Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
CULater
Posts: 1037
Joined: Sun Nov 13, 2016 10:59 am

Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by CULater » Tue Jan 17, 2017 11:25 pm

According to the website http://www.Portfoliocharts.com, the worst drawdown of the U.S. total stock market since 1972 was about 37%, and the longest drawdown period until the market recovered was 13 years. Even diversified portfolios such as Rick Ferri's Core Four and the Three Fund Portfolio, which include foreign stocks, REITS, and bonds had significant drawdowns and drawdown recovery periods of 10 years. Of course, these data exclude the worst drawdowns of the stock markets that occurred prior to 1972.

So, my question is should investors such as me use these "worst case" portfolio return scenarios to benchmark their "risk tolerance?" More specifically, does it make sense to ask oneself this sort of question to help determine the best (for me) asset allocation: "if a stock market drawdown of 37% or greater were to begin tomorrow and take a decade or longer to recover, what asset allocation can I stick with (and continue to invest new money into)?"

Both the magnitude and the duration of negative portfolio returns are taken into consideration.
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

Dottie57
Posts: 3378
Joined: Thu May 19, 2016 5:43 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Dottie57 » Tue Jan 17, 2017 11:27 pm

What stage of life are you in?

Atgard
Posts: 355
Joined: Wed Apr 09, 2014 2:02 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Atgard » Tue Jan 17, 2017 11:34 pm

While I certainly think a worst-case scenario should be contemplated, it should not control your entire decision. If you base everything on worst-case, you'll end up with cash under the mattress, which is sub-optimal 90% of the time.

taguscove
Posts: 135
Joined: Sun Dec 11, 2016 6:49 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by taguscove » Wed Jan 18, 2017 12:07 am

Assuming the worst likely leads to an investment that's too conservative. By analogy, if I assume the worst that I'll get hit by a car while commuting, then i'd never leave home.

-37% is the worst 1 year return in recent US history, but no reason why the future can't be worse. You could imagine a nuclear war scenario where losses are greater; thankfully, stock losses are bounded by -100%. I would also look at European and Russian stocks during WW1 and WW2 for ample evidence.

larryswedroe
Posts: 15625
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by larryswedroe » Wed Jan 18, 2017 8:56 am

BTW- the worst drawdown was far worse than 37%, in 2008 bear from top to bottom was more like 60%, and in 2000-02 was closer to 50% if memory serves.

As to your question, while you certainly should CONSIDER the worst case, that doesn't imply that it alone should determine you AA. What you need to consider is what options you have, if any, that you could exercise if the worst case shows up so that your plan doesn't blow up. For example, you could take more risk if you could cut expenses, move to lower cost of living area, perhaps work longer than planned (assuming economy allows that), and so on. The ability to adopt options is important in planning, but unfortunately too many ignore that when building plans.

Larry

CULater
Posts: 1037
Joined: Sun Nov 13, 2016 10:59 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by CULater » Wed Jan 18, 2017 10:11 am

I should have explained that my situation is as a retired investor, so my portfolio is akin to a "lump sum" investment since I'll not be investing more capital in the future. If I were a young investor in the accumulation stage, I'd be less concerned about the impact of the "worst case" scenario for stocks. In fact, I'd probably be rooting for a big market setback if that were the case. My investment horizon is relatively short.
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

Random Walker
Posts: 2666
Joined: Fri Feb 23, 2007 8:21 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Random Walker » Wed Jan 18, 2017 10:20 am

I think you are thinking very correctly. I believe you need to assume the equity portion of your portfolio will experience one or two 50% drops in your investing lifetime. I started investing in 1996 and felt the pain in 2000-2002 and 2008-2009. Rick Ferri has a paper where he describes taking clients through the mind experiment of investing through the 1972-1974 bear. I think it's a great exercise. And I totally agree with Larry's description of having Plan B above.

Dave

CULater
Posts: 1037
Joined: Sun Nov 13, 2016 10:59 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by CULater » Wed Jan 18, 2017 10:30 am

I think the Portfoliocharts website must report annual drawdowns. As Larry says, point in time drawdowns have been quite a bit worse and perhaps should be the benchmark for "worst case". Something on the order of 50% - 60% market losses would not be out of the question here.
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

User avatar
Watty
Posts: 13439
Joined: Wed Oct 10, 2007 3:55 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Watty » Wed Jan 18, 2017 11:00 am

larryswedroe wrote:What you need to consider is what options you have, if any, that you could exercise if the worst case shows up so that your plan doesn't blow up. For example, you could take more risk if you could cut expenses, move to lower cost of living area, perhaps work longer than planned (assuming economy allows that), and so on. The ability to adopt options is important in planning, but unfortunately too many ignore that when building plans.
+1

One of my pet peeves is that some of the retirement simulators report a chance of "failure" like you would keep mindlessly spending until you are broke and homeless.

