"Maximum Tolerable Loss" -- Not just a fear factor

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Taylor Larimore
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"Maximum Tolerable Loss" -- Not just a fear factor

Post by Taylor Larimore »

Bogleheads:

Most of us are familiar with Adrian's Formula:

Maximum Tolerable Loss X 2 = Maximum Stock Allocation

Nearly all our posts equate "Maximum tolerable loss" with "risk tolerance" (fear). We may feel confident we would not sell because of fear, but this does not mean we should never sell stocks.

Let's assume we have a $800,000 retirement portfolio providing $32,000 annual return (4%). We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).

Adrian's Forumula can be a big help. It tells us that our Maximum Tolerable Loss ($200,000) X 2 = $400,000 (Maximum Stock Allocation).

But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.

We should not invest in stocks if we cannot afford to lose (especially in retirement).

Happy New Year!
Last edited by Taylor Larimore on Tue Jan 06, 2009 11:26 am, edited 1 time in total.
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Post by larryswedroe »

Taylor
Exactly. All well thought out plans include a "PLAN B."
The plan you will implement if the "unexpected" happens.

That might include working longer, spending less, moving to lower cost area, etc. And it might include having to take less risk also.
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Post by Adrian Nenu »

My formula is just a rule of thumb, an average estimate of sorts of bear market declines. Investors should take into account but there are other investor unique issues to consider. This bear market falls within the formula's loose parameters. Investors must decide based on their personal circumstances what is the appropriate course of action and re-evaluate their risk exposure. Generally it is a bad idea to sell during a bear market and lock in losses unless absolutely necessary.

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'adjusting' AA's

Post by Beagler »

Interesting conversation about asset allocation.

Here's a link from a respected M* poster re: altering AA: http://tinyurl.com/7anwox

"Now, regarding what's been going on recently: I admittedly haven't been following the Bogleheads board as frequently as I used to follow this board. However, I don't think you can pin everything on a bunch of novice posters. e.g. Adrian Nenu is a veteran poster who used to say stuff like this ( http://tinyurl.com/7vtelq ) only a few years ago. Now, the same poster has abandoned his AA is going 100% stocks, quoting all kinds of value investing gurus. As far as I can tell, that is representative of what's going on over on the Bogleheads board - principles that were supposedly timeless are turning out not to be so timeless after all."

The post links Adrian's 2004 post stating "Maybe geniuses like Sharpe and Schiller can time the market based on valuations....or fall flat on their faces like the other geniuses at LTCM. Dummies like me will stick to passive investing, earn market returns and sleep well at night. " Perhaps all this learning on the BH's board means he's surpassed the likes of Sharpe and Schiller and is truly now able to adjust his AA based upon valuations. :D
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Re: "Maximum Tolerable Loss" -- Not just a fear fa

Post by Leif »

Taylor Larimore wrote:Bogleheads:

Most of us are familiar with Adrian's Formula:

Maximum Tolerable Loss X 2 = Maximum Stock Allocation

Nearly all our posts equate "Maximum tolerable loss" with "risk tolerance" (fear). We may feel confident we would not sell because of fear, but this does not mean we should never sell stocks.

Let's assume we have a $800,000 retirement portfolio providing $32,000 annual return (4%). We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).

Adrian's Forumula can be a big help. It tells us that our Maximum Tolerable Loss ($200,000) X 2 = $400,000 (Maximum Stock Allocation).

But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.

Happy New Year!
OK, so we reach $600,00 and we move to 100% bonds/cash. Given that AA can we still expect a 4% SWR, which is the basis for our move? If not perhaps our plan B is not so well thought out.
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Re: "Maximum Tolerable Loss" -- Not just a fear fa

Post by sport »

Taylor Larimore wrote:Bogleheads:

Most of us are familiar with Adrian's Formula:

Maximum Tolerable Loss X 2 = Maximum Stock Allocation

Nearly all our posts equate "Maximum tolerable loss" with "risk tolerance" (fear). We may feel confident we would not sell because of fear, but this does not mean we should never sell stocks.

Let's assume we have a $800,000 retirement portfolio providing $32,000 annual return (4%). We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).

Adrian's Forumula can be a big help. It tells us that our Maximum Tolerable Loss ($200,000) X 2 = $400,000 (Maximum Stock Allocation).

But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.

Happy New Year!
Taylor,
Adrian's formula is a reasonable guideline for general use. However, if an investor cannot afford to lose more than 50% and still survive, perhaps the factor of "2" is too high. In this case I would suggest that the maximum stock allocation should be only 1.5 times the maximum tolerable loss, or perhaps even 1.25. I would suggest that a plan, even a "Plan B" that causes an investor to sell low, is not a good plan. I believe it would be preferable to be less aggressive initially and thereby avoid this scenario.

