Wall Street Veteran Jared Dillian: A 30% Crash Would Wipe $150,000 Off a $500,000 401(k)

A 30% drawdown would turn a $500,000 401(k) into $350,000, and Jared Dillian thinks most investors have never priced that in. The Wall Street veteran, who spent seven years running the ETF trading desk at Lehman Brothers before its 2008 collapse, says investors are blind to crash risk in a stock market now in its fourth year of a bull run.

"The average investor sees no need to diversify," Dillian told MarketWatch. "If we were in the middle of a crash, the 'Awesome Portfolio' would probably be selling a lot more."

What is Dillian warning about?

Dillian, founder and principal of commodity trading adviser Armington Capital and editor of The Daily Dirtnap newsletter, makes his case in his latest book, "The Awesome Portfolio: A Simple, Stress-Free Approach to Investing." His core message: investors need diversification, split in equal parts across stocks, bonds, cash, gold and real estate.

He sees danger signs everywhere. "Excessive risk-taking is usually prevalent close to the top of the market, and we have more risk-taking than ever, and by the way, not just in the financial markets but also in things like sports betting and prediction markets," he said.

Investors with 40-year careers will have lived through a drawdown of 50% or more, Dillian noted. His own experience shaped his caution: "When I started investing in 1998, I had two in the first 10 years, which really kind of calibrates your thinking about risk. The typical person out there doesn't think about risk. They don't have to, they haven't had to."

Why don't recent bear markets count?

The early-2020 selloff was the fastest bear market in history, but the S&P 500 recovered. The index's 20% drop in 2022 doesn't stack up as historically severe either, Dillian said. He thinks it takes a 30% loss to force real reflection on risk.

"If you have $500,000 in a 401(k) and that becomes $350,000, then you start to do some soul-searching," he said. "Because you say, what if it goes to $300,000, what if it goes to $250,000?"

Even investors who believe they can handle a bear market will be miserable "the whole time until you get back to the high-water mark," he added.

How does the 'Awesome Portfolio' perform?

The strategy — 20% each in stocks, bonds, cash, gold and real estate — needs rebalancing only once a year. That "cuts your volatility in half and eliminates your drawdowns," Dillian says.

The numbers: over the last 10 years, the Awesome Portfolio has returned 9% a year. He compares that with the S&P 500's 10% annual return over 100 years, 11% over the past 54 years, and roughly 15% or more over the past decade. Investors who can't live without that extra 1% return, he argues, focus on returns when they should first decide how much risk they'll accept to get it.

His specific ETF picks:

• Stocks: Vanguard Morningstar Total Stock Market ETF, which adds exposure to underperforming small caps he thinks could turn around
• Bonds: Vanguard Total Bond Market ETF, covering Treasurys, credit and mortgages
• Cash: F/m US Treasury 3 Month Bill Fund
• Gold: iShares Gold Trust
• Real estate: Vanguard Real Estate ETF

Why is he buying unloved long-term bonds?

Dillian recently put a chunk of his own money into long-term bonds, an asset most investors avoid. He quoted his own book: "If you do not have something in your portfolio that you hate, you are not diversified."

Bond aversion, he said, stems from an "irrational fear" of inflation — above the Fed's target for six years, but not by much — plus a $2 trillion deficit he doesn't view as a forever problem. "When I look at a 30-year Treasury bond at 5.33%, that looks pretty attractive to me," he said. A 5% yield for 10 years has also been historically pretty good, he added.

What scares him about the AI trade?

Like others, Dillian worries about artificial intelligence, specifically big tech companies funding build-outs with billions in debt that will linger for decades — to pay for chips that could be obsolete in three years. "That's been the one thing that scares me about this particular cycle, that a lot of it is debt-financed," he said, contrasting it with the dot-com bubble, which was equity-financed and produced no real economic consequences. While the post-dot-com recession was mild, he's "much more worried this time around" about a possible debt crisis.

His own approach: "I sit around and think of ways for things to go wrong, so I'm not fully invested in stocks, and I missed out on this big bull market. I've done pretty well over the past 10 or 15 years with the Awesome Portfolio or some variation of it, and there hasn't been a point where I've said to myself I'm scared about what's going to happen."

The trade-off Dillian accepted — 9% a year instead of 15% — is the price of sleeping through the next crash.