• The mild share-price corrections of recent years could give way to deeper, longer-lasting declines. 

• The confluence of forces that led to subdued drawdowns in the last 15 years may be evolving, creating a more challenging risk backdrop. 

• We believe that investors should be optimistic but be prepared for downturns. 

Investors have faced significant ups and downs in 2025, and the higher volatility, for better or worse, may not be over. Equity and fixed income markets took less than a month to recover after US tariff announcements in early April sent them reeling, giving investors a valuable opportunity to reexamine their relationship with risk.

A healthy relationship with risk starts with understanding that downturns aren’t always as shallow and recoveries not always as swift as we’ve seen over the last 15 years or so. Three essential principles for dealing with risk can improve outcomes even during periods of high volatility.

Principle 1: Be humble in the face of unknowable risk

The late financial historian Peter Bernstein once observed that certain risks are inherently unknowable ahead of time. These risks tend to be the most disruptive, having the potential to befall investors without warning. For example, a key factor in the 2008 global financial crisis that became clear only with the benefit of hindsight was the amount of systemic risk that had built up from the use of credit derivatives. The degree to which risk-taking on credit, particularly US mortgage loans, was concentrated within the system was not well understood until the crisis deepened. This uncertainty drove the panic that set in at the height of the crisis.

In a similar vein, what alarmed the market about the recent tariff announcements was not that new tariff policies were being pursued. Rather, it was the magnitude and scope of these policies, along with the pace at which they unfolded, that had been largely unknowable and exacerbated the volatility.

Truly disruptive risk is often unknowable ahead of time. Humility regarding this truth can help investors maintain a healthy perception of risk. Accepting that unknowable risks periodically roil markets can foster a flexible and measured response when tail risks (extreme market developments that are highly unlikely but have a severe effect) emerge, mitigating the impact of unforeseen events and preventing panic-driven decisions.

Principle 2: Have a robust asset allocation

Because the future is uncertain, and some risks are unknowable, it makes sense to find a robust asset allocation solution. A solution that provides results that are good enough across a range of different circumstances, rather than optimal under some scenarios but highly undesirable under others. A robust portfolio is one an investor can maintain, especially in extreme market conditions.

Rigorous capital market return projections that consider the extremes are also critical to robustness. That’s because poor long-term results are a greater risk than short-term volatility for long-term investors. In practice, a robust approach to portfolio construction considers a diverse range of return environments over a client’s investment horizon and achieves an allocation that would be suitable across these environments. 

Principle 3: Be optimistic but prepared for downturns

Balanced investors must thoughtfully manage downside risk. Sticking with an allocation during significant drawdowns requires realistic expectations about one’s tolerance for pain. In today's market, this means having realistic expectations about potential drawdowns and not relying on overly optimistic return expectations based on recent performance.

Market Corrections 1920s to 2020s

Mild share-price corrections of recent years could give way to deeper, longer-lasting declines 

Past performance is not a guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Notes: Each dot represents the average time and magnitude of all US equity market drawdowns greater than 10% observed during the respective period. Periods are decades, with two exceptions: The 1920s start on 31 December 1927, and 2010–2024 captures the 15-year period starting on 4 January 2010 and ending on 31 December 2024. The time periods reflect the number of trading days from market peaks through troughs. Percentages reflect price-only declines (dividend payments are ignored) in the level of the Standard & Poor’s 500 Index (or the S&P 90 Index prior to April 1957). Dots for the 1930s and 1940s are not shown because the recovery from the last drawdown of the 1920s took over two decades to reach the level of the prior peak, which was established on the eve of the stock market crash of 1929. 

Sources: Vanguard calculations, based on index returns from Bloomberg. 

As the chart shows, the last 15 years have been favourable for US equities (and non-US equity markets), with shallow and short-lived drawdowns. Some investors may be tempted to look back over this period, which they may consider to be “long”, and surmise that such relative market tranquillity is here to stay. The quick snapback from the sharp declines after the broad US tariff announcements on 2 April 2025 may only reinforce such a stance. But as we can see from previous decades, equity market drawdowns can run longer and deeper than we’ve become accustomed to recently. Looking forward, it is this potentially changing landscape that investors may want to prepare for.

Feeling our way towards sources of future risk and potentially recalibrating expectations

The confluence of forces that led to subdued drawdowns in the last 15 years may be evolving, creating a more challenging risk backdrop: 

• A renewed focus on fiscal responsibility may imply a reduced scope for fiscal stimulus in future economic downturns. 

•  Adverse supply-side developments and the potential for stagflation may limit efforts by central banks to mitigate market volatility.

• The prospect of a rearranged global trading ecosystem has a wide range of significant long-term implications that could create sources of disruption, many of which are unknowable. 

For some investors, prudent risk management might mean recalibrating expectations to include deeper and longer-lasting drawdowns that are more in line with previous historical periods. Even if this recalibration doesn’t change asset allocation dramatically, its insights may increase the odds of an investor maintaining their allocation during downturns.