Equity allocation for young investors: am I missing something?

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redbarn
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Equity allocation for young investors: am I missing something?

Post by redbarn » Mon Feb 10, 2020 5:33 pm

It is my first time posting here but I have been reading and benefiting from all the great advice for a few years now. I am really very grateful for this forum.

There is one thing that I have always had some doubts about and was hoping to get some help in clarifying my thinking. A question that often comes up here is why early-stage investors should not hold 100% of their portfolio in stocks. The general argument given against 100% stocks is behavioral, that people are more likely to make the wrong decision when they see huge chunks of their portfolio evaporate. The fact that this behavioral argument is the one that is always provided seems to concede the point that from a purely rational financial standpoint, it would indeed make most sense to go 100% equities. To me, 100% equities (or anything too close to that) really does not seem to make sense for early-stage investors even from a perfectly rational standpoint but I am not sure if my reasoning has any merit.

Running some return and contribution scenarios using a very simple spreadsheet, it seems clear that even with conventionally strong stock market returns, portfolio growth would be overwhelmingly dominated by contributions rather than asset returns for quite a long time. This means that having a substantial fixed income allocation might be a moderate drag on asset returns but it is fairly negligible drag on overall portfolio growth until you have enough money relative to your contributions. On the flip side, a realistic bear market a few years in could easily wipe out a few years of contributions. This is not the end of the world of course because you have plenty of time to recover before retirement, but it can significantly delay the stage where your asset returns begin to matter significantly relative to new contributions. So basically, 100% equities when you don't have too much money to begin with seems to be a very low return but decently high risk proposition to me.

If you have a very strong risk tolerance, I can even see the case for going 100% equities 7-10 years in (just based on the rough numbers I was looking at) when you have enough money, but starting with a fairly substantial fixed income allocation seems to be a really good deal until then. (Of course, once you have enough money, presumably the behavioral risks could increase too.)

Is this argument reasonable? Am I missing something?

MarkVH0518
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Re: Equity allocation for young investors: am I missing something?

Post by MarkVH0518 » Mon Feb 10, 2020 8:30 pm

I'm having a little trouble following, but if you are suggesting a 60% stock/40% bond allocation for brand new investors,
that allocation can be justified for skittish new investors.
Ordinarily, 60/40 is a moderately aggressive retirement portfolio.
redbarn wrote:
Mon Feb 10, 2020 5:33 pm
So basically, 100% equities when you don't have too much money to begin with seems to be a very low return but decently high risk proposition to me.
100% stocks is *most certainly* not a low return allocation. 100% stock is a *high* return allocation.
On average, 100% stock allocation will have a higher return over a 60/40 allocation.
Remember that any of those very early gains will be compounded for a significant length of time.
For a 25-year-old who is saving for retirement at age 60, 100% stock allocation is perfectly justifiable.

On the other hand, if a young investor is skittish and pulls out of the market after a big downturn,
then the compounding doesn't happen.
And, more significantly, if the investor never, ever returns to the market throughout
the remainder of their working life (as can happen), then the risk of 100% stock allocation too, too high.

I do agree that the loss of earnings in a 60/40 allocation while new contributions are a large percentage of the portfolio
is not a really big impact. But the impact of compounding will begin to have a pretty significant impact pretty quickly.

in conclusion, this is a risk issue, not a return issue.

Regards,
Mark

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Re: Equity allocation for young investors: am I missing something?

Post by rascott » Mon Feb 10, 2020 9:35 pm

In practice...... you turn it on (assuming you are using something simple like a 401k plan)..... and basically forget about it. Only time you should bother with it is to up your contribution %.

I did this for basically my first 15+ years of working..... all 100% equity index funds. Cruised right through 2008 without losing any sleep.... did nothing but increase my contributions until it hurt. Didn't even look at the balances.

I'm almost 40, and remain 100% equities (outside of a comfortable emergency fund) with no plan to change anytime soon.

I see absolutely no reason a young person starting out should hold any bonds. It's just going to be a drag during this early accumulation period.

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redbarn
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Re: Equity allocation for young investors: am I missing something?

Post by redbarn » Tue Feb 11, 2020 12:41 am

I think I might not have been so clear about what I meant. Let me give a fictitious numerical example.

Compare these two options:

(A) 100/0 stock bond
(B) 65/35 stock/bond for 10 years and then 100/0

Assume that a person contributes 20 (thousand) in real terms each year starting with 0. Since the asset allocation would be identical at 10 years, we can just compare what might happen in year 10.

Scenario 1 (reasonable expected returns): Stock returns are 5% real, bond returns 0% real. In this case, you end up with 259 under (B) vs. 284 for (A). (A) is 25 better.

Scenario 2 (good stock market): Stock returns are 7% real, bond returns 0%. In this case, you end up with 316 vs. 278, so scenario (A) is 38 better.

Scenario 3 (bear market in the middle): Assume stock returns are 5% but a 35% loss in year 5. Bond returns are still 0%. In this case, you end up with 240 under (B) vs. 228 under (A). (B) is better in this case, by about 12.

Scenario 4 (late bear market): Assume stock returns are 5% but a 35% in year 7 this time. Bond returns still assumes 0%. Now you get 210 for (B) vs. 159 for (A). So (B) is 51 better.

Looking at numbers like these, (B) seems pretty defensible for young investors even apart from any behavioral argument. I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period. It is obviously a risk vs. reward thing, but the point is that there is a "real" risk that matters in this context even for young investors, not just a behavioral risk.

(I am not fully convinced by my reasoning though and would like to see the potential flaws.)

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andromeda2k12
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Re: Equity allocation for young investors: am I missing something?

Post by andromeda2k12 » Tue Feb 11, 2020 12:57 am

redbarn wrote:
Tue Feb 11, 2020 12:41 am
I think I might not have been so clear about what I meant. Let me give a fictitious numerical example.

Compare these two options:

(A) 100/0 stock bond
(B) 65/35 stock/bond for 10 years and then 100/0

Assume that a person contributes 20 (thousand) in real terms each year starting with 0. Since the asset allocation would be identical at 10 years, we can just compare what might happen in year 10.

Scenario 1 (reasonable expected returns): Stock returns are 5% real, bond returns 0% real. In this case, you end up with 259 under (B) vs. 284 for (A). (A) is 25 better.

Scenario 2 (good stock market): Stock returns are 7% real, bond returns 0%. In this case, you end up with 316 vs. 278, so scenario (A) is 38 better.

Scenario 3 (bear market in the middle): Assume stock returns are 5% but a 35% loss in year 5. Bond returns are still 0%. In this case, you end up with 240 under (B) vs. 228 under (A). (B) is better in this case, by about 12.

Scenario 4 (late bear market): Assume stock returns are 5% but a 35% in year 7 this time. Bond returns still assumes 0%. Now you get 210 for (B) vs. 159 for (A). So (B) is 51 better.

