Actual Experience as true measure of risk tolerance

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alexfoo39
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Actual Experience as true measure of risk tolerance

Post by alexfoo39 » Fri May 17, 2019 9:16 pm

Need some brainstorming here =)

You know the idea of risk taking in investment. Typically one should assess his ability, need, and willingness to take risk. From there a suitable asset allocation will be designed to suit his temperament. The thing is, one often feels some form of regret when the tide turns. Let's assume that AA is set under a normal market condition. Say, 60/40. When the storm comes, the bear ruthlessly sinks a significant equity portion of our portfolio. Then we wonder if we have been too confident all these while. The thought that 'I should have been more conservative and have more bonds' hits us.

How do you go about this? Do you think actual experience* is needed to reveal who we really are as investors?

*experience as in the experience of going through bull and bear markets, and the experience of gaining / losing significant portion of our money in the market.

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Taylor Larimore
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Re: Actual Experience as true measure of risk tolerance

Post by Taylor Larimore » Fri May 17, 2019 9:23 pm

alexfoo39:

At age 95, I have been through many bear markets. They are no fun. This was my first bear market:

Our family owned "Larimore's Diner" in Foxboro, Mass. in 1929 (I was 5 years old at that time). When the depression hit, we lost the Diner and moved into my grandfather's home in Miami. Grandfather, who was a millionaire investor and chief executive of an investment trust company, lost everything--including the Miami home we lived in.

BEAR MARKET OF 1929-1937 (Dow plunged 89%)
-1929--1930--1931--1932
(-31%)(-25%)(-43%)(-08%) Large Cap Stocks
(-34%)(-35%)(-47%)(-06%) Mid/Small Cap Stocks
(-47%)(-38%)(-50%)(-05%) Micro Cap Stocks

(+04%)(+07%)(-02%)(+09%) 5-Year Treasury Bonds

BEAR MARKET OF 1973-1976 (S&P fell 43%)
-1973--1974
(-15%)(-26%) Large Caps
(-39%)(-29%) Micro Caps

---(-70%) Coca-Cola
---(-82%) Intel
---(-73%) McDonald's
---(-86%) Merrill Lynch
---(-86%) Walt Disney
---(-71%) Xerox

Figures cannot convey the horrifying and debilitating effects of a bear market. You watch in agony as month after month your life savings evaporate before your eyes. Gloom and doom talk is everywhere. Nearly everyone else is selling. You have no idea when, or if, your portfolio will stop losing money.

Your friends and relatives urge you to sell. Nearly all financial experts recommend "sell". You are ridiculed for trying to hold on. You begin to have self-doubt. Despair sets in. Buying stocks is unthinkable. Suicides increase. That's a REAL bear market.

This is why many people in retirement have 40-70% in bonds.

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

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Re: Actual Experience as true measure of risk tolerance

Post by MotoTrojan » Fri May 17, 2019 9:24 pm

I am sure many people thought they had better risk tolerance than they actually did. Humans have been proven to take a loss harder than a gain, but that works in both directions as being too conservative can result in an opportunity loss.

As an early accumulator a risk-on approach does have a win-win aspect to it; if the market is doing well you are making money, and if it is doing poorly you are buying more shares per $1 invested.

I would think things get more interesting in the home-stretch as retirement approaches.

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Re: Actual Experience as true measure of risk tolerance

Post by DonIce » Fri May 17, 2019 11:38 pm

alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
How do you go about this? Do you think actual experience* is needed to reveal who we really are as investors?
Yes. No one knows how they will react to a severe bear market until they've actually lived through one while having at least several years salary invested in the markets. I had like $5k in the markets in 2008 so that doesn't really count. I think I have a high risk tolerance, and that I won't be phased at all if markets drop by 50% or even 80%, but only time will tell! Even people who have been through a severe bear market may react differently the next time one hits... they only tend to happen once every decade or two, and people's personal and financial circumstances change drastically from one time to another.

Someone who was 30 and single in one bear market and eagerly invested more at the low prices may react differently when the next bear market hits when they're 50, is starting to feel like they may get pushed out of their job soon, and has kids in college.

My guess is that most people vastly overestimate their risk tolerance. Almost everyone I know who invests anything at all is 100% equities, the whole idea of investing in bonds never even crossed their minds. And they've only been getting in over the last year or two, having missed the entire run-up from 2009-2018. They'll be in for a rude awakening come the next major decline.

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Re: Actual Experience as true measure of risk tolerance

Post by randomguy » Sat May 18, 2019 12:06 am

DonIce wrote:
Fri May 17, 2019 11:38 pm
alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
How do you go about this? Do you think actual experience* is needed to reveal who we really are as investors?
Yes. No one knows how they will react to a severe bear market until they've actually lived through one while having at least several years salary invested in the markets. I had like $5k in the markets in 2008 so that doesn't really count. I think I have a high risk tolerance, and that I won't be phased at all if markets drop by 50% or even 80%, but only time will tell! Even people who have been through a severe bear market may react differently the next time one hits... they only tend to happen once every decade or two, and people's personal and financial circumstances change drastically from one time to another.

Someone who was 30 and single in one bear market and eagerly invested more at the low prices may react differently when the next bear market hits when they're 50, is starting to feel like they may get pushed out of their job soon, and has kids in college.

My guess is that most people vastly overestimate their risk tolerance. Almost everyone I know who invests anything at all is 100% equities, the whole idea of investing in bonds never even crossed their minds. And they've only been getting in over the last year or two, having missed the entire run-up from 2009-2018. They'll be in for a rude awakening come the next major decline.
I don't know. There are a lot of people on bogleheads with insanely low risk tolerance and you get a bit of an echo chamber effect. I don't remember anyone in real life thinking you were crazy to buy stocks in 2000-2 or 2007-9. We sure cracked jokes about opening the 401(k) statements every month but nobody talked about stop buying stocks.. The suicide rate maintained the same trend line that started a couple years before and didn't change during during the whole 2000-2019 period.

I think the people that hold bonds are actually more tested by market drops. Why? Because they are the people that worry about market drops to begin with. Sure some of the high stock people are being delusional but a lot of them also understand 2-5 year volatility just doesn't matter when you are worried about 10+ years in the future. On the other than the people holding large percentages of bonds have a fear of volatility and when things hit they are more likely to panic. We like to say things like well the portfolio is only off 20% instead of 40% but I have a feeling that most people can't delude themselves that much and they look at the individual holdings and see the damage that has been done. But it is all guess work. I haven't seen any long term studies about it.

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Re: Actual Experience as true measure of risk tolerance

Post by Thesaints » Sat May 18, 2019 12:17 am

Most people have a "medium-high" risk tolerance when markets go up, only to discover it is actually "low" when they go down.
It is hard-wired in our brains and it takes substantial discipline, or a tad of psychopathy.

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Re: Actual Experience as true measure of risk tolerance

Post by Eagle33 » Sat May 18, 2019 12:32 am

If one can reach the same point as Jack Bogle regard AA, then one has hit the best AA for themselves. When the market is up ok to wonder a little of why so low a % of stocks and when market is down ok to wonder a little of why so low a % of bonds - but not losing any sleep over it.

