Prepare for a Crash, Even If You Don't Think It's Coming

Jeffrey Gundlach was kind enough to let everyone know his view of the equity market Tuesday. For whatever reason, the media scoop up Gundlach equity calls like dogs go for table scraps despite Gundlach's current reign as bond "king." Gundlach believes the S&P 500 has just 2% of upside in his estimation and 20% of downside. Not a great risk reward. I've yet to hear a timeframe for these targets, but I'm guessing it's shorter then yours or mine.

Even if you believe Gundlach is off base, can I offer a suggestion? Prepare for him to be correct. You should do this on a regular basis. Can you handle a 20% correction in the equity market? Have you actually run the numbers? I do the math on a regular basis, and I suggest you do the same. If you lost 20% tomorrow, would it change your lifestyle? If it does, adjust accordingly. Call this your portfolio crash test. Banks do it, why not you?

You can go even in more depth and adjust each stock you own. Example, I own Under Armour. It's trading around $80 as I write this. Could it go back to the low $60s where it was in January? Of course it could. Would I sell it there? Not a chance, at least based on current information. That's more than a 20% pullback, but it's important to remember that many stocks will perform worse than the overall market in time of turmoil.

The purpose of this test is not to solely asses risk tolerance for that drop but also to determine where to get cash from to put to work and how. The global financial crisis caused a 57% drop in assets. I'm in my mid-30's, a drop like that is likely to happen again in my lifetime, but not often. How will I handle it when it does? These are questions you should be able to ask yourself often.

Did you know from peak to trough that the horrendous drop of the global financial crisis lasted just 510 days? Meanwhile the current rally from the bottom is pushing close to 2,500 days. That's almost five times more pleasure than pain. During that time we've had minor pullbacks of 10% and one teasing 20%, which is all quite normal and not signaling a 21st century depression.

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