The 50% fallacy

[tadamsmar]

Bogleheads derive lessons about risk and bond/equity allocation from the idea that a 50% equity loss can be treated as a maximum for a severe bear market. See the bottom of page 142 in "The Bogleheads Guide to Retirement Planning" for an example.

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20th century when some equity markets totally collapsed, like Russia 1919.

2. The US equity market experienced a 90% loss 80 years ago.

I wonder if there are any Bogleheads have made an attempt to square their philosophy of investment risk on the facts rather than on a fallacy?

If so, please speak up.

[richard]

Anyone who believes equities can't lose more than 50% is not paying attention.

One reason that equities are expected to return more than bonds is the possibility of massive losses.

However, one shouldn't plan as if the worst case were a certainty.

Perhaps I don't understand exactly what you're asking. Are you asking whether it makes sense to invest in equities knowing that you might lose the investment?

[jpmorganfunds]

Good! More risk means more return. :lol:

[conundrum]

We take potential total loss of the equity portion of our portfolio into account (although I think it is very unlikely).
We have a fixed income floor in our portfolio (60% fixed income) which would supply our basic needs. The 40% equities is for growth, some inflation protection and discretionary spending. We don't expect this portion of our portfolio will go to zero but if it did we would not have to eat alpo. We would, however, have to cut our discretionary expenses significantly.

Drum

[bob90245]

Is this a case for Dow 100 or Dow 0?

Back in March 2009, there were those who were expecting the Great Depression 2.0. It appears this expectation is alive and well.

[Taylor Larimore]

Hi Tad:

Bogleheads derive lessons about risk and bond/equity allocation from the idea that a 50% equity loss can be treated as a maximum for a severe bear market. See the bottom of page 142 in "The Bogleheads Guide to Retirement Planning" for an example.

The Bogleheads Guide Index has twelve separate "risk" listings-some with multiple pages. Nowhere does the book say stocks (or any investment) can't fall more than 50%. In fact, we included a Table (top of page 144) showing "Worst U.S. Stock Index Returns, 1871-2008, Adjusted for Inflation." We can't get more specific than that.

The book is not perfect, but we did our best.

[Specialized]

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20% century when some equity markets totally collapsed, like Russia 1919.]

I'd guess that the Tsarist government defaulted on its bonds as well.

2. The US equity market experienced a 90% loss 80 years ago.

This could happen again, although I don't think it's very likely. Dollar cost averaging through market downturns as well as upturns is likely to smooth out your equity return. That being said, I consider a large emergency fund essential.

[Opponent Process]

diversify globally. and don't panic in bear markets.

[realitytruthprozac]

Many stocks lose 100%
But they are conveniently replaced in the broad indices.
Classic case of Survivorship Bias.

[yobria]

Bogleheads derive lessons about risk and bond/equity allocation from the idea that a 50% equity loss can be treated as a maximum for a severe bear market. See the bottom of page 142 in "The Bogleheads Guide to Retirement Planning" for an example.

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20% century when some equity markets totally collapsed, like Russia 1919.

2. The US equity market experienced a 90% loss 80 years ago.

I wonder if there are any Bogleheads have made an attempt to square their philosophy of investment risk on the facts rather than on a fallacy?

If so, please speak up.

You're confused.

The 50% loss idea is a rule of thumb for gauging risk tolerance. It has nothing to do with history's worst case scenario.

For example, I assume, worst case, it will take me 30 minutes to get to work.

Now there's no doubt that during the earthquake of 1906, it might have taken me 10 hours to get from home to work.

However, I don't leave 10 hours early for work each day. The historical maximum, while interesting to know, is a lousy rule of thumb.

Nick

[cannedham]

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20% century when some equity markets totally collapsed, like Russia 1919.

I would also wager the Russian bond market fell to zero and all private land was seized. So, where does that leave us?

[TJAJ9]

Bogleheads derive lessons about risk and bond/equity allocation from the idea that a 50% equity loss can be treated as a maximum for a severe bear market. See the bottom of page 142 in "The Bogleheads Guide to Retirement Planning" for an example.