When it is time (per your written ISP) rebalance into the lower asset to take advantage of the buying opportunities that the market presents over time based on your chosen AA.
Rocket science is not “rocket science” to a rocket scientist, just as personal finance is not “rocket science” to a Boglehead.

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Re: Actual Experience as true measure of risk tolerance

Post by alexfoo39 » Sat May 18, 2019 4:40 am

Taylor Larimore wrote:
Fri May 17, 2019 9:26 pm
alexfoo39:

At age 95, I have been through many bear markets.
Thank you uncle Taylor =) Your willingness to share the experience will help youngsters like me to be more conservative in my AA.

Losing businesses, assets, and properties in a severe downturn, and substantially reduced income sources... these are significant financial events. It is sobering. To stay invested in the midst of intense financial pressure, relatives urging to sell, and gloomy talks dominating virtually every discussion.

Can I ask you? Do you get it right after the first bear market experience? Or it takes time to get a AA that allows you to stay the course.
Last edited by alexfoo39 on Sat May 18, 2019 7:58 pm, edited 1 time in total.

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Re: Actual Experience as true measure of risk tolerance

Post by Dandy » Sat May 18, 2019 5:19 am

How do you go about this? Do you think actual experience* is needed to reveal who we really are as investors?
Pretty much think that actual experience may be the best teacher. Also, the risk tolerance in the accumulation stage may be different near or in retirement. I invested moderately for a few decades and at age 60 was forced to retire in 2008-9. I went from more than enough to maybe not enough rather quickly. Even though I understood intellectually the risks I didn't appreciate it, especially at the beginning of retirement, as much as I should have given my age/likely retirement. I didn't have those thoughts when the market tanked in 2000. I was making good money, getting bonuses and company matches and just kept investing.

I think one way to test your risk tolerance is to see how a 50% drop in you equity dollars would affect you. Looking at risk is dollar terms can be more informative than percentages. A nice long bull market tends to make you underestimate the level of risk. If you are 2 years away from retirement a 50% drop, or even a 25% drop can be a real game changer. When you are 40 not nearly the same.

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Re: Actual Experience as true measure of risk tolerance

Post by nisiprius » Sat May 18, 2019 5:35 am

alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
Do you think actual experience is needed to reveal who we really are as investors?

*experience as in the experience of going through bull and bear markets, and the experience of gaining / losing significant portion of our money in the market.
Yes, I do.

Worse yet, the memory of pain--all kinds--fades with time. I went through 2008-2009 with nearly a lifetime of savings in the markets. But the passage of time, and decade-long bull market has deadened the pain.

It also has taught the inaccurate lesson "we know how these things go." In fact, the recovery turned out to be much faster, robust, and sustained than most people expected. Around 2009 and 2010 there was a lot of talk about whether we were in a "V-shaped recovery" (fast) or an "L-shaped recovery" (interminably slow). It turned out to be V-shaped last time. The next one might well be L-shaped.

2008-2009 is now in the past and has turned into a story. We know how it went. The characteristic of a long string of horrible surprises is gone and can't really be recaptured in memory. By "surprises," I mean the series of failures of giant, seemingly immortal financial institutions. A test of whether we remember what 2008-2009 is, how many of that string of failures can we even remember?

My feelings were blunted by its having occurred in the UK, but even so I remember being stunned by pictures of a bank run and anxious Northern Rock depositors waiting in line for their money. I thought that was, you know, stuff that happened in the 1930s that was impossible in the modern era.

Image

What were the ones in the US? Washington Mutual, Bear Stearns (remember Jim Cramer shouting "Bear Stearns is all right?), Fannie Mae, Freddy Mac, AIG. That's all I can think of right now. Five. OK, let's look it up. Oh em gee I forgot the Big Kahuna, Lehman Brothers. Guys in suits carrying out their desk contents in big cardboard boxes. 150-year-old company, down in flames. Merrill Lynch (we tend to forget them if the names survived), similarly Goldman Sachs and Morgan Stanley "as we knew them." IndyMac. The giant, old--maybe the oldest--money market fund, Reserve Primary. GM. So there you go. I remembered five out of twelve. I remembered less than half of them.

Every time I started to calm down, there would be big headlines and, da dum, da da da dum, another one bites the dust.

I was very conservatively invested in heading into 2008 and thought I was well within my risk tolerance. I was even thinking that I was being a bit of a fraidycat and considering increasing my stock allocation a little. In 2008-2009 I discovered that I was not. My wife and I agreed that the best course was to do nothing, but I have to say that I was very close to my breaking point and had not known it until the event.

Fred Schwed said it well:
Like all of life's rich emotional experiences, the full flavor of losing important money cannot be conveyed by literature. Art cannot convey to an inexperienced girl what it is truly like to be a wife and mother. There are certain things that cannot be explained to a virgin either by words or pictures. Nor can any description that I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.
Last edited by nisiprius on Sat May 18, 2019 5:52 am, edited 3 times in total.
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Re: Actual Experience as true measure of risk tolerance

Post by JoeRetire » Sat May 18, 2019 5:45 am

alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
How do you go about this? Do you think actual experience* is needed to reveal who we really are as investors?
I don't know if experience is needed, but I do know that people often reveal their true colors at times of financial stress.

I was shocked when an otherwise cool headed boss panicked during the Great Recession. He would have been the last person I would have expected to completely withdraw from the market, rather than ride it out. He still hasn't recovered financially from the moves he made.

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Re: Actual Experience as true measure of risk tolerance

Post by warner25 » Sat May 18, 2019 6:57 am

alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
How do you go about this?
I think we still don't have any good way to go about this.

Like DonIce said, I was just getting started in 2008-2009 as a single guy with a very low five-figure sum invested. I know how I felt at that time, but now I'm married with three kids and we have a high six-figure sum invested, so I don't trust that I would feel the same way again.

I am certain that looking at historical charts and trying really hard to imagine a 50% loss isn't very helpful. The problem with charts is that they lack context. Looking at the chart of a market crash and recovery in retrospect, you miss out on the feeling that the entire financial and political and social system as we know it might be on the verge of collapse. We already know that it turned out OK, except when it didn't in Russia, China, etc.

Seeing market prices decline when corporate earnings and employment numbers are still strong, as we've seen a few times since 2009, is a very different feeling too, so any experience short of a once-in-a-lifetime bear market might not be very helpful either.

Anyway, we've chosen the most agnostic portfolio, about 50/50, and plan to reach our goals mainly through a high savings rate instead of depending on investment returns. In the end, I think this will minimize feelings of regret while maximizing the feeling that we're in control of the outcome.

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Re: Actual Experience as true measure of risk tolerance

Post by Taylor Larimore » Sat May 18, 2019 7:21 am

alexfoo39 wrote:
Sat May 18, 2019 4:40 am

Can I ask you? Do you get it right after the first bear market experience? Or it takes time to get a AA that allows you to stay the course.
alexfoo39:

It took me (and my family) a long time to invest in stocks again.

