Prep Your Portfolio for Disaster With a Stress Test

Nevertheless, understanding the impact of various scenarios does help craft better portfolios.

"We put portfolios together that we think would respond a certain way if an event unfolded," Dawal says. "Then we go back and test to see whether we were right. If they didn't perform the way we thought they would, then we dive into what didn't wok or what was different."

Prognostication is often the product of studying history and the many trends, cycles, bubbles and busts that have unfolded throughout the years.

"If you have a mutual fund portfolio, we can back-test it through a period," he says. "With a robust enough database you can isolate time periods that coincide with catastrophic events and see how a portfolio held up."

Dawal says such analysis can help gauge an investor's true risk tolerance.

"We can show them that 'This what happened on Black Monday' and what happened the 12 months after it," Dawal says. "This is a way to show the client that we are going to have these events. We don't know when an earthquake is going to strike Japan, New Zealand or the U.S., but we can tell them that, historically, this is what occurs when such events do happen. If you were in the midst of that, what could you have done, or should have done, within the context of your portfolio and maybe have fared better?"

"The closer you are to the point that you actually need to draw down this capital is when you have to be the most sensitive and aware of the impact of those sorts of events," he adds. "They can be catastrophic."

Rebalancing, reallocating asset classes and buying into specialized mutual funds and ETFs (engineered for specific financial outcomes or hedges) are among the potential corrective strategies when your portfolio isn't shock-resistant.

"If you can express to an adviser what your goals are over the next several years, they should be able to construct a portfolio that not only will show you, based on simulations, whether you can reach that goal," Dawal says. "These events happen. They are going to happen again. Clients have to be prepared for that. If you can show what different combinations of portfolios would do, I think that's a good thing."

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