“Adrian’s” 50% rule

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“Adrian’s” 50% rule

Postby Heath » Fri Jan 02, 2009 3:11 pm

People continue to discuss and apparently implement “Adrian’s” 50% rule. This rule originated years ago with Larry Swedroe’s table that was intended to help people measure their “willingness”, which is the psychological reaction to loss. In Larry’s view willingness is only one part of the ability-need-willingness approach to determining a fixed/equity allocation. A while back Adrian began to suggest 50% as a maximum tolerable loss, and only recently seems to have expanded it to something more than willingness. I can’t figure what this rule means so maybe Adrian can explain it and other can decide if the rule is helpful to them. For starters maybe Adrian can respond to my question from an earlier thread.

Much of the confusion centers on what exactly is meant by 50% “loss”. You have only recently added “catastrophic” loss to your rule of thumb. Can you please explain in detail what you mean by catastrophic loss? Above you say it means “loss which would cause significant or irrecoverable damage to the portfolio”. Almost everyone on this forum has had significant damage to their portfolio in the latest decline. When Rick F. discusses the Taylor example he points out that the damage is not irrecoverable. Many point to the Trinity study or similar historic data to support the position that the market has always recovered. So if you do intend to define catastrophic as “significant or irrecoverable” please explain exactly what you mean by those terms. Is it possible for the “typical” investor with 25-30 years until retirement to suffer a catastrophic loss?
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Postby craigr » Fri Jan 02, 2009 3:26 pm

Stock market losses are like anything in life. You can't get a true flavor for it by reading alone. Sometimes you need to experience it first hand to really understand how you'll react when the situation comes around.

A generic (and incorrect*) rule is never going to be capable of determining what your risk tolerance will or won't be until the situation happens.


* The rule's main problem is history has already shown it to be incorrect. Multi-year bear markets can and have incurred losses of more than 50% in equity. The worst was the nearly 90% decline in the early 1930's of stocks from their highs.
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Postby Heath » Fri Jan 02, 2009 4:31 pm

craigr wrote:Stock market losses are like anything in life. You can't get a true flavor for it by reading alone. Sometimes you need to experience it first hand to really understand how you'll react when the situation comes around.

A generic (and incorrect*) rule is never going to be capable of determining what your risk tolerance will or won't be until the situation happens.


* The rule's main problem is history has already shown it to be incorrect. Multi-year bear markets can and have incurred losses of more than 50% in equity. The worst was the nearly 90% decline in the early 1930's of stocks from their highs.


I disagree that the rule's main problem is that the loss percentage is incorrect. By far more important IMO is what is meant by "loss" as discussed in the OP.
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Postby matt » Fri Jan 02, 2009 4:48 pm

craigr wrote:
* The rule's main problem is history has already shown it to be incorrect. Multi-year bear markets can and have incurred losses of more than 50% in equity.


Another problem is that it assumes no rebalancing, contrary to every other piece of advice given by Bogleheads. If you decide that you have a 25% tolerance for loss and choose a 50% equity portfolio, you better not rebalance on the way down. Anyone rebalancing too frequently over the past year took the risk of buying a full set of falling knives and potentially exceeded the 25% loss.
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Postby HomerJ » Fri Jan 02, 2009 4:55 pm

Man, I feel like I'm repeating myself on too many threads...

Adrian's 50% rule never made any sense to me, as a accumulator. I'm guessing he meant it for people who were retired or near-retired?

Long-term investors have plenty of time to get the money back, so it's never really "lost"
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Postby Adrian Nenu » Fri Jan 02, 2009 5:18 pm

This rule originated years ago with Larry Swedroe’s table that was intended to help people measure their “willingness”, which is the psychological reaction to loss.


- don't be too sure about that. I started advising investors to assume their equity allocation could decline by 50% after the bear market ended in 2003. Or maybe Swedroe's table originated from my advice to take into account 50% bear market declines based on 1973-1974 and 2000-2003. Tolerable loss means just that - you have to think!

Adrian's 50% rule never made any sense to me, as a accumulator. I'm guessing he meant it for people who were retired or near-retired?

Long-term investors have plenty of time to get the money back, so it's never really "lost"


- I will not be offended if you don't use the rule. Use something else if you think it is better. The rule of thumb is intended for everyone regardless of allocation. It shows that equity could decline by ~50% during a bear market. It can't tell how long the bear market will last so I hope you can wait as long as the dot-com and Nikkei investors to get your money back. Their money is not really lost either is it?!

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Postby craigr » Fri Jan 02, 2009 5:24 pm

Heath wrote:I disagree that the rule's main problem is that the loss percentage is incorrect. By far more important IMO is what is meant by "loss" as discussed in the OP.


Acceptable loss is something that each person needs to decide. No investment is 100% safe and each has unique risks.

The problem with generic rules and tables of losses in a portfolio is that most people will still over-estimate their tolerance for risk.
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Postby Adrian Nenu » Fri Jan 02, 2009 5:28 pm

The problem with generic rules and tables of losses in a portfolio is that most people will still over-estimate their tolerance for risk.


