Periodic Investing and Wanting the Market to Drop

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tchasteen
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Periodic Investing and Wanting the Market to Drop

Post by tchasteen » Wed Apr 19, 2017 5:21 pm

Hello,

I have read countless times that if you are routinely and periodically investing in a market that you should be happy when that market drops because you start to get shares at a cheaper price.

I struggle to wrap my head around that philosophy and am hoping for your help to understand it. I ran a few scenarios using the S&P 500 Periodic and Dividend Reinvestment Calculator: http://dqydj.com/sp-500-dividend-reinve ... alculator/

1. A 6 year period with 25k already invested, the market crashed and came back to where it originally was, all the while I continued to invest $1950 a month.
2. A 6 year period with 25k already invested, the market continued to rise all the while I continued to invest $1950 a month.

In scenario 2 I made almost triple that of scenario 1. I don't understand how a dip is something to be happy about especially considering how it affects the money you had invested prior to the dip.

As always I appreciate all of your bright insight and feedback.

Thanks,
Tim

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Re: Periodic Investing and Wanting the Market to Drop

Post by ACM4297 » Wed Apr 19, 2017 5:34 pm

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backpacker
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Re: Periodic Investing and Wanting the Market to Drop

Post by backpacker » Wed Apr 19, 2017 5:41 pm

tchasteen wrote: I have read countless times that if you are routinely and periodically investing in a market that you should be happy when that market drops because you start to get shares at a cheaper price.


When you buy a stock, you are buying the future earnings of the company issuing the stock. When prices go down, it is usually because the market has every reason to think that future earnings will be lower than originally expected. This bad news for you and everyone else even if most of your investing is going to happen in the future.

It's like this. Suppose you go to the store to buy a pack of beer. The owner tells you, great news! Pakcs that use to be $10 are now only $5. There's a catch though. Each pack used to have six bottle but now they have only three.

Sure the price has gone down, but this isn't good news for you because you're getting less beer. The same goes for stocks.

The caveat to all this is that sometimes, investors go overboard. There is bad news and the market overreacts. There's no consensus on how often this happens or even if it ever happens. Hardcore free market types think that no matter how far stocks have dropped in price, they are no better deal than they used to be. The drop in price corresponds to the same drop in the real value of the company. Others think that it happens pretty often. Markets are run by people who get swept away by their emotions and you, as a regular investor, can benefit from this.

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Re: Periodic Investing and Wanting the Market to Drop

Post by Tyler Aspect » Wed Apr 19, 2017 6:13 pm

tchasteen wrote:Hello,

I have read countless times that if you are routinely and periodically investing in a market that you should be happy when that market drops because you start to get shares at a cheaper price.

I struggle to wrap my head around that philosophy and am hoping for your help to understand it. I ran a few scenarios using the S&P 500 Periodic and Dividend Reinvestment Calculator: http://dqydj.com/sp-500-dividend-reinve ... alculator/

1. A 6 year period with 25k already invested, the market crashed and came back to where it originally was, all the while I continued to invest $1950 a month.
2. A 6 year period with 25k already invested, the market continued to rise all the while I continued to invest $1950 a month.

In scenario 2 I made almost triple that of scenario 1. I don't understand how a dip is something to be happy about especially considering how it affects the money you had invested prior to the dip.

As always I appreciate all of your bright insight and feedback.

Thanks,
Tim

Hi, for an equivalent comparison it is required that the starting point and the ending point to have the same price, otherwise it is not apple to apple comparison. One possible comparison is to compare between a case of no price change versus market going down then going back up to the same price. Alternatively, you can compare between a case of no price change versus market going up then going back down to the same price.
Last edited by Tyler Aspect on Wed Apr 19, 2017 6:17 pm, edited 1 time in total.
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Re: Periodic Investing and Wanting the Market to Drop

Post by rebellovw » Wed Apr 19, 2017 6:23 pm

Definitely thought provoking.

I'd say that given time - the price will likely reach the same point - at 6 years the one is back to where it started while the other has grown - but what about another 6 years - they would probably even out - and at that point the one that took the hit could be higher - since it was able to buy more shares at a lower price for a 6+ year period.

And in this situation - the price wouldn't have to catch up for a break even - it could be considerably lower. At break even it would be a much larger portfolio due to higher volume of shares.

Just my rookie guess.

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Re: Periodic Investing and Wanting the Market to Drop

Post by onourway » Wed Apr 19, 2017 6:42 pm

Consider a stock that is currently priced at $100 and pays a $2 per share dividend for a dividend yield of 2%. That $100 price is 25x future earnings. You have $25,000 to invest which buys you 250 shares. In order to double your money the stock must go to $200 which is 50x future earnings - way higher than most stocks ever get valued. Since the price relative to earnings is already so high at $100/share, your upside is limited. Most of your return will be on the 2% paid in dividends.

