2024 Overconfidence - Let’s have a look at asset allocation

[unwitting_gulag]

The message of the authors experience as I read it was that holding government bonds was or would have been the one safe holding, which definitely got my attention. It's not an exciting read - but comes across as very real.

Much has been said about 1929, 1937, 1987 or 2007-2009. But have we already forgotten 2022? What exactly happened to bonds then? What happened to VWIUX (intermediate-term tax exempt bond fund)? How has it done cumulatively since 2022, during our so-called bull market? If we say that our careers or human capital are "bond like", do we mean, like bonds in 2022?

Nay, the complacency and overconfidence, are that in a true depression, bonds will save us. Think again! What would most likely save us is a witheringly austere material lifestyle. People who have deliberately and voluntarily lived in poverty their whole lives, despite sporting a very handsome retirement portfolio, could theoretically lose it all... and yet, ultimately lose nothing. Except for their pride, of course!

[Beensabu]

Forgive me, but I’m not understanding this approach to the math. Shouldn’t we be using different return rates for each portfolio?

Not if you want to understand the overconfidence in high equity allocations.

$90 after 0 years of 10% returns = $90
$75 after 0 years of 10% returns = $75

90-75 = 15

15/100 = 15%

By this math, you're 15% ahead before the simulation has even begun.

You can't have a difference in return without a return.

Assuming bonds return zero, you need to add back the $10 and $25 respectively.
145+10 = 155
121+25 = 146

After 5 years you've made an extra $9 with the 90/10 allocation. Since current bond yields are not zero, the difference in real life going forward will probably be smaller than this, especially if there's a gigantic market crash in the middle of whatever time period you're looking at and the person rebalances on the way down like they're supposed to.

That's very good. Thank you.

[sambb]

The most important thing in a huge depression is not necessarily your long term retirement investments - the largest risk is losing your job and finding employment. The best thing you can do to prepare, is to be enthusiastic and valuable at work, enjoy the mission of the company, and be seen as someone who can work well with management in easy and tough times. Pick a career that is more recession proof as a defensive move. it is challenging to prepare for this, and for some employees it is an adjustment. In this future state, You ought to be happy just having your job in the absence of bonuses, raises, etc.

[MrNarwhal]

I think Nisi means there was absolutely no reason to think the US wouldn't go the way of the Tsars.

Plenty of thought then supported the Bolshevics- only thing to do would be flee, leaving it all behind.

One characteristic of successful people is they are not afraid to fail. They are willing to fail many times if that is what it takes to succeed. Stocks going to zero does not prevent financial success. You simply have to have the wherewithal to recover from your stocks going to zero - whether that is working longer, saving more, or working until the day you can not work any more.

Maybe some people are just willing to fail to help their chance of succeeding.

There may be a valid psychological argument here, but "financial success" is subjective. If "success" is defined as minimizing years of earned income before retirement, then buying and holding stocks is probably the strategy with the best expected outcome.

On the other hand, unplanned expenses can occur during the planned accumulation period. Such as a health condition impacting earned income or with experimental treatments not covered by insurance, support for a family member facing financial ruin, specialized care for a child with special needs, etc. There are also variable consumption scenarios such as moving to an area with more expensive housing or paying for a child to attend a more expensive university.

The benefit of having income >> expenses can be security against various contingencies which may or may not follow the timeline of retirement in many years. Trading some returns for reduced volatility makes sense in that context. I am not saying that this is right for you, just that it is not necessarily wrong for everyone.

[unwitting_gulag]

The most important thing in a huge depression is not necessarily your long term retirement investments - the largest risk is losing your job and finding employment. The best thing you can do to prepare, is to be enthusiastic and valuable at work, enjoy the mission of the company, and be seen as someone who can work well with management in easy and tough times. Pick a career that is more recession proof as a defensive move. it is challenging to prepare for this, and for some employees it is an adjustment. In this future state, You ought to be happy just having your job in the absence of bonuses, raises, etc.

