A One Question Test for 100% Equities

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Kulak
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Re: A One Question Test for 100% Equities

Post by Kulak »

At 36 I hold 100% equities with overwhelming small-value and int'l/EM tilts. And yes, "back in 2008" I held firm and lost over half my net worth (which, admittedly, was less than half of my current number). And yes, I'm displeased with the '13 run-up and expecting to give back quite a bit of my gains soon.

You guys are making a tacit assumption that I don't share: that you can make it to retirement on today's expected returns with a Ben Graham 25-75% AA. Right now the Gordon equation predicts a 3.0-3.5% real return for stocks, and fixed income is priced for negative real returns. Look around at 60-70yo people today and it's obvious that the true risk is ending up with not nearly enough money.

A one-question test for 60% equities or less: Are you willing and able to save 40-60% of your gross income your whole working life? Because that's what you'll need with a real CAGR of ~2%.
Depriving ourselves to boost our 40-year success probability much beyond 80% is a fool’s errand, since all you are doing is increasing the probability of failure for [non-financial] reasons. --wbern
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stemikger
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Re: A One Question Test for 100% Equities

Post by stemikger »

JoMoney wrote:
stemikger wrote: LOL. Just curious why a Hyundai? LOL.
http://www.topgear.com/uk/photos/hyunda ... 2013-10-11
Image
LOL. That should work!! Is that the 2014 model?
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grap0013
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Re: A One Question Test for 100% Equities

Post by grap0013 »

berntson wrote:
grap0013 wrote:
EmergDoc wrote:
Why is it that these threads were non-existent in late 2008 and happen twice a week now?
I wasn't a member in 2008. :)
Ha! I was just getting ready to post precisely the same thing. :)
Great minds think alike.......and so do ours! :)
There are no guarantees, only probabilities.
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grap0013
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Re: A One Question Test for 100% Equities

Post by grap0013 »

Kulak wrote:At 36 I hold 100% equities with overwhelming small-value and int'l/EM tilts. And yes, "back in 2008" I held firm and lost over half my net worth (which, admittedly, was less than half of my current number).
I admit I didn't have much skin in the game in 2008 with 100% equities. Although I have been down 30K+ during some pullbacks over the past couple years. I know, I know, chump change to a lot of posters.

I am not sure why we always talk in terms of percentage losses on here. If one's portfolio is down 6 figures the percentage doesn't matter. It's how much it's down, not what percent. It's not like some magical percentage makes one panic and sell low. That being said, even if you only have 25% equities and your portfolio is supersized, you will have to be willing to endure some big time total $ losses if you want to make some real money.
There are no guarantees, only probabilities.
staythecourse
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Re: A One Question Test for 100% Equities

Post by staythecourse »

Kulak wrote:At 36 I hold 100% equities with overwhelming small-value and int'l/EM tilts. And yes, "back in 2008" I held firm and lost over half my net worth (which, admittedly, was less than half of my current number). And yes, I'm displeased with the '13 run-up and expecting to give back quite a bit of my gains soon.

You guys are making a tacit assumption that I don't share: that you can make it to retirement on today's expected returns with a Ben Graham 25-75% AA. Right now the Gordon equation predicts a 3.0-3.5% real return for stocks, and fixed income is priced for negative real returns. Look around at 60-70yo people today and it's obvious that the true risk is ending up with not nearly enough money.

A one-question test for 60% equities or less: Are you willing and able to save 40-60% of your gross income your whole working life? Because that's what you'll need with a real CAGR of ~2%.
Glad to see others see there is NO free lunch. Too many folks on here seem to think just go conservative and reduce risk. Sure it reduces volatility risk, but does NOT reduce all risk. It actually increases shortfall risk/ longevity risk. Since no one knows when they will die it is hard to estimate the importance of that risk for each person. Nothing wrong with going conservative, but folks have to stop thinking the only risk that exists is volatility.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
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stemikger
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Re: A One Question Test for 100% Equities

Post by stemikger »

staythecourse wrote:
Kulak wrote:At 36 I hold 100% equities with overwhelming small-value and int'l/EM tilts. And yes, "back in 2008" I held firm and lost over half my net worth (which, admittedly, was less than half of my current number). And yes, I'm displeased with the '13 run-up and expecting to give back quite a bit of my gains soon.

