The Worst U.S. Portfolio Disasters — A Historical Comparison

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Bacchus01
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by Bacchus01 » Sun Jul 08, 2018 9:41 am

columbia wrote:
Fri Jul 06, 2018 6:11 pm
It seems like a good argument for a 50/50 portfolio over the long run.
Why? I’m not being obtuse, I just don’t see that resounding in this analysis. If anything, I see a “it probably doesn’t matter” result.

Park
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by Park » Sun Jul 08, 2018 9:49 am

grok87 wrote:
Sun Jul 08, 2018 5:12 am
SimpleGift wrote:
Sat Jul 07, 2018 3:25 pm
garlandwhizzer wrote:
Sat Jul 07, 2018 2:45 pm
Graphs, like statistics, if tortured sufficiently will confess to the desired conclusion. Few things are as certain as advertised where investing is involved. Whether bonds are safer than stocks varies during a given time frame. Sometimes they are safer (1929 - 1941): sometimes they are riskier (1941 - 1982).
I find it hard to accept this notion that investors today should be weighing "bond crises" equally with "stock crises." Certainly, there have been long periods in the past (the 1940s, the 1970s) when high inflation seriously eroded the real value of bond-heavy portfolios. But this is why TIPS were created. Thankfully, we no longer live in a time when nominal bonds are our only choice — which makes past "bond crises" mostly an artifact of history in my view (and a bit oxymoronic today, if I may add).

In short, yes, bond-heavy portfolios were risky in the past — but stocks today are still as risky as they have ever been!
Agree that investors should pay more attention to stock crises than bond crises.

I'm probably one of the more vocal supporters of Tips. But i would not go as far as to say that TIPS have made "bond crises" a thing of the past or an artifact of history.

The risk of tips is that real interest rates will spike. That could happen for any number of reasons. US could default or be downgraded.
That's why liability matching is so important. If you can hold US government bonds to maturity you will likely be fine (barring default).

cheers,
grok
Tips in a tax advantaged account will keep up with inflation. But in a taxable account, I don't see that. Tips yields aren't enough to keep up with inflation and taxes. Also, the good majority of most portfolios won't be Tips. So even in a tax advantaged account, inflation risk is present.

https://www.morningstar.com/articles/80 ... vered.html

"When U.S. equities plummeted by more than 25% and market liquidity evaporated in September and October 2008, TIPS dropped by 12%—even as nominal Treasuries eked out a small gain. In fact, TIPS lost almost exactly the same amount as investment-grade corporates over that period.

To this day it is not exactly clear why this happened. The most plausible hypothesis combines lower inflation expectations, due to recession, and the markets’ insatiable appetite for liquidity. Even though TIPS are technically as safe as nominal Treasuries from a credit perspective, the TIPS market is not anywhere near as liquid"

However, if you hold Tips to maturity, liquidity is not an issue.

There are those who lose with inflation, but there are those who profit from it. If you really want to protect you portfolio from inflation, you want something there that will profit from inflation. And one way to profit from unexpected inflation is by borrowing at a fixed rate.

http://awealthofcommonsense.com/2015/08 ... inflation/
http://www.fortunefinancialadvisors.com ... lue-stocks

Value stocks and international stocks are other ways to deal with inflation. And the second link makes the point that currency hedging international stock would negate the inflation benefit.

Much of this post is a digression from the thread, but I hope it is of interest and use.

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nedsaid
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by nedsaid » Sun Jul 08, 2018 9:58 am

willthrill81 wrote:
Fri Jul 06, 2018 5:30 pm
The 1970s seem to make a compelling case that inflation-linked bonds should comprise a substantial part of one's fixed income holdings. Of course, one counter-argument to that is that if bonds are meant to smooth out portfolio volatility and offer stability, inflation-linked bonds are less than ideal as they are quite volatile compared to other bonds.
I remember the 1970's well, one reason that I am an inflation hawk. We have seen rather subdued inflation since the early 1980's, when Federal Reserve Chairman Paul Volcker pretty much killed it. We forget however, the corrosive effects of inflation over time at even a relatively low rate of 2%. Over a decade, this is a loss of about 22% of purchasing power of a dollar.