I think members of the Boglehead Forum have a much better chance to stay-the-course because of Jack Bogle and topics such as this.

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

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Re: Actual Experience as true measure of risk tolerance

Post by retiredjg » Sat May 18, 2019 7:30 am

alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
How do you go about this?
I think it is a little like having kids. Nobody knows how to do it but most people try anyway. Some do OK. Others do not. The all learn from it. Much of the learning is from making mistakes.

Do you think actual experience* is needed to reveal who we really are as investors?
Yes. Same as the kids analogy.

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Re: Actual Experience as true measure of risk tolerance

Post by 272 Sheep » Sat May 18, 2019 7:59 am

Taylor Larimore wrote:
Sat May 18, 2019 7:21 am
alexfoo39 wrote:
Sat May 18, 2019 4:40 am

Can I ask you? Do you get it right after the first bear market experience? Or it takes time to get a AA that allows you to stay the course.
alexfoo39:

It took me (and my family) a long time to invest in stocks again.

I think members of the Boglehead Forum have a much better chance to stay-the-course because of Jack Bogle and topics such as this.

Best wishes
Taylor
Hi Taylor,
I didn't grow up in the Great Depression but I did grow up with my mother and father who were right in the middle of it. Inevitably or eventually any and all of their life stories ended up there or colored by it. I think, no one can really know unless they've been there. The words "horrifying" and "despair" are only a few of the apt words to describe it. They did have family and there were good things too. People stuck together and helped each other. In a sense, even though I never directly experienced it, I did see how strongly it affected my mother and father.
Carl W.

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Re: Actual Experience as true measure of risk tolerance

Post by dbr » Sat May 18, 2019 8:08 am

I think people do overestimate their risk tolerance until they have had the experience. I also think some people react to the above mentioned "echo chamber" effect and become too conservative. One possible bad result of 2008 is to leave the impression that a downturn will be quickly followed by a rapid recovery and bull market.

Larry Swedroe has suggested that when applying need, ability, and willingness to risk that the trump card is take no more risk than necessary as the marginal utility of wealth is a diminishing function and most people underestimate risk.

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Re: Actual Experience as true measure of risk tolerance

Post by Sandtrap » Sat May 18, 2019 8:10 am

nisiprius wrote:
Sat May 18, 2019 5:35 am
. . . . . .
Fred Schwed said it well:
Like all of life's rich emotional experiences, the full flavor of losing important money cannot be conveyed by literature. Art cannot convey to an inexperienced girl what it is truly like to be a wife and mother. There are certain things that cannot be explained to a virgin either by words or pictures. Nor can any description that I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.
Outstanding!
Thanks for posting this.
j :happy
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Re: Actual Experience as true measure of risk tolerance

Post by Sandtrap » Sat May 18, 2019 8:19 am

Not in the "market" but similar impact.

R/E development in the 70's.
1. Apartment buildings. Vacancy 70%. Rents cut 50%. Did everything. Did not hire out. Rented to anyone that could pay.

Construction development early 80's.
1. Commercial construction contracts dried up. Two years of projects already in progress, cancelled. Layoffs. Closed most of company except for small projects. Then, closed completely.

Actionably:
As a result of these, and more, life experiences:

Present allocation 50/50.
Considering sloping to 40/60, then 30/70, deeper into retirement.

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Re: Actual Experience as true measure of risk tolerance

Post by Phineas J. Whoopee » Sat May 18, 2019 11:28 am

I can tell you my experience over time, as an adult.

Barely into 18-ness, I graduated from high school, moved out of my parents' house, and sunk into debt to pay for further education. That continued through a bachelor's and a master's program (both completed). I wasn't so much worried about losing as I was about repaying. I remember well the day my paycheck flipped my net worth from slightly negative to slightly positive.

Having paid my debts I saved and invested the payments I used to make, rather than change my continued starving student lifestyle (except for an adequate business wardrobe). Something was better than less than nothing, but not all that much better. Once I had a bit of a cash cushion I started investing with Vanguard, my having researched my options and having concluded index funds were the way to go and at the time, at least, theirs were objectively the best.

Slightly positive grew into modestly positive. I had an eye on robustness in the event of loss of income. For a very long time I didn't have enough to survive all that far. During that period I had little risk aversion, because the worst that could happen is I could go from clearly not having enough to clearly not having enough. Qualitatively it would work out the same.

As an investor my first recession and bear market, simultaneously, happened just around the time I started buying fund shares. I had practically nothing to lose, at that moment in time.

Still clearly not having enough and therefore with a very high risk tolerance, I was amazed by the late 1990s bull market, but was almost all in stocks so there was little for me to do. Also, that was during the time I quit my full-time job to get my second masters degree and then start my business. Spoiler alert - like many it financially failed after a few years. I knew going in that was the most likely outcome. I chose to take the risk.

During the early-2000s and 2007-2009 recessions and bear markets I had higher income and maxed out retirement accounts and saved and invested outside of them, but still clearly did not have enough. The worst that could happen was I'd go from clearly not enough to clearly not enough. By the latter example I had reduced my equity slice, so yes I invested and rebalanced all the way down and all the way back up, which as nisiprius said upthread was faster than we had any right to expect. That, along with a lot of other things in my life, was luck, not skill.

In the years after the crisis my assets grew to be probably enough if nothing went wrong. That reduced my risk tolerance. Then, up to probably enough even in the face of a problem or two. My risk tolerance decreased. Then, probably enough. My risk tolerance became still lower.

This is what I did, and a couple of years later I answered some questions about it.

For the record, I think an age-based asset allocation strategy will be far more practical for most investors to commit to and carry out.

That's my experience story.

PJW

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Re: Actual Experience as true measure of risk tolerance

Post by garlandwhizzer » Sat May 18, 2019 12:01 pm

How do you go about this? Do you think actual experience* is needed to reveal who we really are as investors?

Yes.

True risk tolerance is often discovered in the depths of a bear market. Objective rational analysis tend to disappear in many of us at those times due to fear/panic. After you've been through a couple of bad bear markets, they're still scary but hopefully by then you have discovered what your capacity to handle it is and have aligned your portfolio accordingly.

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Re: Actual Experience as true measure of risk tolerance

Post by Fallible » Sat May 18, 2019 12:29 pm

alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
...
Do you think actual experience* is needed to reveal who we really are as investors?

*experience as in the experience of going through bull and bear markets, and the experience of gaining / losing significant portion of our money in the market.
There's no doubt that investing experience should help us know who we are as investors, and the more we know the better we should be able to understand the risks we are taking. I think Taylor's example showing what he and his family members endured in the '29 crash is the best example of that. (Thank you for sharing that, Taylor.)

What's important are the lessons we learn from our experiences, in BOTH bear and bull markets, and how well we understand and apply those lessons. For example, those who have more experience in market crashes should realize that bear markets can differ greatly, meaning that how well or poorly we do in one crash won't necessarily tell us how we'll do in the next crash (e.g., compare the '87 crash to the 2000-2002 tech crash to the '08 financial crisis). Making it through one bear market with our allocations reasonably intact tells us something about our investing selves, but only in that bear market and maybe not the next (when we'll also be older and have less time horizon).