Jeff
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Post by Adrian Nenu »

The post links Adrian's 2004 post stating "Maybe geniuses like Sharpe and Schiller can time the market based on valuations....or fall flat on their faces like the other geniuses at LTCM. Dummies like me will stick to passive investing, earn market returns and sleep well at night. " Perhaps all this learning on the BH's board means he's surpassed the likes of Sharpe and Schiller and is truly now able to adjust his AA based upon valuations.
First of all, I have always advocated passive, low cost CONSERVATIVE "buy & hold" as the best strategy for the vast majority of investors. My own stock/bond mix was 60/40 at the time and only changed recently (85/15 currently).

Secondly, market timing based on past rerturns stats is a dead end but it keeps the analysts and gurus employed.

Thirdly, the vast majority of investors MIGHT be capable of maintaining conservative buy and hold strategy (at best). Overweighing stocks during one of the biggest bear markets in recent history when stocks are bargains takes risk tolerance and willingness and ability to stomach the volatility...and a little bit arrogance and madness. It does not take genius and a PhD.

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Post by frank black »

Adrian Nenu wrote:This bear market falls within the formula's loose parameters, so far....

Fixed that for you.
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Post by Robert T »

.
Adrian,

I understand what you are trying to do (timing equity overweights and underweights based on market valuation), but not sure how much value it adds. At least, this is what I think you are trying to do (may be wrong).
My own stock/bond mix was 60/40 at the time and only changed recently (85/15 currently).
As I understand your plan is to move to 100% equity soon (so 60:40 in 2004 with imminent shift to 100:0). I'm curious as why you just don't maintain a long-term 80:20 stock:bond portfolio (halfway between 60:40 and 100:0)? As you say, you have willingness and ability for higher equity allocation.

Here are the returns of the MSCI world stock index and the US total bond index from 2004. Assuming your shift from 60:40 to current 85:15 captured more of the downside than a 60:40 held throughout the year (let's say the equivalent of a 70:30 portfolio). The annualized returns of a 60:40 with the recent shift to 85:15 would be almost exactly the same as an 80:20 portfolio held throughout the 2004-08 period.

Code: Select all


                                                                                                       
                                               60:40                 80:20
Year    MSCI Global Stock    LB Agg. Bond     -------------------    -------------------
             Return              Return       Return   $1 growth     Return   $1 growth

2004          15.23               4.34         10.87     1.11         13.05     1.13
2005          10.84               2.43          7.48     1.19          9.16     1.23
2006          20.95               4.33         14.30     1.36         17.63     1.45 
2007          11.66               6.97          9.78     1.50         10.72     1.61 
2008         -43.38               5.74        -28.64*    1.07        -33.56     1.07

*Assumes 70:30 to capture shift from 60:40 to 85:15

Source: MSCI and Vanguard.

It seems difficult to time markets based on valuation.

Robert
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Re: "Maximum Tolerable Loss" -- Not just a fear fa

Post by nisiprius »

Leif Eriksen wrote:
Taylor Larimore wrote:Nearly all our posts equate "Maximum tolerable loss" with "risk tolerance" (fear). We may feel confident we would not sell because of fear, but this does not mean we should never sell stocks.

Let's assume we have a $800,000 retirement portfolio providing $32,000 annual return (4%). We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).

Adrian's Forumula can be a big help. It tells us that our Maximum Tolerable Loss ($200,000) X 2 = $400,000 (Maximum Stock Allocation).

But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.
OK, so we reach $600,00 and we move to 100% bonds/cash. Given that AA can we still expect a 4% SWR, which is the basis for our move? If not perhaps our plan B is not so well thought out.
Plan B seems OK (unless you're playing by the customary unwritten artificial rules that prohibit using TIPS and single-premium-immediate annuities in retirement planning).

By opting for a 4% SWR you've already decided that it's OK to draw down your portfolio and compromise on the size of the legacy. Using an annuity is a decision to compromise a little more.

If TIPS are earning at least 1.31% real, then we can get a 4% SWR for 30 years with nothing but TIPS. Because of "Kentucky windage" you'd really need higher than 1.31%; Bob90245 worked out a detailed plan once. If that won't do it, or if TIPS aren't available at a high enough rate when reinvestment is needed, then you annuitize as much of the money is needed to make up the difference.

An inflation-adjusted annuity for a 65-year-old is currently paying 5.7% of the premium, annually, in the first year, then COLAed thereafter.