Now, if the market drops 50% that stock now costs $50 and may still pay the same $2 per share dividend. The company is sound, so the future earnings potential is effectively the same, but at $50 it's only 12.5x future earnings. Your $25,000 now buys 500 shares. When the stock hopefully recovers to its pre-recession price at 25x price/earnings, your $25k will now be worth $50k, plus dividends on twice as many shares as in scenario 1.

This is a greatly simplified example, and doing this with individual stocks is highly risky, because any 1 given company may well go out of business. But when you use the passive method of investing and own the entire market, the failure of even a large number of companies has relatively minimal effect on you. The expectation is that the market as a whole will recover eventually.

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Re: Periodic Investing and Wanting the Market to Drop

Post by Christian NY » Wed Apr 19, 2017 7:10 pm

Ohhh I've asked this question many times and people that are knowledgeable about investing always say "don't time the market, time to start investing is now, don't worry about the downturn". I don't understand why either but I took their advice. It is very rare that someone suggests timing the market, they always say don't worry about it and concentrate on the allocation.

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Re: Periodic Investing and Wanting the Market to Drop

Post by CyclingDuo » Wed Apr 19, 2017 7:25 pm

tchasteen wrote:Hello,

I have read countless times that if you are routinely and periodically investing in a market that you should be happy when that market drops because you start to get shares at a cheaper price.

I struggle to wrap my head around that philosophy and am hoping for your help to understand it. I ran a few scenarios using the S&P 500 Periodic and Dividend Reinvestment Calculator: http://dqydj.com/sp-500-dividend-reinve ... alculator/

1. A 6 year period with 25k already invested, the market crashed and came back to where it originally was, all the while I continued to invest $1950 a month.
2. A 6 year period with 25k already invested, the market continued to rise all the while I continued to invest $1950 a month.

In scenario 2 I made almost triple that of scenario 1. I don't understand how a dip is something to be happy about especially considering how it affects the money you had invested prior to the dip.

As always I appreciate all of your bright insight and feedback.

Thanks,
Tim


If you are working, raising a family, and focusing on life - most are way too busy to even notice what is going on. Like Jack Bogle says, avoid the "noise", and don't even peek. Every month the contributions from your paycheck and the employer match keeps the chunks accruing through thick and thin. Thick and thin (expansion and recession) are part of the journey. After 30 or 40 years, you come up for air to take a look and see what you have.

If you want to time all of your entries, feel free. Our contributions are the last day of every month, and have been for 30 years.

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Re: Periodic Investing and Wanting the Market to Drop

Post by Grt2bOutdoors » Wed Apr 19, 2017 7:26 pm

Christian NY wrote:Ohhh I've asked this question many times and people that are knowledgeable about investing always say "don't time the market, time to start investing is now, don't worry about the downturn". I don't understand why either but I took their advice. It is very rare that someone suggests timing the market, they always say don't worry about it and concentrate on the allocation.


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Re: Periodic Investing and Wanting the Market to Drop

Post by arcticpineapplecorp. » Wed Apr 19, 2017 8:15 pm

Burton Malkiel and Charles Ellis covered this nicely in their book, "The Elements of Investing". In the chapter that explains dollar cost averaging they give a scenario of two investors who invest $1000 a year for five years. The only difference is that in one investor invests in a market that goes down, then up (above where the market started) then back down to where the market started and the other investor invests in a market that goes up straight for all five years. The question is if you were this investor would you rather invest in a "volatile, ending flat" market or a "continually rising" market? I'll even show you a picture of what these two markets look like and see what seems like the better investment opportunity:

Image

Now that you've thought about it, let's see what did better:

Image

Yep, you guessed it...even thought the first market was volatile AND ended exactly where it started, this was the better investment than investing in a continually rising market. Buying stocks at lower prices tends to lead to higher returns and buying stock at higher prices tends to lead to lower returns. Does that help?
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Re: Periodic Investing and Wanting the Market to Drop

Post by avalpert » Wed Apr 19, 2017 8:24 pm

arcticpineapplecorp. wrote:Burton Malkiel and Charles Ellis covered this nicely in their book, "The Elements of Investing". In the chapter that explains dollar cost averaging they give a scenario of two investors who invest $1000 a year for five years. The only difference is that in one investor invests in a market that goes down, then up (above where the market started) then back down to where the market started and the other investor invests in a market that goes up straight for all five years. The question is if you were this investor would you rather invest in a "volatile, ending flat" market or a "continually rising" market? I'll even show you a picture of what these two markets look like and see what seems like the better investment opportunity:

Image

Now that you've thought about it, let's see what did better:

Image

Yep, you guessed it...even thought the first market was volatile AND ended exactly where it started, this was the better investment than investing in a continually rising market. Buying stocks at lower prices tends to lead to higher returns and buying stock at higher prices tends to lead to lower returns. Does that help?