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20% century when some equity markets totally collapsed, like Russia 1919.

2. The US equity market experienced a 90% loss 80 years ago.

I wonder if there are any Bogleheads have made an attempt to square their philosophy of investment risk on the facts rather than on a fallacy?

If so, please speak up.

A possible 50 percent equity loss is a very good rule of thumb. Most market crashes (mainly US) in the past 40 years or so have declined somewhere around that maximum range.

Sure, the markets could decline 75%, or 100%.

Planet earth could also get blown up by an asteroid some day -- it's happened before. Has anyone built their underground shelter yet? It's a fallacy if you think your house will keep you safe.

[Bob's not my name]

I'd guess that the Tsarist government defaulted on its bonds as well.

As long as you bought individual Tsarist bonds and held them to maturity, you'd have been fine.

[tadamsmar]

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20% century when some equity markets totally collapsed, like Russia 1919.]

I'd guess that the Tsarist government defaulted on its bonds as well.

2. The US equity market experienced a 90% loss 80 years ago.

This could happen again, although I don't think it's very likely. Dollar cost averaging through market downturns as well as upturns is likely to smooth out your equity return. That being said, I consider a large emergency fund essential.

I think that's a pretty good basis for a reality-based risk policy. Certainly better than the one I cited from the Boglehead Guide, IMO.

[tadamsmar]

Bogleheads derive lessons about risk and bond/equity allocation from the idea that a 50% equity loss can be treated as a maximum for a severe bear market. See the bottom of page 142 in "The Bogleheads Guide to Retirement Planning" for an example.

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20% century when some equity markets totally collapsed, like Russia 1919.

2. The US equity market experienced a 90% loss 80 years ago.

I wonder if there are any Bogleheads have made an attempt to square their philosophy of investment risk on the facts rather than on a fallacy?

If so, please speak up.

You're confused.

The 50% loss idea is a rule of thumb for gauging risk tolerance. It has nothing to do with history's worst case scenario.

For example, I assume, worst case, it will take me 30 minutes to get to work.

Now there's no doubt that during the earthquake of 1906, it might have taken me 10 hours to get from home to work.

However, I don't leave 10 hours early for work each day. The historical maximum, while interesting to know, is a lousy rule of thumb.

Nick

I am not sure how to respond to your post.

You did not point out a single error in my OP.

But you called me confused.

Now, I really am confused!

[tadamsmar]

Bogleheads derive lessons about risk and bond/equity allocation from the idea that a 50% equity loss can be treated as a maximum for a severe bear market. See the bottom of page 142 in "The Bogleheads Guide to Retirement Planning" for an example.

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20% century when some equity markets totally collapsed, like Russia 1919.

2. The US equity market experienced a 90% loss 80 years ago.

I wonder if there are any Bogleheads have made an attempt to square their philosophy of investment risk on the facts rather than on a fallacy?

If so, please speak up.

A possible 50 percent equity loss is a very good rule of thumb. Most market crashes (mainly US) in the past 40 years or so have declined somewhere around that maximum range.

Sure, the markets could decline 75%, or 100%.

Planet earth could also get blown up by an asteroid some day -- it's happened before. Has anyone built their underground shelter yet? It's a fallacy if you think your house will keep you safe.

50% is not somewhere around the maximum range.

I am not interested in another argument founded in a fallacy.

[TJAJ9]

50% is not somewhere around the maximum range.

Look up how much stocks declined in the bear markets of 1973-1974, 2000-2002 and 2008-2009. Then get back to me.

[tadamsmar]

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20% century when some equity markets totally collapsed, like Russia 1919.

I would also wager the Russian bond market fell to zero and all private land was seized. So, where does that leave us?

I think the default of most is to not plan for it. I don't have a plan for it.

[tadamsmar]

50% is not somewhere around the maximum range.

Look up how much stocks declined in the bear markets of 1973-1974, 2000-2002 and 2008-2009. Then get back to me.