Looking at numbers like these, (B) seems pretty defensible for young investors even apart from any behavioral argument. I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period. It is obviously a risk vs. reward thing, but the point is that there is a "real" risk that matters in this context even for young investors, not just a behavioral risk.

(I am not fully convinced by my reasoning though and would like to see the potential flaws.)
Stocks can underperform bonds for a decade, but there has never been a 20 year period where stocks have underperformed short term treasuries.

If a young investor has a 30+ year time horizon, the stock investment is almost guaranteed to outperform bonds. That’s why people recommend 100% equity to young people from a rational sense.

If someone will need the money in 10 years or less then what your saying might make sense for them, but if it’s in a retirement account or they won’t touch it for 30 years then 100% equities is almost certain to give you the best result.

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Re: Equity allocation for young investors: am I missing something?

Post by oken » Tue Feb 11, 2020 1:19 am

If you've been investing for 2 years and lose 50%, you will make it up in a year.
If you're investing for 10 years and lose 50%, you will need 5+ years to make it up.
I'd much rather meet the bear after 2 years than after 10.
Meeting the bear after 2 years will hopefully also help to steel you for the next bear when you will probably lose much more...

rascott
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Re: Equity allocation for young investors: am I missing something?

Post by rascott » Tue Feb 11, 2020 1:26 am

Is this the reverse lifecycle investing thread?

The Benjamin Button portfolio?



OP.... if you can predict bear markets in advance... you should be 100% bonds once your prediction triggers. Better yet.. start a hedge fund tomorrow.

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Re: Equity allocation for young investors: am I missing something?

Post by msk » Tue Feb 11, 2020 1:34 am

Sigh. Most of these AA arguments are based on the imagining that anyone learns from others' wisdom and experience. Maybe true for the 50 year-olds who have already missed the get-rich boat; almost certainly not true for many of us when we were in our 20s and 30s. Any 25 year old "knows" that it is possible to accumulate great wealth in the stock market, that it is "possible" to time the market (all the TV talking heads say so many times a day), etc. What makes you insist that the kid is not the next Buffett? IMHO the best advice to give the 25 year old is to go 100% diversified stocks. He may listen, but I expect that he will still play individual stock picks...There WILL be a market correction. The kid WILL try to time the market and have his fingers burnt and he WILL learn BH principles. Permanently, first hand. We oldsters learned the same way :mrgreen: But you never know. The kid may actually listen to the BH philosophy and simply stick it out. Either way he will be set for life. The other nonsense that gets repeated endlessly is that you do not put the $ in the market that you will need for down payments on your home, etc. within a few years. "Few" seems to vary from anything between 2 and 10. I absolutely disagree. Practically all our prospective expenditures are flexible in timing. Take the home deposit. So what if there is a stock market collapse 5 years from now and your carefully planned home purchase is in Year 6. Big deal. Just wait! In the meantime staying out of the stock market might well have lost you a doubling of your savings. Extending this logic beyond reason is to set aside several 100k$ for a possible medical emergency. That certainly is not time flexible. Kid: load up on 100% stocks today and start getting rich :moneybag from a 75 year-old still at 100% stocks worldwide by market weight :shock:

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Steve Reading
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Re: Equity allocation for young investors: am I missing something?

Post by Steve Reading » Tue Feb 11, 2020 1:36 am

redbarn wrote:
Tue Feb 11, 2020 12:41 am
I think I might not have been so clear about what I meant. Let me give a fictitious numerical example.

Compare these two options:

(A) 100/0 stock bond
(B) 65/35 stock/bond for 10 years and then 100/0

Assume that a person contributes 20 (thousand) in real terms each year starting with 0. Since the asset allocation would be identical at 10 years, we can just compare what might happen in year 10.

Scenario 1 (reasonable expected returns): Stock returns are 5% real, bond returns 0% real. In this case, you end up with 259 under (B) vs. 284 for (A). (A) is 25 better.

Scenario 2 (good stock market): Stock returns are 7% real, bond returns 0%. In this case, you end up with 316 vs. 278, so scenario (A) is 38 better.

Scenario 3 (bear market in the middle): Assume stock returns are 5% but a 35% loss in year 5. Bond returns are still 0%. In this case, you end up with 240 under (B) vs. 228 under (A). (B) is better in this case, by about 12.

Scenario 4 (late bear market): Assume stock returns are 5% but a 35% in year 7 this time. Bond returns still assumes 0%. Now you get 210 for (B) vs. 159 for (A). So (B) is 51 better.

Looking at numbers like these, (B) seems pretty defensible for young investors even apart from any behavioral argument. I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period. It is obviously a risk vs. reward thing, but the point is that there is a "real" risk that matters in this context even for young investors, not just a behavioral risk.

(I am not fully convinced by my reasoning though and would like to see the potential flaws.)
The difference in those results is due to market timing outside of your control. Evidently, if you invest conservatively first and then aggressively, you’ll do better if the market drops first (scenarios 3 and 4) and rallies later than otherwise.

The correct framework however is to understand what’s the biggest risk to an accumulator. Scenario 2 is a very risky one for an accumulator. If stocks rally now, when he barely has money in, he doesn’t participate. Then prices are high and he’s stuck buying high. So a high stock allocation when accumulating serves as a hedge; of the market does poorly and you lose money, you’ll get to accumulate shares slightly cheaper. If the market skyrockets, forcing your contributions to buy expensive stock, well at least you made money on your current savings. Investing conservatively at first is totally backwards and only serves to exacerbate the worst case scenario of the accumulator

That’s why theory (Lifecycle Investing) and historical data suggests accumulators should actually leverage in stocks (go past 100%) when young.

Something to consider

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Re: Equity allocation for young investors: am I missing something?

Post by Ari » Tue Feb 11, 2020 10:25 am

I think your argument makes sense and the replies you've had seem to be missing your point entirely. It's interesting stuff. Personally, I've always been 100% stock, but it makes sense that your allocation matters little when your contributions dwarf your asset growth. What you're protecting against would be a bear market that cuts down your portfolio and also costs you your job, forcing you to withdraw your money early.

In practice, I think most people here would encourage the construction of an emergency fund, which would give a result more in line with what you're suggesting. You'd be bond/cash-heavy in the beginning, building up your emergency fund, then you'd be increasing your equity portfolio. Once your equity grows enough, you might even skip the emergency fund, since your equity portfolio is large enough that it can support you for some time even if the value drops significantly.
All in, all the time.

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Re: Equity allocation for young investors: am I missing something?

Post by nisiprius » Tue Feb 11, 2020 10:45 am

What you are missing is that you probably are not "purely rational," and your mistake is in thinking that you are already, or that you can become "purely rational" simply by deciding to be.