There should be some better way to phrase that since it means that you would need to change your plans and cut cut some of your expenses.

As long as you were planning on more than a minimal retirement then you can likely cut your spending some and still be comfortable.

User avatar
Tyler9000
Posts: 342
Joined: Fri Aug 21, 2015 11:57 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Tyler9000 » Wed Jan 18, 2017 11:03 am

CULater wrote:I think the Portfoliocharts website must report annual drawdowns. As Larry says, point in time drawdowns have been quite a bit worse and perhaps should be the benchmark for "worst case". Something on the order of 50% - 60% market losses would not be out of the question here.
37% is the drawdown for the single worst year, but Portfolio Charts also has data on deepest drawdown over multiple years. For reference, the deepest drawdown since 1970 for the total US stock market was 51%. This is based on year-end data, and it's true that if you look at daily or monthly it could be a little different in absolute terms, but for the purposes of your question I think it is a suitable and valuable reference point for portfolio comparison.
Last edited by Tyler9000 on Wed Jan 18, 2017 11:38 am, edited 5 times in total.

User avatar
Taylor Larimore
Advisory Board
Posts: 26971
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Correction--Bear Market decline

Post by Taylor Larimore » Wed Jan 18, 2017 11:09 am

According to the website http://www.Portfoliocharts.com, the worst drawdown of the U.S. total stock market since 1972 was about 37%.
CULater:

According to The Independent Guide to the Vanguard Funds, the Maximum Cumulative Loss for Vanguard U.S. Total Stock Market Index Fund in the 2008-2009 bear market was -50.9%.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

User avatar
VA_Gent
Posts: 195
Joined: Thu Jul 24, 2014 10:29 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by VA_Gent » Wed Jan 18, 2017 11:12 am

Go check out the Dow high of 386.10 falling to 40.56 in July 1932. -89.50%

You are also making an assumption that your bonds will save you by being negatively correlated. What if they also lose 50% at the same time?

CULater
Posts: 1037
Joined: Sun Nov 13, 2016 10:59 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by CULater » Wed Jan 18, 2017 11:49 am

VA_Gent wrote:Go check out the Dow high of 386.10 falling to 40.56 in July 1932. -89.50%

You are also making an assumption that your bonds will save you by being negatively correlated. What if they also lose 50% at the same time?
And of course I don't think any these figures are based on real (inflation adjusted) losses, are they?
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

rkhusky
Posts: 5200
Joined: Thu Aug 18, 2011 8:09 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by rkhusky » Wed Jan 18, 2017 12:09 pm

CULater wrote:
VA_Gent wrote:Go check out the Dow high of 386.10 falling to 40.56 in July 1932. -89.50%

You are also making an assumption that your bonds will save you by being negatively correlated. What if they also lose 50% at the same time?
And of course I don't think any these figures are based on real (inflation adjusted) losses, are they?
Inflation factors out of a percent calculation if the time period is short enough. I doubt that milk, bread and egg prices dropped by 90% during the market crash. Here are some inflation numbers, which show that was deflation, but nowhere near 90%: http://inflationdata.com/articles/infla ... 1930-1939/

I think that considering a potential 50% drop in the market is perfectly reasonable, but it shouldn't paralyze you, because there can be multiple years of gains before and after that could offset it. However, if your portfolio is barely able to maintain your lifestyle, than you may want to have fewer equities than someone who has 2X their expected needs. But there is also the risk that a 100% bond portfolio might not provide enough gains. Note that Vanguard's Target Retirement funds end up at about 50/50 on their target date and drop to 30/70 within 7 years. That seems like a reasonable approach for most people.
Last edited by rkhusky on Wed Jan 18, 2017 12:27 pm, edited 1 time in total.

User avatar
David Jay
Posts: 5031
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by David Jay » Wed Jan 18, 2017 12:14 pm

VA_Gent wrote:You are also making an assumption that your bonds will save you by being negatively correlated. What if they also lose 50% at the same time?
Any historic examples? Vanguard shows a historical worst annual return for bonds at -8.1%.

