The 50% fallacy

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tadamsmar
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Re: The 50% fallacy

Post by tadamsmar »

dbr wrote:
tadamsmar wrote: 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.
I really was not offended. I am usually very blunt myself, so I would not be justified in being offended by a post frankly stating a criticism.
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Re: The 50% fallacy

Post by donocash »

"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 error in your argument lies in the first sentence. Bogleheads do NOT universally 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.

Several bogleheads have already told you that they don't use this idea. The fact that you can find a passage in a book that a few bogleheads wrote means nothing. We don't have any Holy Scripture here. Could the passage in the book you quoted been worded better? Maybe. I would not be surprised, however, if most folks who have posted on this site have not even read the book. I know I haven't. Everyone is free to define risk however they would like. This is not a cult, and no one is run off because of heterodoxy.

There is no official Boglehead definition of risk, or anything else.

It is clear to me that someone who says, "I wonder if Bogleheads have made an attempt to square their philosophy of investment risks on the facts rather than on a fallacy?" is overly fond of being disputatious and is looking to evoke an inflammatory exchange.

I personally assume that equity markets can plunge to zero.
I also assume that government debt markets can also default. Many people believe that this a more likely possibility.

My definition of risk is uncertainty of future outcomes, and I don't believe that extreme risk can be meaningfully quantified.
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rcshouldis
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Re: The 50% fallacy

Post by rcshouldis »

tadamsmar wrote:
yobria wrote:
tadamsmar wrote: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!

If you think that the markets can drop more than 50%, do you choose to not invest or severely limit your risk to equities due to this fear? What were you implying when you initiated this topic? That we should give up on the market?
Lucio
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Re: The 50% fallacy

Post by Lucio »

SamB wrote: 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
An historical aside to this discussion, but the market in St. Petersburg did reopen after the war, in 1917, for a few months. The results were disastrous, a situation perhaps worth considering in light of this discussion. The St. Petersburg market soared in the few months of operation before the Revolution finally succeeded. That is, the market greatly increased in value, then closed permanently.

My source for these statements are web pages published by William Goetzmann's group at Yale. See:
St. Petersburg Stock Exchange Project
Shanghai Stock Exchange Project

Lucio
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tadamsmar
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Re: The 50% fallacy

Post by tadamsmar »

ddb wrote:
bob90245 wrote: 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%.


junior wrote: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
Great question about how Japan's Bogleheadsans (buy and holders/retiremet investors) have faired all these decades. I wonder why no journalist or freelance writer has looked into that question? I wonder if many of them loaded up on Japanese stock during the boom instead of diversifying globally.

Come to think of it, that efficient frontier with 70/30 US/EAFE that you see everywhere (including the Boglehead Guide) sort of begs the question on country-specific risk. That efficient frountier is calculated on a few decades of data if I recall correctly, but I think it probaly takes more than a few decades of data to capture country-specific risk.

Now you got me thinking that I am kind of heavy in US equities...
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Post by tadamsmar »

This is sort of OT, but why is the EAFE so much more volatile (over the last few decades) than the US market? One would think a bunch of countries together would be more risk-diversified than one country.
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Re: The 50% fallacy

Post by tadamsmar »

rcshouldis wrote:
tadamsmar wrote:
yobria wrote:
tadamsmar wrote: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!

If you think that the markets can drop more than 50%, do you choose to not invest or severely limit your risk to equities due to this fear? What were you implying when you initiated this topic? That we should give up on the market?
No. As I mentioned in a couple of post, I think that passage in the Boglehead Guide also tends to inflate the consequences of a market downturn, encouraging investors to think of it as a loss and encouraging them to try to think of some maximum threshold of loss that represents there limit of toleration. Imagine doing that back in March 2009, you really needed to know the future to determine if you could tolerate the loss, so the whole tolerable loss thing is fuzzy at best and you can tolerate a huge loss in a market that bounces back.
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Re: The 50% fallacy

Post by bob90245 »

ddb wrote:
bob90245 wrote: 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).
Your Japan example doesn't persuade me. Although, it does strike similarities to the 90% collapse from the 1929 peak that the opening post cited.