The problem is not with the rule of thumb, but with the investors over-estimating their risk tolerance (psychological and catastrophic). But there is nothing like a few bear markets with 40%-50% declines to better help them understand the rule of thumb and equity risk.

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Postby craigr » Fri Jan 02, 2009 5:28 pm

rrosenkoetter wrote:Long-term investors have plenty of time to get the money back, so it's never really "lost"


Long-term can be really long sometimes in the stock market. Like decade or more long. A 40% decline means you need to earn 66% to get back to where you started. So losses have a disproportionate impact on portfolios over gains and need to be taken seriously and balanced against prospective gains. IMO.

Most people will make the bulk of their money from their career and that money is used to invest and grow. If you lose a large amount of your savings you may not be able to earn it back again depending where you are in life.
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Postby Heath » Fri Jan 02, 2009 5:34 pm

Adrian

Could you please respond to the OP including the portion in quotes. Thanks
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Postby HomerJ » Fri Jan 02, 2009 5:46 pm

Adrian Nenu wrote:
drian's 50% rule never made any sense to me, as a accumulator. I'm guessing he meant it for people who were retired or near-retired?

Long-term investors have plenty of time to get the money back, so it's never really "lost"


- I will not be offended if you don't use the rule. Use something else if you think it is better. The rule of thumb is intended for everyone regardless of allocation. It shows that equity could decline by ~50% during a bear market. It can't tell how long the bear market will last so I hope you can wait as long as the dot-com and Nikkei investors to get your money back. Their money is not really lost either is it?!

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I understand what you're saying, and the Nikkei shows that a market can stay down a very very long time...

But I still submit that if an accumulator looks at his portfolio and asks how much can I afford to lose FOREVER? The answer is pretty small. Your advice can't be the same for 30 year olds and 60 year olds.

Look a retiree can figure out how much income he/she needs, put that much in safe(r) investments to generate that much income, and then put the rest in stocks...

But for accumulators, the concept doesn't make any sense...

Example (made up numbers): How much can I afford to lose if I have $150,000 of investments and I'm 40 and saving $10,000 a year on a $60,000 a year salary? I really can't afford to lose any of it...

I also really can't afford to leave a huge chunk of it in CDs either, since I won't make enough to retire...

See, here's the thing... if you're a long term investor, you shouldn't worry about losing 50%.... No one (yet) has EVER been down 50% after 25-30 years (someone who inherited all his money and invested at the very top of the Nikkei is getting close though)

You have to quantify your rule. Only invest what you can afford to lose (in the short term).

Of course, the Nikkei, as you point out, has been way down for a very long time. So maybe it is possible to lose in the stock market long term. Well then I guess all us accumulators are screwed.

See, retirees CAN remove enough from the stock market to live on. Accumulators cannot.

How in the world does a 40 year old decide what he can afford to lose in the stock market? Sure, your rule seems simple. But "what you can afford" is not an easy calculation for an accumulator. A retiree, yes, an accumulator, no.
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Postby Adrian Nenu » Fri Jan 02, 2009 6:00 pm

Much of the confusion centers on what exactly is meant by 50% “loss”.

- no confusion at al, look at 1973-1974 and 2000-2003. That's what the rule is based on.

You have only recently added “catastrophic” loss to your rule of thumb. Can you please explain in detail what you mean by catastrophic loss? Above you say it means “loss which would cause significant or irrecoverable damage to the portfolio”. Almost everyone on this forum has had significant damage to their portfolio in the latest decline.

- people didn't get it so I was asked to give more details. It's the opposite of tolerable loss - intolerable loss. A loss you cannot recover from or one which significantly lowers your standard of living/retirement. It's different for everyone. Have to do the math and figure it out yourself because no formula or rule of thumb can come up with it. It's not just psychological.


When Rick F. discusses the Taylor example he points out that the damage is not irrecoverable.

- I don't know Taylor's particulars and I am not sure that the example he gave reflects his own situation. Also, depends on time horizon and portfolio returns.

Many point to the Trinity study or similar historic data to support the position that the market has always recovered.

- yes, but it has to recover in your lifetime or before you run out of money.

So if you do intend to define catastrophic as “significant or irrecoverable” please explain exactly what you mean by those terms.

- it depends on each investor's situation. The investor has to figure it out and plug it in the rule of thumb formula. Also have to think about psychological loss tolerance - the breaking point when the plan is abandoned.

Is it possible for the “typical” investor with 25-30 years until retirement to suffer a catastrophic loss?

- anything is possible. Depends on the goal, the amount lost, the ability to save to make up the loss and the forward returns which will be earned. How will a catastrophic loss affect the investor? Just as important as catastrophic loss is psychological loss tolerance - could abandon plan and invest too conservatively and come up short at the end and have to work longer or lower standard of living during retirement.

The rule of thumb should be considered but should not be the only consideration when determining a suitable asset allocation. There are many other individual specific issues to ponder.