Short of nuclear war or an extinction-level asteroid strike, I don't see the mechanics for a 50% bond drop. It feels like you are playing "scare the dickens out of the newbie".
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

User avatar
VA_Gent
Posts: 195
Joined: Thu Jul 24, 2014 10:29 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by VA_Gent » Wed Jan 18, 2017 12:27 pm

1978-82 long bonds had a -39% real drawdown.
1972-81 10 year treasuries had a -38.21% real drawdown.

We also until recently had never seen negative interest rates. That is the "beauty" of a black swan, no one ever sees it coming.
Last edited by VA_Gent on Wed Jan 18, 2017 1:49 pm, edited 1 time in total.

Random Walker
Posts: 2666
Joined: Fri Feb 23, 2007 8:21 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Random Walker » Wed Jan 18, 2017 12:51 pm

I think for the case of making necessary assumptions in determining AA, I would assume equities can drop 50% at any given time and that bonds would at least hold stable under those circumstances. Larry has made an excellent recommendation that I wholeheartedly agree with. When pondering asset allocation and potential losses, think in terms of absolute dollars lost, not just percentage losses.

Dave

Hyoga
Posts: 35
Joined: Wed May 11, 2016 2:40 am
Location: Japan

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Hyoga » Thu Jan 19, 2017 10:10 pm

What I do is to monitor my holdings according to the following assumptions:
Stocks can drop 50%
Bonds can drop 5%
That gives me a very roughly estimated minimum amount where all of this can drop to, in $$. I also calculate the same, but based on the maximum value historically reached, for reference (it only makes sense if you're not taking money out of your investments).

These numbers give you an idea of where it could go down, compared to what is the value today. You might not be too comfortable with what you read, you could wonder what you would do if your portfolio actually dropped there for example. That would be a sign that maybe you're not going to be able to stay the course if a bear market comes, in which case you might want to consider modifying your AA. But of course you cannot make your AA based only on that.
よろしくお願いします

User avatar
Taylor Larimore
Advisory Board
Posts: 26971
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Taylor Larimore » Thu Jan 19, 2017 11:30 pm

Hyoga wrote:What I do is to monitor my holdings according to the following assumptions:
Stocks can drop 50%
Bonds can drop 5%
That gives me a very roughly estimated minimum amount where all of this can drop to, in $$. I also calculate the same, but based on the maximum value historically reached, for reference (it only makes sense if you're not taking money out of your investments).

These numbers give you an idea of where it could go down, compared to what is the value today. You might not be too comfortable with what you read, you could wonder what you would do if your portfolio actually dropped there for example. That would be a sign that maybe you're not going to be able to stay the course if a bear market comes, in which case you might want to consider modifying your AA. But of course you cannot make your AA based only on that.
Bogleheads:

No one knows the "worst case" in a bear market.

It is easy to look at statistics, imagine what it will be like, and set our bond allocation accordingly. The problem is that when the stock market continues to fall we don't know when (or if) we will stop losing our life savings. We worry, lose sleep, and many sell to avoid losing more.

Bear markets cannot be visualized with statistics.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Rodc » Fri Jan 20, 2017 6:50 am

larryswedroe wrote:BTW- the worst drawdown was far worse than 37%, in 2008 bear from top to bottom was more like 60%, and in 2000-02 was closer to 50% if memory serves.

As to your question, while you certainly should CONSIDER the worst case, that doesn't imply that it alone should determine you AA. What you need to consider is what options you have, if any, that you could exercise if the worst case shows up so that your plan doesn't blow up. For example, you could take more risk if you could cut expenses, move to lower cost of living area, perhaps work longer than planned (assuming economy allows that), and so on. The ability to adopt options is important in planning, but unfortunately too many ignore that when building plans.

Larry
+1
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

Bob
Posts: 173
Joined: Mon Feb 26, 2007 5:15 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Bob » Fri Jan 20, 2017 9:05 am

+1 to what Larry says.... historic "worst case" definitely should be a consideration even though history is very unlikely to forecast the future.

Especially for someone near or entering their retirement years, understanding a "terrible" scenario where asset values drop like in a past "worst case" fashion, where rates of return continue be low and where U.S. inflation ramps up significantly beyond what the Fed wants as a target gives one insight into what one's spending levels might need to be if all these things happened together. That insight might then be a consideration in setting one's budget level for annual spending (and withdrawals) which is another critical decision.