Yep, it sure is easy to contrive a scenario where it works out better to have the volatility - of course it is just as easy to contrive one where it doesn't.

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Re: Periodic Investing and Wanting the Market to Drop

Post by JoMoney » Wed Apr 19, 2017 8:34 pm

To me, the goal of periodic investing is to aquire your shares at an "average price" over the period you're able to invest.
It would be nice if your dollar cost averaging lowers your average cost while accumulating, but the goal is to get an average cost. Similarly when your withdrawing small amounts over the years. It's hard not to anchor on whatever amount your portfolio balance last peaked at, but I think for someone who's taking a passive approach you should focus on "staying the course" and making sure you get the average returns available to you over whatever time period by just keeping with the plan and trying to ignore the short term fluctuations whatever which way they go.
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tchasteen
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Re: Periodic Investing and Wanting the Market to Drop

Post by tchasteen » Fri Apr 21, 2017 5:51 am

Thanks everyone,

I understand it better now and it seems I'm right in thinking that it isn't always necessarily always a good thing. The examples provided show it certainly can be, especially over longer periods of time. In summary, sometimes it helps because when you purchase shares at a lower price during a dip those shares get much, much higher returns later when the market returns.

It seems that this is a kind of mental reassurance to help people not get scared and pull their money out when markets start to decline, instead with this kind of thinking they want to keep on buying! I guess the good thing is that I don't have to fully understand it, so long as I stay the course and keep investing periodically. :o

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Re: Periodic Investing and Wanting the Market to Drop

Post by NiceUnparticularMan » Fri Apr 21, 2017 6:33 am

backpacker wrote:It's like this. Suppose you go to the store to buy a pack of beer. The owner tells you, great news! Pakcs that use to be $10 are now only $5. There's a catch though. Each pack used to have six bottle but now they have only three.

Sure the price has gone down, but this isn't good news for you because you're getting less beer. The same goes for stocks.


Here's the thing, though--if $5 is the right price, the packs always only had three bottles, meaning future earnings will be what they will be. It was just that back in the day people thought they had six, so $10 was too much. Of course even now, we don't know it will be three--maybe it is only two, or maybe six was right all along. Again, it will be what will be--all that is changing is people's guesses and the prices that result.

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Re: Periodic Investing and Wanting the Market to Drop

Post by onourway » Fri Apr 21, 2017 6:46 am

It might be interesting to look at a couple of visual representations of two scenarios.

Let's consider what happens if one had invested a lump sum of $10,000 in the year 2000 at the peak of the dot-com boom:

Image

Because of the high valuations (ie. 'bubble') stocks were in that year, the $10k invested in year 2000 gives comparatively low returns over the next 17 years at just 4.69% CAGR.

Compare that to what happens if we'd invested $10,000 in the same index fund 3 years later:

Image

Despite 3 years less time in the market we have more than double the growth at 9.27% annually! Pretty good case for waiting, right?

Well hold on, let's look at the same scenarios if we had contributed the first initial $10k seed amount in year 2000, but then continued to invest your $1950 into the fund every month:

Image

That looks a little better. Not bad at all in fact!

So what happens if we'd waited until the market bottom of 2003 to invest our $10k seed and our $1950 monthly? (I'll even give you the benefit of the doubt and assume you'd saved that $1950 every month for 3 years in a savings account, and then put that amount ($70,200) plus your original $10k in as a lump sum.

Image

Surprise! It's exactly the same amount as if you'd just invested monthly all along! That's the power of the Boglehead passive method of investing. Even if markets are highly overpriced at the time you begin investing, by investing regularly month in and month out year over year, you get the average price, and are guaranteed to get above-average returns.

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Re: Periodic Investing and Wanting the Market to Drop

Post by nisiprius » Fri Apr 21, 2017 7:31 am

tchasteen wrote:...I have read countless times that if you are routinely and periodically investing in a market that you should be happy when that market drops because you start to get shares at a cheaper price...
It's my personal belief that this is a) propaganda, and b) meaningless in terms of being anything you can or should act on.

It's propaganda, because under the efficient market hypothesis, the market drops because there is something that's happened that makes everyone think the stocks in it really are worth less. They are not the same shares as they were.

They are not like a supermarket sale where you know that the can of soup at 2 for $2.49 is literally the same can that was on the shelf yesterday at $1.99 (and has a 'best before 9/2017' stamped on it so you can calculate that its shelf life is 99% or 98% of what it was yesterday). It's more like day-old bread, or a DVD player that's on sale because it's out of its box and has a little scuff mark on the plastic.