This is why I have such things as REITs and TIPS in the portfolio. Inflation is public enemy number one. What really matters over time is purchasing power.
A fool and his money are good for business.

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willthrill81
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by willthrill81 » Sun Jul 08, 2018 10:00 am

nedsaid wrote:
Sun Jul 08, 2018 9:58 am
willthrill81 wrote:
Fri Jul 06, 2018 5:30 pm
The 1970s seem to make a compelling case that inflation-linked bonds should comprise a substantial part of one's fixed income holdings. Of course, one counter-argument to that is that if bonds are meant to smooth out portfolio volatility and offer stability, inflation-linked bonds are less than ideal as they are quite volatile compared to other bonds.
I remember the 1970's well, one reason that I am an inflation hawk. We have seen rather subdued inflation since the early 1980's, when Federal Reserve Chairman Paul Volcker pretty much killed it. We forget however, the corrosive effects of inflation over time at even a relatively low rate of 2%. Over a decade, this is a loss of about 22% of purchasing power of a dollar.

This is why I have such things as REITs and TIPS in the portfolio. Inflation is public enemy number one. What really matters over time is purchasing power.
I agree. If inflation weren't present, investors would have a far simpler go of it. In particular, retirees could make plans with far more certainty than they actually can.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

magneto
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by magneto » Sun Jul 08, 2018 10:08 am

InvMoney wrote:
Sat Jul 07, 2018 10:21 am
When we're in a stock bull market such as we currently are, some investors loose site of the consequences of a bear market on a stock heavy, indexed portfolio that by its very nature takes no steps to mitigate losses during bear markets.
Beyond Asset Allocation; there is the less discussed issue as to how and at what speed the prepared investor should react to portfolio drift resulting from Stock gains or losses?
A late rebalancer in the 30's might have seen less portfolio damage?
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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willthrill81
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by willthrill81 » Sun Jul 08, 2018 10:14 am

magneto wrote:
Sun Jul 08, 2018 10:08 am
InvMoney wrote:
Sat Jul 07, 2018 10:21 am
When we're in a stock bull market such as we currently are, some investors loose site of the consequences of a bear market on a stock heavy, indexed portfolio that by its very nature takes no steps to mitigate losses during bear markets.
Beyond Asset Allocation; there is the less discussed issue as to how and at what speed the prepared investor should react to portfolio drift resulting from Stock gains or losses?
A late rebalancer in the 30's might have seen less portfolio damage?
It seems that the consensus regarding how frequently portfolio balancing is done doesn't really matter much over the long-term. Doing it annually seems to be about as effective as anything else.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

rgs92
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by rgs92 » Sun Jul 08, 2018 10:23 am

Totally fascinating charts. Lots of food for thought and a great planning tool.
Certainly a cure for recency bias.
Thanks!!

rgs92
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by rgs92 » Sun Jul 08, 2018 10:32 am

So would a (partial) cure to a 1970s inflation-fueled meltdown be a substantial allocation to a money-market fund? At least your principal is protected and you benefit from high interest rates.
Maybe 30-40% of your fixed income allocation should be invested this way...
What is the downside of this approach (assuming there is no huge drop in rates, which doesn't seem possible with rates still from 2 to 3 %)?

AlohaJoe
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by AlohaJoe » Sun Jul 08, 2018 10:37 am

willthrill81 wrote:
Sun Jul 08, 2018 9:34 am
Thanks for the post. Those charts seem to suggest to me that having a 'side' portfolio with an extra year or two of expenses at the point of retirement might help retirees to avoid having to withdraw from a distressed portfolio in the worst ravages of a downturn. ERN recently studied this and found it to be surprisingly effective for the worst retirement starting years in the U.S., 1929 and 1966.
That's getting into what McClung calls "Income Harvesting", which he treats in detail in his book. McClung argues that not using a static asset allocation improves portfolio efficiency. Some readers have disagreed. 8-) I think, however, that McClung does a much superior job introducing the subject and surveying the options than ERN has done. For instance, instead of ERN's "for a September 1929 retirement have $100,000 in a side portfolio and withdraw from it when your portfolio is 20% underwater" we could instead apply the much simpler "Bonds First" strategy from Spitzer & Singh's 2007 paper which turns out to require only $63,000 extra. That means ERN's suggestion requires nearly 60% more cash than a better strategy.