Experience also should include how well we study up on investing, how much we read the best books and blogs that help us understand risk in general and our own individual tolerance for it.
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Re: Actual Experience as true measure of risk tolerance

Post by nedsaid » Sat May 18, 2019 12:34 pm

Taylor Larimore wrote:
Fri May 17, 2019 9:23 pm
alexfoo39:

At age 95, I have been through many bear markets. They are no fun. This was my first bear market:

Nedsaid: Taylor, this is one of your all-time best posts. Good to see that you are still turning out your very best work. In your case, age doesn't matter at all.

Our family owned "Larimore's Diner" in Foxboro, Mass. in 1929 (I was 5 years old at that time). When the depression hit, we lost the Diner and moved into my grandfather's home in Miami. Grandfather, who was a millionaire investor and chief executive of an investment trust company, lost everything--including the Miami home we lived in.

BEAR MARKET OF 1929-1937 (Dow plunged 89%)
-1929--1930--1931--1932
(-31%)(-25%)(-43%)(-08%) Large Cap Stocks
(-34%)(-35%)(-47%)(-06%) Mid/Small Cap Stocks
(-47%)(-38%)(-50%)(-05%) Micro Cap Stocks

Nedsaid: It is very good to see the breakdown of how stocks performed by market cap. Very instructive that Large Cap did the best during the crisis. A sort of the cleanest dirty shirt in the laundry hamper thing.

(+04%)(+07%)(-02%)(+09%) 5-Year Treasury Bonds

Nedsaid: The big reason we all need a big helping of bonds in our portfolio.

BEAR MARKET OF 1973-1976 (S&P fell 43%)
-1973--1974
(-15%)(-26%) Large Caps
(-39%)(-29%) Micro Caps

Nedsaid: Again, you are seeing the greater stability of the Large Caps.

---(-70%) Coca-Cola
---(-82%) Intel
---(-73%) McDonald's
---(-86%) Merrill Lynch
---(-86%) Walt Disney
---(-71%) Xerox

Nedsaid: I have often posted about the "Nifty-Fifty" stocks of the 1960s. The belief was that you could buy the big Blue Chip stocks and hold them forever. Long term, the belief was 100% true but many of these stocks were bid up to Price to Earnings ratios of 50 or more. Perfectly good companies but their valuations were bid up to the stratosphere. Hence, the stocks that were bid up the most suffered the most during the ensuing bear market. Most of these companies were good investments but you had to be very, very, very patient. It took time for earnings to catch up with the very high expectations of the go-go 1960's.

I have been issuing warnings about the FAANG stocks, which have powered the High Tech sector as well as the Growth Index and the S&P 500. Tech, when you add the Technology Sector and much of the Communications sector of the S&P 500, High Tech is more than 25% of the index. So we have the "Nifty Five" rather than "Fifty."

Just saying that valuations matter and matter a lot. For the 3 fund portfolio, if the FAANG stocks do poorly from here out, it won't be disaster. Far from it. But the Small/Value tilters will have their day.


Figures cannot convey the horrifying and debilitating effects of a bear market. You watch in agony as month after month your life savings evaporate before your eyes. Gloom and doom talk is everywhere. Nearly everyone else is selling. You have no idea when, or if, your portfolio will stop losing money.

Your friends and relatives urge you to sell. Nearly all financial experts recommend "sell". You are ridiculed for trying to hold on. You begin to have self-doubt. Despair sets in. Buying stocks is unthinkable. Suicides increase. That's a REAL bear market.

This is why many people in retirement have 40-70% in bonds.

Nedsaid: I haven't had the trauma of losing a home or a business or having to move in with grandparents. What Taylor experienced pretty well made a deep impression on his mind. Markets are risky and can at times be very risky. I did lose about 2 years of take home pay during the 2008-2009 bear market and that was sobering. I was scared spitless. But I held on and the portfolio recovered and then some.

Best wishes.
Taylor
A fool and his money are good for business.

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Re: Actual Experience as true measure of risk tolerance

Post by RadAudit » Sat May 18, 2019 7:22 pm

One of the problems I had with measuring my risk tolerance was that my tolerance for losses decreased as I aged. So, during each drop after 1987, I found out that my AA was too aggressive and I adjusted downward. I am really looking forward to the next drop; maybe this time I will have it right.
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Re: Actual Experience as true measure of risk tolerance

Post by Achkelone » Sat May 18, 2019 7:57 pm

Awesome thread, thank to the participants for these thought-provoking remarks and feedback from life experiences.
nedsaid wrote:
Sat May 18, 2019 12:34 pm
I did lose about 2 years of take home pay during the 2008-2009 bear market and that was sobering. I was scared spitless. But I held on and the portfolio recovered and then some.
Could you specify how you lost that money ? Is it because you sold under panic ? Or were you holding company-specific shares which never recovered (or went bust) ?

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Re: Actual Experience as true measure of risk tolerance

Post by alexfoo39 » Sat May 18, 2019 8:07 pm

Achkelone wrote:
Sat May 18, 2019 7:57 pm
Awesome thread, thank to the participants for these thought-provoking remarks and feedback from life experiences.
nedsaid wrote:
Sat May 18, 2019 12:34 pm
I did lose about 2 years of take home pay during the 2008-2009 bear market and that was sobering. I was scared spitless. But I held on and the portfolio recovered and then some.
Could you specify how you lost that money ? Is it because you sold under panic ? Or were you holding company-specific shares which never recovered (or went bust) ?
nisiprius wrote:
I think he meant at one point his portfolio is down the amount of 2 years salaries. He chose to hold on, and then the market went back up and he recovered his *losses.

I myself was a naive stockpicker just 2 years ago. Had the euphoria of seeing 140% gain in portfolio, and then losing 25% of them. That 25% taught me a lot about myself (even when the overall effect is green, amazing huh?). Really appreciate that quote by Fred Schwed (thanks nisiprius) on the experience of actually losing the money we used to own.

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Re: Actual Experience as true measure of risk tolerance

Post by nedsaid » Sat May 18, 2019 11:15 pm

Achkelone wrote:
Sat May 18, 2019 7:57 pm
Awesome thread, thank to the participants for these thought-provoking remarks and feedback from life experiences.
nedsaid wrote:
Sat May 18, 2019 12:34 pm
I did lose about 2 years of take home pay during the 2008-2009 bear market and that was sobering. I was scared spitless. But I held on and the portfolio recovered and then some.
Could you specify how you lost that money ? Is it because you sold under panic ? Or were you holding company-specific shares which never recovered (or went bust) ?
What happened was that the value of my portfolio dropped. My response was to hold on to everything that I owned and also to put 100% of new monies into the US and International Stock Markets for a year. My portfolio recovered as the markets rebounded. So the losses were temporary. Too smart to sell at the bottom and too scared to rebalance from bonds back into stocks. From peak to trough, my losses (though temporary) were 35%.
A fool and his money are good for business.