That depends entirely where one is in one's lifecycle... it's the ratio of human capital to investment-capital. For older workers, who are nearing retirement anyway, and who have a large ratio of portfolio to annual W2, the HC to IC ratio is small. Unrecoverable investment losses are vastly more consequential than job loss.

[ScubaHogg]

Not trying to be snarky (truly not), but one could just as well read the diary of a cancer patient, and reach other conclusions: don't worry about stocks and bonds, find some healthy work as a sheep shephard, enjoying what time you have in the beauty of nature, eating healthy and playing a flute.

In general, reading about bad scenarios will have you optimizing more for bad case scenarios.

I mean, there are books out there like that. Reading them probably really good for keeping daily problems in perspective

Personally I like reading about books about tough times. I hope that it helps build some mental fortitude for when they inevitably appear. The Stoics call it “negative visualization.”

[Chili Powder]

This isn't the best way to analyze these things as I noted above, but if you do look at peaks and troughs, VGLT (Vanguard Long Term Treasuries) was at 104.14 on July 31, 2020 and dropped to 52.37 on October 20, 2023, representing a drop of about 50%. It is currently at 61.77 which is about 40% below the peak of July 31, 2020, which means we don't know how long it will take to reach the peak again, but it will be at least 4 years and 2 months.

As I said before, if anything, there appears to be overconfidence in bonds.

[monkeytoad]

Not trying to be snarky (truly not), but one could just as well read the diary of a cancer patient, and reach other conclusions: don't worry about stocks and bonds, find some healthy work as a sheep shephard, enjoying what time you have in the beauty of nature, eating healthy and playing a flute.

In general, reading about bad scenarios will have you optimizing more for bad case scenarios.

I mean, there are books out there like that. Reading them probably really good for keeping daily problems in perspective

Personally I like reading about books about tough times. I hope that it helps build some mental fortitude for when they inevitably appear. The Stoics call it “negative visualization.”

I agree about the Stoic perspective. My point is, and perhaps that is what you're saying as well, is that considering some scenarios is useful as a contemplation for perspective, not necessarily as something for which to concretely prepare.

[watchnerd]

I am a little concerned that recent downturns have been "spoiling" us - 2020 and 2022 were both pretty strong corrections but they were brief and followed by nice rallies, so getting through them gives me the impression that I have a high risk tolerance. For the market to go nowhere year after grinding year for a decade like the 70s, it's hard to imagine how I'd react.

Yep.

A whole new crop of investors thinks the recoveries from 2020 and 2022 is normal.

Lots of people seem blase about stock crashes now.

[HomerJ]

I am a little concerned that recent downturns have been "spoiling" us - 2020 and 2022 were both pretty strong corrections but they were brief and followed by nice rallies, so getting through them gives me the impression that I have a high risk tolerance. For the market to go nowhere year after grinding year for a decade like the 70s, it's hard to imagine how I'd react.

Yep.

A whole new crop of investors thinks the recoveries from 2020 and 2022 is normal.

Lots of people seem blase about stock crashes now.

Agreed.

[firebirdparts]

I’d be curious if anyone agrees with me that the general recommendations do not always reflect the interests of people who’s earnings would be devastated by an economic crash. The general recommendations out there seem to assume that in your working years, you will always find a way to earn.

I think only you can choose your "emergency" and I've said that many times. I don't really care about anybody else's emergency and I mean it.

If, for instance, you wanted to be able to live 2 or 3 years without working, and you manage your money accordingly, it'll create quite a drag on your investing early in life. If you wanted to do this, then a reasonably smart unemotional person could certainly curtail expenses drastically to make it happen in a reasonable amount of time. You need to get it over with. If it caused you to avoid real investing until age 35 then that's not a good bargain, really.

Later in life, it's a nothing burger. If you have 20X saved up, and you have 10% in bonds, well, that's 2 years with only 10%. No problem.

Compare this to people who live hand to mouth and even the worst version of it is a "good problem to have".

[ScubaHogg]

I agree about the Stoic perspective. My point is, and perhaps that is what you're saying as well, is that considering some scenarios is useful as a contemplation for perspective, not necessarily as something for which to concretely prepare.