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SimpleGift
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by SimpleGift » Sun Jul 08, 2018 11:39 am

In a PM, a Forum member asked about the most essential lessons we should take from past portfolio disasters. These are the ones that came to mind for me, ones that hopefully apply to a broad spectrum of investors (basic Boglehead principles):
  • 1. Don't let emotions drive your investment decisions. The worst time for action is a period of market distress. That's when we make most of our mistakes, I believe.

    2. Diversification is still an investor's best protection against disaster.

    3. Don't try to time the markets. Occasional rebalancing may help reduce risk (e.g., once a year for tax-deferred investors, less often for taxable accounts).

    4. Don't take unnecessary risk with fixed-income allocations. Taking on credit, liquidity and default risk reduces a portfolio's resiliency in a crisis. TIPS and short-term bonds can protect against inflation in bond-heavy portfolios.

    5. Buy-and-hold is still the best time-tested strategy for long term investors.
Others may have additional general lessons to suggest, gleaned from the history of portfolio disasters.
Cordially, Todd

Park
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by Park » Sun Jul 08, 2018 12:47 pm

"Between January 1941 and September 1981, a period of over four decades of American inflation that was relatively tame by international historical standards, long Treasuries experienced deep risk by losing 67.3% of their real value (with interest reinvested) before recovering nearly half a century later; in the U.K., the losses were even greater, around 73%."

Bernstein, William J. Deep Risk: How History Informs Portfolio Design (Investing for Adults Book 3) (p. 21). . Kindle Edition.

"Finally, tilting towards value stocks also provides a buffer against inflation, for the same reason a fixed-rate mortgage does: since value stocks are more highly leveraged than the market, they benefit when the real value of their fixed-rate obligations falls. Between 1975 and 1981, for example, the Fama-French U.S. Large Value/ Growth indexes returned 20.98%/ 12.15% on a nominal, annualized basis, while the Fama-French International (developed) Value/ Growth indexes returned 20.39%/ 13.15%. (Domestic inflation ran at 8.86% during those years.)"

Bernstein, William J. Deep Risk: How History Informs Portfolio Design (Investing for Adults Book 3) (p. 43). . Kindle Edition.

You want an asset that can keep ahead of taxes and inflation. I don't see Tips doing that. But value stocks might.

"it is hard to imagine an internationally diversified stock portfolio suffering a permanent inflationary capital loss, an outcome that would require a combination of both universal global hyperinflation and horrible luck. (That is, a large majority of nations would have to experience not only high inflation, but also have stocks respond with very low returns, as they did in Argentina and Peru, as opposed to with high returns, as they did in Chile and Israel.) Simply put, a long-term negative global stock return requires not merely universal inflation, but universal Armageddon."

Bernstein, William J. Deep Risk: How History Informs Portfolio Design (Investing for Adults Book 3) (pp. 29-30). . Kindle Edition.

grok87
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by grok87 » Sun Jul 08, 2018 1:26 pm

Park wrote:
Sun Jul 08, 2018 9:49 am
grok87 wrote:
Sun Jul 08, 2018 5:12 am
SimpleGift wrote:
Sat Jul 07, 2018 3:25 pm
garlandwhizzer wrote:
Sat Jul 07, 2018 2:45 pm
Graphs, like statistics, if tortured sufficiently will confess to the desired conclusion. Few things are as certain as advertised where investing is involved. Whether bonds are safer than stocks varies during a given time frame. Sometimes they are safer (1929 - 1941): sometimes they are riskier (1941 - 1982).
I find it hard to accept this notion that investors today should be weighing "bond crises" equally with "stock crises." Certainly, there have been long periods in the past (the 1940s, the 1970s) when high inflation seriously eroded the real value of bond-heavy portfolios. But this is why TIPS were created. Thankfully, we no longer live in a time when nominal bonds are our only choice — which makes past "bond crises" mostly an artifact of history in my view (and a bit oxymoronic today, if I may add).