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Re: Actual Experience as true measure of risk tolerance

Post by Explorer » Sat May 18, 2019 11:36 pm

One of the most interesting threads I have read in a long time... life experiences being shared liberally.

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Re: Actual Experience as true measure of risk tolerance

Post by Achkelone » Sun May 19, 2019 2:36 am

alexfoo39 wrote:
Sat May 18, 2019 8:07 pm
I think he meant at one point his portfolio is down the amount of 2 years salaries. He chose to hold on, and then the market went back up and he recovered his *losses.
nedsaid wrote:
Sat May 18, 2019 11:15 pm
What happened was that the value of my portfolio dropped. My response was to hold on to everything that I owned and also to put 100% of new monies into the US and International Stock Markets for a year. My portfolio recovered as the markets rebounded. So the losses were temporary. Too smart to sell at the bottom and too scared to rebalance from bonds back into stocks. From peak to trough, my losses (though temporary) were 35%.
I see, it was said in terms of a temporary loss and not a definitve one. Holding on was the right thing to do, but indeed, when the virtual loss is worth two years of salaries, it must be quite nerve wrecking :?

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Re: Actual Experience as true measure of risk tolerance

Post by pdavi21 » Sun May 19, 2019 3:55 am

Risk tolerance doesn't have to mean incorrectly selling at a low, it can mean incorrectly selling at a high. Contrarian investors I know have underperformed in 2000s and 2010s selling too early before the market roared higher (some famous ones too).
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

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Re: Actual Experience as true measure of risk tolerance

Post by jpdion » Sun May 19, 2019 7:42 am

Looking back, I think I was lucky to be ignorant about asset allocation. Starting over with very little in 1992 in with a new job, and a new wife in 1994, the need was to accumulate enough assets to retire by my mid-sixties. I naively reasoned that stocks historically out performed bonds and cash, so 100% stocks in S&P 500 type funds. Both of us ramped up to maximum 401(k) contributions to assure maxing out employer match funding. Fluctuations of value in the early years didn't phase us, as the actual value change was relatively small and we believed in dollar cost averaging was the best way forward. Then the dot.com boom and bust hit, and we at first chided ourselves for not jumping on "great opportunities" and then were relieved we didn't do so. But, we did add some bond exposure, 15-20%, inside our 401(k) accounts. The great recession was a shock, ~40% of value gone very quickly with less than ten years to intended retirement. But, we stayed the course and dollar cost averaged all the way down and all the way back up - the incredible Bull market made that work. Didn't panic when the house was "under water" in 2009, and actually had some nice equity on sale in 2015 - we had our jobs and could make our payments. During 2013 I got serious about learning about asset management in retirement and discovered Bogleheads, Vanguard and low fee index fund investing. I had the ability to take a one-time rollover distribution from my 401(k) prior to retirement and moved 95% of it to a Vanguard TIRA (60% TSM, 35% TBM, 5% MM). At retirement in 2015, on advice of a 401(k) advisor I added some international in the stock and bond allocations, and TIPS, but since have dropped international bonds and TIPS, and adjusted to 55/40/5 allocation, with the MM representing about 2 years spending requirements - those adjustments mainly because of reading this forum. Experiencing the volatility of the market, up and down, the anxiety of loss and the skepticism of gain, led me to learn and build in downside protection in our portfolio. I think the one significant fact that the great recession taught me is if you don't have to liquidate to live, then don't. Just always protect yourself on the downside.

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Re: Actual Experience as true measure of risk tolerance

Post by GAAP » Sun May 19, 2019 10:17 am

My experience over the last 40 or so years is that I do have a higher risk tolerance -- but that is based upon hindsight, and not really useful to help someone just starting out.

Don't look all the time -- it magnifies the volatility. I think the modern ease of access to "market knowledge" and the ability to react to that knowledge cuts both ways. Yes, you can rebalance easily, sell losers, TLH, etc. It also makes people more nervous and more likely to "do something" rather than wait. 40 years ago, it was a lot harder to actually do something, and there was an intermediary who, in theory anyway, might offer an opposing opinion.

If I were starting out today as a new investor, I would use a 50/50 allocation of stocks/bonds and I would use global funds for both. From there, I would adjust over time as my knowledge increased about both the choice of assets (stocks/bonds, domestic/international) and as real world conditions taught me about my personal risk tolerance. Starting conservatively has the additional benefit of fairly consistent returns -- which makes continuing to save much easier and more likely over the long term.
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Re: Actual Experience as true measure of risk tolerance

Post by Dottie57 » Sun May 19, 2019 10:26 am

Taylor Larimore wrote:
Fri May 17, 2019 9:23 pm
alexfoo39:

At age 95, I have been through many bear markets. They are no fun. This was my first bear market:

Our family owned "Larimore's Diner" in Foxboro, Mass. in 1929 (I was 5 years old at that time). When the depression hit, we lost the Diner and moved into my grandfather's home in Miami. Grandfather, who was a millionaire investor and chief executive of an investment trust company, lost everything--including the Miami home we lived in.

BEAR MARKET OF 1929-1937 (Dow plunged 89%)
-1929--1930--1931--1932
(-31%)(-25%)(-43%)(-08%) Large Cap Stocks
(-34%)(-35%)(-47%)(-06%) Mid/Small Cap Stocks
(-47%)(-38%)(-50%)(-05%) Micro Cap Stocks

(+04%)(+07%)(-02%)(+09%) 5-Year Treasury Bonds

BEAR MARKET OF 1973-1976 (S&P fell 43%)
-1973--1974
(-15%)(-26%) Large Caps
(-39%)(-29%) Micro Caps

---(-70%) Coca-Cola
---(-82%) Intel
---(-73%) McDonald's
---(-86%) Merrill Lynch
---(-86%) Walt Disney
---(-71%) Xerox

Figures cannot convey the horrifying and debilitating effects of a bear market. You watch in agony as month after month your life savings evaporate before your eyes. Gloom and doom talk is everywhere. Nearly everyone else is selling. You have no idea when, or if, your portfolio will stop losing money.

Your friends and relatives urge you to sell. Nearly all financial experts recommend "sell". You are ridiculed for trying to hold on. You begin to have self-doubt. Despair sets in. Buying stocks is unthinkable. Suicides increase. That's a REAL bear market.

This is why many people in retirement have 40-70% in bonds.

Best wishes.
Taylor
Thankyou Taylor. Sometimes I think 50/50 stock to bonds is too conservative. But your post makes me more confident.

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Re: Actual Experience as true measure of risk tolerance

Post by MathWizard » Sun May 19, 2019 10:35 am

How to go about this?

I would suggest figuring your risk tolerance, both behavioral and job stability, then backing off the equity portion a bit.

If you think you can handle 100% stocks, try 70 or 80% stocks for a while through a cycle.

If you think you can handle 80%, maybe go to 60/40 or 50/50

If you find yourself not wanting to rebalance into stocks during a large drop, you shouldn't go higher in stocks, and maybe need to have a lower percentage.