I don’t necessarily disagree. But in the case of the Great Depression diary I think if people can read about how it felt to live during that time, it might help them more accurately judge their actual risk tolerance

[Chili Powder]

This isn't the best way to analyze these things as I noted above, but if you do look at peaks and troughs, VGLT (Vanguard Long Term Treasuries) was at 104.14 on July 31, 2020 and dropped to 52.37 on October 20, 2023, representing a drop of about 50%. It is currently at 61.77 which is about 40% below the peak of July 31, 2020, which means we don't know how long it will take to reach the peak again, but it will be at least 4 years and 2 months.

As I said before, if anything, there appears to be overconfidence in bonds.

To elaborate on this, I don't think peak and trough analysis is best since people engage with the market many times over a long period of time. I do think there is a lot of irrationality in how people think about bonds though. If you are afraid of stocks because of 50% peak to trough drops, then shouldn't you also be afraid of bonds that have had this similar peak to trough drop? The fact that this is seemingly completely ignored indicates an excessive fear of stocks and too little fear of bonds. And if it's not fair to compare the 7/31/2020 peak bond price to the October 20, 2023 trough, why is it fair to compare the peaks and troughs of various stock down turns?

[HomerJ]

This isn't the best way to analyze these things as I noted above, but if you do look at peaks and troughs, VGLT (Vanguard Long Term Treasuries) was at 104.14 on July 31, 2020 and dropped to 52.37 on October 20, 2023, representing a drop of about 50%. It is currently at 61.77 which is about 40% below the peak of July 31, 2020, which means we don't know how long it will take to reach the peak again, but it will be at least 4 years and 2 months.

As I said before, if anything, there appears to be overconfidence in bonds.

To elaborate on this, I don't think peak and trough analysis is best since people engage with the market many times over a long period of time. I do think there is a lot of irrationality in how people think about bonds though. If you are afraid of stocks because of 50% peak to trough drops, then shouldn't you also be afraid of bonds that have had this similar peak to trough drop? The fact that this is seemingly completely ignored indicates an excessive fear of stocks and too little fear of bonds. And if it's not fair to compare the 7/31/2020 peak bond price to the October 20, 2023 trough, why is it fair to compare the peaks and troughs of various stock down turns?

The lesson to be learned from the large interest rate changes in 2022-2023 is to duration match your bonds.

I admit this is something I didn't usually specify in the past when talking about bonds here. But it is indeed important.

See, bonds are still "safe", because they automatically recover on their own. They are self-correcting.

Individual bond: If rates go up, the bond value goes down, but if you hold to maturity, you get exactly what you're supposed to get.
Bond funds: If rates go up, the bond fund values goes down, but as old bonds mature, new bonds are bought that pay more, so you get more interest over time which gets you back to even.

For example:

• Bond fund is paying 2%, rates go up, Bond fund goes down 10% in value, but starts paying 3% the next year, and 3.5% the year after. It doesn't take too long before you have the same amount of money you would have had if rates had remained constant.

But it's important to realize that long-term bond funds can take a long time to recover, while a short-term bond fund can recover fairly quickly.

So it's a good idea to match your bond funds with your needs. I wouldn't suggest anyone getting close to retirement to have all their bond money in a long-term fund like VGLT.

I personally have:

• a couple years of expenses in money-market funds
• a couple years of expenses in a short-term treasury fund
• a couple of years of expenses in a single 5-year TIPs bond
• some I-bonds
• Total Bond Market Index Fund (intermediate bond fund)

[monkeytoad]

in the case of the Great Depression diary I think if people can read about how it felt to live during that time, it might help them more accurately judge their actual risk tolerance

+1

[beardsicles]

An older but interesting read contending the Great Depression stock recovery period was 4.5 years, once you account for everything. CPI in 1936 was still 18% lower than 1929.

So when did the overall stock market really make it back to its pre-crash peak? Just four years and five months after its mid-1932 low, according to data provided to Sunday Business by Ibbotson Associates, a division of Morningstar.