If you want to limit yourself to data after 1973 go ahead. But I don't think I will follow you.

I suppose there might be some sort of argument for ignoring even the white swans and claiming that the maximum really is 50%. If you have an argument, I like to hear it.

I think a better approach is the one Specialized alluded to. There are actually two fallacies on page 142 of the Boglehead Guide. The 50% Fallacy is so blatant that it's easy to see. The other fallacy is the idea that investors should apply some sort of maximum tolerance value to market downturns. The fallacy implies that back in March of 2009 the market might have exceeded your maximum tolerance for losses. But, to know your actual tolerance you would have to know the future. In fact the actual tolerance is so god-awful fuzzy that it's useless. And, the sort of maximum tolerable losses I see people throw around as realistic are actually way too low when compared with the Trinity Study analysis of what it takes to for buy and hold to actually fail, and the Trinity Study allowed for no belt-tightening.

So there are two fallacies that tend to cancel out each other:

1. The maximum equity loss you may see is much larger than 50%

2. Your maximum tolerable loss, when rationally derived, is much larger than you think it is.

I'd say there is no maximum tolerable loss, as a practical matter. Once you think you are there, there is no point in selling. The only real decision at that point is are you in Russia 1919 or USA 1933? If its USA 1933, then some belt-tightening will get you through. If its Russia 1919, then I hope you have some gold stashed in Switzerland.

[G-Money]

Like others have said, most investors understand that the maximum potential equity loss is 100%, however, the maximum likely equity loss is around 50%. In fact, I'm not sure I've met anyone who didn't understand that a stock could go to $0.

I'd be very interested to see your AA, given your enlightened view of equity (but not fixed income?) risk.

[CMMCC]

50% is not somewhere around the maximum range.

I'd say there is no maximum tolerable loss, as a practical matter. Once you think you are there, there is no point in selling. The only real decision at that point is are you in Russia 1919 or USA 1933? If its USA 1933, then some belt-tightening will get you through. If its Russia 1919, then I hope you have some gold stashed in Switzerland.

Might have been tough to get to Switzerland at that point. Also, who is to say Switzerland is safe?

[JCW500]

Practically, if the US stock market falls 90%, then perhaps your retirement savings are the least of your worries. You'd probably lose your job, and with the economic chaos, you'd have more things to worry about.

Also, even for the most risk averse, I'm not sure how this helps. What is the answer--- sock it away all in gold? You may hedge against this catastrophe, but at the cost of losing any real return on your investment. You'd die safe but poor. For that matter, maybe even gold will lose all its value someday if someone invents a dirt cheap method of making it.

As many have noted, people's risk tolerance is actually lower than it is. A 40% loss might be bearable on paper, but not in real life. Using 90% in your planning will probably lead to overly conservative strategies.

[Regal 56]

1. The maximum equity loss you may see is much larger than 50%

2. Your maximum tolerable loss, when rationally derived, is much larger than you think it is.

I'd say there is no maximum tolerable loss, as a practical matter.

So what's your argument? Should one not be in stocks at all? If you want to base investment decisions on worst case scenarios, then you're indulging in your own fallacy: treating a very rare event as a lead-pipe certainty. That's not rational behavior. For example, in the long run, there's a 100% chance that I'll eventually be dead. Should I give up and lie in bed for the rest of my life, awaiting the inevitable?

Both TJAJ9 and yobria have answered your question, and you're not telling us anything we don't already know. The 50% rule of thumb is exactly that: a rule of thumb. At one point in 2008, my loss on an 80% portfolio was 46%. So I'm well aware that I can lose more than 50% of my equity stake in a severe downturn. I'm also aware that I can lose 100% if I invest with someone like Bernie Madoff or Allen Stanford.

Regarding the crash of 1929, you're ignoring two factors that would mitigate the 90% loss:

1) Investors then couldn't buy into an index fund that reflected the entire United States stock market.

2) Investors who stayed in for the long term with something equivalent to VTSMX wouldn't have stayed at a 90% loss.

