The Pain Index: How much can you take?
- Noel Watson
- 5 days ago
- 6 min read
Updated: 3 days ago
Introduction
There is a scene in Road House where Dalton (played by the late, great Patrick Swayze) is getting fixed up after yet another barroom brawl. When offered pain relief, he refuses, stating, "Pain don't hurt".
However, this isn't always the case for many investors during times of market turbulence; they may feel nervous and wonder if staying invested remains the best choice. Some may decide to pull the plug. One investor, who recently featured in the FT, decided to sell everything in his portfolio (other than gilts) due to recent turbulence and worries about the future.
“I can’t see any upside at the moment and lots of potential downside.,..it's better to move to cash and sit out the market for six months because I have no idea what is going to happen.”
A recent study by Morningstar attempted to measure the pain of historical market volatility. In this blog, we attempt a similar analysis.
The Rules of the Road(House)
The Morningstar research measured pain in the following way:
The pain index is the ratio of the area between the cumulative value line and the peak-to-recovery line, compared with that area for the worst market decline since 1870.
Our study will be more rudimentary. We will be measuring:
The maximum drawdown (how far the portfolio's value falls from peak to trough).
Every investor has a breaking point, and if they see the value of their portfolio fall below a certain level, they may decide that enough is enough and sell to cash.
Each percentage portfolio fall will score 1 point on the pain index.
How long it takes to get back to the previous portfolio high
Some investors may have limited patience, and after their portfolio is in the doldrums for a few years, they may decide to give up on the strategy and try something else.
Every month where the portfolio is below the previous peak will score 1 point.
Previous historic volatility
We will start our research in 1990. That's as far back as we can go for this particular dataset, but this demonstrates that you don't have to go far back in time to encounter painful periods (and if we went back much further, the blog would be too long!). We will only incorporate periods where we see drawdowns exceeding 10%, again to limit the length of the blog.
60/40 portfolio
The Morningstar study examined just the S&P 500, adjusted for inflation. For this blog, we will use the No Brainer portfolio (NPB), starting with 60% global equities and 40% global bonds. This is hopefully more representative of what a typical retiree holds. We won't be adjusting for inflation as we believe investors tend to look at their portfolio balances in nominal terms (not adjusted for inflation).
Early 90s recession
Driven by the recession and Iraq's invasion of Kuwait, our NBP 60 portfolio fell around 17.5% from peak to trough and took 9 months to recover. 17.5+9 = 26.5 points.
.com bust
The .com bust was a challenging time, even for holders of diversified portfolios. The maximum drawdown was around 29%, and it took approximately 57 months to climb back to the starting point. 86 points!
Global financial crisis
The Global Financial Crisis was somewhere between the two previous examples on the pain index, with a maximum drawdown of 23% and a time to recovery of 16 months. 39 points.
COVID
As the Morningstar article points out, COVID was a relatively brief affair.
"And the covid crash of March 2020 was actually the least painful of these 19 crashes, due to the quick subsequent recovery. Though the downturn was sharp and severe (a 19.6% decline over roughly a month), the stock market ultimately recovered to its previous level a mere four months later."
The maximum drawdown was 17%, and the recovery took around 3 months. 20 points.
2022
The market declines in 2022 were driven by several factors, including rising interest rates and inflation. The maximum drawdown was around 13%, and it took the portfolio 23 months to recover. 36 points.
100% equities portfolio
Of course, not everyone holds a diversified portfolio such as the NBP 60. Some investors prefer to direct their asset allocation towards what has performed well in recent years, which would favour equities over bonds if we look at just the last decade.
For this investor, we will use a portfolio consisting of just global equities (100% NBP). We will use the same time periods as for the diversified investor, but it's worth noting that additional episodes such as the 1998 Russian crisis are not included (which caused a fall of over 10% for the 100% equity investor, but not for the 60/40).
Early 90s recession
An impressive 74 points to start us off!
.com bust
But nowhere near the .com busts' 131! You have to wonder how many retirees could cope with a 50% drawdown.
Global Financial Crisis
After a brief respite, our 100% equity investor endures another painful period. 62 points.
COVID
In contrast to the above examples, COVID was a mere flesh wound on the pain index: 30 points.
2022
We included a slightly longer time period for 2022, as although the portfolio recovered in February 2023, it dipped again soon afterwards. We will be generous and stick with February 2023, giving a score of 26.
Recent events
It can be very easy to worry about what might happen, rather than what has actually happened. While this is understandable, markets are pretty good at pricing in the probabilities of future events occurring, so we'd recommend trying to worry less about the future. Easier said than done.
If we examine the current volatility, NBP 60 is currently scoring 12, with NBP 100 scoring 18.
Tech investor
We finally look at the investor who dedicates all of his efforts to investing in "what is working now," investing all of their money into tech funds.
Unfortunately, our tech investor could not come up for breath between the .com bust and GFC, and with an 80% drawdown and an almost 15-year recovery, this scores an impressive 256!
Conclusion
If we summarise all the events in a table (we will exclude the tech investor as they will skew the results!), we can summarise the following:
Recent events are (currently) insignificant when compared to recent history.
It's understandable why bonds have fallen out of favour. 2022 was more painful for holders of a diversified portfolio than it was for those with a 100% equity portfolio.
The .com bust was really painful for those holding a 100% equity portfolio. Using our rules, it was over four times as bad as COVID!
Successful retirement outcomes are based on two things:
The portfolio generating sufficient returns to deliver sufficient returns to deliver the desired retirement outcome. It's worth pointing out that none of the periods analysed have been particularly challenging for those holding a diversified portfolio from an income sustainability perspective, in part because inflation has generally remained relatively subdued.
The retiree sticking with the plan during tough times. We passionately believe that studying history is a big factor in determining this. If you are managing your retirement on a DIY basis, build a picture of your pain threshold. Is it driven more by maximum drawdown, how long the portfolio balance remains underwater (not forgetting that our examples don't include withdrawals or fees), or a mixture of the two?
Want to find out more?
If you would like to know more about designing and implementing a robust withdrawal strategy, please get in touch.
About us
The team at Pyrford Financial Planning are highly qualified Independent Financial Advisers based in Weybridge, Surrey. We specialise in retirement planning and provide financial advice on pensions, investments, and inheritance tax.
Our office telephone number is 01932 645150.
Our office address is No 5, The Heights, Weybridge KT13 0NY.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Comments