So what is the lesson here? Don't invest in stocks after a Japan 1989 or US 1929 bubble, else your stocks will go bust? OK, lesson learned.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Re: The 50% fallacy

Post by grayfox »

tadamsmar wrote: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.
You are right, the maximum loss is clearly 100%. We should be thankful that it is limited to only 100%, although I suppose people who are leveraged can lose more than 100%. I think it is best to think of possible loss scenarios in terms of probabilities or how often they occur over your investing lifetime.

Suppose you start investing at age 25 and continue to invest as long as you live. Let's say you live to the ripe old age of 100. That would be 75 years of investing. Let's call it a 100 year lifetime to make it simple. How likely or how frequent are various losses over your century?

<table width="800" border="1">
<caption>Frequency of Various Level of Drawdown</caption>
<tr><th>Drawdown</th><th>Event</th><th>Frequency Per Century</th><th>Comment</th></tr>
<tr><td>0 to 10%</td><td>Off Peak</td><td>100</td><td>Except when the stock market is making new highs it is below peak. I think about 95% of the time the market is down between 0 and 10% from the peak</td></tr>
<tr><td>10% to 20%</td><td>Market Correction</td><td>40 to 50</td><td>I would expect 4 or 5 market corrections every decade.</td></tr>
<tr><td>20% to 50%</td><td>Bear Market</td><td>10 to 20</td><td>I would expect 1 or 2 bear markets per decade</td></tr>
<tr><td>50% to 90%</td><td>Market Crash</td><td> 1 or 2</td><td>This was The Great Depression in the 1930s (-90%) and The Great Recession in 2008 (-60%). This is like the 100 year flood.</td></tr>
<tr><td>100%</td><td>Total Permanent Loss</td><td>5% chance</td><td>This would require some catastrophic event like the collapse of the governement, socialist revolution, etc.. I think it depends on the country. For the U.S. I would guestimate a 5% to 10% chance of this happening in 100 years. For a place like Russia that already has a history of this, I would say 75% chance. If you held the whole world, maybe 5% chance.</td></tr>
</table>

I am just guessing at the frequency of these events. (in other words, I just made the numbers up from my gut feel.)
Maybe I'll look at the actual numbers, or maybe someone else already has. (I think I did look one time a few years ago.) I would be curious what other people think the likelihood of these events are, or if they have any actual numbers.

But to summarize, over the course of your life, you have to expect dozens of corrections, lots of bear markets, a crash or two and if you are lucky the communists don't take over the country and nationalize everything.
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Re: The 50% fallacy

Post by Lauren Vignec »

tadamsmar wrote:Come to think of it, that efficient frontier with 70/30 US/EAFE that you see everywhere (including the Boglehead Guide) sort of begs the question on country-specific risk. That efficient frountier is calculated on a few decades of data if I recall correctly, but I think it probaly takes more than a few decades of data to capture country-specific risk.

Now you got me thinking that I am kind of heavy in US equities...
Hello Tadamsmar,

Time diversification is a fallacy, but international diversification should work theoretically and has worked in practice.

In the late 1990's Phillipe Jorion (probably not the right spelling) studied all the global stock market data he could get his hands on at that time. He found that the average county had a 22% chance of losing money (adjusted for inflation and including dividends) over any 10 year period. However, a global stock portfolio with all countries had only a 12% chance.

Also, he used a concept called "95% Value at Risk" that I think you would find interesting. The idea is to look back at all historical stock scenarios. Create a range that includes the middle 95% of all ten-year total returns. The bottom of that range is the "95% Value at Risk". So it is not a "maximum loss", but maybe I can call it a "very bad but quite realistic loss."

For the average country, the "very bad but quite realistic loss" was 43%. Now, this is over ten years! However, for the global portfolio, the "very bad but quite realistic loss" was only 11%.

He was quite clear that all this was not predictive of the future. It was just a study of the past.