You guys are making a tacit assumption that I don't share: that you can make it to retirement on today's expected returns with a Ben Graham 25-75% AA. Right now the Gordon equation predicts a 3.0-3.5% real return for stocks, and fixed income is priced for negative real returns. Look around at 60-70yo people today and it's obvious that the true risk is ending up with not nearly enough money.

A one-question test for 60% equities or less: Are you willing and able to save 40-60% of your gross income your whole working life? Because that's what you'll need with a real CAGR of ~2%.
Glad to see others see there is NO free lunch. Too many folks on here seem to think just go conservative and reduce risk. Sure it reduces volatility risk, but does NOT reduce all risk. It actually increases shortfall risk/ longevity risk. Since no one knows when they will die it is hard to estimate the importance of that risk for each person. Nothing wrong with going conservative, but folks have to stop thinking the only risk that exists is volatility.

Good luck.
Warren Buffett seems to agree.
http://finance.fortune.cnn.com/2012/02/ ... er-letter/

However, the question one has to ask themselves especially after they build up a big portfolio is can they stay the course when the market falls 50%. I'm not a big earner, but after 20 years of saving, the amount in my 401K is more money then some of the houses in my area. At 49 It would really scare me to see that amount go down by 50%.
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ogd
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Re: A One Question Test for 100% Equities

Post by ogd »

berntson wrote:Thanks ogd! I thought your post was especially well-written and you made lots of good points worth thinking about.
Thanks berntson. I really wanted to point out that neither investor psychology nor the significance of stock prices should be minimized or derided. Didn't have time to respond over the weekend, sorry.
berntson wrote:
ogd wrote:So if you ask me, the person who wants their stock holdings to drop 50% is in one of the following situations:

1) Has very little invested compared to yearly earnings
The better way to put (1), I think, is has very little invested compared to expected total life-time contributions
...
Average investors (i.e. non-Bogleheads) have several bad habits. One of them is thinking in terms of absolute losses rather than in terms of losses as a percentage of lifetime contributions.
Actually, I intentionally put it in terms of current earnings. In my experience, the losses really only sting when it will take a long time to make them back -- ballpark of a year of earnings, or 5-10 years of savings. It's an emotional argument to be sure, but your thread asked "would you prefer" and I don't think anyone likes to see years of their savings flushed down the toilet in exchange for the promise of being able to buy cheap, damaged stocks. Remember, I covered the case of the fully objective, forward thinking, unwavering etc investor in #4 "I'm a robot" and #5 "I'm making an argument for the sake of the argument".
berntson wrote:
ogd wrote:
Even the iron-willed robot view of things mistakenly assumes that the stocks that are down 50% are the same companies that the foolish human was willing to buy at 140% higher prices. This is false. Those discounted companies are bruised and battered, their credit lines frozen, their customers shaken and tight-pursed, in the middle of massive layoffs, some of them a month or less from bankruptcy , the others firing off cautiously reassuring PR releases about the immediate health of the company and less reassuring internal memos about the immediate need to control spending.
The companies need not be the same companies they were before the crash. Suppose Acme Widgets has earnings of $10,000,000 and is selling for $200 a share. After the crash, the company is permanently damaged and only earns $5,000,000 a year. The share price, though, has dropped to $50. I would rather buy Acme after the crash, battered and bruised, than before. Worse companies often make for better investments. Young investors can permanently lose their early investments, but make up those losses by buying worse companies at better prices.
If the P/E has dropped by half then there's something else going on. Perhaps the company no longer has any growth prospects or is threatened by bankruptcy. A nice current case is Blackberry, who looks like it's going to ride an ever-more-attractive P/E and book value right into the dustbin. Would you, without the benefit of hindsight, say that BB was a better buy at the height of its power ($230 in 2007, still $82 in 2009), or a year ago when it was still very profitable, at $7? These two are not the same company, and you could argue either way about which one was the attractive long-term investment. The 2007 Blackberry could have been Apple, the 2012 Blackberry looks much more like Eastman Kodak.