One of the more depressing results of behavioral economics is that knowing about behavioral errors does not necessarily enable you to avoid them. For example, one kind of behavioral error is "anchoring," and:

Difficulty of avoiding anchoring
Other studies have tried to eliminate anchoring much more directly. In a study exploring the causes and properties of anchoring, participants were exposed to an anchor and asked to guess how many physicians were listed in the local phone book. In addition, they were explicitly informed that anchoring would "contaminate" their responses, and that they should do their best to correct for that. A control group received no anchor and no explanation. Regardless of how they were informed and whether they were informed correctly, all of the experimental groups reported higher estimates than the control group. Thus, despite being expressly aware of the anchoring effect, participants were still unable to avoid it. A later study found that even when offered monetary incentives, people are unable to effectively adjust from an anchor.
Now, where is the magic in 100%? Why is 100% the right number, and not 90% or 110%? If 100% is better, why isn't 110%? Why not 120%? Why not 200%? My suspicion is that 100% is, in fact, an example of a behavioral error: "anchoring" on the number 100% simply because of irrelevant appearances in phrases like "100% effort" or "100% commitment," as if stocks loved people who were 100% faithful. There is an argument based on the "Kelly criterion" that I half-understand on a good day that actually does give a rational reason for there being a limit, but unfortunately there's no recognized accurate value for a stock market investment; the calculation applies to betting sequences in which the precise odds are known in advance. Basically, the idea is that the more leverage you use, the higher will be your mathematically expected return--but, unfortunately, the higher is your probability of ruin. Parlaying leveraged bets year after year gives you a near-certainty of ruin coupled with a microscopic probability of astronomical wealth. If you calculate logarithm of average wealth, it says you should do it, but if you calculate average logarithm of wealth, it says you should not. I think.

There certainly are people in the world who really have a high risk tolerance, and they often have biographies that say that they "made and lost several fortunes." The stock operator Jesse Livermore did, finally losing it all and committing suicide. One can ask the question, "from a purely rational point of view, was he was better off than if he had never made a fortune at all?" I think that by simply asking that question, I've exposed a limitation in the idea of trying to evaluate things from a "purely rational" point of view.
Last edited by nisiprius on Tue Feb 11, 2020 11:01 am, edited 3 times in total.
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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 10:51 am

redbarn wrote:
Mon Feb 10, 2020 5:33 pm

On the flip side, a realistic bear market a few years in could easily wipe out a few years of contributions. This is not the end of the world of course because you have plenty of time to recover before retirement,
redbarn,

In a recession, the bear market and unemployment tend to happen at the same time for many people. For those people, it could be the end of the world if they cannot find sufficient employment before the recovery.

In the coming recession, the fresh batch of young investors will learn this lesson. Being young does not mean the person does not need to pay the bills.

It is very simple.

A) Keep 3 to 6 months of the emergency fund.

B) Keep an AA of 60/40 at all times.

It works.

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by rockstar » Tue Feb 11, 2020 10:56 am

KlangFool wrote:
Tue Feb 11, 2020 10:51 am
redbarn wrote:
Mon Feb 10, 2020 5:33 pm

On the flip side, a realistic bear market a few years in could easily wipe out a few years of contributions. This is not the end of the world of course because you have plenty of time to recover before retirement,
redbarn,

In a recession, the bear market and unemployment tend to happen at the same time for many people. For those people, it could be the end of the world if they cannot find sufficient employment before the recovery.

In the coming recession, the fresh batch of young investors will learn this lesson. Being young does not mean the person does not need to pay the bills.

It is very simple.

A) Keep 3 to 6 months of the emergency fund.

B) Keep an AA of 60/40 at all times.

It works.

KlangFool
And that partially explains why stocks are cheap. When unemployment is high, you have fewer people buying them. They tell you to buy when folks are fearful. However, if you don’t have a job, you can’t buy low because you need to spend your savings on cost of living. It’s why investors with the best intentions buy high and sell low.

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Re: Equity allocation for young investors: am I missing something?

Post by willthrill81 » Tue Feb 11, 2020 11:02 am

nisiprius wrote:
Tue Feb 11, 2020 10:45 am
Now, where is the magic in 100%? Why is 100% the right number, and not 90% or 110%? If 100% is better, why isn't 110%? Why not 120%? Why not 200%?
Because you cannot go above 100% without using leverage. That's easier today with leveraged ETFs, but it's still a different animal.
“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: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 11:04 am

rockstar wrote:
Tue Feb 11, 2020 10:56 am
KlangFool wrote:
Tue Feb 11, 2020 10:51 am
redbarn wrote:
Mon Feb 10, 2020 5:33 pm

On the flip side, a realistic bear market a few years in could easily wipe out a few years of contributions. This is not the end of the world of course because you have plenty of time to recover before retirement,
redbarn,

In a recession, the bear market and unemployment tend to happen at the same time for many people. For those people, it could be the end of the world if they cannot find sufficient employment before the recovery.

In the coming recession, the fresh batch of young investors will learn this lesson. Being young does not mean the person does not need to pay the bills.

It is very simple.

A) Keep 3 to 6 months of the emergency fund.

B) Keep an AA of 60/40 at all times.

It works.

KlangFool
And that partially explains why stocks are cheap. When unemployment is high, you have fewer people buying them. They tell you to buy when folks are fearful. However, if you don’t have a job, you can’t buy low because you need to spend your savings on cost of living. It’s why investors with the best intentions buy high and sell low.
rockstar,

The other part of this is the investors that are 100% stock with a minimal emergency fund capitulated when they find out they have no job security. Many people assume that they have great job security until their employers start laying off people in a recession.

They have to sell at any price. They need the money to pay the bills. This has nothing to do with the investors' emotional makeup. Pay the bill or sleep on the street. They do not have the ability to take risk.

KlangFool

rockstar
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Re: Equity allocation for young investors: am I missing something?

Post by rockstar » Tue Feb 11, 2020 11:08 am

KlangFool wrote:
Tue Feb 11, 2020 11:04 am
rockstar wrote:
Tue Feb 11, 2020 10:56 am
KlangFool wrote:
Tue Feb 11, 2020 10:51 am
redbarn wrote:
Mon Feb 10, 2020 5:33 pm

On the flip side, a realistic bear market a few years in could easily wipe out a few years of contributions. This is not the end of the world of course because you have plenty of time to recover before retirement,
redbarn,

In a recession, the bear market and unemployment tend to happen at the same time for many people. For those people, it could be the end of the world if they cannot find sufficient employment before the recovery.

In the coming recession, the fresh batch of young investors will learn this lesson. Being young does not mean the person does not need to pay the bills.

It is very simple.

A) Keep 3 to 6 months of the emergency fund.

B) Keep an AA of 60/40 at all times.

It works.

KlangFool
And that partially explains why stocks are cheap. When unemployment is high, you have fewer people buying them. They tell you to buy when folks are fearful. However, if you don’t have a job, you can’t buy low because you need to spend your savings on cost of living. It’s why investors with the best intentions buy high and sell low.
rockstar,

The other part of this is the investors that are 100% stock with a minimal emergency fund capitulated when they find out they have no job security. Many people assume that they have great job security until their employers start laying off people in a recession.