This paper was published before 2000. So what happened after the paper was published? According to Simba's backtesting spreadsheet, the US total stock market lost 24% in real terms from 2000 through 2009. A half US total market and half total international portfolio lost 13% from 2000 through 2009.

On your question about the volatility of the EAFE index--perhaps some of the countries in that index are riskier than the US, swamping the benefits of diversification. Or, perhaps it is due to currency fluctuations. If it is not just random noise, those would be my first two guesses.

L
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Post by nisiprius »

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

http://www.bogleheads.org/wiki/Safe_Withdrawal_Rates
It's important to note that

a) When the Trinity study (and similar studies) were published, it was a shock, because up until then advisors and retirement calculators had been merrily plugging in the stock market's historical rate of return and in essence asking the question "what withdrawal rate could be sustained for thirty years by a bank account earning 10% per year?"

b) The most important message of the Trinity paper is:
Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz wrote:The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning.
tadamsmar wrote:Table 3 in particular.
c) The big take-home message of table 3--which is consistent with other studies--should be that 3% is always OK and 5% is never OK.

In the Trinity study, 3% works for any asset allocation except 100% nominal bonds--but it would work for 100% TIPS as long as they had a coupon of 0% or greater. Boosters of stocks like to point out that in these studies the lowest failure rates occur with high equity allocations and sometimes imply that retirees should be increasing their equity exposure rather than reducing it. But this is only true with withdrawal rates that are so high that the failure rate is high for all portfolios.

Again, in the Trinity study, at a 5%-then-COLAed withdrawal rate the lowest failure rate was obtained at 100% equities but that failure rate was 15%.

The right message to take home from these withdrawal-rate studies is to use the asset allocation that appeals to your personal risk/reward preference, keep your spending down--down to 3%-initial-then-COLAed--and not worry about it. If you need more than 3%, sophisticated withdrawal strategies do not succeed in squeezing much more safe income out of the same lump sum. (Single-premium immediate annuities, love 'em or hate 'em, are a way of doing that).

It always amazes me that the rugged individualists who want nothing to do with insurance companies will strain at the gnat of insurance company insolvencies--I'm sure they seem like more than gnats if they happen to you--while swallowing the camel of a 15% failure rate.
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Re: The 50% fallacy

Post by ddb »

bottlecap wrote:
ddb wrote: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
Okay, then go further to find out how many total flights have taken place since 1942. Also, if you believe plane-safety technology has evolved, you might want to restrict yourself to a more recent time frame.

You still won't have an answer, though, since nobody knows the probability of an 80% market crash. FWIW, I'm more inclined to follow Mandelbrot's probabilities than anything based on a normal distribution. If you believe in a normal distribution on equity returns, and if you assume stock returns have a mean of 10% with a standard deviation of 20%, than an 80% loss is a 4.5 standard deviation event, or basically not possible.
ddb wrote: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?[/quote]

I'm not saying US Bonds can't default, I'm saying I view it as a less likely event than an 80% global equity crash (much less likely, actually).

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB
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Re: The 50% fallacy

Post by ddb »

bob90245 wrote:Your Japan example doesn't persuade me. Although, it does strike similarities to the 90% collapse from the 1929 peak that the opening post cited.

So what is the lesson here? Don't invest in stocks after a Japan 1989 or US 1929 bubble, else your stocks will go bust? OK, lesson learned.
I find few similarities. If you invested a lump sum in the S&P 500 on the last day of 1929 and looked just at year-end values, you were actually ahead of your initial investment at the end of 1935. Then there was another big drop in 1937, but you still got back above your initial investment at the end of 1938. Then another big drop 1940-1941, but back above water and never looked back by the end of 1944 (assumes dividend reinvestment and figures are on a real-dollar basis). That's "only" 15 years of flat inflation-adjusted returns, but there were lots of opportunities to increase returns via re balancing and/or systematically investing.

Japan is down 75% (nominal, no dividends, so I realize not direct comparison) after TWENTY years, and the trend was basically down, down, down.