Warren Buffett actually has a pithy saying about "hamburger on sale," but in real life at my local supermarket, hamburger mostly goes on sale the day before the sell-by date. If there's a reason why I can use it today, it may be smart for me to buy it instead of the long-dated hamburger. But if someone said "I'm waiting for the meat to get old so that I can buy it as a 'manager's special'" I'd say "whatever, you do that, but don't tell me everybody should try to do that for all of their hamburger." And if they said "prices always go back up and then I can sell this hamburger back to the supermarket for a profit," I'd say "Nope, this particular package of hamburger ain't getting any better than it is right now."

GE didn't lower the price of its stock from $40 a share in October, 2007 to $8 a share in March of 2009 in order to lure people into their store in hopes they would pick up some light bulbs and locomotives while they were in there. GE didn't set the price of its stock at all. The market looked at the economy and GE's businesses and balance sheets in 2007 and said "looks good," and when they looked again in 2009 they said "Whoa, what with the economy and all we just don't see them selling as many light bulbs and locomotives as we thought. No way they will earn what it looked like they would be earning, no way we are going to pay $40 a share given the earnings we expect to see." So now, you and I go in, maybe not even having gone over the balance sheet, and say "Two years ago everyone else was willing to pay $40 for this stock and we thought they were right; now, they are only willing to pay $8 for it and we think they are wrong, just because it has gone down?"

I hate it when my investments go down, and to counter this and keep selling me stuff they have a whole raft of talking points that say I should be happy when that happens. Phooey.

I stay the course, but I'm happy when my investments go up, and I'm unhappy when they go down.
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Re: Periodic Investing and Wanting the Market to Drop

Post by NiceUnparticularMan » Fri Apr 21, 2017 8:04 am

tchasteen wrote:It seems that this is a kind of mental reassurance to help people not get scared and pull their money out when markets start to decline, instead with this kind of thinking they want to keep on buying! I guess the good thing is that I don't have to fully understand it, so long as I stay the course and keep investing periodically. :o


So I think it is worth noting that while if you more or less assume a random walk, there is no expected benefit to periodic investment overall, it nonetheless remains true that when you buy shares at a lower price, that is more helpful in the long run than buying the same shares at a higher price.

So it is not wrong for an accumulating periodic investor to think to themselves, "Now that the markets have gone down, I am buying shares at a more favorable price than back when the markets were higher." Of course since you can't predict those dips, you shouldn't deliberately wait for them. But when they do happen, you benefit in that sense.

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Re: Periodic Investing and Wanting the Market to Drop

Post by NiceUnparticularMan » Fri Apr 21, 2017 8:21 am

nisiprius wrote:It's propaganda, because under the efficient market hypothesis, the market drops because there is something that's happened that makes everyone think the stocks in it really are worth less. They are not the same shares as they were.


That's two different thoughts. EMH implies that all the information that is available (or perhaps publicly available) is reflected in present stock prices. EMH doesn't imply that the prices in question are "correct," because even collectively we don't have perfect information about the future. So EMH implies stock prices represent our collective current "best guess" about the future, but despite our best efforts, that guess could be wrong.

Accordingly, when we get new information, stock prices may change. But that doesn't mean the future has changed, just our best guess about it.

In that sense, the shares have not necessarily changed, in the sense that the future of the companies in question has not actually changed. But again our best guess about the future of those companies may have changed (or some other best guess may have changed, but not necessarily the actual future of the companies).

Assuming you always accept the current best guess as the best guess, then what you should be thinking now is not that the shares have changed, but rather that our old best guesses were wrong. So, people who bought at the higher prices of the past, including perhaps us, made a "mistake" in that they overvalued those shares given our updated best guesses. Oh well.

But in a sense we really are now buying the "same shares" for less. So that's good, in the same sense it was bad we used to be paying too much for them (according to our current best guess).

As an aside--from my perspective, stocks ALWAYS seem underpriced. Even at historically high valuations, they seem underpriced relative to any sort of reasonable ground-up model. When they are lower valuations, they seem even more underpriced. So from my perspective, over time I am buying stock shares at a range between "a bargain" and "even more of a bargain," but never at "too much."

Of course if I want to start selling these shares, then it may become a problem if, say, I bought them at "a bargain" and I have to sell them at "even more of a bargain". But that's a withdrawal problem, and I have plans for addressing that problem that go outside of just a stock strategy.

In terms of accumulating shares, though, I really do think when stock prices decrease, the future hasn't changed, just our best guesses about the future. And if stock valuations decrease as a result, then they are just going from "a bargain" to "even more of a bargain." So I don't even really regret much buying at the old prices--I'm just doing even better now.