In short, yes, bond-heavy portfolios were risky in the past — but stocks today are still as risky as they have ever been!
Agree that investors should pay more attention to stock crises than bond crises.

I'm probably one of the more vocal supporters of Tips. But i would not go as far as to say that TIPS have made "bond crises" a thing of the past or an artifact of history.

The risk of tips is that real interest rates will spike. That could happen for any number of reasons. US could default or be downgraded.
That's why liability matching is so important. If you can hold US government bonds to maturity you will likely be fine (barring default).

cheers,
grok
Tips in a tax advantaged account will keep up with inflation. But in a taxable account, I don't see that. Tips yields aren't enough to keep up with inflation and taxes. Also, the good majority of most portfolios won't be Tips. So even in a tax advantaged account, inflation risk is present.

https://www.morningstar.com/articles/80 ... vered.html

"When U.S. equities plummeted by more than 25% and market liquidity evaporated in September and October 2008, TIPS dropped by 12%—even as nominal Treasuries eked out a small gain. In fact, TIPS lost almost exactly the same amount as investment-grade corporates over that period.

To this day it is not exactly clear why this happened. The most plausible hypothesis combines lower inflation expectations, due to recession, and the markets’ insatiable appetite for liquidity. Even though TIPS are technically as safe as nominal Treasuries from a credit perspective, the TIPS market is not anywhere near as liquid"

However, if you hold Tips to maturity, liquidity is not an issue.

There are those who lose with inflation, but there are those who profit from it. If you really want to protect you portfolio from inflation, you want something there that will profit from inflation. And one way to profit from unexpected inflation is by borrowing at a fixed rate.

http://awealthofcommonsense.com/2015/08 ... inflation/
http://www.fortunefinancialadvisors.com ... lue-stocks

Value stocks and international stocks are other ways to deal with inflation. And the second link makes the point that currency hedging international stock would negate the inflation benefit.

Much of this post is a digression from the thread, but I hope it is of interest and use.
great point about holding tips in tax advantaged accounts and no i don't think its a digression.

Thanks for reminding us all of that. I have all my retirement liability matching tips in tax advantaged and hold ibonds as well for retirement liability matching purposes.

cheers,
grok
Keep calm and Boglehead on. KCBO.

Dottie57
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by Dottie57 » Sun Jul 08, 2018 1:54 pm

Random Poster wrote:
Fri Jul 06, 2018 5:17 pm
Looks to me like a 50/50 split would have many advantages---perhaps it is the best way to ensure that one gets an average of the average returns?

Makes me feel good about my 50/50 split in retirement.

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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by Dottie57 » Sun Jul 08, 2018 2:04 pm

AlohaJoe wrote:
Sat Jul 07, 2018 12:06 am
marcopolo wrote:
Fri Jul 06, 2018 6:37 pm
columbia wrote:
Fri Jul 06, 2018 6:11 pm
It seems like a good argument for a 50/50 portfolio over the long run.
Maybe.

But, i fear that looking at the data starting just before the meltdown periods may lead to the wrong conclusions.
Not sure about the oil/stagflation shock of the 70s, but both the great depression and the tech bubble were proceeded by huge run up in equities.
To elaborate on marcopolo's point, here's a series of charts showing the years before 1929.

Let's start with the usual 1929 chart, showing 100% stocks (the blue line) and a 60/40 portfolio (the orange line). This is inflation-adjusted portfolio values assuming 4% inflation-adjusted withdrawals.

Image

That's the kind of chart many of us have seen many times. But let's wind back the clock a little bit. What if someone didn't retire in 1929. What if they retired in 1922, just a few years earlier?

Image

You can still see the steep drawdown of the 1929 crash. But you can also see how big the runup was. They retired with $1 million and it got up to $4 million. Even after the worst equity crash in US, the 100% stock portfolio solidly trounces the 60/40 portfolio. (And that's without playing second guessing games like, "Wow, when it got to $3 million they wouldn't have bought a $1 million annuity or something with all of that extra windfall?)