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB
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Re: The 50% fallacy

Post by bob90245 »

ddb wrote:Japan is down 75% (nominal, no dividends, so I realize not direct comparison) after TWENTY years, and the trend was basically down, down, down.
It just goes to show the massive degree of overvaluation of Japanese stocks in 1989. So one should expect Japan to take longer to return to its prior highs.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Re: The 50% fallacy

Post by junior »

bob90245 wrote:
ddb wrote:Japan is down 75% (nominal, no dividends, so I realize not direct comparison) after TWENTY years, and the trend was basically down, down, down.
It just goes to show the massive degree of overvaluation of Japanese stocks in 1989. So one should expect Japan to take longer to return to its prior highs.
Yeah, if you aren't taking PE into account at all when evaluating the likelihood of a crash, then I think you are doing something wrong.

Would be interesting to know what Shiller PE would have indicated for Japan in 89.
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Re: The 50% fallacy

Post by SamB »

Lucio wrote:
An historical aside to this discussion, but the market in St. Petersburg did reopen after the war, in 1917, for a few months.
St. Petersburg Stock Exchange Project
Shanghai Stock Exchange Project

Lucio
Interesting. I lifted the statement right out of Bernstein's book, which referenced 1914. Apparently, 1917 is the correct date. Bernstein made the statement that the exchange never reopened. Nevertheless, this is a sobering history. The risk is real, and things do not always necessarily recover in your lifetime. I guess your success or failure is always a combination of unpredictable events that you have no control over, and then how you react to them, which you do have control over.

Sam
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Post by Random Musings »

Since the OP threw out the first pitch, I'm going to throw it back.

How do you specifically handle risk in your portfolio? Are you going to change your philosophy in handling risk after this discussion?

RM
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Post by djw »

To put this discussion further into perspective, a large percentage of Americans, not to mention the citizens of other countries, currently have a net worth which is very close to zero or well below zero.

In the nightmare investment scenarios being discussed in this thread, the immediate worst case result would be that a whole lot of Bogleheads would find themselves in exactly the same financial condition that their less fortunate neighbors are in today. Talk about leveling the playing field!

Allow me to coin the following term for this potential black swan event: a Global Financial Reset.

Another way to look at it is turning back the clock a few centuries, or even a millennium or two, when almost no one's personal balance sheet (hut, clothing, cooking pot, spear) would have been very impressive by current financial calculations.

This helps one to appreciate the true danger in this worst-case situation -- global productivity plummets, transportation, water, and sewage systems grind to a halt, and the folks who've migrated to cities and suburbs in huge numbers are suddenly unable to feed and warm themselves or access clean water and pharmaceuticals. Welcome to the Third World everybody!

If you need help visualizing this, imagine yourself as an average citizen in Haiti the day before the earthquake with no money and no American passport. Then, the earthquake hits EVERY city in the world, not just Haiti, so no one's coming to your rescue. Are you part of a community that will work together to help each other and watch your back? You might want to work that into your personal disaster plan.

I've heard that the Mormon church tells its people to keep one year of non-perishable food in their homes at all times. Total cost? Maybe a few thousand dollars. You might throw in some chickens and gardening supplies while you're at it.

Holding one year's worth of emergency cash is a deflation hedge while a one year stockpile of canned food is an inflation hedge. Put the rest of your money in widely diversified financial, intellectual (aka skills), physical (aka tools), and real (aka mortgage-free home) assets. That's true diversification. Food for thought.
Last edited by djw on Fri Feb 12, 2010 4:58 pm, edited 1 time in total.
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Re: The 50% fallacy

Post by LH »

tadamsmar wrote: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.
I have read a lot on here, and in boglehead books, I have never read anyone saying 50 percent is a maximum loss........................
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Re: The 50% fallacy

Post by TJAJ9 »

tadamsmar wrote: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.
Here are the facts:

It's a fallacy to say that all Bogleheads believe/follow something based on what one person wrote in a book.

You have also taken a 50% rule of thumb in the book completely out of context and you present it here as a stated fact that markets cannot decline more than 50%. More importantly -- that, in itself, is a fallacy.