If a non-equity $100,000 portfolio can sustain a 3%-then-COLAed withdrawal rate, then we can take $38,000 to buy an annuity with a 5.7%-then-COLAed payout and retain $62,000 in the portfolio. The annuity and portfolio together will sustain a COLAed payout that starts with 5.7% * $38,000 = $2166 from the annuity, plus 3% * $62,000 = $1860 from the portfolio SWR plan, for a total of $4026 = 4% in total.

That's only annuitizing 38% of the portfolio. Obviously there's no way to tell what TIPS and annuities will be down the road, but a safe 4% seems pretty easily achievable without equities.
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Post by Adrian Nenu »

Robert, I plan to increase to 100% stocks by March and keep on buying. A conservative stock/bond mix during bull markets makes cash available which can be used to buy stocks during bear markets or if not, the large bonds/cash allocation dampens the bear market declines and volatility.

I held 60/40 since 1996 because it was suitable to my risk tolerance. I was tempted to increase equity exposure in 2001-2002 but did not. My M* Diehards forum posts from that period prove my bullishness on stocks because I made positive comments regarding stock valuations and increasing equity exposure while practically every post was about bonds and CDs. I view the current bear market as an extraordinary opportunity to invest in stocks and earn higher future returns.

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Post by Trebor »

Taylor,

I have been sticking to my plan. I have maintained my asset allocation by using new funds coming in and by rebalancing. Having said that, there is a floor to my willingness to rebalance….a cash/ bond position I refuse to drop below. While I have maintained stubborn discipline so far, there is a point at which I would no longer rebalance.
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Re: "Maximum Tolerable Loss" -- Not just a fear fa

Post by dbr »

nisiprius wrote:
Leif Eriksen wrote:
Taylor Larimore wrote:Nearly all our posts equate "Maximum tolerable loss" with "risk tolerance" (fear). We may feel confident we would not sell because of fear, but this does not mean we should never sell stocks.

Let's assume we have a $800,000 retirement portfolio providing $32,000 annual return (4%). We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).

Adrian's Forumula can be a big help. It tells us that our Maximum Tolerable Loss ($200,000) X 2 = $400,000 (Maximum Stock Allocation).

But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.
OK, so we reach $600,00 and we move to 100% bonds/cash. Given that AA can we still expect a 4% SWR, which is the basis for our move? If not perhaps our plan B is not so well thought out.
Plan B seems OK (unless you're playing by the customary unwritten artificial rules that prohibit using TIPS and single-premium-immediate annuities in retirement planning).

By opting for a 4% SWR you've already decided that it's OK to draw down your portfolio and compromise on the size of the legacy. Using an annuity is a decision to compromise a little more.

If TIPS are earning at least 1.31% real, then we can get a 4% SWR for 30 years with nothing but TIPS. Because of "Kentucky windage" you'd really need higher than 1.31%; Bob90245 worked out a detailed plan once. If that won't do it, or if TIPS aren't available at a high enough rate when reinvestment is needed, then you annuitize as much of the money is needed to make up the difference.

An inflation-adjusted annuity for a 65-year-old is currently paying 5.7% of the premium, annually, in the first year, then COLAed thereafter.

If a non-equity $100,000 portfolio can sustain a 3%-then-COLAed withdrawal rate, then we can take $38,000 to buy an annuity with a 5.7%-then-COLAed payout and retain $62,000 in the portfolio. The annuity and portfolio together will sustain a COLAed payout that starts with 5.7% * $38,000 = $2166 from the annuity, plus 3% * $62,000 = $1860 from the portfolio SWR plan, for a total of $4026 = 4% in total.

That's only annuitizing 38% of the portfolio. Obviously there's no way to tell what TIPS and annuities will be down the road, but a safe 4% seems pretty easily achievable without equities.
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Given all the above why would the investor have held any equities when he had $800,000?
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Re: "Maximum Tolerable Loss" -- Not just a fear fa

Post by daryll40 »

Taylor Larimore wrote:Bogleheads:

Most of us are familiar with Adrian's Formula:

Maximum Tolerable Loss X 2 = Maximum Stock Allocation

Nearly all our posts equate "Maximum tolerable loss" with "risk tolerance" (fear). We may feel confident we would not sell because of fear, but this does not mean we should never sell stocks.

Let's assume we have a $800,000 retirement portfolio providing $32,000 annual return (4%). We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).

Adrian's Forumula can be a big help. It tells us that our Maximum Tolerable Loss ($200,000) X 2 = $400,000 (Maximum Stock Allocation).

But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.

Happy New Year!