[nisiprius]

With regard to 50%: I don't think anyone, not even Adrian Nenu, ever suggested that there was a guarantee that stocks would never lose more than 50%.

My interpretation has been that it is a good rule-of-thumb number for planning purposes in trying to assess, as best one can, one's own risk tolerance.

The important thing about 50% is that it is large, it is dramatic, it is not an end-of-the-world black swan occurrence--and it is much more than most inexperienced investors have in mind.

Consider the number of little footnotes under marketing statements, "Stock investments may lose value." Or the statements people are sometimes asked to sign saying that investments may lose value, without saying how much. Or the risk assessment questionnaires, such as Vanguard's, in which the biggest losses mentioned are "31%" and "$3639 on $10,000." The unstated implication, and the inference many would draw, is that 1/3 is the worst-case scenario.

50% losses occur in normal experience and many people do not understand that.

I am completely convinced that if everyone understood that 50% losses are something you should plan on actually experiencing... and more likely than not an inconvenient time, e.g. at the same time as losing a job... on the average people would have much lower stock allocations than they do. They have not been told this plainly. They believe their target retirement funds are safe savings accounts. They are used to bank accounts that never lose money. When they sign off on "stocks may lose money," they are thinking 10%, 20%. After all, it's not just any stocks, it's a "diversified" portfolio that will protect them in a downturn because whenever some stocks go down, other stocks will go up to balance them. Right? That's irony, by the way.

[nisiprius]

With regard to 100%... that is, the possibility of 100% or near-100% unrecoverable loss, yes, it is not to be dismissed. I have always kept that possibility in mind in determining my own stock allocation.

The argument that "stocks recover" does not hold water, for two reasons. First, stocks don't recover if the country doesn't recover. I don't know about the Confederate stock market but I will point out that there were British holders of Confederate bonds hoping into the late 1800s that the United States would honor them. William C. Bernstein guesstimates that there is only an 80% chance of any given country lasting 40 years without an economic, social, or political discontinuity.

Second, just because stocks recover doesn't mean the investor who holds them recovers. There was some clown circa 1928 who wrote an article with a title like "Everybody should be rich" saying that all your ordinary middle-class worker needed to do was invest $15 a month in sound common stocks to become rich. Some idiot booster of stocks argued that the clown was right, because if you'd continued to invest $15 a month through that little downturn you'd have done very well indeed. The problem is that selling apples only gets you about $22 a month. Taylor Larimore was criticized for talking about "Plan B," but real is real. In the sort of dislocation that causes a 90% loss in stocks, there comes a point when people must draw on the resources they have, and even if those resources are stocks worth 10% of what they were a year ago and what they will be in ten years, the stocks get sold.

I think people forget what they were really thinking in late 2008. What I was thinking was "Is this the big one?" A total discontinuity, a turning point in history, a collapse of the old system and something new rising from the ashes--but without my old stock certificates necessarily giving me a share of the new?

Now, we say, "of course it wasn't." And for me it never has been. "If hopes were dupes, fears may be liars" and almost always are. I wasn't immolated by nuclear war following the Cuban missile crisis. There wasn't a national revolution in 1968 (and believe me the impact of three assassinations in one decade certainly made you feel the foundations of the world were shaky).

But during the next 50% drop, some people will say "Scaredy-cat, look at 2008, you thought the world was coming to an end and it was no big deal." Because that is their natural temperament. And I will again be saying "But if this were The Big One, this is just how it would look. And of course we've never experienced anything like that, but in a sense that is a kind of survivorship bias." Because that is my natural temperament. And I will be wrong. Again. I hope. But maybe not!

And I hope I will stay the course, as I did in 2008--more or less!--because I have a low stock allocation that, it turns out, is fairly well aligned with my low risk tolerance. Know thyself!