That seems remarkably fast, given that the stock market lost more than 80 percent of its value from its 1929 high to its mid-1932 low.

But the quick recovery of the 1930s is consistent with the typical experience after other bear markets in the United States.

DETERMINING the precise length of such recoveries is a problem, given the many definitions of a bear market. Whatever definition is used, however, the typical recovery time is quite quick.

In fact, according to a Hulbert Financial Digest study of down markets since 1900, the average recovery time is just over two years, when factors like inflation and dividends are taken into account. The longest was the recovery from the December 1974 low; it took more than eight years for the market to return to its previous peak, which was reached in late 1972.

https://www.nytimes.com/2009/04/26/your ... =url-share

[ScubaHogg]

An older but interesting read contending the Great Depression stock recovery period was 4.5 years, once you account for everything. CPI in 1936 was still 18% lower than 1929.

But like 3 months later it crashed again and didn’t get back to 1929 levels till somewhere after or near the end of the war

[beardsicles]

An older but interesting read contending the Great Depression stock recovery period was 4.5 years, once you account for everything. CPI in 1936 was still 18% lower than 1929.

But like 3 months later it crashed again and didn’t get back to 1929 levels till somewhere after or near the end of the war

Again, in nominal or real terms? It matters when the 1930s were broadly deflationary. It’s hard for our brains to even understand what that looks like. And account for dividends. As the article notes, those stocks that crashed kept paying out an average dividend of 14%.

[delamer]

An older but interesting read contending the Great Depression stock recovery period was 4.5 years, once you account for everything. CPI in 1936 was still 18% lower than 1929.

But like 3 months later it crashed again and didn’t get back to 1929 levels till somewhere after or near the end of the war

Again, in nominal or real terms? It matters when the 1930s were broadly deflationary. It’s hard for our brains to even understand what that looks like. And account for dividends. As the article notes, those stocks that crashed kept paying out an average dividend of 14%.

Just a general comment about dividends as a percentage of share price, because it confounds me a bit.

Say the dividend is $1/share and the share price drops from $25 to $10. So the payout goes from 4% to 10%.

I’d rather have the 4% payout. But is that scenario realistic? Depending on the reason for the share price drop, wouldn’t it be more likely that the dividend would fall to 25 cents (or something similar)? So the new payout would be 2.5%?

I do understand that companies are reluctant to reduce dividends, but it does happen (like in the Great Recession).

[beardsicles]

An older but interesting read contending the Great Depression stock recovery period was 4.5 years, once you account for everything. CPI in 1936 was still 18% lower than 1929.

But like 3 months later it crashed again and didn’t get back to 1929 levels till somewhere after or near the end of the war

Again, in nominal or real terms? It matters when the 1930s were broadly deflationary. It’s hard for our brains to even understand what that looks like. And account for dividends. As the article notes, those stocks that crashed kept paying out an average dividend of 14%.

Just a general comment about dividends as a percentage of share price, because it confounds me a bit.

Say the dividend is $1/share and the share price drops from $25 to $10. So the payout goes from 4% to 10%.

I’d rather have the 4% payout. But is that scenario realistic? Depending on the reason for the share price drop, wouldn’t it be more likely that the dividend would fall to 25 cents (or something similar)? So the new payout would be 2.5%?

I do understand that companies are reluctant to reduce dividends, but it does happen (like in the Great Recession).

Well in this example, it gets even weirder. The high dividend yield is a function of the depressed share price. But if yields in absolute terms stay the same (let's just say that $1 whether the share is $25 or $10), but you're in a deflationary economic climate, the net value of that $1 is higher. Deflation is really weird.

[Robin1234]

...My plan worked in 1929. Is it overconfidence or is it taking an actual look at what would have happened?...

It's imagination.

You weren't alive in 1929 and you have no way to be sure you'd been able to follow your plan through the Great Depression.

Benjamin Roth was alive in 1929, and he was a lawyer, a "professional man" as he said. He wasn't a farmer or a coal miner or an auto worker. He wanted to buy stocks at bargain prices, and complained repeatedly of not having money to do it.

