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Our Portfolio Is Built To Withstand Market Drops

While we don’t know when exactly a market drop will happen, we’ve already prepared for it.

Articles by Matthew Murphy
By Matthew Murphy Quantitative Investing Associate, Betterment Published Mar. 24, 2020
Published Mar. 24, 2020
8 min read

We’ve recently seen a sizable drop—or in other words, a drawdown—in the stock market. In fact, it’s large enough to push U.S. equity markets into the first bear market in over ten years.

While the last decade has been generally great for investors, there have been a few bumps along the way—like in 2018, when the Dow and S&P 500 both experienced the worst performance during the month of December since 1931.

Seeing your investments lose value can cause feelings of fear or concern, but it’s important to remember that any long-term investor is going to see short-term losses at some point in time.

Let’s ride this out together

There Will Always Be Ups And Downs

Even in a good year, your portfolio can experience losses. Let’s take a look at how Betterment’s diversified 75% stock portfolio would have performed over the last sixteen years, assuming the makeup of our current portfolio.

The graph below shows the portfolio’s largest drawdown within each year in red, as well as total return for each year in blue. As you can see, even though the portfolio ended the year with positive returns three times as often as it ended with negative returns, it experienced a negative return at some point during every year.

Betterment’s 75% Stock Portfolio—Yearly Returns and Largest Drawdowns

Betterment’s 75% Stock Portfolio—Yearly Returns and Largest Drawdowns

Source: Returns data from Xignite. Calculations by Betterment. Data ranges from January 1, 2004 to January 1, 2020. The Betterment portfolio historical performance numbers are based on a backtest of the ETFs or indices tracked by each asset class in a Betterment IRA portfolio as of March 2020. Though we have made an effort to closely match performance results shown to that of the Betterment Portfolio over time, these results are entirely the product of a model. Actual client experience could have varied materially. Performance figures assume dividends are reinvested and daily portfolio rebalancing at market closing prices. The returns are net of a 0.25% annual management fee and fund level expenses. Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance for client accounts may be materially lower. Backtested performance results have certain inherent limitations. Such results do not represent the impact that material economic and market factors might have on an investment adviser’s decision-making process if the adviser were actually managing client money. Backtested performance also differs from actual performance because it is achieved through the retroactive application of model portfolios designed with the benefit of hindsight. As a result, the models theoretically may be changed from time to time and the effect on performance results could be either favorable or unfavorable. See additional disclosure here.

Despite an average drawdown of 12%, as well as four years with drawdowns greater than 15%, the portfolio had an average yearly return of +8.2%. Even when things looked to be at their worst during the 2008 financial crisis, the portfolio’s largest drawdown was more extreme than the actual ending loss for that year.

We Designed Our Portfolios With Drawdowns In Mind

Betterment has over 100 portfolios to choose from—but don’t worry, we’ll recommend the right level of risk for each investing goal that you set up. Our recommendations consider both the amount of time you’ll be investing for, as well as the possibility that you could experience market drawdowns during that time frame.

For goals with a longer time horizon, we advise that you hold a larger portion of your portfolio in stocks. A portfolio with more stocks is more likely to experience losses in the short-term, but is also more likely to generate greater long-term gains.

For shorter-term goals, we recommended a lower stock allocation. This helps to avoid large drops in your balance right before you plan to use what you’ve saved.

As your goal’s end date gets closer, we recommend that you reduce your risk — we can also do it for you — which helps to reduce the chance that your balance will drastically fall if the market drops.

Below, we show the performance of three Betterment portfolios at different risk levels—90% stocks, 50% stocks, and 10% stocks. First, we look at the returns over a shorter period, a year-to-date snapshot ending March 17, 2020. Stock markets have experienced a significant drawdown to start 2020, and as expected, the lower risk (10% stock) portfolio had a smaller drawdown than the higher risk portfolios during this period.

Betterment Portfolio Returns at Different Risk Levels (Jan 1, 2020 – March 17, 2020)

Betterment Portfolio Returns at Different Risk Levels

Source: Returns data from Xignite. Calculations by Betterment. Data ranges from January 1, 2020 to March 17, 2020. The Betterment portfolio historical performance numbers are based on a backtest of the ETFs or indices tracked by each asset class in a Betterment IRA portfolio as of March 2020. Though we have made an effort to closely match performance results shown to that of the Betterment Portfolio over time, these results are entirely the product of a model. Actual client experience could have varied materially. Performance figures assume dividends are reinvested and daily portfolio rebalancing at market closing prices. The returns are net of a 0.25% annual management fee and fund level expenses. Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance for client accounts may be materially lower. Backtested performance results have certain inherent limitations. Such results do not represent the impact that material economic and market factors might have on an investment adviser’s decision-making process if the adviser were actually managing client money. Backtested performance also differs from actual performance because it is achieved through the retroactive application of model portfolios designed with the benefit of hindsight. As a result, the models theoretically may be changed from time to time and the effect on performance results could be either favorable or unfavorable. See additional disclosure here.