[DaveS]

Yes, but do you know how hard you would have to work to loose 100% In the stock market. First, you decide that Sony Beta max technology was the future and put 100% of you money into it. Then you decided that satellite phones were the wave of the future so you poured your money into Iridium (The satellite Co that went bankrupt in the end of the 90's) Finally you reason that phones were wrong and you should stick to something basic like pipelines and get ENRON at the top. So yes you can loose more than 50% but you have to be a genius to do it. Get a broad based index fund, keep you bond allocation funded, rebalance and you can't. Dave

[tadamsmar]

1. The maximum equity loss you may see is much larger than 50%

2. Your maximum tolerable loss, when rationally derived, is much larger than you think it is.

I'd say there is no maximum tolerable loss, as a practical matter.

So what's your argument? Should one not be in stocks at all? If you want to base investment decisions on worst case scenarios, then you're indulging in your own fallacy: treating a very rare event as a lead-pipe certainty. That's not rational behavior. For example, in the long run, there's a 100% chance that I'll eventually be dead. Should I give up and lie in bed for the rest of my life, awaiting the inevitable?

Both TJAJ9 and yobria have answered your question, and you're not telling us anything we don't already know. The 50% rule of thumb is exactly that: a rule of thumb. At one point in 2008, my loss on an 80% portfolio was 46%. So I'm well aware that I can lose more than 50% of my equity stake in a severe downturn. I'm also aware that I can lose 100% if I invest with someone like Bernie Madoff or Allen Stanford.

Regarding the crash of 1929, you're ignoring two factors that would mitigate the 90% loss:

1) Investors then couldn't buy into an index fund that reflected the entire United States stock market.

2) Investors who stayed in for the long term with something equivalent to VTSMX wouldn't have stayed at a 90% loss.

Actually, my argument was in the post you quoted, but I think you overlooked it or something. I agree with you about the factors that mitigate the 90% loss. In my argument referred to the Trinity Study as a kind of shorthand, perhaps you are unaware of the Trinity Study?

[Chuck]

If you were invested in the total stock market and the total stock market went down 100%, that would sure suck.

If you were 100% cash, and the total stock market went to zero, I don't think you'd be better off, because society would have collapsed, and it would be hard to spend your cash.

[etarini]

Wonderful, thoughtful posts, nsiprius. Great perspective.

If there's a stock market crash that exceeds 80%, then matches, can openers, and bullets will exceed all other commodities and financial instruments in value. And yes, almost no one wants to think of that, let alone develop a lifelong financial plan for it, which implies keeping that eventuality fixed in your mind forever.

tadamsmar, now that you have everyone's attention, what do you think your insight implies for our financial planning? You've identified that nearly all of us have failed to take the 90-100% case into serious consideration, so what should we do?

I'll confess that I'm six years away from retirement and that I'm hoping I can save enough so that I won't ever feel obliged to take equity risk. I've read Zvi Bodie's book and I've just bought a passel of the bond books recommended on the forum, since most of my past reading was on stocks. I've already moved a lot into bonds, and am seriously considering a 0% equity portfolio for the remaining accumulation years and on into decumulation. I'm looking into the advantages and disadvantages of such a portfolio, with regard to safety, taxes, expected return, etc.

Any thoughts on tadamsmar's observation?

Eric

[junior]

Wonderful, thoughtful posts, nsiprius. Great perspective.

If there's a stock market crash that exceeds 80%, then matches, can openers, and bullets will exceed all other commodities and financial instruments in value. And yes, almost no one wants to think of that, let alone develop a lifelong financial plan for it, which implies keeping that eventuality fixed in your mind forever.

Eric

Yeah, it's not clear to me that bonds or currency will have much worth in a world where the market plunges more than 80% and stays at that rate for a considerable amount of time. At the very least, there's going to be significant political unrest in such a scenario.

[metalman]

It's pretty scarey to consider retirees with large equity positions. If they think they can't make it with less than 25% in stocks, maybe they should consider continuing to work, no matter what all the Monte Carlo models tell them. Even crazier is that some of those same people think inflation is going to explode, the dollar is going to plunge, and you can't "trust" TIPS. What do they think will happen to equities under those circumstances?

[hamishdad]

Great insight, nisiprius.

