Larry Swedroe: Driver’s Behind The Dip

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Random Walker
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Larry Swedroe: Driver’s Behind The Dip

Post by Random Walker » Mon Feb 12, 2018 10:32 am

http://www.etf.com/sections/index-inves ... nopaging=1

Great article. In the end, no one really knows why the dip occurred. But Larry sure teaches a lot in 3 pages hypothesizing on possible sources. He reviews valuations, discount rate, investor demand for risk premium, the effect of interest rate changes, and some investment strategies that could contribute: Managed volatility, risk parity, and momentum. He reminds us that actual investor returns (as opposed to strategy returns) depend tremendously on investor behavior. Finishes up by asking us to ponder how Buffett would behave when everyone else is selling in panic.
In the article, Larry also links to another recent article of his on valuations and a recent Asness essay on risk parity. Both of those good reads as well.

Dave

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Taylor Larimore » Mon Feb 12, 2018 10:40 am

Dave:

In my opinion, this is the most important part of the article:
The important message I hope you will take away is that your investment plan should incorporate the virtual certainty you will experience severe bear markets, on average, about once a decade or so, and that you will have to live through many other “corrections” along the way. Each will test your discipline.

That is why it is so critical to ensure your investment policy does not allow you to assume more risk than you have the ability, willingness or need to take.
Bogleheads should assume that our portfolios will fall about 50% of its stock allocation in the next bad bear market. In other words, a portfolio with a 60% stock/40% bond allocation will plunge about 30%.

If you might lose sleep or sell your stocks in a bad bear market, this is a good time to lower your stock allocation.

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

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by HomerJ » Mon Feb 12, 2018 10:55 am

Taylor Larimore wrote:
Mon Feb 12, 2018 10:40 am
Dave:

In my opinion, this is the most important part of the article:
The important message I hope you will take away is that your investment plan should incorporate the virtual certainty you will experience severe bear markets, on average, about once a decade or so, and that you will have to live through many other “corrections” along the way. Each will test your discipline.

That is why it is so critical to ensure your investment policy does not allow you to assume more risk than you have the ability, willingness or need to take.
Bogleheads should assume that our portfolios will fall about 50% of its stock allocation in the next bad bear market. In other words, a portfolio with a 60% stock/40% bond allocation will plunge about 30%.

If you might lose sleep or sell your stocks in a bad bear market, this is a good time to lower your stock allocation.

Best wishes.
Taylor
I agree... I always say one should set an Asset Allocation assuming the market could start a 50% drop tomorrow. Because it might.

If one wants to be conservative, one could also plan around it taking 5-10 years to recover. Because it might.

And this is true regardless of valuations. The risk never goes to zero.

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by garlandwhizzer » Mon Feb 12, 2018 10:58 am

Excellent article by Larry, thanks for posting it, Dave. A thoughtful analysis of the factors behind recent volatility and timeless advice about portfolio construction to stay the course through the tough times.

Garland Whizzer

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Random Walker » Mon Feb 12, 2018 11:00 am

Taylor and Homer,
Completely Agree! I assume equities can drop 50% in any given year as well.

Dave

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Lauretta » Mon Feb 12, 2018 11:07 am

HomerJ wrote:
Mon Feb 12, 2018 10:55 am
Taylor Larimore wrote:
Mon Feb 12, 2018 10:40 am
Dave:

In my opinion, this is the most important part of the article:
The important message I hope you will take away is that your investment plan should incorporate the virtual certainty you will experience severe bear markets, on average, about once a decade or so, and that you will have to live through many other “corrections” along the way. Each will test your discipline.

That is why it is so critical to ensure your investment policy does not allow you to assume more risk than you have the ability, willingness or need to take.
Bogleheads should assume that our portfolios will fall about 50% of its stock allocation in the next bad bear market. In other words, a portfolio with a 60% stock/40% bond allocation will plunge about 30%.

If you might lose sleep or sell your stocks in a bad bear market, this is a good time to lower your stock allocation.

Best wishes.
Taylor
I agree... I always say one should set an Asset Allocation assuming the market could start a 50% drop tomorrow. Because it might.

If one wants to be conservative, one could also plan around it taking 5-10 years to recover. Because it might.

And this is true regardless of valuations. The risk never goes to zero.
Yes that's one of the criteria I used when coming up with my AA; but may I ask why use a DD of 50%? (in the Great Depression the market fell by more than 80% - I know this is not at all probable, but wouldn't it be possible as a black swan event?)
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Re: Larry Swedroe: Driver’s Behind The Dip

Post by AtlasShrugged? » Mon Feb 12, 2018 11:15 am

He reminds us that actual investor returns (as opposed to strategy returns) depend tremendously on investor behavior.
Random Walker....Thx for sharing the article.