Taylor, does this mean that you will NOT rebalance back to 60/40 as you indicated in a reply to a thread last fall?
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Re: "Maximum Tolerable Loss" -- Not just a fear fa

Post by dbr »

daryll40 wrote:
Taylor Larimore wrote:Bogleheads:

Most of us are familiar with Adrian's Formula:

Maximum Tolerable Loss X 2 = Maximum Stock Allocation

Nearly all our posts equate "Maximum tolerable loss" with "risk tolerance" (fear). We may feel confident we would not sell because of fear, but this does not mean we should never sell stocks.

Let's assume we have a $800,000 retirement portfolio providing $32,000 annual return (4%). We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).

Adrian's Forumula can be a big help. It tells us that our Maximum Tolerable Loss ($200,000) X 2 = $400,000 (Maximum Stock Allocation).

But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.

Happy New Year!

Taylor, does this mean that you will NOT rebalance back to 60/40 as you indicated in a reply to a thread last fall?
It appears to advocate bailing completely when the loss meets a certain "stop loss" criterion. I think the question as to whether this is a good plan has been asked before in this context and no one wanted to propose such a strategy. I still can't figure out why a person who has this as Plan B would not simply execute Plan B before the crash and immunize the portfolio to an equities crash from the get go.
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Re: "Maximum Tolerable Loss" -- Not just a fear fa

Post by jeffyscott »

Taylor Larimore wrote:But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.
Wow, I am shocked that you would suggest that one should normally not sell stocks in a decline and perhaps even buy them to rebalance, but then if they do decline enough (50%) you should then sell them all. That just seems nuts.

This seems to me to be a far worse idea than other timing strategies such as the ever-popular (or is it just newly popular :?: ) moving average. That would at least have one bailing out long before a 50% decline.

Trebor wrote:I have been sticking to my plan. I have maintained my asset allocation by using new funds coming in and by rebalancing. Having said that, there is a floor to my willingness to rebalance….a cash/ bond position I refuse to drop below. While I have maintained stubborn discipline so far, there is a point at which I would no longer rebalance.
This makes sense to me. For example, if $24,000 is needed from the portfolio each year, a reasonable policy might be to not rebalance if cash/bond would fall to less than 10X this amount ($240,000).
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Post by Adrian Nenu »

You either believe the inverted yield curve as predictive of recession studies or you don't. If you don't, then conservative buy & hold is the best option. But you have to get the stock/bond mix right using my formula and taking other personal factors into consideration. Or at least know bear market history and project what might happen to your portfolio during a bear market decline of ~50%. These things should be done before a bear market.

If you believe the inverted yield studies have validity, then you know that the inverted yield curve predicts a recession 12-18 months ahead and that means an increase in risk. Granted, it doesn't tell how bad it will get or how long it will last but it does indicate an increase in risk. Then there are other factors, for example the RE bubble and the increasing MBS defaults. The decision must be made: reduce equity and lower risk to appropriate level, do nothing, or rebalance, or increase equity during the bear market to have the opportunity to earn higher returns.

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Post by Heath »

Taylor’s comment is the same as that made recently by Jack Bogle. One important point is that there is REAL risk in the market and not just psychological risk. Adrian’s formula is wrong to the extent it is meant to apply solely to psychological risk (as originally intended by Larry Swedroe).

A formula that is intended to say, “don’t invest more than twice tolerable loss (but remember that equities have historically returned more than fixed in the long run and on average have returned over 10%/year)” is bad advice. The added assurance of everything works out well in the long run turns the formula back to one of purely psychological risk, at least for those with a longer time horizon. There is a lot of confusion on these points, IMO.
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Post by unclemick »

Hmmm - perhaps a couple of tongue in cheek thoughts from unclemick's lefthanded general unified theory of chickenheartedness:

There was this fella who started a fund(Wellington) in 1929 who made sure the fund produced dividends and interest which is almost as good as real money. I believe he also went on to hire this young man from Princeton named Bogle which is another story.

Toward the end of my accumulation cycle and now in retirement - I picked 3% SEC yield and using a no 2 pencil sans MPT or any spreadsheet stuff converted my portfolio yield into $ and compared that with my estimated 'hard times' living expenses/core budget.

For example:
So at one end(optimism) I use 4 or 5% variable of say a 1mil portfolio = 40 or 50k or 30k in hard times with the range 30-50k.

Now note that when Mr Market does dastardly things the SEC yield has a tendency to climb so for example handgrenade wise my TR 2015 has climbed from below 3% to ballpark 3.9 % with the current unpleasantness.

Theoretical purity not being my strongpoint - I do old school div's and interest in hard times and more modern 5% of portfolio value in good times - using that hightech non emotional finger in the belly button and estimating the coming year.