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Postby nisiprius » Fri Jan 02, 2009 6:47 pm

craigr wrote:
rrosenkoetter wrote:Long-term investors have plenty of time to get the money back, so it's never really "lost"
Long-term can be really long sometimes in the stock market. Like decade or more long.
More like two decades, please.

I asked earlier whether Siegel ever defines what he means by the "long run" in "Stocks for the Long Run." I haven't had a chance to take it out of the library and skim through it, but based on what I can glean from Amazon "search inside the book" and from what others have said, no, he never does, but it is clear from context that he's talking about two to three decades. In the introduction Peter Bernstein (not Siegel) defines it to mean "20 years." Someone did a quote from Siegel, elsewhere, where he makes it clear that he means "20 years or longer."

Historically, there have already been two periods over which stocks experienced slight losses (correcting for inflation and including reinvested dividends) over periods 13 years (year-end 1929-1942) and 17 years (year-end 1965-1982).

Historically, it has taken a holding period of about thirty years to insure that stocks decisively beat bonds and earn something like the "historical rate of return" that people plan on.

I have yet to figure out why many people seem to think that five or ten years counts as "the long run."
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Postby craigr » Fri Jan 02, 2009 7:53 pm

nisiprius wrote:
craigr wrote:
rrosenkoetter wrote:Long-term investors have plenty of time to get the money back, so it's never really "lost"
Long-term can be really long sometimes in the stock market. Like decade or more long.
More like two decades, please.


I was being generous. I've had battles here about the myth that "Stocks always beat bonds" and my personal favorite "Stocks get less risky the longer you own them."

I guess if you have an infinite time horizon that may be true. But if you are a typical investor with a finite amount of time to invest it may not be true.
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Postby SmallHi » Fri Jan 02, 2009 8:19 pm

Adrian Nenu wrote:
This rule originated years ago with Larry Swedroe’s table that was intended to help people measure their “willingness”, which is the psychological reaction to loss.


- don't be too sure about that. I started advising investors to assume their equity allocation could decline by 50% after the bear market ended in 2003. Or maybe Swedroe's table originated from my advice to take into account 50% bear market declines based on 1973-1974 and 2000-2003. Tolerable loss means just that - you have to think!

Adrian's 50% rule never made any sense to me, as a accumulator. I'm guessing he meant it for people who were retired or near-retired?

Long-term investors have plenty of time to get the money back, so it's never really "lost"


- I will not be offended if you don't use the rule. Use something else if you think it is better. The rule of thumb is intended for everyone regardless of allocation. It shows that equity could decline by ~50% during a bear market. It can't tell how long the bear market will last so I hope you can wait as long as the dot-com and Nikkei investors to get your money back. Their money is not really lost either is it?!

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I think its all totally insane, to be honest with you. The idea that at some particular level of loss someone will capitulate...but not before that? Give me a break.

The fact is, the 50%+ losses of 73-74, 69 (on SV), 37-41, as well as 29-32 were around well before the 00-02 market, and many people were aware of it long before Adrian started talking about it (apparently just a few years ago?).

The reality is pretty simple: devise an allocation that carries the expectation of reaching your goals. Understand how much risk that entails and live with it. If you can't stomach it, reduce your living expectations. Thats it.

Far too many are trying to find the magic combo of asset classes that hedge every risk while still producing equity like returns, or some timing scheme (the latest being yield curve analysis and moving averages) that produces superior results. Better yet, some are trying to find the bear minimum standard of living they can subsist at, and figure out how to assemble the most cautious portfolio of investments possible (CDs, TIPS, immediate annuities) to immunize with...it just cracks me up--all of it.

99.9% of investors will be best served by investing passively, diversifying by the 5 factors, and getting on with their lives. Obsessing about this "max loss X 2" garbage is a waste of time. The proof is in the pudding. You are finding (prior) stalwarts of the forum reaching some arbitrary loss level and considering going all to cash/bonds (as expected returns are now higher than at any point in recent memory).

You are much better off with the rule:

Sometimes you are going to lose a ton in the stock market. Its the price of admition for the ride. If you want to ride, you have to pay for it.

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Postby SmallHi » Fri Jan 02, 2009 8:27 pm

nisiprius wrote:
Historically, there have already been two periods over which stocks experienced slight losses (correcting for inflation and including reinvested dividends) over periods 13 years (year-end 1929-1942) and 17 years (year-end 1965-1982).

Historically, it has taken a holding period of about thirty years to insure that stocks decisively beat bonds and earn something like the "historical rate of return" that people plan on.

I have yet to figure out why many people seem to think that five or ten years counts as "the long run.


Its funny. Yes -- stocks sucked during the Great Depression. During 65-82 and the last 12 years--Large Cap growth stocks sucked. Everything else did fine. And during the GD, I doubt you would have cared much. The world wouldn't have looked much different from the perspective of a bond investor rolling over their 5YR T-Notes. A small annual gain (followed by 50 years of misery--which killed far more retirement plans than the equity results of the Great Depression). And after taxes, TIPS would have been brutally painful as well.