As Larry cautioned in one of his columns in 2009: "... it is important for you to consider the risk of fat tails when designing your investment policy statement, making sure you do not take more risk than you have the ability, willingness and need to take. It is also important to understand that just because something has not happened does not mean it cannot or will not happen. The potential for devastating losses should not be ignored when designing a plan. Making that mistake can have disastrous results."

CULater
Posts: 1037
Joined: Sun Nov 13, 2016 10:59 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by CULater » Fri Jan 20, 2017 9:43 am

Bob wrote:As Larry cautioned in one of his columns in 2009: "... it is important for you to consider the risk of fat tails when designing your investment policy statement, making sure you do not take more risk than you have the ability, willingness and need to take. It is also important to understand that just because something has not happened does not mean it cannot or will not happen. The potential for devastating losses should not be ignored when designing a plan. Making that mistake can have disastrous results."
That needs to be framed on put on the wall.
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

pkcrafter
Posts: 12722
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by pkcrafter » Fri Jan 20, 2017 10:22 am

CULater wrote:
Bob wrote:As Larry cautioned in one of his columns in 2009: "... it is important for you to consider the risk of fat tails when designing your investment policy statement, making sure you do not take more risk than you have the ability, willingness and need to take. It is also important to understand that just because something has not happened does not mean it cannot or will not happen. The potential for devastating losses should not be ignored when designing a plan. Making that mistake can have disastrous results."
That needs to be framed on put on the wall.
Yes, and that's why they call stocks risky. Also why I never recommend 100% stocks, as in they really aren't risky. Far better to tilt if you are trying to increase returns, although I don't think a very high percentage of retail investors can hold such a portfolio. Best for most investors is the 3 fund, including #3 and stop worrying about it.

In the end, every decision is a trade-off or compromise between risk, which isn't fully known, and hope for reward, which is also not fully known and certainly not guaranteed.

CULater, I wonder what concerns you the most - The depth of a drawdown or the recovery period?

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

User avatar
bertilak
Posts: 5911
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by bertilak » Fri Jan 20, 2017 10:57 am

What you need to do is offload some of that worst case risk to someone else. That's what annuities are for.

Just be careful how you do that. Don't just dive in. There are sharks in the waters surrounding Annuity Island! This is not a real problem if you ask about annuities on this website.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker, the Cowboy Poet

User avatar
Sandtrap
Posts: 4588
Joined: Sat Nov 26, 2016 6:32 pm
Location: 10/90 Allocation - Hawaii😀 Northern AZ.😳

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Sandtrap » Fri Jan 20, 2017 2:53 pm

bertilak wrote:What you need to do is offload some of that worst case risk to someone else. That's what annuities are for.

Just be careful how you do that. Don't just dive in. There are sharks in the waters surrounding Annuity Island! This is not a real problem if you ask about annuities on this website.
Good point, "bertilak".
So. . . . SPIA's at the proper time and in the proper amounts?

User avatar
HomerJ
Posts: 11161
Joined: Fri Jun 06, 2008 12:50 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by HomerJ » Fri Jan 20, 2017 3:22 pm

I think it is indeed wise to pick an AA assuming that the stock market could crash 50% tomorrow and stay down for 5-10 years.

If you are young to middle-aged, this may not affect your AA very much at all. Nothing wrong with having 90% in stocks when you are 30, even if a crash does happen.

if you are within 5-10 years of retirement, or IN retirement, this would lead to a much more conservative AA.

Or you could just use age in bonds, which approximates the above decision process fairly well.

User avatar
Taylor Larimore
Advisory Board
Posts: 26971
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

SPIAs

Post by Taylor Larimore » Fri Jan 20, 2017 3:25 pm

So. . . . SPIA's at the proper time and in the proper amounts?
sandtrap:

Yes. SPIAs (Single Premium Immediate Annuities) are not right for everyone, but they can be an excellent purchase for many. Avoid other type annuities.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

User avatar
HomerJ
Posts: 11161
Joined: Fri Jun 06, 2008 12:50 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by HomerJ » Fri Jan 20, 2017 3:48 pm

Watty wrote:One of my pet peeves is that some of the retirement simulators report a chance of "failure" like you would keep mindlessly spending until you are broke and homeless.

There should be some better way to phrase that since it means that you would need to change your plans and cut cut some of your expenses.

As long as you were planning on more than a minimal retirement then you can likely cut your spending some and still be comfortable.
I agree... People on this very board constantly mention "failure" as something to be completely avoided...

"5% chance of failure! That's unacceptable!"

And then they work 5-10 years longer and die at their desk trying to double their money one more time to get to a 0.1% chance of "failure".