:roll: :wink:

heh heh heh - after 15 years of retirement I should take this stuff more serious but 3-5% seems to keep me within compass. 8)
Last edited by unclemick on Tue Dec 30, 2008 5:39 pm, edited 1 time in total.
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Only risk what we can afford to lose

Post by Taylor Larimore »

Hi Jeffy:
Taylor Larimore wrote:
"But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash."


Wow, I am shocked that you would suggest that one should normally not sell stocks in a decline and perhaps even buy them to rebalance, but then if they do decline enough (50%) you should then sell them all. That just seems nuts.
It is not "nuts" if we cannot afford to lose what we have. But it is "nuts" to continue investing in risky stocks.
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Re: "Maximum Tolerable Loss" -- Not just a fear fa

Post by ddb »

Taylor Larimore wrote:Let's assume we have a $800,000 retirement portfolio providing $32,000 annual return (4%). We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).
Haven't read the replies yet, so apologize if this is a repeat.

The 4% rule as commonly stated (4% of initial balance, adjust each year thereafter for inflation) already accounts for the possibility that the portfolio could drop from $800K to $600K. In other words, even if the portfolio hits $580K, the "rule" says to just keep taking distributions per the original schedule. Although this may now mean that you are taking out 6% of the current value, this could be okay, as supported by research which shows that when equity valuations are lower, the SWR is higher (paper by Michael Kitces, I believe).

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Post by larryswedroe »

ddb
But that formula is based on one specific history, and history doesn't have to repeat---alternative universes can show up. Just ask the Japanese
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Post by jeffyscott »

Heath wrote:Taylor’s comment is the same as that made recently by Jack Bogle.
Two of the most ardent B&H advocates "capitulating", perhaps :?: .
The timing is wierd, though, perhaps they actually sold all stocks at or near the (so far) bottom and now are trying to justify their actions :? .
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Post by jeffyscott »

larryswedroe wrote:ddb
But that formula is based on one specific history, and history doesn't have to repeat---alternative universes can show up. Just ask the Japanese
Larry, do you agree with Taylor's "strategy" to sell all stocks after they have already declined by 50%?
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Post by Robert T »

.
Adrian,

Thanks.
Adrian Nenu wrote:I held 60/40 since 1996 because it was suitable to my risk tolerance.
Adrian Nenu wrote:I plan to increase to 100% stocks by March and keep on buying.
How do you define risk?

Is it tolerable loss (re: your formula) or is it expected return (re: current valuation)? They seem to lead to significantly different asset allocations.

By your formula – your maximum tolerable loss has gone up from 30 to 50% (an increase in risk), but by your valuation assessment – re: opportunity to earn higher returns, risk (per unit of return) is lower by implication. So do you think your risk exposure has gone up or down, or stayed the same with a shift from 60:40 stock:bond to 100% stock?

Just curious.

Robert
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A misunderstanding

Post by Taylor Larimore »

Jeffy wrote:
Larry, do you agree with Taylor's "strategy" to sell all stocks after they have already declined by 50%?
That's not my strategy. I wrote:
We decide we need a minimum $24,000 annual return. This means we cannot allow our portfolio to be less than $600,000 ($600,000 X 4% = $24,000).


The basic idea is that we should not risk money we can't afford to lose. It has nothing to do with "50%." I admit the "4%" figure is somewhat arbitrary.
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Post by Christine_NM »

It's certainly necessary to know the floor of your portfolio. It's just as useful to recognize the expected ceiling.

When returns exceed your expected ceiling, do not spend or put at risk the excess. Stash it in no-risk investments like T bills, which will be selling at a discount when stocks look good. This reduces the possibility of ever hitting the portfolio floor and being forced to sell.
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Post by jeffyscott »

Let's assume we have a $800,000 retirement portfolio...Adrian's Forumula tells us that our Maximum Tolerable Loss ($200,000) X 2 = $400,000 (Maximum Stock Allocation).

But what if our portfolio starts to go below $600,000 (maximum tolerable loss)? In this case we must exchange stocks for bonds or cash.
My reading of this is saying: you have $400,000 in stocks and $400,000 in bonds. If stocks fall by 50%, you have reached your "maximum tolerable loss". The only way to avoid the possibility of losing more is to then sell all stocks. So the strategy is to sell all stocks after they go down by 50%.
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Post by rgarling »

jeffyscott wrote:
larryswedroe wrote:ddb
But that formula is based on one specific history, and history doesn't have to repeat---alternative universes can show up. Just ask the Japanese
Larry, do you agree with Taylor's "strategy" to sell all stocks after they have already declined by 50%?
It seems to me you are putting words in his mouth. He gave an illustration using Adrian's formula as a planning tool.