The same risk can be said for any investment. And an even greater risk is that of the investor. The likelyhood that your standard of living or your demand for capital later in life will exceed your accumulated savings -- especially if that is invested too conservatively. That is one risk I am afraid of.

Stocks aren't guaranteed over any period, but on average, the longer you can hold them, the better off you will be. There are always exceptions to everything.

Don't overthink this one, its not getting you anywhere. As a matter of fact, to the extent you are underweight equities cause you are overestimating their risks in 15-20 years (especially from these levels), you are actually harming yourself.

Some investors may not have 15-20 years...but their beneficiaries do. Of course, it is part of the boglehead way to ignore this fact (while they continue to pay your SS benefits).

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Postby n42 » Fri Jan 02, 2009 9:16 pm

rrosenkoetter wrote:Long-term investors have plenty of time to get the money back, so it's never really "lost"


Boy, this is a myth that has staying power (in that I have heard it for years, if not decades). It is simply not true. A loss, is a loss, is a loss. Who would not argue that it is better to have never lost it in the first place?

I dodged, loosing $90K in 2008. This is $90K, I don't have to re-earn, to catch up. I never lost it in the first place. I don't have to earn 100% on 90K to get back to where I was. Instead I still have my $180K that need only plug along at reasonable returns. (numbers are artificial examples, except - I really did dodge loosing $90K)

I woke up New Years day 2009, thankful I'd dodged last years potential loss - only to be gripped by fear - Oh my - yet, another year stretches before us -- hopefully to make a return (like today), but Oh My, 2009 could be just as bad as 2008 - there are no guarentees when it comes to equities - there could be returns, there could be losses. Just the way equities are.

Better to have never lost it in the first place ... Except, your first big loss is a great teacher, if you listen to it. You young people ... Listen, to 2008 and what you learned, if about nothing else, then what you learned about yourself.
Best, to all of us, and our futures.
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Re: “Adrian’s” 50% rule

Postby Rick Ferri » Fri Jan 02, 2009 10:12 pm

Heath wrote:People continue to discuss and apparently implement “Adrian’s” 50% rule. This rule originated years ago with Larry Swedroe’s table that was intended to help people measure their “willingness”, which is the psychological reaction to loss.


I serously doubt this concept was Larry's idea. Give Adrian credit where credit is due.
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Re: “Adrian’s” 50% rule

Postby bob90245 » Fri Jan 02, 2009 10:21 pm

Rick Ferri wrote:
Heath wrote:People continue to discuss and apparently implement “Adrian’s” 50% rule. This rule originated years ago with Larry Swedroe’s table that was intended to help people measure their “willingness”, which is the psychological reaction to loss.

I serously doubt this concept was Larry's idea. Give Adrian credit where credit is due.

Well, Larry does have that table in one of his books. And it does resemble the "50% rule of thumb". It's even in the Help Sticky Thread:

viewtopic.php?t=6211

Selling in the face of a decline is about the worst thing you can do. Here is a table offered by author Larry Swedroe, based on the 1970s bear market, showing the amount of decline for various stock/bond allocations:

Max Equity - Exposure Max loss
20%...............5%
30%..............10%
40%..............15%
50%..............20%
60%..............25%
70%..............30%
80%..............35%
90%..............40%
100%.............50%
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Postby nisiprius » Fri Jan 02, 2009 10:41 pm

SmallHi wrote:Some investors may not have 15-20 years...but their beneficiaries do.
That's an interesting point, and one I've thought about since you brought it up.

There is actually a spectrum of investment choices that can be arranged, not so much according to risk and reward, but according to their relative benefit to yourself versus your heirs. The extreme at the selfish end is the life annuity, which gives you the most because it sort of seals off assets into a leakproof container so that none of it can escape to your heirs. Next are conservative investments. And the other point of the scale is stocks.

Indeed, if you have enough that you are quite certain you can set aside a "bucket of money" that you will never need at all, the best thing to do with it would probably be to earmark it for your heirs and put it 100% in stocks.

My own viewpoint was indeed somewhat myopic. My mindset is that ones' financial responsibilities to ones' children end when they reach adulthood, and that from that point on you manage your money selfishly so as to reduce the chances that you will ever become a burden on them.

But if you are really thinking in a multigenerational way, and if you really have a family with a "family fortune," then you could safely put a lot of it in stocks because the time horizon for managing it could be several generations long.

I don't think this is practical for me in my circumstances and with my income, but it deserves to be thought through as an investment philosophy.
Of course, it is part of the Boglehead way to ignore this fact.
I don't think that's fair, and I don't think it is limited to Bogleheads. My "self-contained" point of view is the one that is espoused in every investment book I've read. It is a "lifecycle" point of view. You accumulate enough for your own retirement. Your financial responsibilities to your children only occupy a short interval of your own lifecycle.