People who simply followed John J. Raskob's 1929 suggestion of putting $15/month into "good common stocks" through the Great Depression would have done fine. And anyone who, like Milo of Croton, simply lifts a calf every day, will soon be able to lift a 2000-pound bull. The spreadsheet says so.

The Achilles heel in a lot of backtesting is the inability to multiply the results of the plan by the probability of being able to follow the plan. It's not easy to follow a plan continuously, without fail, for forty years. "Stuff happens" compounds, too.

Looking for Raskob I found https://www.dividendgrowthinvestor.com/ ... o%20%2422.:

From that blog:
Now, I am not aware if any investor stuck to this investment program between 1929 and 1949. It would have been incredibly difficult to remain calm and to continue investing through the Great Depression, and the calamities of the World War II. After all, even if you had the mindset to ignore fluctuations and just put money to work, there was a 25% chance that you become unemployed at some point by the early 1930s. Since there were no social safety nets at the time, chances are that our investor would have had to sell their securities at fire-sale prices merely to survive the calamity. In addition, that person may have been drafted in the army during World War II and become of the casualties of the bloody war. So, a lot of things could have happened to derail the process of accumulating that portfolio.

[gavinsiu]

I haven't read the book but believe 1929 was a terrible time to live. I am not sure how many people invested in the stock market compare to now, but starving and not finding work, then get sent out to war in WWII. However, knowing this does not affect my investment plan. 1929 is just one event. There are a bunch of others. For example, the 1966 period that was the dark path to Bill Bengen's 4% rule where stocks and bond failed to keep up with inflation. In the recent times there was the dotcom bubble burst with 3 years of downmarket then a massive crash 5 years later. There is the 2022 where stocks and bonds did poorly. Looking around the world, we had Japan with 3 years of stagnant stock market. There are countries with hyperinflation like Turkey and failed states. One cannot structure the portfolio to handle it all.

Life is also full of ups and downs. If we are lucky our life will be a steady and rapid progression. However many of us will get laid off sometimes for more than a year. Our career can stall. We can also develop a chronic condition or die. We try to do our best but there are things beyond our control.

Personally, I tried to keep my fixed expenses down, avoid all debt other than a mortgage. If I am laid off, I can last longer on my emergency fund. I tried to keep my skills relevant, which is needed to keep working, but is hard due to opportunity and time. I still keep a high equity portfolio but less equity than before because I am closer to retirement. All of this is based on decades of living my life and not that of someone in 1929, or 1966 or another country.

Ironically, my high equity in my early days partly comes from my pessimism. In my 20's, I was convinced that SS will go away before I retire. I went for high equity because the odds stated that in 30 years, I will most likely make out better in stocks and that even if the market wasn't great, I could still make it up by saving a higher rate. A high rate of saving, and high equity, and staying to the plan. The 1929 period was bad not because of the stock market crash but because no one can find work. If you don't have work, you can't contribute and there is no fuel for the recovery. If you structure your portfolio for the worse, you will essentially shoot yourself in the foot because the stock market goes up more than down.

On another note, I notice another thread that another poster observing that Bogleheads are too conservative. I guess it depends who you ask. A person who is too conservative has a lower equity allocation than you and those who are too aggressive have higher equity allocation than you.

[ScubaHogg]

An older but interesting read contending the Great Depression stock recovery period was 4.5 years, once you account for everything. CPI in 1936 was still 18% lower than 1929.

But like 3 months later it crashed again and didn’t get back to 1929 levels till somewhere after or near the end of the war

Again, in nominal or real terms? It matters when the 1930s were broadly deflationary. It’s hard for our brains to even understand what that looks like. And account for dividends. As the article notes, those stocks that crashed kept paying out an average dividend of 14%.

Always real

Nisiprius has posted the larger data several times. I’m sure you can find it if you search

[birdbard]

This thread has been an interesting read, so thanks to op and all contributors.