But "Failure" for most of the people on this board means there might be a 3-5 year stretch in your retirement where you only take 2 vacations a year instead of 4, or maybe you still take 4 vacations a year, but you skip out on that trip to Europe and opt for a trip to Washington DC or Yosemite instead.

Most us have enough of a buffer that we can cut back our spending 10%-15% for a few years if there's a 50% stock market crash.

User avatar
HomerJ
Posts: 11161
Joined: Fri Jun 06, 2008 12:50 pm

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by HomerJ » Fri Jan 20, 2017 3:49 pm

VA_Gent wrote:1978-82 long bonds had a -39% real drawdown.
1972-81 10 year treasuries had a -38.21% real drawdown.

We also until recently had never seen negative interest rates. That is the "beauty" of a black swan, no one ever sees it coming.
You warning against inflation, not bonds. TIPs and I-bonds and short-term bonds take care of that problem.

User avatar
Sandtrap
Posts: 4588
Joined: Sat Nov 26, 2016 6:32 pm
Location: 10/90 Allocation - Hawaii😀 Northern AZ.😳

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Sandtrap » Fri Jan 20, 2017 5:30 pm

Doesn't the "worse case" AA determination make it less unsuitable for "middle case" and "best case"?
Nay?
Last edited by Sandtrap on Fri Jan 20, 2017 11:02 pm, edited 2 times in total.

Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Rodc » Fri Jan 20, 2017 5:38 pm

HomerJ wrote:
Watty wrote:One of my pet peeves is that some of the retirement simulators report a chance of "failure" like you would keep mindlessly spending until you are broke and homeless.

There should be some better way to phrase that since it means that you would need to change your plans and cut cut some of your expenses.

As long as you were planning on more than a minimal retirement then you can likely cut your spending some and still be comfortable.
I agree... People on this very board constantly mention "failure" as something to be completely avoided...

"5% chance of failure! That's unacceptable!"

And then they work 5-10 years longer and die at their desk trying to double their money one more time to get to a 0.1% chance of "failure".

But "Failure" for most of the people on this board means there might be a 3-5 year stretch in your retirement where you only take 2 vacations a year instead of 4, or maybe you still take 4 vacations a year, but you skip out on that trip to Europe and opt for a trip to Washington DC or Yosemite instead.

Most us have enough of a buffer that we can cut back our spending 10%-15% for a few years if there's a 50% stock market crash.
+1
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

CULater
Posts: 1037
Joined: Sun Nov 13, 2016 10:59 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by CULater » Fri Jan 20, 2017 10:47 pm

pkcrafter wrote:
CULater, I wonder what concerns you the most - The depth of a drawdown or the recovery period?

Paul
I (and probably others) are probably a little more familiar with the magnitude of stock drawdowns -- having been through a couple of the worst case scenarios in the last 15 years. I'm less familiar with the possible length of drawdown periods and so learning that 10 year or even longer periods are not unusual is somewhat attention-getting. That's what can wear you down and finally get you to abandon your best-laid allocation plans. So, I tilt toward recovery period as the thing that probably concerns me most. I want to make as sure as I can that I'm allocated so that I'll have the ability to hang in there for a decade without capitulating if it still doesn't look like it's getting better. That's a harder thing to experience vicariously.
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

itstoomuch
Posts: 5343
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by itstoomuch » Fri Jan 20, 2017 11:49 pm

Sorta.
Older Bro's big bank does this plus using various hedges and options and selling/sharing risks with other entities.
That Big bank also removed the RedLine that prevent Risk/Hazards from endangering the Bank. The rationale was that the "chance" of this Risk event was exceedingly rare and the payoff for winning was very big.

In 2008, I couldn't figure out the AA and if the Markets would continue falling and stay down for an indeterminate time. I sold off risk for high fee, GLWB deferred annuities (Laddered in time and amounts)(I didn't like the SPIA at that time, @age 58/61).