Thinking of investments in terms of interlocking, overlapping generations is not something I've seen described in the average investment-advice magazine article.
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Postby Adrian Nenu » Fri Jan 02, 2009 10:56 pm

I got the idea about the 50% decline rule of thumb based on the 1973-1974 bear market from a guy named Errold F. Moody Jr., back in 1998. Moody told me that the 1973-1974 bear market loss is the litmus test and investors should take it (and other things) into account when determining their suitable asset allocations. During the 2000-2003 bear market, the concept of the 50% bear market decline was reinforced in mind and I mentioned it to investors on the M* Diehards board who were trying to come up with a suitable stock/bond mix. Then I put it in a simple mathematical formula to make it easier to remember and use. A few years later, I e-mailed Taylor and we talked about the rule of thumb. He thought it had some value and it was worth considering when developing the asset allocation. Not perfect, but it gives a ballpark indication of how bear markets could affect a portfolio. That's about it.

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Postby Adrian Nenu » Fri Jan 02, 2009 11:09 pm

The fact is, the 50%+ losses of 73-74, 69 (on SV), 37-41, as well as 29-32 were around well before the 00-02 market, and many people were aware of it long before Adrian started talking about it (apparently just a few years ago?).


You know about such events, but I spoke and e-mailed with dozens of investors, maybe hundreds and practically none of them thought about the mentioned bear markets when attempting to determine their stock/bond mix. Go ask average investors how about market risk and how they came up with their stock/bond mix. And even fewer thought about the impact of a bear market decline of 50% on their long term retirement plans or their retirement income. They thought about return first, not about risk. They did not even know the risk, it was something that would happen only to someone else at another time. Well, the unthinkable bear market happened twice in the last 10 years so Mandelbrot was right. But judging by the losses investors complain about, they did not take such events into account. They took on too much risk because they did not know the risk.

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Postby craigr » Sat Jan 03, 2009 1:45 am

nisiprius wrote:
SmallHi wrote:Some investors may not have 15-20 years...but their beneficiaries do.
That's an interesting point, and one I've thought about since you brought it up.


The assumption is that these multi-generation family trusts are invested 100% in stocks. I'm not convinced that's how the managers of these funds operate. They are likely much more widely diversified like a University Endowment. That means public stocks, bonds, cash, hard assets, timber, oil, real estate, private placements, organized crime, etc. They likely have assets to grow money and assets to protect money. I'd be surprised if these types of funds were 100% in stocks.
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Postby Sammy_M » Sat Jan 03, 2009 9:24 am

SmallHi wrote:Some investors may not have 15-20 years...but their beneficiaries do. Of course, it is part of the boglehead way to ignore this fact (while they continue to pay your SS benefits).
sh

I've always liked Merriman's strategy. It's about the only time I'd consider a VA.
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Postby Heath » Sat Jan 03, 2009 12:28 pm

It is not important who gets the credit (or blame) for the 50% rule. In Larry’s 2001 book he gives three tables for determining the fixed-equity split. The first deals with “ability” and generally deals with investment time frame. The third deals with “need” and the return required to meet that need. The second table is headed “Maximum Tolerable Loss” (loss rising to 50%) that specifically deals with “willingness”, or the psychological aversion to risk.

Now no one has to agree with Larry’s approach, but at least it deals with ability and need as well as willingness. Adrian now seems to claim that his term “maximum tolerable loss” somehow also deals with ability and need, but it is confusing at best to figure how that can be so.

The biggest problem that I have with Adrian’s rule is that for most people it probably understates ACTUAL risk. The discussions about 50% loss are generally within the overall Boglehead philosophy that equities outperform in the long run. That line of reasoning always subjugates the nature of risk to psychological (willingness), because the Trinity and other studies “prove” equities will (90%+ probability) outperform in the long term. Under this line of reasoning there is no such thing as catastrophic loss unless one goes beyond his "ability" to assume risk based on time frame (which Adrian now claims is somehow incorporated in the term “maximum tolerable loss”).
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Postby HomerJ » Sat Jan 03, 2009 12:48 pm

Heath wrote:The biggest problem that I have with Adrian’s rule is that for most people it probably understates ACTUAL risk. The discussions about 50% loss are generally within the overall Boglehead philosophy that equities outperform in the long run. That line of reasoning always subjugates the nature of risk to psychological (willingness), because the Trinity and other studies “prove” equities will (90%+ probability) outperform in the long term. Under this line of reasoning there is no such thing as catastrophic loss unless one goes beyond his "ability" to assume risk based on time frame (which Adrian now claims is somehow incorporated in the term “maximum tolerable loss”).


Exactly...

For an accumalator with a long term horizon, "maximum tolerable loss" loses it's meaning except for psychological risk
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Postby Heath » Sat Jan 03, 2009 1:10 pm

SmallHi wrote:

The reality is pretty simple: devise an allocation that carries the expectation of reaching your goals. Understand how much risk that entails and live with it. If you can't stomach it, reduce your living expectations. Thats it.


