If a Stock Market Crash Is Coming, History Says This Strategy Can Cut Your Portfolio's Recovery Time in Half

The last few years have been absolutely fantastic for stock investors. The bull market of the last four years has pushed the S&P 500 (SNPINDEX: ^GSPC) 116% higher while the tech-heavy Nasdaq Composite (NASDAQINDEX: ^IXIC) is up an even more impressive 156%.

While the bull market has been strong and supported by stellar earnings growth and improving outlooks, many investors can't help but notice that stock market valuations are particularly high. That's not a sustainable position for stocks: Either earnings have to grow fast enough to bring valuations lower, or stock prices have to come down.

In fact, it's a practical inevitability that stock prices crash 20% or more in the future. The markets move in cycles, and eventually, some event will trigger a big sell-off in the stock market. If you want to position your portfolio to recover in less than half the time it takes for others, here's exactly what you should do.

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The best portfolio for a market crash

It doesn't take any groundbreaking portfolio strategy to produce rapid recoveries in the event of a stock market crash. Investors can hold a simple 60/40 stock/bond portfolio with periodic rebalancing and achieve superior results in maintaining portfolio stability.

Since 1988, the 60/40 portfolio has recovered from drawdowns of 20% or more in just 11 months on average, according to data compiled by J.P. Morgan analysts. Meanwhile, the S&P 500 took an average of 24 months to recover, even with dividends reinvested.

It's worth noting that the 60/40 portfolio only stands out against an all-stock portfolio in terms of recovery when the portfolio drops at least 20%. Smaller drops don't exhibit much difference in how long it takes the portfolio to recover. That said, that's exactly the kind of protection an investor should hope for from bonds: a stabilizing force amid big long drops without providing too much drag amid shorter pullbacks.

The stability of the 60/40 portfolio is further evidenced by the likelihood that it will produce a positive return over any given five- or 10-year period. Since 1989, the 60/40 portfolio has produced a positive return 99% of the time over any five-year period and 100% of the time over 10 years. The S&P 500 alone only achieves positive returns 87% of the time over five years and 93% of the time over 10 years.

Why the portfolio can recover so quickly

Maintaining a 60/40 ratio between stocks and bonds in your portfolio requires periodic rebalancing. When more volatile stocks crash, you'll end up with a lower ratio of stocks to bonds in your portfolio. You'll have to sell some bonds and buy some stocks to return the portfolio to the 60/40 balance.

This act of rebalancing means you automatically buy stocks when they go down. The reverse is also true; you'll sell stocks when they climb higher or if bonds decline. That means you can be opportunistic in buying and selling stocks, which ultimately produces more stable returns and helps a portfolio recover quickly after a crash.

While some have concerns about whether bonds can truly act as a good diversifying asset for stocks after both asset classes fell sharply in 2022, that situation was more of an anomaly than a new normal. Bonds produced positive returns in 21 of the last 25 years in which the S&P 500 declined. As such, investors should remain confident that bonds can provide diversification when it matters most.

With bond prices sinking lower in 2026, right now could be an opportune time to increase your allocation to the asset class. The Vanguard Total Bond Market ETF (NASDAQ: BND), which tracks the Bloomberg U.S. Aggregate Bond index, currently offers a yield to maturity of 5.5%.

Splitting a portfolio between the Vanguard bond ETF and the Vanguard S&P 500 ETF (NYSEMKT: VOO) can provide significant downside protection and the potential to recover from a market crash more quickly with the help of rebalancing into stocks.

However, investors should understand that bonds have more limited upside than stocks, and they could drag down performance somewhat over the long run. On average, the 60/40 portfolio has produced an annualized return of 9.4% since 1950, versus 11.7% for the S&P 500. That's the price of downside protection. But with bond values sinking lower this year, that downside protection doesn't look as expensive as in the past.

Adam Levy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF and Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.