So, What is the "worst case" :?: :x :greedy

YMMV :mrgreen:
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

pkcrafter
Posts: 12722
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by pkcrafter » Sat Jan 21, 2017 10:27 am

CUlater, here's an article that puts things in perspective

https://www.thebalance.com/u-s-stock-be ... es-2388520

Here's peak/trough/recovery

https://blog.wealthfront.com/no-need-to ... rrections/

I realize you are familiar with the data, but to address your specific question:
So, my question is should investors such as me use these "worst case" portfolio return scenarios to benchmark their "risk tolerance?" More specifically, does it make sense to ask oneself this sort of question to help determine the best (for me) asset allocation: "if a stock market drawdown of 37% or greater were to begin tomorrow and take a decade or longer to recover, what asset allocation can I stick with (and continue to invest new money into)?"
No, you should not be concerned about recovery times in accumulation until you are about 10 years from retirement, then you should consider drawdowns and recovery times. While in accumulation prior to 10 years from retirement recovery times aren't going to test your emotional tolerance, it's only big drawdowns that will do that. It is difficult to determine your true tolerance without experiencing panic and fear all around you. It can be contagious if unprepared. Keep in mind that big market drops are the result of investors selling, many of whom claimed that wouldn't.

The fact is, you will experience something close to a 50% drop or possibly more, and if you are concerned about it, then yes, your asset allocation should reflect that. This is especially true when starting out and not having experienced your first real test. Better to take a little less risk than to sell. You can adjust your AA after that with a lot more accuracy and confidence.

It's difficult to hold, that's why we recommend an Investment Policy Statement, which I reinforce by calling it a contract. These "contracts" may even come with a clause that says if you are considering selling, you much first talk it over with an experienced friend or on the board.

It's very good that you are considering this now, rather than getting caught in a turmoil and then jumping without thinking.


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

Rodc
Posts: 13601
Joined: Tue Jun 26, 2007 9:46 am

Re: Using "worst case" portfolio results to help determine asset allocation - yea or nay?

Post by Rodc » Sat Jan 21, 2017 10:44 am

pkcrafter wrote:CUlater, here's an article that puts things in perspective

https://www.thebalance.com/u-s-stock-be ... es-2388520

Here's peak/trough/recovery

https://blog.wealthfront.com/no-need-to ... rrections/

I realize you are familiar with the data, but to address your specific question:
So, my question is should investors such as me use these "worst case" portfolio return scenarios to benchmark their "risk tolerance?" More specifically, does it make sense to ask oneself this sort of question to help determine the best (for me) asset allocation: "if a stock market drawdown of 37% or greater were to begin tomorrow and take a decade or longer to recover, what asset allocation can I stick with (and continue to invest new money into)?"
No, you should not be concerned about recovery times in accumulation until you are about 10 years from retirement, then you should consider drawdowns and recovery times. While in accumulation prior to 10 years from retirement recovery times aren't going to test your emotional tolerance, it's only big drawdowns that will do that. It is difficult to determine your true tolerance without experiencing panic and fear all around you. It can be contagious if unprepared. Keep in mind that big market drops are the result of investors selling, many of whom claimed that wouldn't.

The fact is, you will experience something close to a 50% drop or possibly more, and if you are concerned about it, then yes, your asset allocation should reflect that. This is especially true when starting out and not having experienced your first real test. Better to take a little less risk than to sell. You can adjust your AA after that with a lot more accuracy and confidence.

It's difficult to hold, that's why we recommend an Investment Policy Statement, which I reinforce by calling it a contract. These "contracts" may even come with a clause that says if you are considering selling, you much first talk it over with an experienced friend or on the board.

It's very good that you are considering this now, rather than getting caught in a turmoil and then jumping without thinking.


Paul
I would add that the good news is that even if you hold a smaller percentage in stocks early while learning, and you learn you can and want a larger percentage, you can then increase the percentage and in the end you have done very little to hurt your eventual portfolio size. Easy to model this. The issue is that early you do not have very much invested compared to what you will have later, so how you allocate early has a very modest effect compared to how you allocate later.

Another way to say that is it is far more important to get the allocation right once your portfolio is large than it is when the portfolio is small.

So you can start out cautious and learn without hurting yourself long term.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

User avatar
Sandtrap
Posts: 4588
Joined: Sat Nov 26, 2016 6:32 pm
Location: 10/90 Allocation - Hawaii😀 Northern AZ.😳

Re: SPIAs

Post by Sandtrap » Sun Jan 22, 2017 7:44 am

Taylor Larimore wrote:
So. . . . SPIA's at the proper time and in the proper amounts?
sandtrap:

Yes. SPIAs (Single Premium Immediate Annuities) are not right for everyone, but they can be an excellent purchase for many. Avoid other type annuities.

Best wishes.
Taylor
Thanks "Taylor", always always grateful.
I will further research the proper timing and application of SPIA's in the forum archives, etc.
Perhaps, given a "worst case". . . . .
"Bond Allocation" + "SPIA" = Retiree "Sleep Factor"?

Post Reply