99.9% of investors will be best served by investing passively, diversifying by the 5 factors, and getting on with their lives.

You are much better off with the rule:

Sometimes you are going to lose a ton in the stock market. Its the price of admition for the ride. If you want to ride, you have to pay for it.

sh


I agree with your basic proposition that rules of thumb for the most part are worse than nothing at all.

When you say "Understand how much risk that entails and live with it" how does one do that. You say, "Sometimes you are going to lose a ton in the stock market" how much is a ton? Seriously, rules of thumb may do more harm than good, but don't you think it necessary to provide some clue as to how much risk exists in the market?
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Postby Adrian Nenu » Sat Jan 03, 2009 2:28 pm

The biggest problem that I have with Adrian’s rule is that for most people it probably understates ACTUAL risk.

- Huh?! You did not criticize Larry's table which "understates" risk even more! So far in this bear market, my rule of thumb has held up splendidly. There are many investors who now wished they used it before the bear market.

The discussions about 50% loss are generally within the overall Boglehead philosophy that equities outperform in the long run.

- my rule of thumb does not state that equities will outperform in the long run. How did you come to that conclusion?

That line of reasoning always subjugates the nature of risk to psychological (willingness), because the Trinity and other studies “prove” equities will (90%+ probability) outperform in the long term.

- my rule forces the investor to consider psychological risk as well as catastrophic risk - the risk that financial goals might not be attained due to bear markets.

Under this line of reasoning there is no such thing as catastrophic loss

- catastrophic loss exists for everyone, except possibly early accumulators.

unless one goes beyond his "ability" to assume risk based on time frame (which Adrian now claims is somehow incorporated in the term “maximum tolerable loss”).

- there are many investors on this board who don't need the rule of thumb because they have risk all figured out. Others read too much into it. "Tolerable loss" is just that. It means different things to different people but it remains "tolerable loss" and requires thinking.

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Postby jeffyscott » Sat Jan 03, 2009 3:06 pm

Just a tangent, but in 1973 inflation was about 6% and in '74 about 11% so the decline in real terms was a bit closer to the post 1929 decline than the nominal figures would imply.

If I interpreted Shiller's data correctly, in the post 1929 decline, an investor would have had a real decline of about 70% (after adjusting for dividends paid out during the decline). I have not done the calculations, but eyeballing shiller's spread sheet, it appears that by about a year after the low point (the low was in mid 1932) the loss (after accounting for dividends) would have been reduced back to 50% (real), or less.

Based on history of the US market, the rule seems like a decent baromoter of a reasonable worst case, possibly unrecoverable loss. I think to use it as a bail-out trigger is a mistake, however...if losses temporarily exceed 50%, it does not necessarily mean capitalism is coming to and end and you better get your money out while you still have a bit left.
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Postby Heath » Sat Jan 03, 2009 3:53 pm

Adrian Nenu wrote:
The discussions about 50% loss are generally within the overall Boglehead philosophy that equities outperform in the long run.

- my rule of thumb does not state that equities will outperform in the long run. How did you come to that conclusion?

Adrian
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Ok, let’s take you at your word that your rule of thumb truly means unrecoverable loss and that none of the historical rules apply. You are advising someone to assume that they might lose 50% of their equity assets and none of this loss will ever be recovered. In the long run then the individual will have fixed type returns on the remaining 50% forevermore. Well if that is what you are saying, then I must admit that you are certainly not understating actual risk. On the other hand, if someone interpreted the rule as you now say it is intended, I can’t imagine anyone ever investing in equities.
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Postby dbr » Sat Jan 03, 2009 4:10 pm

Heath wrote:
Adrian Nenu wrote:
The discussions about 50% loss are generally within the overall Boglehead philosophy that equities outperform in the long run.

- my rule of thumb does not state that equities will outperform in the long run. How did you come to that conclusion?

Adrian
anenu@tampabay.rr.com


Ok, let’s take you at your word that your rule of thumb truly means unrecoverable loss and that none of the historical rules apply. You are advising someone to assume that they might lose 50% of their equity assets and none of this loss will ever be recovered. In the long run then the individual will have fixed type returns on the remaining 50% forevermore. Well if that is what you are saying, then I must admit that you are certainly not understating actual risk. On the other hand, if someone interpreted the rule as you now say it is intended, I can’t imagine anyone ever investing in equities.


It sure seems that the actul meaning of some of the things being said on this forum is that no one should ever invest in equities. The more people try to tangle their way out of that conclusion the more contradictory it gets.
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Postby Adrian Nenu » Sat Jan 03, 2009 4:46 pm

Ok, let’s take you at your word that your rule of thumb truly means unrecoverable loss and that none of the historical rules apply.

- What historical rules?! I didn't know there were any.

You are advising someone to assume that they might lose 50% of their equity assets and none of this loss will ever be recovered.

- No, I am just telling them to be ready for 50% market declines. Where did I say that none of the loss will ever be recovered? It could be recovered if they stick to their plans, providing they have enough time to wait.