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Re: Periodic Investing and Wanting the Market to Drop

Post by nisiprius » Fri Apr 21, 2017 8:34 am

All valid points.
NiceUnparticularMan wrote:Accordingly, when we get new information, stock prices may change. But that doesn't mean the future has changed, just our best guess about it.
Dead seriously, though--in your best rational analysis, do you think the future of GE was the same after the financial collapse as it was before? (I admit that I shouldn't have talked about "light bulbs and locomotives" when the big lesson was that GE was more of a financial company than an industrial company...)
In that sense, the shares have not necessarily changed...
Well, OK. They are "the same shares," but there's no guarantee that the company has the same future prospects.
As an aside--from my perspective, stocks ALWAYS seem underpriced. Even at historically high valuations, they seem underpriced relative to any sort of reasonable ground-up model. When they are lower valuations, they seem even more underpriced. So from my perspective, over time I am buying stock shares at a range between "a bargain" and "even more of a bargain," but never at "too much."
Have you ever read 'Dow 36,000' by Glassman and Hassett? That was exactly their point, and in their presentation it was based on fundamentals. Stock prices, they said, were far too low in 1999, and it was a near-mathematical certainty that they would rise to their "perfectly reasonable price." The rate-limiting step was diffusion of understanding of Jeremy Siegel's work throughout the investment community, and "A sensible target date for Dow 36,000 is early 2005, but it could be reached much earlier."
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Re: Periodic Investing and Wanting the Market to Drop

Post by NiceUnparticularMan » Fri Apr 21, 2017 9:12 am

nisiprius wrote:Dead seriously, though--in your best rational analysis, do you think the future of GE was the same after the financial collapse as it was before?


So this is a bit of a philosophical question. But prior to the financial collapse, I'd say the financial collapse was coming, with all the same implications for GE's future. We just didn't know it at the time, so our best guess about GE's future was wrong, because it didn't include predicting that coming financial collapse. After it happened, we changed our best guess, but that was because our information changed, not the actual future.

There is one important caveat here: you can imagine an asset which returns a bunch of income in Year 1, then in Year 2 it starts producing much less income for ever after. I would agree that after Year 1, that's a different asset in the sense that Year 1 is no longer part of its future.

However, usually with stocks you are looking pretty far in the future for your expected income. So, there is a bit of a difference between the asset for Years 1-20 versus Years 2-21, but usually not that much. So usually big swings in price are not because there was a bunch of income we expected in Year 1 and now that is over. Instead, usually it is because our best guess about Years 2-21 just changed.

But again philosophically, all this was coming. We just didn't know it.

To get even more philosophical--my perspective is the future private economy will be what it will be, and people who own shares of the means of production will get the income they get. I don't know what all that will end up being, but I do know the more shares I have, generally the more income I will get. And I can avoid company-specific, industry-specific, and country-specific risk with diversification. After that--it is out of my hands.

Well, OK. They are "the same shares," but there's no guarantee that the company has the same future prospects.


I'd just emphasize again that from my perspective the company's actual future hasn't changed, just our best guess about that future. I think "future prospects" could be used to refer to our best guess, so I don't object to the term per se, but I do think that is an important distinction.

Have you ever read 'Dow 36,000' by Glassman and Hassett? That was exactly their point, and in their presentation it was based on fundamentals. Stock prices, they said, were far too low in 1999, and it was a near-mathematical certainty that they would rise to their "perfectly reasonable price."


Yep, and I agree it is also the same thought behind all the research finding the equity premium seems too high (aka the equity premium "puzzle").

The problem with that thesis, in my view, was not the conclusion that stock prices seemed too low. The problem was the prediction that they would rise to a more reasonable price sometime soon. As I noted, stock prices ALWAYS seem too low. So maybe they will always stay too low far in the future as well.

Again to speak a little more broadly--from a practical perspective, if you can live off the future income from your stock by the time you are done accumulating, this is maybe not such a problem. Note this is distinct from living off dividends--income isn't necessarily paid out as dividends, it could be retained and/or re-invested, and therefore realizing income might require selling some shares. But if you view stocks as having a small present income component and a large speculative future income component, and you can live off just the present income component, you don't necessarily have to worry a lot about how people are currently pricing the large speculative future income component.

Note though if your stocks are going to average $10 in income per year and you only need $10 in income per year, you might still have a problem. That is because if in one year they only average $5, you will need to actually sell off more than just the income component to get your extra $5, and now that portion won't be available to generate income in the future. This is the sequence of returns problem, and it is a real problem, and you need a plan for how to deal with it.

Otherwise, though--there is a way of approaching all this where you are not trying to benefit from speculation on the large price component, and instead are just interested in pre-buying the small income component, in which case stocks really do always seem like a bargain. Of course it is still possible the future will be so horribly bad even that doesn't work with a properly diversified portfolio, but that would require an event outside the normal range of events we have been discussing.

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Re: Periodic Investing and Wanting the Market to Drop

Post by tetractys » Fri Apr 21, 2017 10:39 am

For financial market participants, it's wise to keep emotions out of the equation. Happiness depends on ones position, and each situation affords varying amounts of happiness and/or sadness to it's participants.