They have to sell at any price. They need the money to pay the bills. This has nothing to do with the investors' emotional makeup. Pay the bill or sleep on the street. They do not have the ability to take risk.

KlangFool
It’s why you’re dead on with the emergency fund. It’s a must have to stay the course. Otherwise, you end up selling positions for a loss if you’re riding out a drop.

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Re: Equity allocation for young investors: am I missing something?

Post by nisiprius » Tue Feb 11, 2020 11:09 am

rockstar wrote:
Tue Feb 11, 2020 10:56 am
And that partially explains why stocks are cheap. When unemployment is high, you have fewer people buying them. They tell you to buy when folks are fearful. However, if you don’t have a job, you can’t buy low because you need to spend your savings on cost of living. It’s why investors with the best intentions buy high and sell low.
Right. John Jakob Raskob told an interviewer for the Ladies' Home Journal that Everybody Ought to be Rich. His premise was that if you invested $15 a month (equivalent to $222 today) into "good" common stocks and simply bought, held, and reinvested dividends, you would reach financial independence in twenty years. (By "good" common stocks, he meant stocks paying double the average return of the stock market, but that's another issue).

Anyway, the interview appeared in September, 1929.

Benjamin Roth's The Great Depression: A Diary is really worth reading. Throughout the depression, Roth, a young lawyer, laments how badly the depression is for "professional men," and is constantly aware of screaming bargains in stocks and real estate that he cannot take advantage of.

A side note that I hadn't realized before reading the book, is that even if your bank didn't actually fail, many of them froze withdrawals. Since nobody knew when it would be possible to make a withdrawal, there was actually a market in "bankbooks," i.e. you could sign over your bankbook to a buyer who would assume ownership of your bank account. Newspapers regularly printed the rates for various banks, which IIRC were typically in the range of $0.25 to $0.50 on the dollar.
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: Equity allocation for young investors: am I missing something?

Post by langlands » Tue Feb 11, 2020 11:11 am

Ari wrote:
Tue Feb 11, 2020 10:25 am
I think your argument makes sense and the replies you've had seem to be missing your point entirely. It's interesting stuff. Personally, I've always been 100% stock, but it makes sense that your allocation matters little when your contributions dwarf your asset growth. What you're protecting against would be a bear market that cuts down your portfolio and also costs you your job, forcing you to withdraw your money early.

In practice, I think most people here would encourage the construction of an emergency fund, which would give a result more in line with what you're suggesting. You'd be bond/cash-heavy in the beginning, building up your emergency fund, then you'd be increasing your equity portfolio. Once your equity grows enough, you might even skip the emergency fund, since your equity portfolio is large enough that it can support you for some time even if the value drops significantly.
Agree with this entirely. OP in his own way is rediscovering the concept of an emergency fund. Also as you say, once your equity portfolio is large enough you no longer need a literal separate emergency fund.

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Re: Equity allocation for young investors: am I missing something?

Post by MotoTrojan » Tue Feb 11, 2020 11:12 am

You contribute to bonds for 10 years, market steadily climbs, then you switch to 100% equity and it falls out. Or you freak out that the market hasn't had a significant decline in 20 years, so you stay in bonds, and miss another 10 years.

Pick an AA, stick to it. This makes no sense to me.

FWIW I am a new investor and 100% equity with higher risk profile than 100% Total World.

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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 11:14 am

rockstar wrote:
Tue Feb 11, 2020 11:08 am
KlangFool wrote:
Tue Feb 11, 2020 11:04 am
rockstar wrote:
Tue Feb 11, 2020 10:56 am
KlangFool wrote:
Tue Feb 11, 2020 10:51 am
redbarn wrote:
Mon Feb 10, 2020 5:33 pm

On the flip side, a realistic bear market a few years in could easily wipe out a few years of contributions. This is not the end of the world of course because you have plenty of time to recover before retirement,
redbarn,

In a recession, the bear market and unemployment tend to happen at the same time for many people. For those people, it could be the end of the world if they cannot find sufficient employment before the recovery.

In the coming recession, the fresh batch of young investors will learn this lesson. Being young does not mean the person does not need to pay the bills.

It is very simple.

A) Keep 3 to 6 months of the emergency fund.

B) Keep an AA of 60/40 at all times.

It works.

KlangFool
And that partially explains why stocks are cheap. When unemployment is high, you have fewer people buying them. They tell you to buy when folks are fearful. However, if you don’t have a job, you can’t buy low because you need to spend your savings on cost of living. It’s why investors with the best intentions buy high and sell low.
rockstar,

The other part of this is the investors that are 100% stock with a minimal emergency fund capitulated when they find out they have no job security. Many people assume that they have great job security until their employers start laying off people in a recession.

They have to sell at any price. They need the money to pay the bills. This has nothing to do with the investors' emotional makeup. Pay the bill or sleep on the street. They do not have the ability to take risk.

KlangFool
It’s why you’re dead on with the emergency fund. It’s a must have to stay the course. Otherwise, you end up selling positions for a loss if you’re riding out a drop.
After 10+ years of the bull market, we have plenty of people advocating that the emergency fund is a return drag to the investors. Speaking of that. One just pops up right on time.

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by nisiprius » Tue Feb 11, 2020 11:15 am

willthrill81 wrote:
Tue Feb 11, 2020 11:02 am
nisiprius wrote:
Tue Feb 11, 2020 10:45 am
Now, where is the magic in 100%? Why is 100% the right number, and not 90% or 110%? If 100% is better, why isn't 110%? Why not 120%? Why not 200%?
Because you cannot go above 100% without using leverage. That's easier today with leveraged ETFs, but it's still a different animal.
Yes, but as long as you assume that the average return of the stock market is higher than the average cost of a margin loan, it's still beneficial. It just means that the marginal gain in expected return of going from 100% to 110% isn't as high as the marginal gain in going from 90% to 100%. There's a corner there, but not a discontinuity. There's no reason to stop at 100% unless risk means something. Risk tolerance has to be in the equation somehow. And there isn't any "purely rational" objectively correct risk tolerance.
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Re: Equity allocation for young investors: am I missing something?

Post by willthrill81 » Tue Feb 11, 2020 11:16 am

nisiprius wrote:
Tue Feb 11, 2020 11:15 am
willthrill81 wrote:
Tue Feb 11, 2020 11:02 am
nisiprius wrote:
Tue Feb 11, 2020 10:45 am
Now, where is the magic in 100%? Why is 100% the right number, and not 90% or 110%? If 100% is better, why isn't 110%? Why not 120%? Why not 200%?
Because you cannot go above 100% without using leverage. That's easier today with leveraged ETFs, but it's still a different animal.
Yes, but as long as you assume that the average return of the stock market is higher than the average cost of a margin loan, it's still beneficial. It just means that the marginal gain in expected return of going from 100% to 110% isn't as high as the marginal gain in going from 90% to 100%. There's a corner there, but not a discontinuity. There's no reason to stop at 100% unless risk means something. Risk tolerance has to be in the equation somehow. And there isn't any "purely rational" objectively correct risk tolerance.
100% agree, especially with the underlined (emphasis added).
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Re: Equity allocation for young investors: am I missing something?