In the long run then the individual will have fixed type returns on the remaining 50% forevermore.

- Not if they stick to their plans.

Well if that is what you are saying, then I must admit that you are certainly not understating actual risk.

- If they panic and abandon their plans because they took on too much risk, odds are even better that the loss is catastrophic and irrecoverable. The whole point is to get them to take a suitable amount of risk to allow them to stick with their plans and not lock in a loss or low long term returns which might prevent them from achieving financial goals.

On the other hand, if someone interpreted the rule as you now say it is intended, I can’t imagine anyone ever investing in equities.

- Like it or not, 50% market declines are more frequent than most investors suspect and there is no telling how long the recovery time will be. So all I am doing making investors aware of this. They can apply this information to their own specific circumstances. Otherwise, stay in TIPS and other bonds mostly if equity risk is too much.

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Postby jeffyscott » Sat Jan 03, 2009 4:58 pm

I referred to a "possibly unrecoverable loss" and I meant the same thing as Adrian...you may not have enough time to wait for recovery, before you need to sell some stocks for living expenses, or whatever.

For example, my mom is 83...she may never recover all of this year's losses. Luckily she had an appropiately low equity allocation and the portfolo yield has not declined.
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Postby Heath » Sun Jan 04, 2009 12:19 pm

dbr wrote:
Heath wrote:
Adrian Nenu wrote:
The discussions about 50% loss are generally within the overall Boglehead philosophy that equities outperform in the long run.

- my rule of thumb does not state that equities will outperform in the long run. How did you come to that conclusion?

Adrian
anenu@tampabay.rr.com


Ok, let’s take you at your word that your rule of thumb truly means unrecoverable loss and that none of the historical rules apply. You are advising someone to assume that they might lose 50% of their equity assets and none of this loss will ever be recovered. In the long run then the individual will have fixed type returns on the remaining 50% forevermore. Well if that is what you are saying, then I must admit that you are certainly not understating actual risk. On the other hand, if someone interpreted the rule as you now say it is intended, I can’t imagine anyone ever investing in equities.


It sure seems that the actul meaning of some of the things being said on this forum is that no one should ever invest in equities. The more people try to tangle their way out of that conclusion the more contradictory it gets.


Yeah, check out Adrian's last post. Round and round we go.
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“Adrian’s” 50% rule

Postby YDNAL » Sun Jan 04, 2009 12:34 pm

Heath wrote:
dbr wrote:It sure seems that the actul meaning of some of the things being said on this forum is that no one should ever invest in equities. The more people try to tangle their way out of that conclusion the more contradictory it gets.

Yeah, check out Adrian's last post. Round and round we go.
Heath, dbr,

In its general context, I believe that a 2x loss = equity is a good starting base to help understand (and not underestimate) Equity risk. However, I don't believe in rules of thumbs as they generalize and make assumptions that are not relevant to specific investors under specific circumstances.

When dealing with those specific investors/circumstances, human nature forces those that faithfully believe to begin looking for answers or excuses to justify their belief. Conversely, those that forcefully disagree begin sharpening their knives to scalp the faithful.
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Re: “Adrian’s” 50% rule

Postby Heath » Sun Jan 04, 2009 12:44 pm

YDNAL wrote:
Heath wrote:
dbr wrote:It sure seems that the actul meaning of some of the things being said on this forum is that no one should ever invest in equities. The more people try to tangle their way out of that conclusion the more contradictory it gets.

Yeah, check out Adrian's last post. Round and round we go.
Heath, dbr,

In its general context, I believe that a 2x loss = equity is a good starting base to help understand (and not underestimate) Equity risk. However, I don't believe in rules of thumbs as they generalize and make assumptions that are not relevant to specific investors under specific circumstances.

When dealing with those specific investors/circumstances, human nature forces those that faithfully believe to begin looking for answers or excuses to justify their belief. Conversely, those that forcefully disagree begin sharpening their knives to scalp the faithful.


OK, it can be a good starting base as you suggest, provided that one defines what is meant by loss. Is it just the psychological ramifications of the 50% decline that matter or real loss. If real loss, then real loss must be defined. If not, then not only does it fail in the general sense of rules-of-thumb, but it also fails for lack of definition.
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Postby haberd » Sun Jan 04, 2009 1:02 pm

Bottom line: Like all rules of thumb, such a rule is somewhat arbitrary, but it is worthwhile if only as a warning against the usual overoptimism of the financial "advisors".
While it may be historically pessimistic, it may understate actual (i.e., real risk) given the real possibility of a black swan of all sorts, personal and otherwise.
I would add the question, "Could you watch your investment lose 80% over a few years and not pull out of the market altogether?", except this is harder to answer.
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Re: “Adrian’s” 50% rule

Postby dbr » Sun Jan 04, 2009 1:07 pm

Heath wrote:OK, it can be a good starting base as you suggest, provided that one defines what is meant by loss. Is it just the psychological ramifications of the 50% decline that matter or real loss. If real loss, then real loss must be defined. If not, then not only does it fail in the general sense of rules-of-thumb, but it also fails for lack of definition.