As Taylor mentioned, in other parts of the book, worst case scenarios are listed. Have you read the whole book?
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Post by Triple digit golfer »

Nowhere have I ever seen written that a maximum equity loss in a bear market is 50%. Ever.
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Post by bmelikia »

As long as it only goes down no more than 99.99% then I'm good. Then I can toss all my cash at it and double, triple, quadrouple, etc. my newly invested money. Plus, if the market goes down to absolute zero then I don't really see what good money will do anyone. The new form of currency will be an exchange of bullets no doubt. . .
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Post by DRiP Guy »

nisiprius wrote:b) The most important message of the Trinity paper is:
Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz wrote:The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning.
Amen!
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risk

Post by pkcrafter »

tadamsmar's post is a worthwhile reminder. The main reason it's worthwhile is we see from the evidence that investors during the bear's of both 2008 and 2000 were surprised, stunned, shocked by the loses they incurred. Obviously, they don't understand risk. They don't understand it because it's treated as volatility by the financial world, underplayed by Wall Street, and the rest of us trying to help new investors have not found a reliable way to convey the meaning of risk. Anything that will make newer investors think a little more is a step in the right direction.

And note that Adrian's rule of thumb is tolerable loss = 50%, whatever that means.


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Re: risk

Post by Beagler »

pkcrafter wrote:
And note that Adrian's rule of thumb is tolerable loss = 50%, whatever that means.
Perhaps tolerable loss refers to the G.M.O. point. ("Get Me Out!")
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Re: The 50% fallacy

Post by bb »

tadamsmar wrote:
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 have read through this thread and I assume the OP would agree
with me the answer is YES.
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Re: risk

Post by avalpert »

pkcrafter wrote:tadamsmar's post is a worthwhile reminder. The main reason it's worthwhile is we see from the evidence that investors during the bear's of both 2008 and 2000 were surprised, stunned, shocked by the loses they incurred. Obviously, they don't understand risk. They don't understand it because it's treated as volatility by the financial world, underplayed by Wall Street, and the rest of us trying to help new investors have not found a reliable way to convey the meaning of risk. Anything that will make newer investors think a little more is a step in the right direction.

And note that Adrian's rule of thumb is tolerable loss = 50%, whatever that means.


Paul
I think they understand it just fine, I've worked with many risk managers, they have PhD, understand the nature and mathematics of risk perfectly well. It is not the understanding that is the problem, it is internalizing it and aligning its implications with your individual decisions - it is the part of us not being mechanical computers who can compute risk implications and make the mechanically correct choice and live with the consequences.

To that extent, this post isn't a worthwhile reminder of anything - people understand that stocks value can go to 0% (and bonds, treasuries, gold anything's value can go to 0%). If tadasmar, instead of an awkward confrontational post that accused people here of an assumption they don't actually have, had provided some behaivioral tool to beter internalize the true implications of risk than it could have been worthwhile.
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Re: risk

Post by TJAJ9 »

pkcrafter wrote:tadamsmar's post is a worthwhile reminder.
With respect, there's nothing worthwhile about it at all.

His two stated "facts" are basic knowledge for the majority of people on these boards. Nothing new has been brought to the table.
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Post by Brons »

realitytruthprozac wrote:Many stocks lose 100%
But they are conveniently replaced in the broad indices.
Classic case of Survivorship Bias.
I don't think you know how survivorship bias works as it doesn't affect indices for the retail investors. Because stocks will either be replaced before they lose 100% or after they lose 100%. In the first example the retail investor shouldn't own the stock anymore and as such be unaffected by the drop. In the second case the investor does lose his money and it will be reflected in his return and the return of the index.

If there would be survivorship bias at work here the index would be adjusted up after the stock dropped 100%. This is obviously not the case and certainly not for ETF's.
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risk

Post by pkcrafter »

avalpert wrote:
I think they understand it just fine, I've worked with many risk managers, they have PhD, understand the nature and mathematics of risk perfectly well.
I was referring to individual investors, but since you bring professionals into the picture, they also have not done a very good job of managing risk.

