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When markets become more volatile and the value of portfolios drop, the "fight or flight" response can kick in, making investors want to flee to less-risky investments. But, despite the best of intentions, when investors change strategies in reaction to market volatility, they make temporary losses into permanent ones.

So how can you help insulate your portfolio from losses while also positioning for a recovery?

First, stay invested:

The S&P 500 has fallen over by 20%. Further downside cannot be ruled out, but in such bear market environments, the average drawdown has been -34.5%, which suggests that much of the worst selling may be already behind us (see here for details). 

In times of market uncertainty, it is helpful to think about performance through the lens of meeting your objectives. Our Liquidity. Longevity. Legacy. (3L) framework can be helpful, especially in volatile periods, because it explicitly links parts of your portfolio to future spending objectives.

It is important to make sure you have a Liquidity strategy—the resources that you need to meet your cash flow needs—separated from equity market volatility (e.g. invested in cash and short-term bonds). But for your Longevity and Legacy strategy assets—earmarked for longer-term spending objectives, by which time the market will most likely have recovered—it's important not to lose focus on the main objective: capital appreciation.

Markets remain highly uncertain, and investors may be tempted to sell out of the market now and hope to buy back later when there is more clarity. In theory, that sounds like a good strategy, but in practice, it is very likely to cause more harm than good. It's impossible to predict the exact market bottom, and the first stages of a bull market can feature extremely fast market rallies. Investors would need to perfectly time both decisions—selling out of the stock market and buying back in again—in order to avoid creating permanent damage to their investment growth.

There is ample reason to stay invested. The recovery period could already be imminent, now that central banks across the world have rolled out their entire global financial crisis playbook and fiscal policymakers have unveiled packages of over 10% of GDP, with more to be expected. In addition to policymaker measures, we would also expect markets to rally when we begin to see signs that the pace of COVID-19's spread has slowed.

History also provides us with good reason to stay in the market. In the seven bear markets we've experienced since 1945, it has taken an average of 26 months for the S&P 500 to go from a bear market trough to a fresh all-time high.

Next, diversify:

1. Asset class diversification. High-quality bonds like US Treasuries provide vital diversification in periods of stock volatility, with prices benefitting from lower yields when recession risks rise. A 60%/40% stock/bond portfolio would have experienced an average of -19.9% peak-to-trough drawdown in the past seven bear markets, versus -34.5% for an all-equity portfolio. This portfolio’s recovery period has also been relatively fast, taking 16 months on average to reach a fresh all-time high.
2. Geographic diversification. The COVID-19 crisis is already presenting significant challenges for each individual country. But these challenges will differ from one country to the next, and some economies and markets will be less affected than others. So in addition to , this environment gives us even more reason to expect a globally-diversified approach to provide better risk-adjusted returns throughout the bear market drawdown and recovery periods.

Last, but not least, make sure that you rebalance your portfolio.

With stock markets having dropped by more than 30%, and the bond market mostly holding its value year to date, most portfolios have likely "drifted" from their long-term target asset allocations. For example, a portfolio that started the year 50%/50% between equities and bonds would be closer to 45%/55% today. Without rebalancing, either outright or by averaging-in, this portfolio would take longer to recover from bear market losses, because it would be under-invested in stocks during the recovery period.