Post by alibaba123 » Tue Feb 11, 2020 11:20 am

redbarn wrote:
Tue Feb 11, 2020 12:41 am
I think I might not have been so clear about what I meant. Let me give a fictitious numerical example.

Compare these two options:

(A) 100/0 stock bond
(B) 65/35 stock/bond for 10 years and then 100/0

Assume that a person contributes 20 (thousand) in real terms each year starting with 0. Since the asset allocation would be identical at 10 years, we can just compare what might happen in year 10.

Scenario 1 (reasonable expected returns): Stock returns are 5% real, bond returns 0% real. In this case, you end up with 259 under (B) vs. 284 for (A). (A) is 25 better.

Scenario 2 (good stock market): Stock returns are 7% real, bond returns 0%. In this case, you end up with 316 vs. 278, so scenario (A) is 38 better.

Scenario 3 (bear market in the middle): Assume stock returns are 5% but a 35% loss in year 5. Bond returns are still 0%. In this case, you end up with 240 under (B) vs. 228 under (A). (B) is better in this case, by about 12.

Scenario 4 (late bear market): Assume stock returns are 5% but a 35% in year 7 this time. Bond returns still assumes 0%. Now you get 210 for (B) vs. 159 for (A). So (B) is 51 better.

Looking at numbers like these, (B) seems pretty defensible for young investors even apart from any behavioral argument. I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period. It is obviously a risk vs. reward thing, but the point is that there is a "real" risk that matters in this context even for young investors, not just a behavioral risk.

(I am not fully convinced by my reasoning though and would like to see the potential flaws.)
I didn't run your numbers but you could be assuming the stock market wouldn't bounce back from a 35% drop but instead goes on to return a mild 5-7% annually. Historically, big drops have been followed by big recoveries.


The 5-7% returns you speak of are long term averages which have already taken into account occassional big drops such as your hypothetical 35% drop. So if you pit a 100% stock allocation vs a 65/35 allocation, the 100% stock always has a higher expected return, even for a young investor. And that difference in stash at year 10 will go on to compound even further after that.
Last edited by alibaba123 on Tue Feb 11, 2020 11:45 am, edited 1 time in total.

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Re: Equity allocation for young investors: am I missing something?

Post by rockstar » Tue Feb 11, 2020 11:26 am

KlangFool wrote:
Tue Feb 11, 2020 11:14 am
rockstar wrote:
Tue Feb 11, 2020 11:08 am
KlangFool wrote:
Tue Feb 11, 2020 11:04 am
rockstar wrote:
Tue Feb 11, 2020 10:56 am
KlangFool wrote:
Tue Feb 11, 2020 10:51 am


redbarn,

In a recession, the bear market and unemployment tend to happen at the same time for many people. For those people, it could be the end of the world if they cannot find sufficient employment before the recovery.

In the coming recession, the fresh batch of young investors will learn this lesson. Being young does not mean the person does not need to pay the bills.

It is very simple.

A) Keep 3 to 6 months of the emergency fund.

B) Keep an AA of 60/40 at all times.

It works.

KlangFool
And that partially explains why stocks are cheap. When unemployment is high, you have fewer people buying them. They tell you to buy when folks are fearful. However, if you don’t have a job, you can’t buy low because you need to spend your savings on cost of living. It’s why investors with the best intentions buy high and sell low.
rockstar,

The other part of this is the investors that are 100% stock with a minimal emergency fund capitulated when they find out they have no job security. Many people assume that they have great job security until their employers start laying off people in a recession.

They have to sell at any price. They need the money to pay the bills. This has nothing to do with the investors' emotional makeup. Pay the bill or sleep on the street. They do not have the ability to take risk.

KlangFool
It’s why you’re dead on with the emergency fund. It’s a must have to stay the course. Otherwise, you end up selling positions for a loss if you’re riding out a drop.
After 10+ years of the bull market, we have plenty of people advocating that the emergency fund is a return drag to the investors. Speaking of that. One just pops up right on time.

KlangFool
Or use the bond allocated portion of your portfolio as an emergency fund. But you have to keep it liquid and as risk free as possible to be able to do that.

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Re: Equity allocation for young investors: am I missing something?

Post by Portfolio7 » Tue Feb 11, 2020 11:30 am

KlangFool wrote:
Tue Feb 11, 2020 10:51 am
redbarn wrote:
Mon Feb 10, 2020 5:33 pm
On the flip side, a realistic bear market a few years in could easily wipe out a few years of contributions. This is not the end of the world of course because you have plenty of time to recover before retirement,
redbarn,
A) Keep 3 to 6 months of the emergency fund.
B) Keep an AA of 60/40 at all times.
KlangFool
Klangfool, I thought you advocated basing your AA on annual expense multiples? I copied the below from your post of Feb 10th last year because I liked the thought process behind it. I'm not quite 10R yet, and interestingly enough I'm currently at 75/25. Have you changed your viewpoint/approach (or maybe because you are over 20R you are just thinking in terms of your present day allocation?)

Between 0 and 5R, 80/20
Between 5R and 10R, 75/25
Between 10R and 15R, 70/30
Between 15R and 20R, 65/35
Between 20R and 25R, 60/40
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Re: Equity allocation for young investors: am I missing something?

Post by willthrill81 » Tue Feb 11, 2020 11:31 am

rockstar wrote:
Tue Feb 11, 2020 11:26 am
KlangFool wrote:
Tue Feb 11, 2020 11:14 am
rockstar wrote:
Tue Feb 11, 2020 11:08 am
KlangFool wrote:
Tue Feb 11, 2020 11:04 am
rockstar wrote:
Tue Feb 11, 2020 10:56 am


And that partially explains why stocks are cheap. When unemployment is high, you have fewer people buying them. They tell you to buy when folks are fearful. However, if you don’t have a job, you can’t buy low because you need to spend your savings on cost of living. It’s why investors with the best intentions buy high and sell low.
rockstar,

The other part of this is the investors that are 100% stock with a minimal emergency fund capitulated when they find out they have no job security. Many people assume that they have great job security until their employers start laying off people in a recession.

They have to sell at any price. They need the money to pay the bills. This has nothing to do with the investors' emotional makeup. Pay the bill or sleep on the street. They do not have the ability to take risk.

KlangFool
It’s why you’re dead on with the emergency fund. It’s a must have to stay the course. Otherwise, you end up selling positions for a loss if you’re riding out a drop.
After 10+ years of the bull market, we have plenty of people advocating that the emergency fund is a return drag to the investors. Speaking of that. One just pops up right on time.