Once that target allocation is set, it would be rebalanced along the way. If the 50% loss happened overnight, then you would be faced with liquidation. Not because it is a good investment strategy, but out of necessity.
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Post by daryll40 »

Taylor,

Are you REALLY thinking about not staying the course? We had this discussion back in the fall and you were adamant that thru thick and thin that you would rebalance etc etc. Now it sounds like you are not only thinking about NOT rebalancing, but actually selling the "risky" (your word) equities that you have left.

Is index investing a game where once you lose "X" (half?), you cash in what's left and go home? What about all your posts showing how things have been much worse (economically), implying that you are very comfortable that the world won't end and that our losses (from prior levels) are not permanent? Did you look at your numbers as we approach the year end and get spooked??
Last edited by daryll40 on Tue Dec 30, 2008 2:42 pm, edited 1 time in total.
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Post by ddb »

larryswedroe wrote:ddb
But that formula is based on one specific history, and history doesn't have to repeat---alternative universes can show up. Just ask the Japanese
Larry, I was not trying to argue that the 4% SWR rule makes sense, but rather stating where the 4% rule came from, because I think it is often misunderstood.

I'm personally not a fan of the rule for various reasons, but it still serves as a useful guideline for retirees (IMO).

- DDB
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Staying the course is not buy-and-hold

Post by Taylor Larimore »

Taylor -- Are you REALLY thinking about not staying the course? -- Did you look at your numbers as we approach the year end and get spooked??


Daryll:

Staying-the-course is not buy-and-hold. It is staying with our financial plan. To demonstrate this difference is the primary reason I started this Conversation.

Any good financial plan will have changes during a lifetime. One common-sense change is to not invest in risky stocks if we cannot afford any loss.

So to answer your question: I intend to stay our course--which includes getting out of stocks if our portfolio gets to the point we can't afford further losses. No, I'm not "spooked." It's always been a "Plan B."

Happy New Year!
Last edited by Taylor Larimore on Tue Dec 30, 2008 2:58 pm, edited 1 time in total.
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Re: Staying the course is not buy-and-hold

Post by dbr »

Taylor Larimore wrote:
Taylor -- Are you REALLY thinking about not staying the course?


Daryll:

Staying-the-course is not buy-and-hold. It is staying with our financial plan. To demonstrate this difference is the primary reason I started this Conversation.

Any good financial plan will have changes during a lifetime. One common-sense change is to not invest in risky stocks if we cannot afford any loss.

So to answer your question: I intend to stay our course--which includes getting out of stocks if our portfolio gets to the point we can't afford further losses. No, I'm not "spooked." It's always been a "Plan B."

Happy New Year!
Taylor, why would you just not get out of stocks altogether rather than wait until you have reached a stop-loss asset value?
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Why not get out of stocks early?

Post by Taylor Larimore »

Hi dbr:
Taylor, why would you just not get out of stocks altogether rather than wait until you have reached a stop-loss asset value?
Because I have confidence in the probability that our portfolio (containing about 55% stocks) will not decline to our "stop-loss asset value" and I want to own stocks when the market recovers.
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Re: Staying the course is not buy-and-hold

Post by Kenster1 »

Taylor Larimore wrote:
Taylor -- Are you REALLY thinking about not staying the course? -- Did you look at your numbers as we approach the year end and get spooked??


Daryll:

Staying-the-course is not buy-and-hold. It is staying with our financial plan. To demonstrate this difference is the primary reason I started this Conversation.

Any good financial plan will have changes during a lifetime. One common-sense change is to not invest in risky stocks if we cannot afford any loss.

So to answer your question: I intend to stay our course--which includes getting out of stocks if our portfolio gets to the point we can't afford further losses. No, I'm not "spooked." It's always been a "Plan B."

Happy New Year!
Yes -- in sailing you have to make adjustments to stay-the-course when wind and water conditions change.
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Post by Heath »

There seems to be a lot of confusion around all this. It seems to me that the 800k example guy may have assumed that stocks were safe in the long run and underestimated the REAL risk that exists. His best course of action would have been to begin plan B before the major market downturn.
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Post by bob90245 »

