Thirty-six years ago, on Oct. 19, 1987, the U.S. stock market suffered its worst crash ever. That day, the Dow Jones Industrial Average DJIA lost 22.6%.
We know the odds of a crash because researchers several years ago derived a formula that successfully predicts the average frequency of stock market crashes over long periods of time. One way of judging the researchers’ formula is by comparing the Dow Jones Industrial Average’s big drops over the past century with what that formula would have predicted. As you can see from the chart below, the formula has done an impressive job.
Because stock market gains and losses don’t adhere to a normal distribution, both investors and financial advisers are mistaken in thinking they can simply lower clients’ portfolio risk and proportionally reduce their returns. Instead, an “average” risk portfolio will have below-average performance.
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