Even with your discounted numbers is not as simple as it looks. Consider this: you spend ten years accumulating 1000 shares before the crash; say each controls $10 of earnings, so you got $10K for $200K. After the crash, you spend another ten years accumulating the same amount, $200K, which now buys you 4000 shares controlling $20K of earnings. Together with the $5K left of the crashed earnings, you get $25K earnings having paid $400K. Without the crash in the picture, you would have gotten $20K for those $400K. So a little more, but the trashing of existing assets hurts enough that it's not a slam dunk. And apparently these earnings have a nasty flavor (licorice?) that Wall Street doesn't like, i.e. without the crash the company might have grown quite a bit better than your value-minded earnings. And let's not forget that you can only sell your holdings for $250K instead of $400K if you do actually need the money 10 years into a prolonged crash, not at all unreasonable.

I think your whole argument hinges on the prices being irrational and stocks recovering rather quickly, both in prices and earnings. That may often happen, but I've been arguing that there's a big recency effect that you should be wary of, and at the bottom it sure doesn't look that way. If you rephrase the question as "would you like your stock savings to become damaged goods, in return for being able to buy more damaged goods at very low prices" even the most unwavering of investors might have to think about it a little bit.
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ogd
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Re: A One Question Test for 100% Equities

Post by ogd »

Kulak wrote:You guys are making a tacit assumption that I don't share: that you can make it to retirement on today's expected returns with a Ben Graham 25-75% AA. Right now the Gordon equation predicts a 3.0-3.5% real return for stocks, and fixed income is priced for negative real returns. Look around at 60-70yo people today and it's obvious that the true risk is ending up with not nearly enough money.

A one-question test for 60% equities or less: Are you willing and able to save 40-60% of your gross income your whole working life? Because that's what you'll need with a real CAGR of ~2%.
I think it's dangerous to only look at the "need to take risk". In an extreme example, suppose the only way for your uncle Joe to retire with the income he wants is to go to Vegas, put his savings on number 4, and win. Would you advise him to do that, because nothing else will work, rather than adjust his savings and income expectations? His "risk of ending up with not nearly enough money" is 100% whereas Vegas would at least give him a chance, right? Of course not. That risk is very different vs the risk of #4, in that running out of money will be slow and predictable and he can adjust to it, as opposed to a hammer blow.

Things are of course better for an aggresive stock portfolio, in that one does have the expectation to win (oddly enough, you don't seem to in the short term, which boggles the mind in the same way as the OP's Question). But the point remains that losing 50% or 70% or 90% in an instant is very different from a shortfall you see coming miles away.

I am 40% in fixed income and the way I think about it is that these are the returns I get with the volatility I am willing to tolerate. Such is life. If it's not enough I'll just need to work more or spend less in retirement. I won't accept that what I need to do is take more risk.
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berntson
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Re: A One Question Test for 100% Equities

Post by berntson »

ogd wrote: I am 40% in fixed income and the way I think about it is that these are the returns I get with the volatility I am willing to tolerate. Such is life. If it's not enough I'll just need to work more or spend less in retirement. I won't accept that what I need to do is take more risk.
I'll have to write more complete thoughts later when I have some free time, but just a quick comment for now. Think about risk over the course of an investment lifetime. Increasing your current equity allocation during accumulation can be used to take on more total risk over a lifetime. Alternatively, though, taking more equity risk now would allow you to take less equity risk right before retirement. You can trade future risk for present risk.