If you wish you had more bonds to buy in during a large drop,maybe you would be fine with a larger stock allocation.

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Re: Actual Experience as true measure of risk tolerance

Post by willthrill81 » Sun May 19, 2019 10:46 am

alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
You know the idea of risk taking in investment. Typically one should assess his ability, need, and willingness to take risk.
I've never understand the 'need' aspect to taking risk. If you're able to take on risk and willing to do so, why not do so? Using this metric, most decamillionaires should have very conservative asset allocations, though most of them don't.
alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
From there a suitable asset allocation will be designed to suit his temperament. The thing is, one often feels some form of regret when the tide turns. Let's assume that AA is set under a normal market condition. Say, 60/40. When the storm comes, the bear ruthlessly sinks a significant equity portion of our portfolio. Then we wonder if we have been too confident all these while. The thought that 'I should have been more conservative and have more bonds' hits us.

How do you go about this? Do you think actual experience* is needed to reveal who we really are as investors?

*experience as in the experience of going through bull and bear markets, and the experience of gaining / losing significant portion of our money in the market.
The problem with risk tolerance is that it's a moving target, and experience only goes so far. Someone might not have questioned their strategy back in the financial crisis when they had $10k in their portfolio, but that doesn't mean that they would react the same way now that they have $1 million in their portfolio. Losing $5k is very different than losing $500k. Plus, the mood you're in can certainly impact your risk tolerance. When things are going great at your job/career/business, your risk tolerance goes up, and vice versa.

If you're going to use a buy-and-hold strategy, I really believe that you should reevaluate your risk on something like an annual basis, perhaps when you rebalance your portfolio.
“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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Re: Actual Experience as true measure of risk tolerance

Post by Dandy » Sun May 19, 2019 12:27 pm

I've never understand the 'need' aspect to taking risk.
A retiree with a COLA pension and Social Security that meets or exceeds their expenses and a nice size portfolio may not have a need to take risk. They may have decent risk tolerance and with their financial situation the ability to take risk but haven't the need.

Let's face it most people have some need to take some risk. But there are people who take decent risk when they have no need. They could be investing for charity, heirs a disabled child or just the thrill of seeing their assets grow. Retirees with no human capital often underestimate their financial position when facing decades of retirement. It is hard to feel you have enough even if objectively you do. I think need isn't a yes or no question -- it is a scale to determine the amount of risk -- in most cases.

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Re: Actual Experience as true measure of risk tolerance

Post by Fallible » Sun May 19, 2019 1:21 pm

willthrill81 wrote:
Sun May 19, 2019 10:46 am
...
The problem with risk tolerance is that it's a moving target, and experience only goes so far. ...
And it seems risk tolerance is a moving target because we humans are moving targets. We change, our life circumstances change and our resulting moods. WSJ columnist Jason Zweig explains these changes in his book, Your Money & Your Brain, the chapter on “Risk.” Zweig says our perception of investment risk is in “constant flux, depending on your memories of past experiences, whether you are alone or part of a group, how familiar and controllable the risk feels to you, how it is described, and what mood you happen to be in at the moment.”

Interestingly, Zweig also has written separately about whether risk tolerance is part of our natures, which could influence how we use experience to determine it. He undergoes DNA analyses and brain scans and seems to conclude:

So, while my genes bias my brain toward spooking easily and trying to make a quick buck, that isn’t how I actually behave. I hold investments for years, even decades; I don’t panic in bear markets, and bull markets make me uncomfortable.

Here's the link:
http://jasonzweig.com/is-your-investing ... -your-dna/
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Re: Actual Experience as true measure of risk tolerance

Post by LFS1234 » Tue May 21, 2019 1:34 am

I think "actual experience" has to include the effect of the economic conditions during your formative years; not just your own personal financial experiences.

The Great Depression caused generations of people to avoid stocks for most of their lives, preferring to invest in CDs and the like. They were concerned about deflation, not inflation.

I was born in the early '60's, and inflation rather than deflation was the great worry of my formative years. Consequently, I am much more comfortable with a well-selected diversified basket of stocks than I am with cash or fixed-rate paper. Sure, the basket of stocks can temporarily drop by 50%, but I don't worry about it not recovering. And I have no interest in lots of bonds, because I do worry about bonds having dismal returns on a long-term basis, especially when taxes are taken into account.

So for me having "risk tolerance" per its modern definition is easy. I feel fixed income is very risky, and that a well-selected basket of stocks is not. So the professors' "safe" investment is one I consider risky, while the professors' "risky" investment is one I consider a lot safer. And I've got good company in feeling that way. I would expect that lots of people of my generation share my experience and have reached similar conclusions.

Where I do agree with the Depression generations is that debt is scary. You can't go bankrupt if you don't owe anyone anything. Every few decades there is a recession where banks are forced to call (or fail to renew) large numbers of loans, causing unforeseen disaster to the borrowers. For heavy borrowers, the only way to avoid this is to be either very lucky or very careful. Read enough business biographies and you see this over and over again.

Here's my personal experiences during the various downturns I was aware of living through:

'73 - '74. I was 10 years old. Oil crisis. Friends' parents selling their gas guzzlers in order to buy more economical cars. Lots of talk about inflation. That was the extent of my knowledge at the time.

During much of the rest of the '70's, malaise and inflation was what adults were discussing. Prominent figures were telling us that the standard of living would be dropping in the future and that our generation would have to settle for less. This struck me as stupid. Generations before us cleared the fields, built our infrastructure, built our institutions, etc. The assets left for future generations by past generations vastly exceeds the liabilities they leave behind, with the consequence that we are vastly richer than our ancestors were. I didn't see any reason for this to change going forward. I still don't.

'81 - '82. I was 18 and had a minimum-wage job and a crappy car. Life was grand. Freedom to do whatever I want as an adult. The sense of personal freedom was all-encompassing. I was vaguely aware that older people thought we were having a recession.

'87. Flash crash. I had a small brokerage account and happened to be in my broker's office on that day. The DJIA fell 22.6%. Interesting to read the WSJ the following day. I don't recall how I reacted to that flash crash; most likely I didn't do anything. My account was quite small, and at 24 it didn't even occur to me that I could be worrying about its effect on my retirement.

'90-'91. First Iraq war. Uncomfortable time, but again no feeling that it was affecting me directly.

In the second half of the '90s, I was a member of a NAIC-affiliated investment club. It was a blast. Learned a lot, did a lot of reading. It was quite something to hope a stock would double in five years and instead have it quintuple in one year. It thought it was quite obvious that efficient market theory wasn't credible. Apparently, the professors who felt otherwise didn't own any stocks.

'99 - '2000. I had a telecom stock that went from a 10K position to a 100K position; sold it to buy my first home. Largely lucky timing. Sold most of the rest of my tech high-flyers when I realized that they were selling at 10x sales and that the earnings assumptions you would have to make to justify those prices were such that the stocks had very limited upside and tremendous downside. The tech stocks were sky high and the big caps were very high, but lots of less prominent stocks were selling around 13-15x earnings even at the peak. You had to have a smidgeon of analytical ability to figure this out and to understand what that meant, but I had that. A smidgeon was all that was needed. So I ended up doing fine in the dot.com crash.