Next we look at the returns of our portfolios from the beginning of 2004 to March 17, 2020. As you might expect, the higher risk 90% stock portfolio grows faster than the 10% stock portfolio. It also experiences larger and longer periods of negative returns.

Betterment Portfolio Returns at Different Risk Levels (Jan 1, 2004 – March 17, 2020)

Betterment Portfolio Returns at Different Risk Levels.png

Source: Returns data from Xignite. Calculations by Betterment. Data ranges from January 1, 2004 to March 17, 2020. The Betterment portfolio historical performance numbers are based on a backtest of the ETFs or indices tracked by each asset class in a Betterment IRA portfolio as of March 2020. Though we have made an effort to closely match performance results shown to that of the Betterment Portfolio over time, these results are entirely the product of a model. Actual client experience could have varied materially. Performance figures assume dividends are reinvested and daily portfolio rebalancing at market closing prices. The returns are net of a 0.25% annual management fee and fund level expenses. Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance for client accounts may be materially lower. Backtested performance results have certain inherent limitations. Such results do not represent the impact that material economic and market factors might have on an investment adviser’s decision-making process if the adviser were actually managing client money. Backtested performance also differs from actual performance because it is achieved through the retroactive application of model portfolios designed with the benefit of hindsight. As a result, the models theoretically may be changed from time to time and the effect on performance results could be either favorable or unfavorable. See additional disclosure here.

If you were to focus on a short time frame—such as the beginning of 2020—you might be tempted to think that the 10% stock allocation is a better investment than the 50% or the 90% portfolios. But, when you consider a longer time window, it’s clear that the 10% portfolio lacks the potential for the greater returns that are seen in the portfolios with higher risk.

You Can Reach Your Goals Despite Market Drops

The path to investment growth can be bumpy, and negative returns are bound to make an investor feel uncertain. But, staying disciplined and sticking to your plan can pay off.

Let’s consider a hypothetical 30 year old customer who started a Retirement goal in 2004 with an initial balance of $10,000 and ongoing monthly auto-deposits of $350. Below, we show the goal’s projected growth alongside the actual daily balance that the customer would have had over the 16-year period.

Leading into 2008, the Retirement goal would have performed better than the median projected outcome, but due to the financial crisis in 2008, the balance would have fallen by as much as 45%.

Retirement Goal—Projected vs. Actual Balance

Retirement Goal Projected vs Actual Balance

Source: Returns data from Xignite. Calculations by Betterment. Data ranges from January 1, 2004 to March 17, 2020. The Betterment portfolio historical performance numbers are based on a backtest of the ETFs or indices tracked by each asset class in a Betterment IRA portfolio as of March 2020. Though we have made an effort to closely match performance results shown to that of the Betterment Portfolio over time, these results are entirely the product of a model. Actual client experience could have varied materially. Performance figures assume dividends are reinvested and daily portfolio rebalancing at market closing prices. The returns are net of a 0.25% annual management fee and fund level expenses. Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance for client accounts may be materially lower. Backtested performance results have certain inherent limitations. Such results do not represent the impact that material economic and market factors might have on an investment adviser’s decision-making process if the adviser were actually managing client money. Backtested performance also differs from actual performance because it is achieved through the retroactive application of model portfolios designed with the benefit of hindsight. As a result, the models theoretically may be changed from time to time and the effect on performance results could be either favorable or unfavorable. See additional disclosure here. The goal projections are for a 30 year old’s Retirement goal on January 1st 2004 with a starting balance of $10,000 and a monthly deposit of $350. The monthly deposit is applied on the first of each month. The goal has a target allocation of 90% for the duration of the time period considered. The average projected balance is derived from the median projected outcome.

This hypothetical investor would likely have felt concerned about their portfolio falling below our average projected outcome—and that’s understandable. But, because they continued making their monthly auto-deposits and markets eventually bounced back, the investor would have also come to see their balance grow right back in line with our projections.

The most recent market drop brings the balance below our average projected outcome, but remains within our projected range of returns. We’ve seen from previous market drops that sticking to an investment plan has paid off. Hopefully, this historical context may provide some reassurance to investors who stay the course and wait for their balances to bounce back over time.

Our Advice: Focus On The Future

A sudden drop in the stock market, like the one we’re experiencing now, typically comes with frightening news headlines and panic amongst investors. While some feeling of angst is perfectly normal, it’s important to remember that a temporary slow down in the markets doesn’t mean that they’ll continue to fall forever.

If you need some help zooming out, remember that bad markets bring productive opportunities to tax-loss harvest, move your investments with less tax consequences, or make a one-time deposit to help rebalance your portfolio.

We are working hard to push you closer to achieving your goals both when markets are up and when markets are down.

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