At the final sale of a stock the price is set at some unknown future value, where shares bought at lower cost give either greater profits or less loss than stocks bought at greater cost. -- Tet

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Re: Periodic Investing and Wanting the Market to Drop

Post by telemark » Fri Apr 21, 2017 11:52 am

At the risk of pointing out the obvious, a scenario that ends with a higher stock price will always be better for the investor than a scenario that ends with a lower price. Making money is always going to be harder in a flat or falling market. But if you assume the same starting and ending points, there are going to be different ways to get from one to the other, and we can probably learn something from modeling those.

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Re: Periodic Investing and Wanting the Market to Drop

Post by NiceUnparticularMan » Fri Apr 21, 2017 12:11 pm

telemark wrote:But if you assume the same starting and ending points, there are going to be different ways to get from one to the other, and we can probably learn something from modeling those.


So if you model this as a random walk around an upward trend, you get no expected benefit versus a straight line with the same trend--you might win or you might lose depending on the sequence of returns, but the weighted odds of each balance out. That's true for a flat or downward trend as well.

Note that doesn't guarantee you actually arrive at the same place as the straight line after a certain number of years. That's actually an odd assumption in that if we knew that sort of thing, it would be very powerful information (and would make this whole investing thing much easier).

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Re: Periodic Investing and Wanting the Market to Drop

Post by telemark » Fri Apr 21, 2017 1:01 pm

telemark wrote:a scenario that ends with a higher stock price will always be better for the investor than a scenario that ends with a lower price

Make that "almost always". On further thought I'm pretty sure I could construct scenarios that would let a flat market beat a rising one, although it would be almost pathologically unlikely. It's all about the market prices on the days when money is added.

More obvious thoughts: a concave market (low in the middle, high on the ends) is better for accumulators than a convex market (high in the middle, low on the ends).

NiceUnparticularMan wrote:So if you model this as a random walk around an upward trend, you get no expected benefit versus a straight line with the same trend--you might win or you might lose depending on the sequence of returns, but the weighted odds of each balance out. That's true for a flat or downward trend as well.

I believe that, on average, deviations should provide an expected benefit to investors. The arithmetic of dollar-cost averaging really does work for accumulators (and, sadly, against people making periodic withdrawals). But the days when money is added need to be somewhat evenly distributed between lower and higher prices. I could construct a random looking graph that always happened to be high on contribution days, and that would be worse than a straight line.

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Re: Periodic Investing and Wanting the Market to Drop

Post by NiceUnparticularMan » Fri Apr 21, 2017 1:25 pm

telemark wrote:I believe that, on average, deviations should provide an expected benefit to investors. The arithmetic of dollar-cost averaging really does work for accumulators (and, sadly, against people making periodic withdrawals).


For good or ill, no. You do have to make sure you have done this right with a proper upward trend around which you put the random walk. Hypotheticals showing an advantage are basically cheating on this in one way or another--the trend isn't right, or they have chose a particular path that makes their case and ignores the equally-likely opposite path, or so on.

You actually had this right: concave means the periodic investor beats the straight line. But convex means the straight line beats the periodic investor. With a random walk around an upward trend, whether the path ends up more concave or more convex is just a 50-50 proposition.

The reason this is a real problem for withdrawal portfolios is not that their expected return is lower as a result. Indeed, lots of people here are going to enter retirement with conservative withdrawal rates, the random walk will happen to be favorable for them to start, and they will end up doing better than they would have done with a straight line. Those are the lucky ones. The problem is others will get unlucky to start, and then they will be doing worse than the straight line. And when the random walk hits zero, the game is over.

And that's the fundamental difference. The accumulator is also going to get results either above or below the hypothetical straight line, but those are all positive values, so we never call it a "failure". The withdrawal portfolio is going to experience the same variance around the hypothetical straight line, but we call it a "failure" if the line touches zero.

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Re: Periodic Investing and Wanting the Market to Drop

Post by backpacker » Sat Apr 22, 2017 6:07 am

NiceUnparticularMan wrote:
backpacker wrote:It's like this. Suppose you go to the store to buy a pack of beer. The owner tells you, great news! Pakcs that use to be $10 are now only $5. There's a catch though. Each pack used to have six bottle but now they have only three.

Sure the price has gone down, but this isn't good news for you because you're getting less beer. The same goes for stocks.


Here's the thing, though--if $5 is the right price, the packs always only had three bottles, meaning future earnings will be what they will be. It was just that back in the day people thought they had six, so $10 was too much. Of course even now, we don't know it will be three--maybe it is only two, or maybe six was right all along. Again, it will be what will be--all that is changing is people's guesses and the prices that result.