Heath wrote:There seems to be a lot of confusion around all this. It seems to me that the 800k example guy may have assumed that stocks were safe in the long run and underestimated the REAL risk that exists. His best course of action would have been to begin plan B before the major market downturn.
Maybe the plan A was thought to have an 80% chance of working and the plan B would happen at 20% odds. Does it make sense to implement plan B from the start when it was only 20% odds of happening?
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Post by Heath »

bob90245 wrote:
Heath wrote:There seems to be a lot of confusion around all this. It seems to me that the 800k example guy may have assumed that stocks were safe in the long run and underestimated the REAL risk that exists. His best course of action would have been to begin plan B before the major market downturn.
Maybe the plan A was thought to have an 80% chance of working and the plan B would happen at 20% odds. Does it make sense to implement plan B from the start when it was only 20% odds of happening?
Given the financial position of the guy, it may well have made sense to implement plan B from the start even if those odds were correct. Utility theory and all that.
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Re: Staying the course is not buy-and-hold

Post by daryll40 »

Taylor Larimore wrote:
Taylor -- Are you REALLY thinking about not staying the course? -- Did you look at your numbers as we approach the year end and get spooked??


Daryll:

Staying-the-course is not buy-and-hold. It is staying with our financial plan. To demonstrate this difference is the primary reason I started this Conversation.

Any good financial plan will have changes during a lifetime. One common-sense change is to not invest in risky stocks if we cannot afford any loss.

So to answer your question: I intend to stay our course--which includes getting out of stocks if our portfolio gets to the point we can't afford further losses. No, I'm not "spooked." It's always been a "Plan B."

Happy New Year!

Taylor,

With all due respect...and I have the utmost respect for you....last fall I posted a question about rebalancing and you clearly stated that you would rebalance thru thick and thin. There was NEVER any mention of a Plan B. Now I understand that you are merely one investor here and neither I nor anyone else should invest based on what you or any other individual investor does.

That being said, you are, indeed, one of the leaders here and it's a huge surprise/shock to see you talking about, for the first time ever to my knowledge, potentially bailing out. When Mr. Bogle talked about having to sell stocks if you were down to "X" dollars, I thought he was referring to people who had not invested like a Boglehead IN THE FIRST PLACE. The implication was that BOGLEHEADS would have the right asset allocation from the get-go to "stay the course". "Stay the course" to me, and others please correct me if I am wrong, means not selling when times get tough. I don't recall "Plan B" being in the definition of 'stay the course" I thought "Plan B" was only for people who were not on the right course to begin with (over exposed to equities/not a Boglehead to begin with).
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Re: Staying the course is not buy-and-hold

Post by ddb »

daryll40 wrote:With all due respect...and I have the utmost respect for you....last fall I posted a question about rebalancing and you clearly stated that you would rebalance thru thick and thin. There was NEVER any mention of a Plan B. Now I understand that you are merely one investor here and neither I nor anyone else should invest based on what you or any other individual investor does.

That being said, you are, indeed, one of the leaders here and it's a huge surprise/shock to see you talking about, for the first time ever to my knowledge, potentially bailing out. When Mr. Bogle talked about having to sell stocks if you were down to "X" dollars, I thought he was referring to people who had not invested like a Boglehead IN THE FIRST PLACE. The implication was that BOGLEHEADS would have the right asset allocation from the get-go to "stay the course". "Stay the course" to me, and others please correct me if I am wrong, means not selling when times get tough. I don't recall "Plan B" being in the definition of 'stay the course" I thought "Plan B" was only for people who were not on the right course to begin with (over exposed to equities/not a Boglehead to begin with).
I fully agree with the above post. I've never heard Taylor or the other Boglehead authors make any such comments about bailing out at certain "threshold" levels. Not saying it's a bad idea, but rather than it seems to be out of the blue. Never before have I heard "stay the course" defined as "stay the course until it is no longer possible to stay the course".

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Post by Rick Ferri »

I am a little lost on this post.

Taylor, I assume portfolios are rebalanced. So a $800,000 portfolio would have $400,000 in stocks, and when it fell to $600,000 there would still be $300,000 in stocks. That is buy, hold and rebalancing according to a specified plan.

Or, are you suggesting that a portfolio not be rebalanced, meaning is the portfolio fell from $800,000 to $600,000 the stock allocation falls from $400,000 to only $200,000, and then sell out to $0 in stocks? That seems like panic selling rather than logical portfolio management.

There is no need kill chickens that lay eggs just because those chickens gets a little skinny. The fact is, dividend and interest income is much more stable than stock prices. The CASH FLOW from dividend and interest income is about the same from a $800,000 starting portfolio as it is in a $600,000 ending portfolio after losing 50% of stock 'price' value.

Assuming that income at $800,000 is around $24,000, it will STILL be $24,000 after the portfolio falls to $600,000. As such, no one needing $24,000 in cash flow should be reducing their allocation to stocks, or worse, selling out.