KlangFool
Or use the bond allocated portion of your portfolio as an emergency fund. But you have to keep it liquid and as risk free as possible to be able to do that.
Correct. Investors do not necessarily need an emergency fund. What they do need is liquidity, and the bond portion of one's AA may provide enough of it.
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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 11:35 am

langlands wrote:
Tue Feb 11, 2020 11:11 am
Ari wrote:
Tue Feb 11, 2020 10:25 am
I think your argument makes sense and the replies you've had seem to be missing your point entirely. It's interesting stuff. Personally, I've always been 100% stock, but it makes sense that your allocation matters little when your contributions dwarf your asset growth. What you're protecting against would be a bear market that cuts down your portfolio and also costs you your job, forcing you to withdraw your money early.

In practice, I think most people here would encourage the construction of an emergency fund, which would give a result more in line with what you're suggesting. You'd be bond/cash-heavy in the beginning, building up your emergency fund, then you'd be increasing your equity portfolio. Once your equity grows enough, you might even skip the emergency fund, since your equity portfolio is large enough that it can support you for some time even if the value drops significantly.
Agree with this entirely. OP in his own way is rediscovering the concept of an emergency fund. Also as you say, once your equity portfolio is large enough you no longer need a literal separate emergency fund.
langlands,

I disagreed.

1) My AA is 60/40. My taxable account is 100% stock with 500K in it.

2) I have 1 1/2 years of the emergency fund.

I do not enjoy selling the stock and/or the bond at a loss in a recession.

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by willthrill81 » Tue Feb 11, 2020 11:37 am

KlangFool wrote:
Tue Feb 11, 2020 11:35 am
I do not enjoy selling the stock and/or the bond at a loss in a recession.
Why do you believe that you would need to sell bonds at a loss in a recession?
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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 11:39 am

Portfolio7 wrote:
Tue Feb 11, 2020 11:30 am
KlangFool wrote:
Tue Feb 11, 2020 10:51 am
redbarn wrote:
Mon Feb 10, 2020 5:33 pm
On the flip side, a realistic bear market a few years in could easily wipe out a few years of contributions. This is not the end of the world of course because you have plenty of time to recover before retirement,
redbarn,
A) Keep 3 to 6 months of the emergency fund.
B) Keep an AA of 60/40 at all times.
KlangFool
Klangfool, I thought you advocated basing your AA on annual expense multiples? I copied the below from your post of Feb 10th last year because I liked the thought process behind it. I'm not quite 10R yet, and interestingly enough I'm currently at 75/25. Have you changed your viewpoint/approach (or maybe because you are over 20R you are just thinking in terms of your present day allocation?)

Between 0 and 5R, 80/20
Between 5R and 10R, 75/25
Between 10R and 15R, 70/30
Between 15R and 20R, 65/35
Between 20R and 25R, 60/40
Portfolio7,

1) OP is a young investor. It is not necessary to overcomplicate the AA. If and when OP wants to learn more, we can introduce OP to glide path AA adjustment.

2) Please note that AA of 60/40 is good enough for all the times if the investor is not interested in glide path AA adjustment.

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 11:41 am

willthrill81 wrote:
Tue Feb 11, 2020 11:37 am
KlangFool wrote:
Tue Feb 11, 2020 11:35 am
I do not enjoy selling the stock and/or the bond at a loss in a recession.
Why do you believe that you would need to sell bonds at a loss in a recession?
willthrill81,

Without an emergency fund and if I am unemployed, I have to sell something to pay the bills. In a recession, both the stock and the bond may be down at the same time.

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 11:43 am

rockstar wrote:
Tue Feb 11, 2020 11:26 am
KlangFool wrote:
Tue Feb 11, 2020 11:14 am
rockstar wrote:
Tue Feb 11, 2020 11:08 am
KlangFool wrote:
Tue Feb 11, 2020 11:04 am
rockstar wrote:
Tue Feb 11, 2020 10:56 am


And that partially explains why stocks are cheap. When unemployment is high, you have fewer people buying them. They tell you to buy when folks are fearful. However, if you don’t have a job, you can’t buy low because you need to spend your savings on cost of living. It’s why investors with the best intentions buy high and sell low.
rockstar,

The other part of this is the investors that are 100% stock with a minimal emergency fund capitulated when they find out they have no job security. Many people assume that they have great job security until their employers start laying off people in a recession.

They have to sell at any price. They need the money to pay the bills. This has nothing to do with the investors' emotional makeup. Pay the bill or sleep on the street. They do not have the ability to take risk.

KlangFool
It’s why you’re dead on with the emergency fund. It’s a must have to stay the course. Otherwise, you end up selling positions for a loss if you’re riding out a drop.
After 10+ years of the bull market, we have plenty of people advocating that the emergency fund is a return drag to the investors. Speaking of that. One just pops up right on time.

KlangFool
Or use the bond allocated portion of your portfolio as an emergency fund. But you have to keep it liquid and as risk free as possible to be able to do that.
The bond could still be down regardless of how risk-free it is. It is simpler just to keep some cash in the checking account and the MMF.

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by rockstar » Tue Feb 11, 2020 11:55 am

KlangFool wrote:
Tue Feb 11, 2020 11:43 am
rockstar wrote:
Tue Feb 11, 2020 11:26 am
KlangFool wrote:
Tue Feb 11, 2020 11:14 am
rockstar wrote:
Tue Feb 11, 2020 11:08 am
KlangFool wrote:
Tue Feb 11, 2020 11:04 am


rockstar,

The other part of this is the investors that are 100% stock with a minimal emergency fund capitulated when they find out they have no job security. Many people assume that they have great job security until their employers start laying off people in a recession.

They have to sell at any price. They need the money to pay the bills. This has nothing to do with the investors' emotional makeup. Pay the bill or sleep on the street. They do not have the ability to take risk.

KlangFool
It’s why you’re dead on with the emergency fund. It’s a must have to stay the course. Otherwise, you end up selling positions for a loss if you’re riding out a drop.
After 10+ years of the bull market, we have plenty of people advocating that the emergency fund is a return drag to the investors. Speaking of that. One just pops up right on time.

KlangFool
Or use the bond allocated portion of your portfolio as an emergency fund. But you have to keep it liquid and as risk free as possible to be able to do that.
The bond could still be down regardless of how risk-free it is. It is simpler just to keep some cash in the checking account and the MMF.

KlangFool
I was thinking about 3 months or less t-bills that you can sell on the secondary market if you need fast cash. Of course, you want to keep liquid cash to cover the time difference.

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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 12:03 pm

rockstar wrote:
Tue Feb 11, 2020 11:55 am

I was thinking about 3 months or less t-bills that you can sell on the secondary market if you need fast cash. Of course, you want to keep liquid cash to cover the time difference.
rockstar,

Why would I want to do that when my MMF is paying about the same amount of interest?