The behavioral piece is always the hardest to master. I remind myself constantly that the biggest enemy to my portfolio looks at me in the mirror every morning.
“If you don't know, the thing to do is not to get scared, but to learn.”

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by willthrill81 » Mon Feb 12, 2018 11:27 am

Lauretta wrote:
Mon Feb 12, 2018 11:07 am
Yes that's one of the criteria I used when coming up with my AA; but may I ask why use a DD of 50%? (in the Great Depression the market fell by more than 80% - I know this is not at all probable, but wouldn't it be possible as a black swan event?)
Anything is possible, including the stock market going to zero if everything were nationalized (this has happened multiple times in other countries).

I think that many believe that the likelihood of a drawdown greater than 50% is low enough that investors need not plan for a deeper one than that. If they did, they would probably set their AA to be overly conservative.

That being said, those who are really concerned about real Black Swans might consider a Larry Portfolio with something like a 30/70 AA.
Last edited by willthrill81 on Tue Feb 13, 2018 5:20 pm, edited 1 time in total.
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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Lauretta » Mon Feb 12, 2018 11:40 am

willthrill81 wrote:
Mon Feb 12, 2018 11:27 am

That being said, those who are really concerned about real Black Swans might consider a Larry Portfolio with something like a 30/70 AA.
Thanks for the feedback; yes I have a strong tilt towards a LS portfolio (even though I didn't know it existed when I decided on my AA).
I know you like momentum strategies to limit left tail risk; I have also studied them though I saw from back tests in Alpha Architect that the DD in the great Depression would have been huge. In the end I think it comes down to one's temperament and what one is most comfortable with I think.
When everyone is thinking the same, no one is thinking at all

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by david1082b » Mon Feb 12, 2018 11:51 am

Lauretta wrote:
Mon Feb 12, 2018 11:07 am
but may I ask why use a DD of 50%? (in the Great Depression the market fell by more than 80% - I know this is not at all probable, but wouldn't it be possible as a black swan event?)
If you include dividends and the deflation, 1929-1932 was not actually as bad as all that. The problem is that price-only charts are the main way that stock returns are presented a lot of the time. Total return for your particular portfolio is the only thing that really matters, prices are merely one component. All this doesn't prevent a minus 90% total return from happening to a total US index in future of course. Worser scenarios than the past can always happen.

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Angst » Mon Feb 12, 2018 12:53 pm

Honestly, yawns and milquetoasts come to mind... if all that Bogleheads can conclude from this article is "Oh yeah, Larry's got that right - the market can drop 50% anytime! Better have an appropriate AA, and stay the course!!" Well, duh... but I for one found the article somewhat disappointing. Throughout the introductory paragraphs Larry focused on the VIX - how it had been low (and itself not volatile) for such a long period of time, and how in January it started waking up and on Feb 1st it jumped. He proceeds to correlate the onset of the new volatility in the market (S&P 500) with the movement of the VIX, repeatedly demonstrating the VIX as something of a leading indicator, but then ends his introduction with this:
In his article, Larry wrote:With that in mind, I thought it would be helpful to review the determinants of stock prices and provide some possible, if not likely, explanations for this most recent crash.
My reaction was "Huh?" Why isn't Larry focusing on the VIX? He's just finished suggesting that there appear to be few good fundamental explanations for this correction which the VIX has nonetheless successfully presaged, but decides he better look into what affects the movement of the stocks rather than what affects the VIX! I would have liked to have begun reading an article focusing on the underlying determinants and the workings of the VIX. Many of the subsequent things he brought up of course must also help drive it, but I was disappointed. Sure, I should go and search for info on the VIX, but I would have no higher preference than to have read what Larry thought might have caused it to rise and then jump in front of the market. How did the VIX pick up on things before the wisdom of the market did? Perhaps he has a follow-up article in the works.

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Sandtrap » Mon Feb 12, 2018 2:18 pm

Taylor Larimore wrote:
Mon Feb 12, 2018 10:40 am
Dave:

In my opinion, this is the most important part of the article:
The important message I hope you will take away is that your investment plan should incorporate the virtual certainty you will experience severe bear markets, on average, about once a decade or so, and that you will have to live through many other “corrections” along the way. Each will test your discipline.