One thing to keep in mind is that what would have saved a new retiree in 1929 would have decimated them in 1973 (loaded up on LTT before the SHTF). There isn't an investment strategy that worked well in either situation (aside from being employed, investing steadily throughout, and getting through the crisis or a big piece of it as a wage earner. Keeping or getting new employment wasn't great in either case either via unemployment or low wage).

Since we don't know what the next huge economic firestorm will be, it isn't possible to guard against everything. Just mitigate risk. Because if you futureproof for 1929 redux - you may get served 1973 part 2 instead and you will be screwed. And it would likely take about 2 years or so for everything to fall out so you could even identify that it is going to be a lost decade and what the characteristics of that decade are going to be.

Low fixed expenses as someone mentioned is the only thing that serves both situations. But that does come at a relatively high missed opportunity cost if the market was in high gear and you focused on aggressive debt paydown on a modest salary.

I was 100% stocks for about 20 years. I had so little money to invest that I just figure 20% of this paltry sum isn't going to save me if the market doesn't deliver.

[cosmos]

This thread has been an interesting read, so thanks to op and all contributors.

I was 100% stocks for about 20 years. I had so little money to invest that I just figure 20% of this paltry sum isn't going to save me if the market doesn't deliver.

I agree with this sentiment as well and generally it fits best with starting young but even if you get a later start I tend to think along lines that your 100% stock until you hit the first million. With SS shortfalls right around the corner that is a haircut that puts more pressure on us and the difference in 20% bonds is not going to save much if your nest egg is only 500k or so.

Once that mark is hit I am in the camp of using ITT funds for the safety portion when you derisk the portfolio down to 80/20 60/40 whatever to protect that million heading into retirement. I am also not in the FIRE movement or thinking so standard retirement at 65-70 is the target.

I do not even want to think about getting permanently laid off at 55 or whatnot as that too would just wreak havoc on a small portfolio 10 years from medicare etc.

[warner25]

One thing to keep in mind is that what would have saved a new retiree in 1929 would have decimated them in 1973 (loaded up on LTT before the SHTF)...

Thanks for making this point; it should really shake some folks around here who are confident that some balance of (global) stocks, bonds, and cash-like stuff is just throwing money away or whatever. We're talking about events that are still just 50-100 years ago, when many of us are considering the prospect of 50-year retirements. We must accept that know very little about what the next 50 years could bring. This reminds me again of one of my all-time favorite quotes on this forum from a long time ago (speaking in terms of the modern web)...

...That mysterious human invention, stored wealth, is never safe. The safest thing is to consume it immediately. The second safest thing is to spread it out among as many different classes of instruments as possible, and hope they don't all become worthless at the same time.

[ScubaHogg]

This thread has been an interesting read, so thanks to op and all contributors.

One thing to keep in mind is that what would have saved a new retiree in 1929 would have decimated them in 1973 (loaded up on LTT before the SHTF). There isn't an investment strategy that worked well in either situation (aside from being employed, investing steadily throughout, and getting through the crisis or a big piece of it as a wage earner. Keeping or getting new employment wasn't great in either case either via unemployment or low wage).

Shorter term bonds and TIPS (in theory) would have helped both

Global diversification in equities would definitely had helped the 1966 retiree and at worst not hurt the 1929 retiree

[birdbard]

This thread has been an interesting read, so thanks to op and all contributors.

One thing to keep in mind is that what would have saved a new retiree in 1929 would have decimated them in 1973 (loaded up on LTT before the SHTF). There isn't an investment strategy that worked well in either situation (aside from being employed, investing steadily throughout, and getting through the crisis or a big piece of it as a wage earner. Keeping or getting new employment wasn't great in either case either via unemployment or low wage).

Shorter term bonds and TIPS (in theory) would have helped both

Global diversification in equities would definitely had helped the 1966 retiree and at worst not hurt the 1929 retiree

but the point was, we don't know what the characteristics of the next lost decade will be.

[ScubaHogg]

This thread has been an interesting read, so thanks to op and all contributors.