Here might be a possible explanation.

http://www.bloomberg.com/apps/harvardbu ... fbbff43669

It is obvious that many, probably the majority, of individual investors don't comprehend the consequences of high-risk taking and probably don't even know when they are taking excessive risk. The proof is in the unexpected losses incurred by many investors in the past few years. These investors had no idea they could lose as much as they did.

TJAJ quote:
His two stated "facts" are basic knowledge for the majority of people on these boards. Nothing new has been brought to the table.
Perhaps you assume too much. As to "nothing new", that applies to regulars on the forum, but there are many new readers trying to understand and learn. Reviews and different approaches to explaining risk can be useful.

When a rule of thumb such as tolerable loss = 50% of equity exposure gets enough play without an occasional reminder that it isn't a fact, it tends to be accepted without question. Putting the facts out there is better than letting things slide without question.

It's not a big deal, and I'm surprised the OP received so many responses.


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Re: risk

Post by avalpert »

pkcrafter wrote: It is obvious that many, probably the majority, of individual investors don't comprehend the consequences of high-risk taking and probably don't even know when they are taking excessive risk.
I don't see why that is obvious at all. I think people overestimate thier tolerance and may downplay the likelihood of unlikely events - but that isn't a lack of comprehension it is a combination of overconfidence and denial.
The proof is in the unexpected losses incurred by many investors in the past few years. These investors had no idea they could lose as much as they did.
I just do't think that is true. They knew they could lose it, they just never thought they would. It is a non-trivial difference between the two - if they just didn't know then yes, repeating it over and over may help, but if they knew but thought it couldn't happen to them then we have to address the issue differently.
It's not a big deal, and I'm surprised the OP received so many responses.


Paul
I think he got so many responses because of the tone of his post - accusatory - another reason why it probably couldn't have the intended result if he indeed did it to help educate us to the true risk we face.
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Re: risk

Post by tadamsmar »

TJAJ9 wrote:
pkcrafter wrote:tadamsmar's post is a worthwhile reminder.
With respect, there's nothing worthwhile about it at all.

His two stated "facts" are basic knowledge for the majority of people on these boards. Nothing new has been brought to the table.
My goal was to point out an error in the recently published Boglehead Guide.

Is that not at all worthwhile?
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End of the world

Post by rustymutt »

tadamsmar, do you hedge your investments by chance?
You sound like you’re worried about an end of the world as we know it, or worst case situation. I’d be buying food, and guns in this case.
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Re: The 50% fallacy

Post by tadamsmar »

TJAJ9 wrote:
tadamsmar wrote: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.
Here are the facts:

It's a fallacy to say that all Bogleheads believe/follow something based on what one person wrote in a book.

You have also taken a 50% rule of thumb in the book completely out of context and you present it here as a stated fact that markets cannot decline more than 50%. More importantly -- that, in itself, is a fallacy.

As Taylor mentioned, in other parts of the book, worst case scenarios are listed. Have you read the whole book?
I have not read the whole book, it was good the hear that the book contradicts itself elsewhere.

I see no evidence that you have read the passsage, plot description, and plot on the bottom of page 142 (continuing on to page 143) that I refer to.
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Post by neverknow »

..
Last edited by neverknow on Mon Jan 17, 2011 10:35 am, edited 1 time in total.
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Post by dbr »

Having deleted my original posting, I will come back with an opinion that the section of the BH book that is under discussion here is not very well written as it oversimplifies a point, presumably in the interest of brevity. Whether the BH book literally presents false information at that point is arguable. On re-reading, I can certainly see how a reader relying on no other sources of information could be mislead by the discussion presented there.

I have my own bones to pick about the whole concept of dictating stock/bond AA from an analysis of "how much can you lose," but that is an entirely different discussion.

I also agree that one small section of one book, BH or not, does not establish a "dogma" associated with Bogleheadism, whatever that is.
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Re: End of the world

Post by tadamsmar »

rcasement wrote:tadamsmar, do you hedge your investments by chance?
You sound like you’re worried about an end of the world as we know it, or worst case situation. I’d be buying food, and guns in this case.
I certainly hedge my investments in relation to chance, not "by chance".