That is why it is so critical to ensure your investment policy does not allow you to assume more risk than you have the ability, willingness or need to take.
Bogleheads should assume that our portfolios will fall about 50% of its stock allocation in the next bad bear market. In other words, a portfolio with a 60% stock/40% bond allocation will plunge about 30%.

If you might lose sleep or sell your stocks in a bad bear market, this is a good time to lower your stock allocation.

Best wishes.
Taylor
How do you calculate this for various allocations given a 50% market drop?

Mahalo,
jim :D

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by willthrill81 » Mon Feb 12, 2018 2:32 pm

Lauretta wrote:
Mon Feb 12, 2018 11:40 am
willthrill81 wrote:
Mon Feb 12, 2018 11:27 am

That being said, those who are really concerned about real Black Swans might consider a Larry Portfolio with something like a 30/70 AA.
Thanks for the feedback; yes I have a strong tilt towards a LS portfolio (even though I didn't know it existed when I decided on my AA).
I know you like momentum strategies to limit left tail risk; I have also studied them though I saw from back tests in Alpha Architect that the DD in the great Depression would have been huge. In the end I think it comes down to one's temperament and what one is most comfortable with I think.
Yes, the investor's personality plays a big role, I think, in the type of strategy that is optimal for them.

The maximum drawdown for U.S. equities during the Great Depression was -83%, and I believe that the max. drawdown for those using a 200 day moving average (using cash as the out-of-equities asset) was -50%, still very bad but leaving one with more than four times more dollars in their portfolio compared to buy-and-hold at the worst point.

Keep in mind as well that a bond heavy portfolio would have really suffered from the inflation of the 1970s and early 1980s. In real dollars, the maximum drawdown for intermediate term Treasuries was -32%.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by saltycaper » Mon Feb 12, 2018 2:40 pm

Taylor Larimore wrote:
Mon Feb 12, 2018 10:40 am

Bogleheads should assume that our portfolios will fall about 50% of its stock allocation in the next bad bear market.
I think this is not the best way to look at it. In the absence of any other reason, the 50% number is based on past performance, but the market usually does not drop by 50%. It's not the average decline or the median decline or anything else but a number that people seem to like because it is one-half of 100, and that appeals to some people.

Although 50% is a pretty good number for a "bad bear market", that specific label is not of interest, since when it drops less or drops more, we'll just call it something else.

When thinking about your AA, the percentage drops taken into account are not meaningful IMO unless you assign probabilities to them, even if those probabilities are not exact numbers. For instance, 5-10% declines should be considered very frequent occurrences, 20-30% declines also very likely to happen multiple times during one's investment lifetime, 40-50% perhaps not frequent but also to be expected, 60-80% extremely rare but have occurred so obviously possible and should be accounted for, and total loss also possible under certain circumstances.

Trying to "shortcut" this process by picking a number that looks nice may result in an overly conservative asset allocation or one where things that have actually happened before and may happen again are not accounted for, potentially leaving the investor in a bad spot when they face a situation they should have anticipated, and easily could have if they looked at market history.
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Re: Larry Swedroe: Driver’s Behind The Dip

Post by willthrill81 » Mon Feb 12, 2018 2:43 pm

Sandtrap wrote:
Mon Feb 12, 2018 2:18 pm
Taylor Larimore wrote:
Mon Feb 12, 2018 10:40 am
Dave:

In my opinion, this is the most important part of the article:
The important message I hope you will take away is that your investment plan should incorporate the virtual certainty you will experience severe bear markets, on average, about once a decade or so, and that you will have to live through many other “corrections” along the way. Each will test your discipline.

That is why it is so critical to ensure your investment policy does not allow you to assume more risk than you have the ability, willingness or need to take.
Bogleheads should assume that our portfolios will fall about 50% of its stock allocation in the next bad bear market. In other words, a portfolio with a 60% stock/40% bond allocation will plunge about 30%.

If you might lose sleep or sell your stocks in a bad bear market, this is a good time to lower your stock allocation.

Best wishes.
Taylor
How do you calculate this for various allocations given a 50% market drop?

Mahalo,
jim :D
He calculated it by simply cutting in half whatever the allocation to stocks is. So if 60% is cut in half while the bonds remain stable, then the portfolio would be reduced by 30%.