'07 - '09 great recession. Fully invested all the way through; picked up a couple of inexpensive stocks in late '08 and early '09 but didn't have much free cash so those buys didn't make a big difference. At the end of '08, I thought it was obvious that the pure panic selling had already occurred and that the selling still going on was due to people who had to raise money and could not sell their now unsaleable illiquid assets and therefore had to sell their inexpensive liquid ones. My net worth got cut in half, after which it doubled. The experience reinforced my desire to avoid leverage.

I live in an area where the real estate industry is very important, and where the great recession left lots of depressed people. Around 2010, I spent some time in Silicon Valley and L.A. and discovered there a plentiful supply of the same youthful exuberance that I had at 18: in Silicon Valley the promised innovations of the future were (are) magnificent and in plain sight, and in LA the starving artists were still writing their screenplays while waiting tables - no time to be depressed when fame and fortune - or at least lots of fun - are on the horizon.

Ken Fisher has pointed out that old people tend to be pessimistic. Peter Lynch has pointed out that people would be less depressed if they'd just rent a 12-year old and follow them around. 12-year olds don't get upset by the stuff we get upset by. Life is still an adventure worth living. Our worries are not on their horizon.

When determining risk tolerance, actual investing experience is a factor. The economic conditions during your formative years is a factor. Your age is a factor. Your obligations to others - financial and personal - are factors. And your net worth is a factor.

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Re: Actual Experience as true measure of risk tolerance

Post by MotoTrojan » Tue May 21, 2019 2:14 am

Achkelone wrote:
Sun May 19, 2019 2:36 am
alexfoo39 wrote:
Sat May 18, 2019 8:07 pm
I think he meant at one point his portfolio is down the amount of 2 years salaries. He chose to hold on, and then the market went back up and he recovered his *losses.
nedsaid wrote:
Sat May 18, 2019 11:15 pm
What happened was that the value of my portfolio dropped. My response was to hold on to everything that I owned and also to put 100% of new monies into the US and International Stock Markets for a year. My portfolio recovered as the markets rebounded. So the losses were temporary. Too smart to sell at the bottom and too scared to rebalance from bonds back into stocks. From peak to trough, my losses (though temporary) were 35%.
I see, it was said in terms of a temporary loss and not a definitve one. Holding on was the right thing to do, but indeed, when the virtual loss is worth two years of salaries, it must be quite nerve wrecking :?
This has been beaten on here often but it was a real loss there’s no such thing as a paper or virtual loss, it’s just an emotional technique to cope with market declines. The market doesn’t have to rebound right back and then some before you need to withdraw.

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Re: Actual Experience as true measure of risk tolerance

Post by sschullo » Tue May 21, 2019 8:28 am

People can easily sit comfortably in a financial adviser's office and comfortably say they are comfortable with a 60%, 70% equity allocation and are cool if their portfolio declines 20-30% or more. Then Mr. Bear hits and these same people panic. Some may use it as a lesson and awareness of their "true" risk tolerance and readjust, but I am afraid that most will be angry and stay out of the market forever. I think "actual experience" only works for the emotionally tough largely because they are capable of thinking long term. Bogleheads get it, but the vast majority of people don't. In the last 11 years, its been reported that 2 to 3 trillion assets are still stuck in MM accounts with no end in sight.
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Re: Actual Experience as true measure of risk tolerance

Post by Chicken Little » Tue May 21, 2019 7:27 pm

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Re: Actual Experience as true measure of risk tolerance

Post by sixtyforty » Wed May 22, 2019 8:31 am

Most people tend to overestimate their ability to withstand a brutal bear market and tend to be over-allocated to stocks especially during the bull run prior to when the bear market starts. Calculating your networth frequently, watching the business news etc will make it very difficult to withstand a bear market. Your risk tolerance is also a factor of your age. Of course the younger you are the more risk you can assume, especially while you are working. The older you are, not so much.

I'm reminded by our beloved mentor Jack Bogle, I believe said something to the effect "Invest in a diversified index fund, re-invest the dividends, don't look at your bank statements for 30 years. At the end of 30 years open your bank statement and you will be amazed how much money you will have."
"Simplicity is the ultimate sophistication" - Leonardo Da Vinci

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Re: Actual Experience as true measure of risk tolerance

Post by Nowizard » Wed May 22, 2019 8:51 am

Experience (Time) with market changes is significant, but there are other factors such as the size of one's portfolio and the spending/saving ratio. Larger portfolios and significant savings on an ongoing basis insulate from fear-based moves. Timing of the down turn is also important. If a person has a retirement plan that is sustainable but based on regular withdrawals from retirement accounts, a downturn as one nears retirement is more concerning than a downturn ten years prior to retirement. The financial industry is a source of concern as well in that there are always efforts to encourage investing, just different ones in up and down markets. As always, there are few absolutes in investing, just guidelines.

Tim

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Re: Actual Experience as true measure of risk tolerance

Post by Vanguard Fan 1367 » Wed May 22, 2019 3:03 pm

I avoided the stock market until 1994. I have been through a fair amount of market corrections since then. I am glad that once I got in I have stayed the course, have just stood there, not done anything during the various downturns. I am grateful for John Bogle's advice, I didn't come across that until 2014 but the 5 years from 2014 till now have been great using Bogle's ideas.

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Re: Actual Experience as true measure of risk tolerance

Post by nisiprius » Wed May 22, 2019 3:20 pm

Nowizard wrote:
Wed May 22, 2019 8:51 am
...Larger portfolios and significant savings on an ongoing basis insulate from fear-based moves...
Well, this is a good example of "half-full or half-empty," and possibly of "increasing relative risk aversion versus decreasing relative risk aversion."

The larger the portfolio, the larger the dollar loss for any given percentage decline. Thinking of 2008-2009, a 25% decline on a $20,000 portfolio is a $5,000 loss. A 25% decline on a $1 million portfolio is a $250,000 loss.

You are saying that a $250,000 loss (on a $1 million portfolio) is less fearful than a $5,000 loss (on a $20,000 portfolio). It's not obvious to me that this would be true for everyone.

You can't give exact numbers because it depends on the exact time profile of your savings, but if you express the lost as "X years' savings," if your portfolio represents forty years' savings, a 25% decline is probably a lot more "years of lost savings" than a 25% decline on a portfolio that represents four years' savings.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Actual Experience as true measure of risk tolerance

Post by GCD » Wed May 22, 2019 6:36 pm

alexfoo39 wrote:
Fri May 17, 2019 9:16 pm
How do you go about this? Do you think actual experience* is needed to reveal who we really are as investors?

*experience as in the experience of going through bull and bear markets, and the experience of gaining / losing significant portion of our money in the market.
Training and education can trump experience in stressful stiuations. If you educate yourself about market history, you will be prepared to psychologically weather a bear market.