I was just worried about reasoning on a false basis in a book on investment. I am not particularly worried about the end of the world.
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Re: The 50% fallacy

Post by tadamsmar »

LH wrote:
tadamsmar wrote: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.
I have read a lot on here, and in boglehead books, I have never read anyone saying 50 percent is a maximum loss........................
I can deduce from that that you have never read the bottom of page 142 of "The Boglehead's Guide to Retirement Planning".
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Repeating ourselves

Post by Taylor Larimore »

Hi Tad:
"I can deduce from that that you have never read the bottom of page 142 of "The Boglehead's Guide to Retirement Planning".
I'll repeat my earlier post plus an underline:
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."
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Re: The 50% fallacy

Post by james22 »

tadamsmar wrote:I have not read the whole book...
:roll:
tadamsmar wrote:I can deduce from that that you have never read the bottom of page 142 of "The Boglehead's Guide to Retirement Planning".
Have you?

Because while the figure ("based on a severe bear market") is titled Maximum Loss, the y-axis is title Maximum Tolerable Loss.
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Re: The 50% fallacy

Post by knowmad »

tadamsmar wrote:The facts are:
1. The maximum loss is %100.
2. The US equity market experienced a 90% loss 80 years ago.
If equities lost 100% of their value I would be tempted to Market Time and buy them all.

Seriously, though, the chance of massive losses is why my AA is 30/70 instead of 70/30. Now if stocks AND bonds loose 100% of their value, then I am going to wander off into the woods and learn to live off the land.

http://www.youtube.com/watch?v=iYJKd0rkKss
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Re: The 50% fallacy

Post by tadamsmar »

james22 wrote:
tadamsmar wrote:I have not read the whole book...
:roll:
tadamsmar wrote:I can deduce from that that you have never read the bottom of page 142 of "The Boglehead's Guide to Retirement Planning".
Have you?

Because while the figure ("based on a severe bear market") is titled Maximum Loss, the y-axis is title Maximum Tolerable Loss.
Yeah I have read that. What do you make of that?

Makes no sense. "Maximum Loss" is not the same as "Maximum Tolerable Loss". And, maximum tolerable loss is not based on a severe bear market. If the term has any meaning at all, it's based on the investor's circumstances.

It's completely garbled. The authors are conflating inaccurate observations about the stock market maximum losses with an investor's tolerance of loss.
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Re: Repeating ourselves

Post by tadamsmar »

Taylor Larimore wrote:Hi Tad:
"I can deduce from that that you have never read the bottom of page 142 of "The Boglehead's Guide to Retirement Planning".
I'll repeat my earlier post plus an underline:
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."
50% is labeled as the "Maximum Loss" of equities on page 142.
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"Maximum Loss"

Post by Taylor Larimore »

Hi Tad:

You are right. Figure 9.1 in the book should not use the words "Maximum Loss."

Thank you for the correction.
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Re: "Maximum Loss"

Post by tadamsmar »

Taylor Larimore wrote:Hi Tad:

You are right. Figure 9.1 in the book should not use the words "Maximum Loss."

Thank you for the correction.
Also, I think the sentence above Figure 9.1 is problematic. We had a 90% decline 80 years ago, and someone who starts investing after college and lives a normal lifespan will invest for about 50 years, longer for a couple. Seems to me that a lifetime investing plan should be robust against the worst bear market that can reasonably be expected in a lifetime. But, the text says Figure 9.1 is based on the loss expected from merely the next deep bear market, not on lifetime expectations. And, how did the authors arrive at the notion that the next deep bear market is expected to be a 50% decline?
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Post by nisiprius »

I've been goaded into getting out my copy of the book. Sure, I see some problems with the picture--starting with the fact that's it's uses an awful lot of ink to display one single data point! But in context, what the book says seems clear to me:
Figure 9.1 is a table portfolio based on a severe bear market, showing the loss that should be expected on a $100,000 portfolio for various stock/bond allocations when the next deep bear market will occur.
Notice the word used: when, not if: "when the next deep bear market occurs."