Keep in that the widespread assumption of short-term safety in bonds has not always been the case. The maximum drawdown in real terms for intermediate term Treasuries was -32% from 1976 to 1981.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Toons » Mon Feb 12, 2018 2:46 pm

I believe In What Bogle says.
"Nobody Knows Nothing"
Excellent In 3 Words.
:happy

https://www.youtube.com/watch?v=A0gQiz0pCyI
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by saltycaper » Mon Feb 12, 2018 2:49 pm

Toons wrote:
Mon Feb 12, 2018 2:46 pm
I believe In What Bogle says.
"Nobody Knows Nothing"
Excellent In 3 Words.
:happy

https://www.youtube.com/watch?v=A0gQiz0pCyI
No rational person would invest if they truly believed this.
Quod vitae sectabor iter?

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Toons » Mon Feb 12, 2018 2:51 pm

saltycaper wrote:
Mon Feb 12, 2018 2:49 pm
Toons wrote:
Mon Feb 12, 2018 2:46 pm
I believe In What Bogle says.
"Nobody Knows Nothing"
Excellent In 3 Words.
:happy

https://www.youtube.com/watch?v=A0gQiz0pCyI
No rational person would invest if they truly believed this.
I always thought I may be somewhat irrational at times..
You confirmed it..... :sharebeer
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by HomerJ » Mon Feb 12, 2018 2:53 pm

saltycaper wrote:
Mon Feb 12, 2018 2:49 pm
Toons wrote:
Mon Feb 12, 2018 2:46 pm
I believe In What Bogle says.
"Nobody Knows Nothing"
Excellent In 3 Words.
:happy

https://www.youtube.com/watch?v=A0gQiz0pCyI
No rational person would invest if they truly believed this.
I like the phrase Nobody knows Enough* better

*to predict short-term market movements

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Toons » Mon Feb 12, 2018 2:54 pm

HomerJ wrote:
Mon Feb 12, 2018 2:53 pm
saltycaper wrote:
Mon Feb 12, 2018 2:49 pm
Toons wrote:
Mon Feb 12, 2018 2:46 pm
I believe In What Bogle says.
"Nobody Knows Nothing"
Excellent In 3 Words.
:happy

https://www.youtube.com/watch?v=A0gQiz0pCyI
No rational person would invest if they truly believed this.
I like the phrase Nobody knows Enough* better

*to predict short-term market movements

:sharebeer
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Riley15 » Mon Feb 12, 2018 2:55 pm

willthrill81 wrote:
Mon Feb 12, 2018 2:32 pm


The maximum drawdown for U.S. equities during the Great Depression was -83%, and I believe that the max. drawdown for those using a 200 day moving average (using cash as the out-of-equities asset) was -50%, still very bad but leaving one with more than four times more dollars in their portfolio compared to buy-and-hold at the worst point.

Any type of moving average is just that. A statistically calculated number used for technical analysis, it may not have any relevance to increasing or decreasing returns in any meaningful way when used. It's not any different then 52 week lows/highs or round numbers that end in 00. Which type of moving average would you advocate for?? There's simple moving average, weighted average, exponential moving average or time-series. They may all have different outcomes in various time periods.

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Lauretta » Mon Feb 12, 2018 2:57 pm

willthrill81 wrote:
Mon Feb 12, 2018 2:32 pm
Lauretta wrote:
Mon Feb 12, 2018 11:40 am
willthrill81 wrote:
Mon Feb 12, 2018 11:27 am

That being said, those who are really concerned about real Black Swans might consider a Larry Portfolio with something like a 30/70 AA.
Thanks for the feedback; yes I have a strong tilt towards a LS portfolio (even though I didn't know it existed when I decided on my AA).
I know you like momentum strategies to limit left tail risk; I have also studied them though I saw from back tests in Alpha Architect that the DD in the great Depression would have been huge. In the end I think it comes down to one's temperament and what one is most comfortable with I think.
Yes, the investor's personality plays a big role, I think, in the type of strategy that is optimal for them.

The maximum drawdown for U.S. equities during the Great Depression was -83%, and I believe that the max. drawdown for those using a 200 day moving average (using cash as the out-of-equities asset) was -50%, still very bad but leaving one with more than four times more dollars in their portfolio compared to buy-and-hold at the worst point.

Keep in mind as well that a bond heavy portfolio would have really suffered from the inflation of the 1970s and early 1980s. In real dollars, the maximum drawdown for intermediate term Treasuries was -32%.
ok thanks for your feedback, I believe that Mr Swedroe said ideally one should use TIPs which would thus provide insurance against inflation:
https://seekingalpha.com/article/191219 ... sing-yield
Anyway I only just found out about the LS portfolio yesterday so I need to read more about the details; but a barbell portfolio always appealed to me; I had read about the idea in Taleb; so I had built mine along symilar lines.