When the stuff really hit the fan in 2008, you began to hear "don't invest in stocks if you can't afford to lose it." That's great advice, but I suspect that very few people follow it. You certainly don't get that message from the investment industry. To the contrary, people who do not have enough money saved to meet their needs in retirement are encouraged to take on more risk.

[dbr]

deleted

[SamB]

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20th century when some equity markets totally collapsed, like Russia 1919.

Bernstein (Investor's Manifesto..) points out that the St Petersburg exchange was considered the most respected and active before it was shut down in 1914 due to WWI. It never reopened. He lists Cairo, Bombay, Buenos Aires, and Shanghai as other securities markets that became defunct during the twentieth century.

There is more to risk than standard deviation.

Sam

[junior]

The facts are:

1. The maximum loss is %100. Tens of thousands if not millions of investors experienced this magnitude loss in the 20th century when some equity markets totally collapsed, like Russia 1919.

Bernstein (Investor's Manifesto..) points out that the St Petersburg exchange was considered the most respected and active before it was shut down in 1914 due to WWI. It never reopened. He lists Cairo, Bombay, Buenos Aires, and Shanghai as other securities markets that became defunct during the twentieth century.

There is more to risk than standard deviation.

Sam

The interesting thing is Bernstein is more risk adverse in his advice in Investor's Manifesto than in 4 Pillars, from what I recall, advocating 50% bonds as a starting assumption. He also seems more pessimistic on investor's ability to tolerate market fluctuations. I don't know if that's the result of additional research, or because the recent market crash rattled him as well.

[ddb]

I wonder if there are any Bogleheads have made an attempt to square their philosophy of investment risk on the facts rather than on a fallacy?

If so, please speak up.

I vehemently agree with your post, and am very much against any asset allocation guideline which relies on a 50% loss as a "kind-of-worst-case" scenario. Even though my portfolio is aggressive by most standards, my plan is such that I should be okay even if my equity value disappears overnight.

I find that while many investing books bring up the Great Depression stock returns, they don't paint it as something which could happen again. If the new Bogleheads book covers equity risk adequately, it would be one of the first few books to do so.

- DDB

[bottlecap]

Bogleheads derive lessons about risk and bond/equity allocation from the idea that a 50% equity loss can be treated as a maximum for a severe bear market.

The idea that a maximum equity loss in a severe bear market is 50% is not a Boglehead idea or assumption, so that statement is a fallacy in itself.

I wonder if there are any Bogleheads have made an attempt to square their philosophy of investment risk on the facts rather than on a fallacy?

If so, please speak up.

The 50% rule of thumb is about planning. You just can't plan your life around the worse possible scenario. When you step on an airliner, do you wear a parachute? Is the reason you don't because you believe that airliners never crash? How do you square your philosophy about not wearing a parachute on an airline with the facts rather than on a fallacy?

If you want to get really philosophical, the maximum bond loss is also 100%. If taken together with the truism that the maximum equity loss can be a 100%, how do you go about planning an asset allocation?

I know that in severe bear markets, equities can decline as much as 90 to 100%. For planning purposes, I have to presume that most bear markets will decline less than that - otherwise I would never invest in equities. Worse, I would not be diversified against the potential risk in the bond markets.

JT

[bob90245]

1. The maximum equity loss you may see is much larger than 50%

2. Your maximum tolerable loss, when rationally derived, is much larger than you think it is.

I'd say there is no maximum tolerable loss, as a practical matter.

So what's your argument? Should one not be in stocks at all?

Good question. So what is the plan for Dow 100 and Dow 0? As previous posters suggest, if society colapses, then your bonds will go to zero as well. What else is left? Canned goods, ammo and a remote hideout?

[ddb]

Good question. So what is the plan for Dow 100 and Dow 0? As previous posters suggest, if society colapses, then your bonds will go to zero as well. What else is left? Canned goods, ammo and a remote hideout?

I haven't traveled to Japan lately, but are they living on canned goods while stockpiling ammo in a remote hideout?