This is going to happen, and it will likely happen to you... when the next deep bear market occurs.

The tone is not "Don't worry, 50% is the worst that could possibly happen." The tone is "Do worry, 50% losses happen routinely."

So, OK, the Boglehead editors may have nodded off--it's sourced to Morningstar, I wonder whether those are Morningstar's captions?--and let some muddled captions slip through, but that's evidence of editorial imperfection, not of Boglehead overoptimism.

P. S. And what the heck is a "table portfolio?" :wink:
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Boglehead book reviews

Post by Taylor Larimore »

Hi Tad:

Over two dozen Boglehead retirement and financial experts contributed their time and knowledge to our second Bogleheads' Guide without renumeration.

Like any book, it contains mistakes and some things may not be perfectly clear to every reader. Despite its shortcomings, customer reviews at Amazon give our book a 5-STAR rating and it is recommended by many reviewers, including Vanguard.

http://www.amazon.com/Bogleheads-Guide- ... 631&sr=8-1

Please tell us what you like about the book.

Thank you.
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Re: The 50% fallacy

Post by TJAJ9 »

tadamsmar wrote:
TJAJ9 wrote:
tadamsmar wrote: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.
Here are the facts:

It's a fallacy to say that all Bogleheads believe/follow something based on what one person wrote in a book.

You have also taken a 50% rule of thumb in the book completely out of context and you present it here as a stated fact that markets cannot decline more than 50%. More importantly -- that, in itself, is a fallacy.

As Taylor mentioned, in other parts of the book, worst case scenarios are listed. Have you read the whole book?
I have not read the whole book, it was good the hear that the book contradicts itself elsewhere.

I see no evidence that you have read the passsage, plot description, and plot on the bottom of page 142 (continuing on to page 143) that I refer to.
I've read that -- along with the rest of the book.

Maybe you should give it a try.
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Re: The 50% fallacy

Post by tadamsmar »

TJAJ9 wrote:
tadamsmar wrote:
TJAJ9 wrote:
tadamsmar wrote: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.
Here are the facts:

It's a fallacy to say that all Bogleheads believe/follow something based on what one person wrote in a book.

You have also taken a 50% rule of thumb in the book completely out of context and you present it here as a stated fact that markets cannot decline more than 50%. More importantly -- that, in itself, is a fallacy.

As Taylor mentioned, in other parts of the book, worst case scenarios are listed. Have you read the whole book?
I have not read the whole book, it was good the hear that the book contradicts itself elsewhere.

I see no evidence that you have read the passsage, plot description, and plot on the bottom of page 142 (continuing on to page 143) that I refer to.
I've read that -- along with the rest of the book.

Maybe you should give it a try.
Well, if you read that, then it should be obvious to you that they presented 50% as a maximum equity loss or an equity loss to be expected not as a rule of thumb. There is a difference between a rule of thumb and an observation about the way markets behave. The authors made an incorrect observation concerning the way markets behave.

You may believe its a rule of thumb, but you should pay attention to what the author's actually said and not just see what you believe.

Taylor said that it was incorrect to call it a "maximum loss". Do you think he is wrong?

I don't want to belabor the point, but if I make a correct statement and people keep coming back and telling me I am wrong, then I guess this might continue forever.
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Re: The 50% fallacy

Post by nisiprius »

tadamsmar wrote:Well, if you read that, then it should be obvious to you that they presented 50% as a maximum equity loss or an equity loss to be expected
Tad, I got the book down and read the passage. It does not say what you say it says. There is a big difference between a "maximum loss" and a "loss to be expected." The book says that a 50% loss is to be expected. Taylor has acknowledged that the captions on the graphic are sloppily worded and could be misread.

Here's another clear statement, p. 141, emphasis supplied: "Bear markets such as 1973-74, 2000-2002 and 2007-2008 can cut the value of your stock portfolio in half; therefore, your stock allocation should be no more than twice the amount you can tolerate losing." That's a cautionary limit.

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