I agree that both this rule and comments on the other infamous thread are plagued by lack of definition and have been from the beginning.

More of the discussion than not has concerned lack of meaning rather than contention concerning correct or incorrect.
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Re: “Adrian’s” 50% rule

Postby YDNAL » Sun Jan 04, 2009 1:19 pm

Heath wrote:OK, it can be a good starting base as you suggest, provided that one defines what is meant by loss. Is it just the psychological ramifications of the 50% decline that matter or real loss. If real loss, then real loss must be defined. If not, then not only does it fail in the general sense of rules-of-thumb, but it also fails for lack of definition.
Heath,

Afaic, once you understand and confirm risk tolerance, the only thing that matters is real loss. For instance, in my case, my entire portfolio can be wiped out and I'm not jumping out of the nearest tall building*. Does this mean 100/0? No, it means that I will risk that portion of the portfolio that I don't intend passing to my heirs and neither the piece I intend to piss-off while DW and I enjoy ourselves further.... thus, my signature.

* note to self: start developing a Plan Z (zcape), just in case. :lol:
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Re: “Adrian’s” 50% rule

Postby jeffyscott » Sun Jan 04, 2009 1:50 pm

Heath wrote:OK, it can be a good starting base as you suggest, provided that one defines what is meant by loss. Is it just the psychological ramifications of the 50% decline that matter or real loss.


I believe that this is the way it was intended in Larry's table. It was related to his "stomach acid test" as I recall. Using his construct of need, ability, willingness...my understanding is this is about willingness. Are you willing to see yor portfolio decline by X% and not panic? (I don't think the intent is that if it then declines by X+1%, it is okay to panic)

The idea that one should not risk the stock market with money that they "can not afford to lose", would, I think, be the ability test. IIRC, Larry had a table for that, which was based on the time frame in which the money was needed. I'm not positive, but I think if the money was needed within 5 years, it may have said 0% stocks.

Need to take risk is based on how much money you need to have to meet your goals. If your "need" exceeds your willingness or ability, I don't think a good solution to the conflict is to go with the "need" based allocation and a plan to sell if stocks decline by more than you can tolerate.
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Re: “Adrian’s” 50% rule

Postby dbr » Sun Jan 04, 2009 1:57 pm

jeffyscott wrote:
Heath wrote:OK, it can be a good starting base as you suggest, provided that one defines what is meant by loss. Is it just the psychological ramifications of the 50% decline that matter or real loss.


I believe that this is the way it was intended in Larry's table. It was related to his "stomach acid test" as I recall. Using his construct of need, ability, willingness...my understanding is this is about willingness. Are you willing to see yor portfolio decline by X% and not panic? (I don't think the intent is that if it then declines by X+1%, it is okay to panic)

The idea that one should not risk the stock market with money that they "can not afford to lose", would, I think, be the ability test. IIRC, Larry had a table for that, which was based on the time frame in which the money was needed. I'm not positive, but I think if the money was needed within 5 years, it may have said 0% stocks.

Need to take risk is based on how much money you need to have to meet your goals. If your "need" exceeds your willingness or ability, I don't think a good solution to the conflict is to go with the "need" based allocation and a plan to sell if stocks decline by more than you can tolerate.


I feel that Heath and jeffyscott are making sensible comments.
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Postby ScottW » Tue Jan 06, 2009 3:23 pm

SmallHi wrote:Sometimes you are going to lose a ton in the stock market. Its the price of admition for the ride. If you want to ride, you have to pay for it.


This is one of the more intelligent statements I've seen posted on this board since the markets began spiraling down the toilet. Unfortunately, it's one that few people want to hear because it doesn't provide the short-term "solution" they're seeking, and accepting it forces you to admit that you're not as in control of certain aspects of your life as you'd like to admit. To succeed to have to be willing to take chances. Setbacks will invariably occur along the way, and all you can do is hope that if you make the "right" choices things will ultimately work out.

Believe anything else and you're probably fooling yourself. We frequently have threads discussing how high-powered executives and investment managers lie to the masses, but the truth is that we're pretty good at lying to ourselves, too.
Last edited by ScottW on Tue Jan 06, 2009 6:40 pm, edited 1 time in total.
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Postby Tramper Al » Tue Jan 06, 2009 3:43 pm

ScottW wrote:
SmallHi wrote:Sometimes you are going to lose a ton in the stock market. Its the price of admition for the ride. If you want to ride, you have to pay for it.

This is one of the more intelligent statements I've seen posted on this board . . .

I agree, particularly as the price is left unspecified.

I thought the 50% "rule" was rather harmless until lately, when it seems to have have taken on a role of justifying a reduction of stock %AA exposure after this "maximum tolerable loss" is achieved.

And just for the record I starting using 50% to mean half of something way back in the late 1970s.
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