This is now getting super philosophical, and I don't mean that in a bad way. :D

Suppose I walk into a convenience store and pay $100 for a lottery ticket that has a 1 in 100 chance of paying out $200. As it turns out, I happen to buy the winning ticket. What was the value of my ticket when I purchased it? On the one hand, it was going to be the winning ticket, so the value was $200. On the other hand, my best information indicated that it had only a 1 in a 100 chance of winning, so $1 at best.

Taking your point on board, we might say that value is said in many ways. There's the real value that may be unknowable and then there's the value we assign based on our best evidence. The question then is, which value am I buying when I buy stock in a company?

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Re: Periodic Investing and Wanting the Market to Drop

Post by NiceUnparticularMan » Sat Apr 22, 2017 8:58 am

backpacker wrote:Taking your point on board, we might say that value is said in many ways. There's the real value that may be unknowable and then there's the value we assign based on our best evidence. The question then is, which value am I buying when I buy stock in a company?


So I was sort of trying to get to this question in one of my posts above. The way I see it, when you buy an ownership share of a company, you are now entitled to share in the income the company is going to produce as long as you continue to be one of the company's owners. I'd say that's the "real value" of company stock.

What's unknowable is exactly what income the company is going to produce for its owners in the future. If we did know, calculating the present value of stock shares would be a relatively simple matter (although retention and re-investment of income somewhat complicates things). But because we don't know the future of the company, we have to price shares using our best guesses. So there is some "real present value," and then there is the price, and those two things could be quite different.

The odd thing from my perspective, and the perspective of many others who have studied this, is that stocks seem to be systematically underpriced if this is your model, meaning at least as long as you are properly diversified, odds are you will be getting much more future income than the price of your stock portfolio would suggest (even accounting for risk-aversion). As I noted above, if you are not planning to ever sell off your ownership shares (except when necessary to realize retained/reinvested income), this is not necessarily a problem--indeed, you might just see it as a "free lunch".

The problem is you might actually be planning to sell down your ownership shares at some point. If so, then it actually matters how they are going to be priced in the future, and if they are still underpriced then, and in fact are more underpriced then than they are underpriced when you buy them, you could lose money.

So my answer to your question would be something like this: if you are just planning to buy and hold the stock for the sake of the income it will produce, then the real value is what you are buying (you just don't know what it is). But if you are planning to at some point sell off that stock, then the price the markets will assign to those shares in the future does in fact matter, independent of what the real value might be.

Or to extend the metaphor--if you buy the box and you open it up and drink the beer, then the number of bottles actually in the box is what mattered. But if you buy the box, hold onto it for a while without opening it up, then sell it to someone else, then the number of bottles people think are in the box is what matters.
Last edited by NiceUnparticularMan on Sat Apr 22, 2017 2:16 pm, edited 1 time in total.

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Re: Periodic Investing and Wanting the Market to Drop

Post by tchasteen » Sat Apr 22, 2017 1:54 pm

Onourway,

Wow! Thanks for the visualization. That is really eye-opening and the way you explained it was extremely helpful, I really appreciate you taking the time to share that with me.

Thanks nisiprius, it was Warren Buffet's hamburger analogy that actually pushed me to ask this question, glad to see others agree to my initial thoughts on the matter.

Everyone else, thanks for the discussion, a lot of your dialogue is making me think far deeper about stocks than I even realized was possible.

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Re: Periodic Investing and Wanting the Market to Drop

Post by jjface » Sun Apr 23, 2017 12:31 am

A lot of complicated ways of looking at it. You want to buy as cheap as possible. Simple as that. So dips are good. When you want to spend the money eg 1 Dec 2040 and 1 share of total stock = $350 then money you get by selling will be the same whether you bought it at $50 or $200. You just make lots of profit if you buy at the lower price.

Unfortunately you can't predict crashes so just enjoy them when they arrive.

The op example is actually more like comparing two different markets - like investor 1 invested in total international (scenario 1) and investor 2 invested in total us stock(scenario 2). The end points are different so the overall return is different. 2 is better because the market return is better. You earned more by investing in the second market. That has nothing to do with periodic investing!

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Re: Periodic Investing and Wanting the Market to Drop

Post by NMBob » Fri Aug 11, 2017 11:06 am

At some point, the effect on what you already own has to enter into the equation.

Say i have invested with 0 down but then 750 a month for 24 years making roughtly 6.5 perc average. Now at year 24, Why am I so happy that last year the market was down on avg 5 percent, so i feel like my 750/mo investment of 9k was bought at a 5 percent discount of the original 9450 it would have cost, so ok, wow, i saved $450 dollars during the year with the low cost.

But wait, I am say 50 years old and already had had 500k already in the account at the start of that year 24. My 5 percent loss on my 500k is a $25,000 loss. So the net effect save $450, lose $25,000 hummmm.