Police and fire departments train their first responders for all sorts of crisis situations. These first responders almost always perform well in the face of their first crisis. You can find other professions where people are faced with life and death decisions and these professions use various types of training to enable people to perform well under stress the first time they encounter that stress.

Of course, there are cops, firemen and others who, despite their training, fail at the moment of truth. You may not be able to know for sure that you will be able to weather a bear until you do. But educating yourself on market recoveries will help you.

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Re: Actual Experience as true measure of risk tolerance

Post by alexfoo39 » Thu May 23, 2019 6:32 am

Nowizard wrote:
Wed May 22, 2019 8:51 am
Experience (Time) with market changes is significant, but there are other factors such as the size of one's portfolio and the spending/saving ratio.

Tim
i think both points are mentioned for quite a few times, judging from a small sample of replies here.

So the larger our portfolio, the less risk tolerant we are?

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Re: Actual Experience as true measure of risk tolerance

Post by alexfoo39 » Thu May 23, 2019 6:38 am

GCD wrote:
Wed May 22, 2019 6:36 pm
Training and education can trump experience in stressful stiuations. If you educate yourself about market history, you will be prepared to psychologically weather a bear market.

Police and fire departments train their first responders for all sorts of crisis situations. These first responders almost always perform well in the face of their first crisis. You can find other professions where people are faced with life and death decisions and these professions use various types of training to enable people to perform well under stress the first time they encounter that stress.

Of course, there are cops, firemen and others who, despite their training, fail at the moment of truth. You may not be able to know for sure that you will be able to weather a bear until you do. But educating yourself on market recoveries will help you.
sschullo wrote:
Tue May 21, 2019 8:28 am
People can easily sit comfortably in a financial adviser's office and comfortably say they are comfortable with a 60%, 70% equity allocation and are cool if their portfolio declines 20-30% or more. Then Mr. Bear hits and these same people panic. Some may use it as a lesson and awareness of their "true" risk tolerance and readjust, but I am afraid that most will be angry and stay out of the market forever. I think "actual experience" only works for the emotionally tough largely because they are capable of thinking long term. Bogleheads get it, but the vast majority of people don't. In the last 11 years, its been reported that 2 to 3 trillion assets are still stuck in MM accounts with no end in sight.
If I were to compare both posts, I'd say our discussion must continue. Because obviously there are two camps now. It is a matter of how much weight do we want to ascribe to the experience card.
Last edited by alexfoo39 on Thu May 23, 2019 6:38 am, edited 1 time in total.

longinvest
Posts: 3811
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Re: Actual Experience as true measure of risk tolerance

Post by longinvest » Thu May 23, 2019 6:38 am

alexfoo39 wrote:
Thu May 23, 2019 6:32 am
Nowizard wrote:
Wed May 22, 2019 8:51 am
Experience (Time) with market changes is significant, but there are other factors such as the size of one's portfolio and the spending/saving ratio.

Tim
i think both points are mentioned for quite a few times, judging from a small sample of replies here.

So the larger our portfolio, the less risk tolerant we are?
Different people have different patterns of risk aversion. Here's how John Norstad explains it:

Risk and Time
For example, one reasonable investor might be more conservative when he is rich, perhaps because he is concerned about preserving the wealth he has accumulated, whereas when he is poor he takes on more risk, perhaps because he feels he's going to need much more money in the future. This investor has "increasing relative risk aversion."

On the other hand, a different equally reasonable investor might have the opposite attitude. She is more aggessive when she is rich, perhaps because she feels at some point that she already has more than enough money, so she can afford to take on more risk with the excess, whereas when she is poor, she is more concerned about losing the money she needs to live on, so she is more conservative. This investor has "decreasing relative risk aversion."

We can easily imagine more complicated scenarios, where an investor might have increasing relative risk aversion over one range of wealth and decreasing relative risk aversion over some other range.

These attitudes are all reasonable possibilities. All of these investors are risk-averse. They differ only in their degree of risk aversion and their patterns of risk aversion as their wealth increases and decreases. None of the utility functions corresponding to these preferences and patterns are right or wrong or better or worse than the other ones. Everything depends on the individual investor's attitudes. Utility theory does not dictate or judge these attitudes, it just gives us a way to measure them.

In any case, we often think of iso-elastic utility with constant relative risk aversion as a kind of central or neutral position.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

Topic Author
alexfoo39
Posts: 187
Joined: Sun Jan 06, 2019 2:00 am

Re: Actual Experience as true measure of risk tolerance

Post by alexfoo39 » Thu May 23, 2019 6:49 am

LFS1234 wrote:
Tue May 21, 2019 1:34 am
I think "actual experience" has to include the effect of the economic conditions during your formative years; not just your own personal financial experiences.
Thank you for your sharing. I'm glad you did well especially on that dotcom.

I'd like to ask if you're still subscribing to indexing. I assume that you start it after 2000?

GCD
Posts: 998
Joined: Tue Sep 26, 2017 7:11 pm

Re: Actual Experience as true measure of risk tolerance

Post by GCD » Thu May 23, 2019 8:42 am

alexfoo39 wrote:
Thu May 23, 2019 6:38 am
GCD wrote:
Wed May 22, 2019 6:36 pm
Training and education can trump experience in stressful stiuations. If you educate yourself about market history, you will be prepared to psychologically weather a bear market.

Police and fire departments train their first responders for all sorts of crisis situations. These first responders almost always perform well in the face of their first crisis. You can find other professions where people are faced with life and death decisions and these professions use various types of training to enable people to perform well under stress the first time they encounter that stress.

Of course, there are cops, firemen and others who, despite their training, fail at the moment of truth. You may not be able to know for sure that you will be able to weather a bear until you do. But educating yourself on market recoveries will help you.
sschullo wrote:
Tue May 21, 2019 8:28 am
People can easily sit comfortably in a financial adviser's office and comfortably say they are comfortable with a 60%, 70% equity allocation and are cool if their portfolio declines 20-30% or more. Then Mr. Bear hits and these same people panic. Some may use it as a lesson and awareness of their "true" risk tolerance and readjust, but I am afraid that most will be angry and stay out of the market forever. I think "actual experience" only works for the emotionally tough largely because they are capable of thinking long term. Bogleheads get it, but the vast majority of people don't. In the last 11 years, its been reported that 2 to 3 trillion assets are still stuck in MM accounts with no end in sight.
If I were to compare both posts, I'd say our discussion must continue. Because obviously there are two camps now. It is a matter of how much weight do we want to ascribe to the experience card.
It's a matter of nuance and phrasing. I agree with sschullo too. I think the vast majority of people who panic are uneducated investors -- and there are a lot of them. It's hard to draw distinct lines, because there are uneducated people who will blissfully, ignorantly stay the course. And there are educated, seasoned investors for whom something has recently changed and they panic when one would otherwise not expect them to. But I believe the general rule is an educated investor is mentally prepared for a downturn.
Last edited by GCD on Thu May 23, 2019 9:20 am, edited 1 time in total.

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