One thing to keep in mind is that what would have saved a new retiree in 1929 would have decimated them in 1973 (loaded up on LTT before the SHTF). There isn't an investment strategy that worked well in either situation (aside from being employed, investing steadily throughout, and getting through the crisis or a big piece of it as a wage earner. Keeping or getting new employment wasn't great in either case either via unemployment or low wage).

Shorter term bonds and TIPS (in theory) would have helped both

Global diversification in equities would definitely had helped the 1966 retiree and at worst not hurt the 1929 retiree

but the point was, we don't know what the characteristics of the next lost decade will be.

Yes?

Thus a prudent mix of diversification (global equities), eliminating nominal volatility or laddering (bonds) and eliminating the most serious risk to FI investors (inflation)

Dr. Bernstine’s writings on this are very worthwhile

[Johnnie]

A 10-year bear market looks a lot different at age 70 than at age 40.

[burely]

The original Topic Author is spot-on. Forty-plus years of good stock market returns sprinkled with a few sharp but very short downturns has skewed most peoples' ideas about risk.

In general, we as humans are very bad at estimating small probabilities and even worse at trying to predict how we'd react to extreme events.

Take something that you think is a once-in-a-century economic event or situation. Sounds likely a pretty rare event that you probably shouldn't worry about, right? Well, that once-in-century event has a 70-80% chance of occurring within your lifetime, assuming you don't die young.

Now take an extreme economic event like the great depression. Even if you assume that it was an extreme outlier, say something that happens roughly once every 1,000 years, for the sake of argument, we're still underestimating the potential impact to our lives. Even under that assumption, you've still got a 5% or 1 in 20 chance of an extreme economic event like that happening over the course of your adulthood. Are you comfortable with a retirement strategy that has a 1 in 20 chance of completely failing you? Maybe some people are ok with this, but most aren't. Add to this the fact that an extreme economic event in the future will likely look very different from what we're expecting.

One thing I frequently notice is that folks are quick to ignore large outliers like the depression, or what happened to Japan for the last 30 years or so, when talking about economics or investing. But in a lot things, e.g. airline safety, war, etc., the outliers are the most important part of the story. Economics is no exception here.

[gavinsiu]

The original Topic Author is spot-on. Forty-plus years of good stock market returns sprinkled with a few sharp but very short downturns has skewed most peoples' ideas about risk.

In general, we as humans are very bad at estimating small probabilities and even worse at trying to predict how we'd react to extreme events.

Take something that you think is a once-in-a-century economic event or situation. Sounds likely a pretty rare event that you probably shouldn't worry about, right? Well, that once-in-century event has a 70-80% chance of occurring within your lifetime, assuming you don't die young.

Now take an extreme economic event like the great depression. Even if you assume that it was an extreme outlier, say something that happens roughly once every 1,000 years, for the sake of argument, we're still underestimating the potential impact to our lives. Even under that assumption, you've still got a 5% or 1 in 20 chance of an extreme economic event like that happening over the course of your adulthood. Are you comfortable with a retirement strategy that has a 1 in 20 chance of completely failing you? Maybe some people are ok with this, but most aren't. Add to this the fact that an extreme economic event in the future will likely look very different from what we're expecting.

One thing I frequently notice is that folks are quick to ignore large outliers like the depression, or what happened to Japan for the last 30 years or so, when talking about economics or investing. But in a lot things, e.g. airline safety, war, etc., the outliers are the most important part of the story. Economics is no exception here.

I think the issue is not that people don't expect outlier, but that there can be so many different outlier. Can you come up with a portfolio that will withstand the great depression, Japanese style downturn, hyper inflation, failed state, and war? You can structure your portfolio to account for some of those possibilities but there are tradeoffs.

[delamer]

The original Topic Author is spot-on. Forty-plus years of good stock market returns sprinkled with a few sharp but very short downturns has skewed most peoples' ideas about risk.

In general, we as humans are very bad at estimating small probabilities and even worse at trying to predict how we'd react to extreme events.

Take something that you think is a once-in-a-century economic event or situation. Sounds likely a pretty rare event that you probably shouldn't worry about, right? Well, that once-in-century event has a 70-80% chance of occurring within your lifetime, assuming you don't die young.