So lets go back to say year 15 when I was younger. In year 15 should I hope for that 5 percent drop for $450 annual savings on my 9k of purchase while my $227,000 accumulated decreases by 5%, which is $11,000....hummm?

Or lots younger in year 10, do you want to save $450 that year in investment input while you lose $6,300 off your $125,000 lump if the market is down 5 percent?

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Re: Periodic Investing and Wanting the Market to Drop

Post by jbolden1517 » Sat Aug 12, 2017 5:23 am

nisiprius wrote:
tchasteen wrote:...I have read countless times that if you are routinely and periodically investing in a market that you should be happy when that market drops because you start to get shares at a cheaper price...[/quote
It's propaganda, because under the efficient market hypothesis, the market drops because there is something that's happened that makes everyone think the stocks in it really are worth less. They are not the same shares as they were.
In general I'd say that's rather circular logic. The people (like myself) who argue that bear markets create opportunity reject the the efficient market hypothesis. So you are arguing that if you assume argument X is false then argument X is false.

But let's assume the market is efficient. Then sudden drops are caused by the price of systematic risk. We know this is essentially the case on the futures market that the price of holding 1 month or 1 year of stock risk rises and falls dramatically. There is no reason to believe that if 100 year futures existed and were traded on open markets they wouldn't end up looking and behaving a lot like common stock. We would probably expect something like (if there are 100 year bonds as well):
stock return = dividend + dividend growth = return on short 100 year future + 100 year bond return on initial sale price
i.e. stocks are just a short position on volatility for 100 years just like they are for 1 year.

Obviously something happened in a period for a few weeks to a few months to make investors want to charge more to carry volatility risk but that doesn't mean that a corresponding thing happened to the economy. Just as this week, nothing happened over the last 3 days that changed the risk of corporate America's 1 month profits enough to justify a 40% price increase in the volatility, but that's what the market priced in.

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Re: Periodic Investing and Wanting the Market to Drop

Post by jbolden1517 » Sat Aug 12, 2017 5:32 am

NiceUnparticularMan wrote: The odd thing from my perspective, and the perspective of many others who have studied this, is that stocks seem to be systematically underpriced if this is your model, meaning at least as long as you are properly diversified, odds are you will be getting much more future income than the price of your stock portfolio would suggest (even accounting for risk-aversion).
I'm not following. Assume you can borrow short term money at bank rates. Compare two assets. 2 year bond held on say 20::1 leverage and stocks held on say 3::1 leverage. Both positions are held until they either go to 10x their original value or bust out. How would you prove that the stock portfolio is more likely to hit 10x faster or bust out less often?

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Re: Periodic Investing and Wanting the Market to Drop

Post by jbolden1517 » Sat Aug 12, 2017 5:48 am

tchasteen wrote:Hello,

I have read countless times that if you are routinely and periodically investing in a market that you should be happy when that market drops because you start to get shares at a cheaper price.

I struggle to wrap my head around that philosophy and am hoping for your help to understand it. I ran a few scenarios using the S&P 500 Periodic and Dividend Reinvestment Calculator: http://dqydj.com/sp-500-dividend-reinve ... alculator/

1. A 6 year period with 25k already invested, the market crashed and came back to where it originally was, all the while I continued to invest $1950 a month.
2. A 6 year period with 25k already invested, the market continued to rise all the while I continued to invest $1950 a month.

In scenario 2 I made almost triple that of scenario 1. I don't understand how a dip is something to be happy about especially considering how it affects the money you had invested prior to the dip.
Whenever these things aren't obvious make them more extreme.

Investor A buys X a bond that pays 10% interest. Investor B buys Y a bond that pays 10% interest. Both can reinvest at market price. Both put $1m in. A's bond the day after he bought it drops in price 50%, B's portfolio remains flat. Both cash out after 10 years.

B earns 10% on his asset. He end up $2.6m after cashing out (1.1)^10
A takes a huge initial loss of 1/2 his monty. But in compensation he gets to compound at 20% not 10%. He cashes out for $3.1m.

Very quickly that advantage of faster compounding, A's investment at a better rate compensates for the initial loss.

Note we can make the time period longer and so something more appropriate for stocks.
C buys an stock index with a 2% dividend growing at 8%. C is compounding at 10%
D buys a stock index with a 2% dividend growing at 8% that then falls immediately by 1/2 after purchase. D has 1/2 as much money to start but compounds at 12%. D catches up in the 39th year.

In reality of course, the value of those future dividends get caught. The market isn't going to allow D to compound faster than C forever. So what's more likely to happen is day D gets to compound at 12% for 10 years and then the price of his shares double back up to their original price to equalize the returns with C's shares. During those 10 years of compounding faster though D earned an extra 1.8% per year or 19% more than C.

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