Rick Ferri
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Re: Staying the course is not buy-and-hold

Post by rgarling »

daryll40 wrote: ...
"Stay the course" to me, and others please correct me if I am wrong, means not selling when times get tough.
If you lose all you can afford to lose, then you have to get out. Your remaining assets must be protected and can no longer be exposed to equity risk.

On the other hand, if you had followed the example (original post) and rebalanced on the way down, you still would not have lost your maximum (assuming a typical bogglehead asset allocation) and would still be in the game.

edit to clean up problem with quote
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Post by Heath »

Jack Bogle wrote:“The probabilities for stock market investing right now are very compelling,” Mr. Bogle said in a telephone interview from his office at the Bogle Financial Markets Research Center, on the Vanguard campus in Malvern, Pa. The cataclysm in world financial markets has brought down valuations to fairly attractive levels, he said, improving the prospects that the broad stock market, over the next decade, can earn an annualized return of perhaps 9 percent.

So this isn’t the time to sell, he said, but he allows one big exception: “If you cannot afford to lose another penny, then you simply have no recourse but to get out of the stock market.”

Stocks could easily fall further, and if you aren’t in a position to absorb more losses, you must protect yourself. And retirees should hold a big dollop of bonds, which generate income and provide ballast in a shaky market. “Investing isn’t just about probabilities,” he said. “It’s about consequences, and you’ve got to be prepared for them.”
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Stock risk when we cannot afford to lose?

Post by Taylor Larimore »

Hi Rick:
Taylor, I assume portfolios are rebalanced. So a $800,000 portfolio would have $400,000 in stocks, and when it fell to $600,000 there would still be $300,000 in stocks. That is buy, hold and rebalancing according to a specified plan.

Or, are you suggesting that a portfolio not be rebalanced, meaning is the portfolio fell from $800,000 to $600,000 the stock allocation falls from $400,000 to only $200,000, and then sell out to $0 in stocks? That seems like panic selling rather than logical portfolio management.
I was not clear. Forget my figures which I (incorrectly) thought would help.

All I was trying to say is:

We should not invest in stocks if we cannot afford to lose (especially in retirement).

I'm trying to say what Mr. Bogle said in the above post made while I was preparing mine.

Happy New Year!

Edit in red
Last edited by Taylor Larimore on Tue Dec 30, 2008 4:14 pm, edited 1 time in total.
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Post by Jack »

I too am confused by this strategy. The initial assumption is that a 50/50 portfolio can provide a 4% withdrawal rate. If you require a minimum withdrawal of $24,000 then you need a portfolio of at least $600,000. But in order to withdraw 4% you still need a 50/50 portfolio. You can't do that with all bonds so I don't understand why your strategy changes to Plan B at $600,000 and what it accomplishes.
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Re: Stock risk when we cannot afford to lose?

Post by Jack »

Taylor Larimore wrote: All I was trying to say is:

We should not invest in stocks if we cannot afford to lose (especially in retirement).
Okay, in honor of his long service to this organization, Taylor deserves this mulligan. (It is the eggnog season :D ).
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Mulligan

Post by Taylor Larimore »

Jack:

Thanks.

Happy Holiday!
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Post by daryll40 »

I'm OK with the mulligan too! :lol:

It is just a little disconcerting to see one of our leaders talking about bailing and redefining "staying the course".
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Post by Gregory »

Rick Ferri wrote: There is no need kill chickens that lay eggs just because those chickens gets a little skinny. The fact is, dividend and interest income is much more stable than stock prices. The CASH FLOW from dividend and interest income is about the same from a $800,000 starting portfolio as it is in a $600,000 ending portfolio after losing 50% of stock 'price' value.

Assuming that income at $800,000 is around $24,000, it will STILL be $24,000 after the portfolio falls to $600,000. As such, no one needing $24,000 in cash flow should be reducing their allocation to stocks, or worse, selling out.
Plenty of people who post on DH's claim that dividends are not secure, we'll see plenty of dividends cuts, etc. I'm in your camp, Rick, I'm not buying their doom and gloom about dividends (no pun intended).
Pecuniae imperare oportet, non servire. | Fortuna vitrea est; tum cum splendit frangitur. -Syrus
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Post by Rick Ferri »

Gregory wrote: Plenty of people who post on DH's claim that dividends are not secure, we'll see plenty of dividends cuts, etc. I'm in your camp, Rick, I'm not buying their doom and gloom about dividends (no pun intended).
Granted, dividends are cut in a recession. However, a 50% stock and 50% bond portfolio should still be producing about 4.8% in cash-flow including all interest and dividends. That is $28,800 per year in cash flow based on a $600,000 account, providing plenty of cushion above the $24,000 in cash flow needed in Taylors example.

Rick Ferri
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