The Nikkei index is 75% below its 1990 high (excluding dividends). Dollar-cost averaging made performance even worse, since the entire trend line for the past 20 years has been sharply negative. We may all have different interpretations of what constitutes a "reasonable probability" for such an event either in the US or on a global basis, but for me it's a risk I don't want to take (as it relates to my required retirement income, that is). I'd place the probability of a severe long-term global equity slump significantly higher than any of the following events already mentioned in this thread as analogies:

1. Having an airplane which I am flying on crash
2. US Government bond defaults
3. Our planet gets blown up by an asteroid
4. My 30-minute commute taking 10 hours on any particular day

FWIW, I don't actually think we should be concerned about a full 100% drop in equities, but I think we should be concerned (maybe "concerned" is the wrong word; perhaps "prepared for" is more appropriate) about a 90% drop. I plan for losing it all because that's close enough to 90%. I'm pretty confident that society can sustain itself and that the US government can meet its debt obligations if the global equity market drops 80-90%.

Yeah, it's not clear to me that bonds or currency will have much worth in a world where the market plunges more than 80% and stays at that rate for a considerable amount of time. At the very least, there's going to be significant political unrest in such a scenario.

Japan, 1989-2010. Japan bonds have done fine, their currency has worth, and their broad index was down more than 80% from its high (dividends excluded).

- DDB

[tadamsmar]

deleted at dbr's request

[avalpert]

Japan, 1989-2010. Japan bonds have done fine, their currency has worth, and their broad index was down more than 80% from its high (dividends excluded).

- DDB

What is it when you include dividends? At least be
--inflammatory remark deleted-- dividends are money too.

[ddb]

Japan, 1989-2010. Japan bonds have done fine, their currency has worth, and their broad index was down more than 80% from its high (dividends excluded).

What is it when you include dividends?

I do not have dividend data for the Nikkei 225, which is why my numbers did not include such.

- DDB

[dbr]

What exactly are you calling a rule of thumb?

The 50% fallacy does not seem to be a rule of thumb, it's used as if it were an observation about severe market downturns in the Boglehead Guide passsage I cited.

Please be specific, what rule of thumb are you talking about?

I am sorry I have offended you. My posting has been deleted as an apology, but unfortunately the quote cannot be deleted unless you do it.

[Mitchell777]

I foolishly used to consider 35% as my max stock loss, even though I knew of the Great Depression losses etc. During the stock market increase of the past year, I rebalanced so that I thought I would have enough to live out my days even if stocks fell 80% (basically enough ST Bond, Intermediate Bond, Stable Value and TIPs). Now my concern is what happens to my fixed income/Bond investments if the economy or the dollar collapse. I increased my Int’l stock allocation but have no Int’l Bond allocation

[junior]

Japan, 1989-2010. Japan bonds have done fine, their currency has worth, and their broad index was down more than 80% from its high (dividends excluded).

- DDB

Interesting point ddb, I guess it depends on what we are talking about.

Japan had a bubble and the bubble burst, but to a long term DCA investor, I imagine it would have been far less of a loss than 80%. A new, young investor who got in at the high point would have had less to lose.

Could U.S. stocks plummeted 80% from their current P/E level of around 20, and stay down without some sort of worldwide catastrophe?

[Taylor Larimore]

I would actually protest that the "50% rule" is not Boglehead investing.

For the record: The "50% rule is not in the Boglehead Guides and it is not a Boglehead rule. It is a rule of thumb (Maximum Tolerable Loss X 2 = Maximum Stock Allocation) promoted by Adrian which many find helpful to help decide our stock allocation.

[tadamsmar]

Wonderful, thoughtful posts, nsiprius. Great perspective.

If there's a stock market crash that exceeds 80%, then matches, can openers, and bullets will exceed all other commodities and financial instruments in value. And yes, almost no one wants to think of that, let alone develop a lifelong financial plan for it, which implies keeping that eventuality fixed in your mind forever.

tadamsmar, now that you have everyone's attention, what do you think your insight implies for our financial planning? You've identified that nearly all of us have failed to take the 90-100% case into serious consideration, so what should we do?