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by willthrill81 » Tue Feb 11, 2020 12:19 pm

KlangFool wrote:
Tue Feb 11, 2020 11:41 am
willthrill81 wrote:
Tue Feb 11, 2020 11:37 am
KlangFool wrote:
Tue Feb 11, 2020 11:35 am
I do not enjoy selling the stock and/or the bond at a loss in a recession.
Why do you believe that you would need to sell bonds at a loss in a recession?
willthrill81,

Without an emergency fund and if I am unemployed, I have to sell something to pay the bills. In a recession, both the stock and the bond may be down at the same time.

KlangFool
With yields at current levels, I'll readily admit that there seemingly isn't much to gain from owning TBM vs. a high-yield savings account or similar instruments right now. But I wouldn't be concerned about bonds being 'down' (from what?) deter me from owning them.
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Re: Equity allocation for young investors: am I missing something?

Post by rockstar » Tue Feb 11, 2020 12:27 pm

KlangFool wrote:
Tue Feb 11, 2020 12:03 pm
rockstar wrote:
Tue Feb 11, 2020 11:55 am

I was thinking about 3 months or less t-bills that you can sell on the secondary market if you need fast cash. Of course, you want to keep liquid cash to cover the time difference.
rockstar,

Why would I want to do that when my MMF is paying about the same amount of interest?

KlangFool
Good point.

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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Tue Feb 11, 2020 12:28 pm

willthrill81 wrote:
Tue Feb 11, 2020 12:19 pm
KlangFool wrote:
Tue Feb 11, 2020 11:41 am
willthrill81 wrote:
Tue Feb 11, 2020 11:37 am
KlangFool wrote:
Tue Feb 11, 2020 11:35 am
I do not enjoy selling the stock and/or the bond at a loss in a recession.
Why do you believe that you would need to sell bonds at a loss in a recession?
willthrill81,

Without an emergency fund and if I am unemployed, I have to sell something to pay the bills. In a recession, both the stock and the bond may be down at the same time.

KlangFool
With yields at current levels, I'll readily admit that there seemingly isn't much to gain from owning TBM vs. a high-yield savings account or similar instruments right now. But I wouldn't be concerned about bonds being 'down' (from what?) deter me from owning them.
I owned both. Diversification is a good thing.

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by TropikThunder » Tue Feb 11, 2020 1:11 pm

redbarn wrote:
Tue Feb 11, 2020 12:41 am
I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period.
How many 35% or greater bear markets have there been in the last 100 years (i.e. is 35% a “reasonably mild” bear market)?

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Re: Equity allocation for young investors: am I missing something?

Post by willthrill81 » Tue Feb 11, 2020 1:41 pm

TropikThunder wrote:
Tue Feb 11, 2020 1:11 pm
redbarn wrote:
Tue Feb 11, 2020 12:41 am
I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period.
How many 35% or greater bear markets have there been in the last 100 years (i.e. is 35% a “reasonably mild” bear market)?
I'm not sure about 35%, but IIRC there have been four bear markets where stocks lost 50% or more of their inflation-adjusted value since 1920.

35% is certainly not what I would call a 'reasonably mild bear market'. That would be something in the 20-25% drawdown range.
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Re: Equity allocation for young investors: am I missing something?

Post by TropikThunder » Tue Feb 11, 2020 1:50 pm

willthrill81 wrote:
Tue Feb 11, 2020 1:41 pm
TropikThunder wrote:
Tue Feb 11, 2020 1:11 pm
redbarn wrote:
Tue Feb 11, 2020 12:41 am
I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period.
How many 35% or greater bear markets have there been in the last 100 years (i.e. is 35% a “reasonably mild” bear market)?
I'm not sure about 35%, but IIRC there have been four bear markets where stocks lost 50% or more of their inflation-adjusted value since 1920.

35% is certainly not what I would call a 'reasonably mild bear market'. That would be something in the 20-25% drawdown range.
That’s what I was thinking, modeling a 35% bear is a bit harsh.

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Re: Equity allocation for young investors: am I missing something?

Post by willthrill81 » Tue Feb 11, 2020 1:55 pm

TropikThunder wrote:
Tue Feb 11, 2020 1:50 pm
willthrill81 wrote:
Tue Feb 11, 2020 1:41 pm
TropikThunder wrote:
Tue Feb 11, 2020 1:11 pm
redbarn wrote:
Tue Feb 11, 2020 12:41 am
I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period.
How many 35% or greater bear markets have there been in the last 100 years (i.e. is 35% a “reasonably mild” bear market)?
I'm not sure about 35%, but IIRC there have been four bear markets where stocks lost 50% or more of their inflation-adjusted value since 1920.

35% is certainly not what I would call a 'reasonably mild bear market'. That would be something in the 20-25% drawdown range.
That’s what I was thinking, modeling a 35% bear is a bit harsh.
Perhaps, but look at how many people here think that the '4% rule of thumb' is much too aggressive and advocate 3% withdrawals or even less for retirees in their 60s or older.

Based on the historic record, it seems reasonable to me to expect to experience at least one -35% stock drawdown over a 30 year period. There were two drawdowns of over 45% between 2000 and 2009 alone.
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Re: Equity allocation for young investors: am I missing something?

Post by nisiprius » Tue Feb 11, 2020 2:00 pm

willthrill81 wrote:
Tue Feb 11, 2020 1:41 pm
TropikThunder wrote:
Tue Feb 11, 2020 1:11 pm
redbarn wrote:
Tue Feb 11, 2020 12:41 am
I think the bear market assumptions I'm making here are reasonably mild and something like this is not at all improbable within any 10 year period.
How many 35% or greater bear markets have there been in the last 100 years (i.e. is 35% a “reasonably mild” bear market)?
I'm not sure about 35%, but IIRC there have been four bear markets where stocks lost 50% or more of their inflation-adjusted value since 1920.

35% is certainly not what I would call a 'reasonably mild bear market'. That would be something in the 20-25% drawdown range.
Your recollections are correct.

According to the 2015 Ibbotson SBBI Classic Yearbook, p. 172, table 13-4, since 1871 there have been four declines that were worse than -50%.

The four declines began in 1/1911, 8/1929, 12/1972, and 8/2000. However, oddly to my mind, they consider 2008-2009 to be part of the one that began in 8/2000, with recovery in 5/2013, so... a thirteen-year decline according to their methodology which is worth noting.

There was a -49.93% decline in 2/1937. So depending on how you count, you could easily say four since 1920, either by stretching the 50% criterion a hair, or by counting 8/2000 and 2008-2009 as two separate declines.

There were two others that were worse than -35%, starting in 11/1968, 5/1946

Their calculations are include dividend reinvestment and are inflation-corrected. (I don't know how they did that for years before 1913...)

Their table includes all declines of worse than -20%. There were seventeen of them since 1871, or an average of one every 8.7 years.
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Re: Equity allocation for young investors: am I missing something?