Take the case of Carolyn from my earlier post. For her, 100% equities at 32 is as risky (in terms of lifetime contributions) as 25% equities at 62. We could decrease her risk at 32 by increasing her risk at 62, but that doesn't seem wise. Losing 10% of your lifetime contributions now leaves you with time for those investments to recover. They might not, but they likely will. Losing 10% of your lifetime contributions right before retirement leaves no time for those investments to recover. Or at the emotional level: I would think that losing several years worth of savings just before retirement would hurt more than losing it when there are 30 years for it to recover.
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Re: A One Question Test for 100% Equities

Post by ogd »

berntson: the argument about having a steeper S-curve of asset allocation, i.e. more equities now possibly allowing for less later, has a lot more merit than what I perceive to be the tone of the 100% equities camp, which is simply a taller S-curve, i.e. higher equities always. I also have a feeling that the said camp will only get louder if stocks do well enough relative to bonds in the next 30 years to make that late reduction possible. As far as I'm concerned though, there is some amount of risk mostly having to do with job security and other unexpected factors that almost doesn't change with age and puts a floor on my bond allocation.

It's also the case that this is getting pretty far from the subject of the thread, which is whether you should cheer for a market crash or not. I think you almost never should, and if you do it's either posturing or an strong belief in the irrationality of the markets that to me smells very much like recency bias.
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Re: A One Question Test for 100% Equities

Post by berntson »

ogd wrote: It's also the case that this is getting pretty far from the subject of the thread, which is whether you should cheer for a market crash or not. I think you almost never should, and if you do it's either posturing or an strong belief in the irrationality of the markets that to me smells very much like recency bias.
I think we may have actually reached something of a consensus. Young investors should prefer irrational crashes, ones in which the price of assets drops significantly relative to the actual future outlook. Investors should not prefer rational crashes, crashes in which a drop in prices merely reflects a drop in future outlook. Whether someone should prefer a crash to an up year depends on how likely they think it is that a crash is rational given that it occurs. If you think that a crash is likely to be most irrational, then a crash happening is (probably) good news for a young investor. If you think it is likely to be mostly rational, then it is likely not good news because it merely reflects worse prospects.

The remaining disagreement, if there is one, is how likely it is that a crash would be rational (an accurate reflection of future probabilities).
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Re: A One Question Test for 100% Equities

Post by White Coat Investor »

Kulak wrote: You guys are making a tacit assumption that I don't share: that you can make it to retirement on today's expected returns with a Ben Graham 25-75% AA. Right now the Gordon equation predicts a 3.0-3.5% real return for stocks, and fixed income is priced for negative real returns. Look around at 60-70yo people today and it's obvious that the true risk is ending up with not nearly enough money.

A one-question test for 60% equities or less: Are you willing and able to save 40-60% of your gross income your whole working life? Because that's what you'll need with a real CAGR of ~2%.
If I really thought I'd only get a CAGR of 2% real on my 75/25 portfolio over the next 20 years I wouldn't be investing in stocks or bonds. Low rates of return change the game completely. If that's really what to expect, I'm going to go invest in real estate, franchises, cash value life insurance etc. That's why I don't believe it. (Aside from the fact that people have been saying that for my entire investing career and I'm still ~ 6% real)

I wrote about it this Spring.

http://whitecoatinvestor.com/making-dif ... d-returns/

Pollyannish? Perhaps. Only time will tell.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
Jebediah
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Re: A One Question Test for 100% Equities

Post by Jebediah »

I get the sense that the 100% equities camp often holds an implicit belief that a) stocks can't actually drop more than 50%, b) stocks are more or less guaranteed to recover after a crash.

Neither has to be true at all. Who says the next century has to look anything like the last?

Remember that an 80% drop requires a 400% gain to break even. That could take a long time. Or not. Who knows?

And why would anyone want to hold ONE asset class when they can diversify with several (as EmergDoc points out)? Granted, less conveniently.
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JoMoney
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Re: A One Question Test for 100% Equities

Post by JoMoney »

Risk preference.