Re trend following and momentum I don't want to deviate too much from the subject of this thread so I'll write a couple of observations in the Dual momentum thread (but yes the DD would have been 50% in the Great Depression).
When everyone is thinking the same, no one is thinking at all

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Lauretta » Mon Feb 12, 2018 3:06 pm

Riley15 wrote:
Mon Feb 12, 2018 2:55 pm
willthrill81 wrote:
Mon Feb 12, 2018 2:32 pm


The maximum drawdown for U.S. equities during the Great Depression was -83%, and I believe that the max. drawdown for those using a 200 day moving average (using cash as the out-of-equities asset) was -50%, still very bad but leaving one with more than four times more dollars in their portfolio compared to buy-and-hold at the worst point.

Any type of moving average is just that. A statistically calculated number used for technical analysis, it may not have any relevance to increasing or decreasing returns in any meaningful way when used. It's not any different then 52 week lows/highs or round numbers that end in 00. Which type of moving average would you advocate for?? There's simple moving average, weighted average, exponential moving average or time-series. They may all have different outcomes in various time periods.
ok I was going to write about this in another thread, but since the comment has been made on the type of MA, another thing is also which day of the month you choose for trading
https://blog.thinknewfound.com/2017/05/ ... e-details/
My point is, this seems a highly empirical method, highly sensitive to the filter you use (sometimes SMA are better, sometimes 12 month momentum etc), the trading day you chose etc. So I like the idea that it tends to reduce left tail risk; but I don't think that data e.g. presenting the CAGR of Dual momentum with a precision of one decimal place is very meaningful.
Last edited by Lauretta on Mon Feb 12, 2018 5:07 pm, edited 1 time in total.
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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Random Walker » Mon Feb 12, 2018 4:22 pm

In previous post up above Lauretta mentioned that the market had dropped around 80% in the depression. Yet many of us use the working assumption that we need to tolerate a roughly 50% equity decline at some point. If we make our base case the worst case, then we may well end up being too conservative with our investing and spending. Instead we can make a much less dramatic base case and hold a plan B in reserve should the horrendous happen. Plan B might include decreased spending, working longer, selling a house, moving to less expensive location. Below is a link to an article where Larry discusses Plan B.


Dave

http://www.etf.com/sections/index-inves ... nopaging=1

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Call_Me_Op » Tue Feb 13, 2018 10:27 am

Taylor Larimore wrote:
Mon Feb 12, 2018 10:40 am
Dave:

In my opinion, this is the most important part of the article:
The important message I hope you will take away is that your investment plan should incorporate the virtual certainty you will experience severe bear markets, on average, about once a decade or so, and that you will have to live through many other “corrections” along the way. Each will test your discipline.

That is why it is so critical to ensure your investment policy does not allow you to assume more risk than you have the ability, willingness or need to take.
Bogleheads should assume that our portfolios will fall about 50% of its stock allocation in the next bad bear market. In other words, a portfolio with a 60% stock/40% bond allocation will plunge about 30%.

If you might lose sleep or sell your stocks in a bad bear market, this is a good time to lower your stock allocation.

Best wishes.
Taylor
Taylor,

Nice summary of all one really needs to know about asset allocation.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Toons » Tue Feb 13, 2018 10:28 am

Driver behind the Dip:
Gravity
:happy
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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Top99% » Wed Feb 14, 2018 8:27 am

Thanks for linking a great article Dave. Some of the replies about expecting a "punch in the face" by Mr Market now and then are right on. The statement "Those investors allowed their need to take risk to dominate the asset allocation decision, ignoring their ability and willingness to take risk." squares with my observation about REITs and (formerly) high dividend stocks getting priced as though they have similar risk to mid-term bonds. The risk will show up. Nobody knows when.
Adapt or perish

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Re: Larry Swedroe: Driver’s Behind The Dip

Post by Random Walker » Wed Feb 14, 2018 11:12 am

Top99%,
I think I remember Larry once writing something to the effect that life is too short to stress over an asset allocation that is too aggressive. The older I get, the more I agree! Moreover, as I’ve gotten older, I’ve tamed down my financial goals and with the aid of Monte Carlo Simulation, seen the surprising lack of aggressive asset allocation effect on meeting goals. And knowing that the pain of a loss is way more than the happiness of equal sized gain is just more reason to be modest with the AA. I’m 55, so this logic not necessarily at all applicable yet to someone in their 20’s or 30’s.

Dave

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