Post by firebirdparts » Tue Feb 11, 2020 3:08 pm

redbarn wrote:
Tue Feb 11, 2020 12:41 am


Scenario 4 (late bear market): Assume stock returns are 5% but a 35% in year 7 this time. Bond returns still assumes 0%. Now you get 210 for (B) vs. 159 for (A). So (B) is 51 better.
The logical flaw in this is very simple. The investors are 30 years old at this point. They have another 30 years to go to retirement. What do they do the next day? If he's investor A, he's 100% equities the day after Scenario 4. If he's investor B, he's 60/40 the next day. That's the key.

You have correctly identified why market timing would be so incredibly awesome if you had a time machine. if you had a time machine, then at any point in a thought experiment, you would swoop in and make a meaningful change of direction. We all agree with you on that. But you don't have one.
A fool and your money are soon partners

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grabiner
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Re: Equity allocation for young investors: am I missing something?

Post by grabiner » Tue Feb 11, 2020 10:12 pm

redbarn wrote:
Mon Feb 10, 2020 5:33 pm
It is my first time posting here but I have been reading and benefiting from all the great advice for a few years now. I am really very grateful for this forum.

There is one thing that I have always had some doubts about and was hoping to get some help in clarifying my thinking. A question that often comes up here is why early-stage investors should not hold 100% of their portfolio in stocks. The general argument given against 100% stocks is behavioral, that people are more likely to make the wrong decision when they see huge chunks of their portfolio evaporate. The fact that this behavioral argument is the one that is always provided seems to concede the point that from a purely rational financial standpoint, it would indeed make most sense to go 100% equities. To me, 100% equities (or anything too close to that) really does not seem to make sense for early-stage investors even from a perfectly rational standpoint but I am not sure if my reasoning has any merit.

Running some return and contribution scenarios using a very simple spreadsheet, it seems clear that even with conventionally strong stock market returns, portfolio growth would be overwhelmingly dominated by contributions rather than asset returns for quite a long time.
And that is actually the argument for 100% equities; you aren't taking as much relative risk.

Suppose that you are retired with a $500K portfolio, and you put 40% in equities. If the stock market loses half its value, you lose $200K, and thus 20% of your retirement income. If the stock market doubles in value, you gain $200K, and thus get 20% more retirement income. You might decide that this is the right level of risk.

Now suppose that you are in mid-career, with a $200K portfolio plus the equivalent of $300K from your future investments. If you put 100% of this portfolio in equities, you are taking the same risk and getting the same benefit as the retiree.

One caution: this depends on your human capital (the source of your future investments) being bond-like. If you are more likely to lose your job when the stock market crashes, a stock-market crash will cost you both current and future income, so you should be somewhat more conservative than this formula suggests.
Wiki David Grabiner

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Re: Equity allocation for young investors: am I missing something?

Post by msk » Wed Feb 12, 2020 1:02 am

Just wondering... Has anyone ever felt that "currently the stock market looks cheap"? I started dabbling in stocks in the early 1980s. The P/E for stocks looked ridiculously high compared to my local RE market. Then came the 1986(?) collapse. Since it wasn't clear to me as to why the market collapsed, the P/E still looked high. But the market kept going higher anyway. So I felt that Japanese stocks will also keep rising. All those Sony Walkmans, etc. So then I learned that P/Es can be too high. But then the dotcom bubble came. But these were the growth companies of the future! So I got caught in the NASDAQ collapse. Then came the second collapse in the 2000s. Yawn. I never really noted it. Perhaps I was finally learning. The market still looks ridiculously over-priced currently. How can a P/E >25 support my desired 5% p.a. real appreciation? Mind you, that averaged over the past 300 years! The stock market is still too expensive! Bonds? Who has declared that the USD will forever be a reserve currency? Sigh... I am 100% stocks worldwide by market weight. There will be a nasty collapse somewhere unexpected, for reasons unexpected. I know nothing; other than Piketty's "trade and industry" has returned 5+% per annum over the past 300 years in multiple countries and Shiller's stocks/dividends/CPI data from 1871 to 2018 has shown 6.9% real returns average. Again, bonds? Reserve currencies seem to have had a life of around 80 years. The USD seems to be getting there. We know nothing but those who do not study history are bound to repeat the follies. Still, in my stock dabbling career since early 1980s, stocks have ALWAYS looked expensive :shock:

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Re: Equity allocation for young investors: am I missing something?

Post by Ari » Wed Feb 12, 2020 2:34 am

KlangFool wrote:
Tue Feb 11, 2020 11:43 am
The bond could still be down regardless of how risk-free it is. It is simpler just to keep some cash in the checking account and the MMF.
I always felt many people here have an overblown attitude to selling at a loss. When it comes to bonds, selling them at a 10% or even 20% loss doesn't seem like a big disaster to me.

I would even argue that selling stocks at a loss isn't as big of a problem as many people make it out to be (though it's certainly not unproblematic). I think that making 100% sure you'll never have to sell stocks at a loss will mean giving up a lot of return. Chances are pretty good you'll make up the loss either before or after it happens. But be that as it may, I don't think anyone should fear selling bonds at a loss.
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Re: Equity allocation for young investors: am I missing something?

Post by KlangFool » Wed Feb 12, 2020 7:20 am

Ari wrote:
Wed Feb 12, 2020 2:34 am
KlangFool wrote:
Tue Feb 11, 2020 11:43 am
The bond could still be down regardless of how risk-free it is. It is simpler just to keep some cash in the checking account and the MMF.
I always felt many people here have an overblown attitude to selling at a loss. When it comes to bonds, selling them at a 10% or even 20% loss doesn't seem like a big disaster to me.

I would even argue that selling stocks at a loss isn't as big of a problem as many people make it out to be (though it's certainly not unproblematic). I think that making 100% sure you'll never have to sell stocks at a loss will mean giving up a lot of return. Chances are pretty good you'll make up the loss either before or after it happens. But be that as it may, I don't think anyone should fear selling bonds at a loss.
When you have enough money, keeping a lot of cash without return is not a problem.

KlangFool

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Re: Equity allocation for young investors: am I missing something?

Post by nisiprius » Wed Feb 12, 2020 7:57 am

msk wrote:
Wed Feb 12, 2020 1:02 am
...Just wondering... Has anyone ever felt that "currently the stock market looks cheap"?...
At first I thought you might be serious. But yes, one difference between today and 1999 is that I have not noticed articles like this:

Image

Image

(When the Dow finally hits 36,000, we will probably see articles saying Glassman and Hassett's prediction finally came true. But it will not have, because their prediction, in their book, was quite specific: "A sensible target date for Dow 36,000 is early 2005, but it could be reached much earlier.")
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: Equity allocation for young investors: am I missing something?

Post by Financologist » Tue Feb 18, 2020 12:41 am

A year of contribution could be wiped out quickly.. could also be doubled quickly.

I invested 100% stocks for 15+ years before making my first bond investment. No regrets.

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