allocations have a few down years, but the losses are quite modest and recovered quickly. That is not the case if the tactical models are not employed.

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