Now take an extreme economic event like the great depression. Even if you assume that it was an extreme outlier, say something that happens roughly once every 1,000 years, for the sake of argument, we're still underestimating the potential impact to our lives. Even under that assumption, you've still got a 5% or 1 in 20 chance of an extreme economic event like that happening over the course of your adulthood. Are you comfortable with a retirement strategy that has a 1 in 20 chance of completely failing you? Maybe some people are ok with this, but most aren't. Add to this the fact that an extreme economic event in the future will likely look very different from what we're expecting.

One thing I frequently notice is that folks are quick to ignore large outliers like the depression, or what happened to Japan for the last 30 years or so, when talking about economics or investing. But in a lot things, e.g. airline safety, war, etc., the outliers are the most important part of the story. Economics is no exception here.

If there is an extreme outlier that brings our economy and financial systems to their knees, what is it that an investor, retiree, working person, etc. do to protect themselves and their family financially? Particularly if the full faith and credit of the US government falters?

[unwitting_gulag]

Now take an extreme economic event like the great depression. Even if you assume that it was an extreme outlier, say something that happens roughly once every 1,000 years, for the sake of argument, we're still underestimating the potential impact to our lives. Even under that assumption, you've still got a 5% or 1 in 20 chance of an extreme economic event like that happening over the course of your adulthood. Are you comfortable with a retirement strategy that has a 1 in 20 chance of completely failing you? ...

It depends on the expectation, in the mathematical sense (integral of the first moment of the probability density function).

I would gladly play a reverse lottery: people pay me $1 for a lottery ticket, and nearly all tickets expire worthless. But I'd owe the winner $1M. If the expected value (in the above sense) of a ticket is only say $0.50, then I'd play this reverse lottery over and over again. The enormity of the loss is outweighed by the steady benefits of the gains.

The broader point, is that insurance is expensive! If it becomes too expense, then it's statistically better to leave ourselves completely exposed to risk of ruin. This applies to retirement, to healthcare decisions, to literal insurance (house, car, ...) and so on. By taking active steps to protect ourselves from potentially dire consequences, we incur a guaranteed cost. We should calculate accurately whether such cost is too high to justify.

[Robin1234]

The original Topic Author is spot-on. Forty-plus years of good stock market returns sprinkled with a few sharp but very short downturns has skewed most peoples' ideas about risk.

In general, we as humans are very bad at estimating small probabilities and even worse at trying to predict how we'd react to extreme events.

Take something that you think is a once-in-a-century economic event or situation. Sounds likely a pretty rare event that you probably shouldn't worry about, right? Well, that once-in-century event has a 70-80% chance of occurring within your lifetime, assuming you don't die young.

Now take an extreme economic event like the great depression. Even if you assume that it was an extreme outlier, say something that happens roughly once every 1,000 years, for the sake of argument, we're still underestimating the potential impact to our lives. Even under that assumption, you've still got a 5% or 1 in 20 chance of an extreme economic event like that happening over the course of your adulthood. Are you comfortable with a retirement strategy that has a 1 in 20 chance of completely failing you? Maybe some people are ok with this, but most aren't. Add to this the fact that an extreme economic event in the future will likely look very different from what we're expecting.

One thing I frequently notice is that folks are quick to ignore large outliers like the depression, or what happened to Japan for the last 30 years or so, when talking about economics or investing. But in a lot things, e.g. airline safety, war, etc., the outliers are the most important part of the story. Economics is no exception here.

If there is an extreme outlier that brings our economy and financial systems to their knees, what is it that an investor, retiree, working person, etc. do to protect themselves and their family financially? Particularly if the full faith and credit of the US government falters?

To draw an analogy with health - folks are exposed to so many possibilities of things going wrong, and we in fact even cross paths with such situations in the family, friends and news. But I am wondering to what practical extent do we analyze it, and are prepared for all of those scenarios. I am wondering if some extreme situations need to be thought of differently.

[Robin1234]

Is this a sign of overconfidence?