What’s a Portfolio Stress Test? with Dr. Jeff Camarda

Video Transcript:

Howdy folks. Dr. Jeff Camarda with another example of a portfolio stress test that I think you’ll find very interesting. It’s going to be a very high-level view, but it’s the sort of thing that we’d be very happy to do for you as an introduction to the quality of our services and to give you some real insight.

This is the anonymized family portfolio stress test using actual data from a prospective client. Their portfolio is the dark green line on the bottom. The light green line up here is the S&P 500, and the gold line is something that we’ll call the Goldilocks portfolio, which basically is the S&P 500 but relies on indicators that drive when it makes sense to get out and when to get back in.

Over this time, from 2016 through almost 2025, the prospective client portfolio did a lot worse. It matched the S&P 500 and Goldilocks up till about 2020 and then really started to underperform. In this example, if they started with $100,000, it would have grown to $212,000 versus $343,000 for the S&P 500 and about $330,000 for Goldilocks.

Thinking that a more conservative portfolio might not go up as much and therefore wouldn’t go down as much—actually, that’s not the case. When we look at the drawdown information, this is really powerful. Over the same time frame, when things hit the fan, the S&P 500 went down the most, the prospective client portfolio went down almost as much, and the Goldilocks portfolio held up pretty well. It dipped, but not nearly as much, and through most periods, particularly through 2022, it held value a lot better than both the client portfolio, which underperformed the S&P 500, and the S&P 500 itself.

At the end of the day, if we look at the maximum drawdown in this panel, the prospective client’s portfolio worst-case scenario was down 55%, which is pretty scary. Goldilocks portfolio worst-case scenario was down 18%, about two-thirds better than the S&P 500. The prospective client portfolio went down more than Goldilocks and didn’t go up nearly enough. That really illustrates the power of stress testing.

Every portfolio is different, but when we do a stress test, this is the first thing we look at: what would the upside have been, and how well would it have held up in a bad market? Particularly for retirement folks who are drawing from their portfolios, if you get into a scenario with a big dip like this, what do you do? Stop taking money out, make peanut butter and jelly sandwiches, and hope for things to get better, because if you continue to consume from a portfolio that is declining in value, you’re locking in losses from which you may never recover. That’s why a Goldilocks-type approach can be very compelling.

The next thing we’ll look at is a so-called scatter plot. Without going too much into detail, the Goldilocks portfolio is here, the S&P 500 is in the middle of the crosshairs by definition, and the dark green pyramids are all the various components in the prospective client’s portfolio. The line on the bottom is standard deviation, which is widely considered a proxy for risk. The higher the standard deviation, the more volatility in returns and the higher the risk.

Things in this quadrant are less risky but perform worse. Things in this quadrant are less risky but perform better. Things in this quadrant are riskier but perform worse. Things in this quadrant are riskier but perform better. In this example, most of the client’s investments underperformed, and only one investment did better than the S&P 500. These underperformed at the cost of taking more risk, which is why the drawdown was so much more pronounced.

Goldilocks, in my opinion, provided a very attractive return with significantly less risk. There’s a lot more detail to the stress test, including asset allocation, comparative returns over different years, individual investments, and portfolio expenses. Some funds are fairly expensive, like Oakmark Global Investor Fund at over 1%, some less expensive, and lots of other data that may be useful.

In a nutshell, this is the Camarda Financial portfolio stress test. We encourage you to allow us to do this for you. We don’t charge for it; it’s a couple thousand dollars’ worth of free work as an example of the quality of our services. Regardless, we think you’ll find the information very valuable and possibly helpful in guiding your portfolio decisions.

Thanks so much for watching. This is once again Dr. Jeff Camarda.