I get the sense that the "everyone must hold some percentage of bonds" camp often holds an implicit belief that a) bonds can't actually drop more than 50% in REAL purchasing power, b) they'll somehow come out ahead by exchanging their bonds for more equities later if they just wait for a crash.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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White Coat Investor
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Re: A One Question Test for 100% Equities

Post by White Coat Investor »

This discussion is way more fun in the middle of a bear than the middle of a bull. I was surprised to see some long time Bogleheads admit to selling out in 2008-2009. Not everyone mind you, but enough that it made you go hmmmm....maybe this stuff isn't as easy as it seems.
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Kulak
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Re: A One Question Test for 100% Equities

Post by Kulak »

EmergDoc wrote:Low rates of return change the game completely. [...]

I wrote about it this Spring.

http://whitecoatinvestor.com/making-dif ... d-returns/
Excellent piece. You at least get it.
Depriving ourselves to boost our 40-year success probability much beyond 80% is a fool’s errand, since all you are doing is increasing the probability of failure for [non-financial] reasons. --wbern
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Re: A One Question Test for 100% Equities

Post by grayfox »

EmergDoc wrote:
If I really thought I'd only get a CAGR of 2% real on my 75/25 portfolio over the next 20 years I wouldn't be investing in stocks or bonds. Low rates of return change the game completely. If that's really what to expect, I'm going to go invest in real estate, franchises, cash value life insurance etc. That's why I don't believe it. (Aside from the fact that people have been saying that for my entire investing career and I'm still ~ 6% real)

I wrote about it this Spring.

http://whitecoatinvestor.com/making-dif ... d-returns/

Pollyannish? Perhaps. Only time will tell.
2% real return is not all that bad and maybe more than anyone deserves. I calculate that for someone that works for 40-years, saves 30% to fund a 40-year retirement, a real return of 2.14% would work.

Even at 0% real return, a savings rate of 50% works. This should be obvious by inspection.

No need to take on more investment risk like real estate, small business or casino gambling. Just save enough. What is hard about saving 30% for high income workers? Now if someone is making $25K per year, then they will have trouble saving enough. But if you make $150K per year, you can't save $50K and live on $100K?
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Re: A One Question Test for 100% Equities

Post by Jebediah »

JoMoney wrote:Risk preference.

I get the sense that the "everyone must hold some percentage of bonds" camp often holds an implicit belief that a) bonds can't actually drop more than 50% in REAL purchasing power, b) they'll somehow come out ahead by exchanging their bonds for more equities later if they just wait for a crash.
1) Who said anything about bonds? 2) If anyone was starting 100% bonds threads, then you might have a point.
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Re: A One Question Test for 100% Equities

Post by grap0013 »

grayfox wrote:What is hard about saving 30% for high income workers? Now if someone is making $25K per year, then they will have trouble saving enough. But if you make $150K per year, you can't save $50K and live on $100K?
Easier said than done. To make that 150K you probably need to borrow at least that amount for school at 6.8% for a lot of people. Add the average 2.05 kids at 1.1K/mo./child daycare and you can quickly see the money disappearing. Not saying people don't have choices about those factors, but I don't like to say generalized statements about how much other people should be able to save because it depends so much on individual circumstances.
There are no guarantees, only probabilities.
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Kulak
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Re: A One Question Test for 100% Equities

Post by Kulak »

Not to mention: read my signature. How much are you willing to sacrifice for a retirement that could easily be undone by a black swan event like hyperinflation, government stealing your assets (see Cypress), your own premature death, etc.? In any one lifetime, the odds of a non-financial failure mode are probably 1 in 5. Years ago I worked with a Russian who had emigrated in 1999 and was explaining to him my retirement plan, and he thought I must be joking, just laughably naive to assume political/institutional continuity out at 30+ years.

Pseudocertainty is the quintessential Boglehead cognitive bias. Assume your retirement can never be more than about 80% "safe" regardless of how you allocate or withdraw.
Depriving ourselves to boost our 40-year success probability much beyond 80% is a fool’s errand, since all you are doing is increasing the probability of failure for [non-financial] reasons. --wbern
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