I'll confess that I'm six years away from retirement and that I'm hoping I can save enough so that I won't ever feel obliged to take equity risk. I've read Zvi Bodie's book and I've just bought a passel of the bond books recommended on the forum, since most of my past reading was on stocks. I've already moved a lot into bonds, and am seriously considering a 0% equity portfolio for the remaining accumulation years and on into decumulation. I'm looking into the advantages and disadvantages of such a portfolio, with regard to safety, taxes, expected return, etc.

Any thoughts on tadamsmar's observation?

Eric

I think the Trinity Study is a pretty good foundation for investing:

http://www.bogleheads.org/wiki/Safe_Withdrawal_Rates

Table 3 in particular. But the fact that it's based on the most successful market for the period, the US market, arguably might bias it to be rosy on stocks. That would imply a tilt toward bonds or less risk assets and a somewhat lower withdrawal rate, but I am not sure how to quantify it. Shiller substituted the world equity rates for the US rates to overcome this kind of bias when he did a study of Social Security private acccount proposal a while back. Maybe a Trinity style study using Shiller's trick would be a good idea.

And, Trinity assumes perfectly smooth consumption. Things get a bit less Draconian if you assume variable consumption, some belt-tighening when things look grim for instance.

Most people don't worry about total market collapse, and that includes me.
Not saying its a bad thing worry about, but I don't know much about planning for it.

[ddb]

Japan, 1989-2010. Japan bonds have done fine, their currency has worth, and their broad index was down more than 80% from its high (dividends excluded).

- DDB

Interesting point ddb, I guess it depends on what we are talking about.

Japan had a bubble and the bubble burst, but to a long term DCA investor, I imagine it would have been far less of a loss than 80%. A new, young investor who got in at the high point would have had less to lose.

Could U.S. stocks plummeted 80% from their current P/E level of around 20, and stay down without some sort of worldwide catastrophe?

Unless your portfolio is all US stocks, I'm not sure that the answer to that question matters. More appropriate, I think, is whether the global equity market can drop 80% and stay down for a prolonged period of time. I would say that this can absolutely happen, and it can happen while many of us still keep our jobs and our bonds keep paying back interest and principal. An 80% drop could be accomplished with a 60% drop in earnings and a 50% drop in P/E valuations, neither of which are out of the realm of possibility.

- DDB

[bottlecap]

I'd place the probability of a severe long-term global equity slump significantly higher than any of the following events already mentioned in this thread as analogies:

1. Having an airplane which I am flying on crash
2. US Government bond defaults
3. Our planet gets blown up by an asteroid
4. My 30-minute commute taking 10 hours on any particular day

Hold on. I'm not expert on probabilities, but...

Number of fatal hull-loss aircraft accidents since 1942 - 2,800 (I'm estimating from this: http://aviation-safety.net/statistics/p ... php?cat=A1).

Number of 80% stock market losses since 1942 - 1

Maybe there were a few more, but I'm estimating based on this:

Japan, 1989-2010. Japan bonds have done fine, their currency has worth, and their broad index was down more than 80% from its high (dividends excluded).

It's also interesting that you mention US Bond defaults. Why? Governments have defaulted on bonds numerous times over the last 50 years. Is the US government different or immune? Can we then make the argument that the US stock market is immune to a Japan-type bear market? Could this be a fallacy as well?

I think this is just one of those things where the OP asked for an answer and disagrees with the answers he received. Note that no one has disagreed with the premise, yet the debate continues...

[Lucio]

I do not have dividend data for the Nikkei 225, which is why my numbers did not include such.

- DDB

There is not much difference; Japanese companies never liked paying dividends.

When dividends are included, the return of the Nikkei 225 from 12/31/1989 to 02/11/2010 was -73.2% in US dollars.

For the same period, in Japanese Yen, the change in value with dividends reinvested was -84%.

These returns are from Morningstar's database.

avalpert, you ought to rethink this.

Lucio