Now let's look at a few more years.

Image
Image
Image
Image
Image
Image

From 1925 and earlier, the 100% equity portfolio does at least as well, and usually much better, than the 60/40 portfolio despite suffering the worst equity crash in US history.

And even in 1925 and (to a lesser extent) 1926 -- the portfolio value of the 100% equity portfolio never really drops below it started. (In 1925 it never drops below the starting value; in 1926 it drops to 88% of its starting value.) So if pause a moment in our "keeping up with the Jones's, compare to a benchmark portfolio" mindset (which I do all the time, too, so I'm not casting aspersions) -- think about it solely from the retiree's perspective. Despite being 100% equities and retiring in 1926 -- 30-40 months before the biggest stock market crash in US history -- the portfolio was never under any stress and the retiree had no real reason for concern. (That's not to say that people wouldn't have felt concerned. After all unemployment was 25% but it wouldn't exactly have been a rational concern.)

So this is something that I personally struggle with. When I look at charts of the massive runup in the US & Japan before their huge equity crashes, part of me wonders whether any retiree would really have retired anywhere close to the peak at exactly Their Number. On the one hand, I know how easy it is for humans to get swept up in hysteria and manias. On the other hand...(at least on this board) it seems that everyone suffers from One More Year syndrome and pads Their Number out quite a bit.

And from what I can tell, at least in the US, as long you retired +/- 24 months away from the absolute worst month you are basically okay no matter what your asset allocation.
How much is used for living expenses each year? I would think this would have an impact on the portfolio.

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willthrill81
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by willthrill81 » Sun Jul 08, 2018 3:41 pm

Dottie57 wrote:
Sun Jul 08, 2018 2:04 pm
AlohaJoe wrote:
Sat Jul 07, 2018 12:06 am
marcopolo wrote:
Fri Jul 06, 2018 6:37 pm
columbia wrote:
Fri Jul 06, 2018 6:11 pm
It seems like a good argument for a 50/50 portfolio over the long run.
Maybe.

But, i fear that looking at the data starting just before the meltdown periods may lead to the wrong conclusions.
Not sure about the oil/stagflation shock of the 70s, but both the great depression and the tech bubble were proceeded by huge run up in equities.
To elaborate on marcopolo's point, here's a series of charts showing the years before 1929.

Let's start with the usual 1929 chart, showing 100% stocks (the blue line) and a 60/40 portfolio (the orange line). This is inflation-adjusted portfolio values assuming 4% inflation-adjusted withdrawals.

...
How much is used for living expenses each year? I would think this would have an impact on the portfolio.
The charts assumed that no contributions or withdrawals were made. So if any withdrawals were made, the charts would obviously look even worse.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

AlohaJoe
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by AlohaJoe » Sun Jul 08, 2018 6:08 pm

willthrill81 wrote:
Sun Jul 08, 2018 3:41 pm
Dottie57 wrote:
Sun Jul 08, 2018 2:04 pm
How much is used for living expenses each year? I would think this would have an impact on the portfolio.
The charts assumed that no contributions or withdrawals were made. So if any withdrawals were made, the charts would obviously look even worse.
I guess both of you missed the part where I wrote "This is inflation-adjusted portfolio values assuming 4% inflation-adjusted withdrawals" :happy

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willthrill81
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Re: The Worst U.S. Portfolio Disasters — A Historical Comparison

Post by willthrill81 » Sun Jul 08, 2018 6:13 pm

AlohaJoe wrote:
Sun Jul 08, 2018 6:08 pm
willthrill81 wrote:
Sun Jul 08, 2018 3:41 pm
Dottie57 wrote:
Sun Jul 08, 2018 2:04 pm
How much is used for living expenses each year? I would think this would have an impact on the portfolio.
The charts assumed that no contributions or withdrawals were made. So if any withdrawals were made, the charts would obviously look even worse.
I guess both of you missed the part where I wrote "This is inflation-adjusted portfolio values assuming 4% inflation-adjusted withdrawals" :happy
Whoops! :oops:
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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