On the risk of investing in stocks for the long run

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FIRE 2018
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Re: On the risk of investing in stocks for the long run

Post by FIRE 2018 » Fri Jul 19, 2019 5:28 pm

When markets are going down and prices are free falling then buy buy buy. I took full advantage of peoples misery in the 2008 / 09 recession in the USA and I accumulated huge positions and this allowed me to FIRE last year.

Seppia
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Re: On the risk of investing in stocks for the long run

Post by Seppia » Sat Jul 20, 2019 1:01 am

Of course I agree, what I was trying to say is that “buy and hold, buy even more aggressively when things look bad” is a textbook example of “very simple / not easy at all”.

Great that you were able to do it.
I was too, but I had less than 1/10th of the money I have now, so muuuch less skin in the game and less to lose.
My parents were able to hold, but not to buy more aggressively than usual.
Most people panicked.

BlueNote
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Re: On the risk of investing in stocks for the long run

Post by BlueNote » Tue Jul 23, 2019 8:31 pm

7Wannabe5 wrote:
Thu Jul 18, 2019 8:12 am
So, the right answer is 80% timberland, meat rabbits, and guard dogs and 20% VTSAX on margin?
@7Wannabe5: Only dairy rabbits for the vegetarians among us.

7Wannabe5
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Re: On the risk of investing in stocks for the long run

Post by 7Wannabe5 » Wed Jul 24, 2019 8:05 am

@BlueNote:

Right. I should have typed meat rabbits/sealed tub of turnip seed.

Lucky C
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Re: On the risk of investing in stocks for the long run

Post by Lucky C » Thu Aug 08, 2019 5:59 am

I think it becomes easier to succeed if you focus more on what is required to limit max drawdown rather than limiting volatility. The trouble is people are more comfortable with trying to limit volatility with a backtested portfolio that is reallocated the same way year after year (or allocated to a different equity % based only on age). Most people are less comfortable with trying to limit max drawdown while getting high returns, which involves very different allocations at different points in time (sometimes not very diversified), more frequent trades, often going against the crowd, and getting burned by whipsaw price movements. A fixed asset allocation can certainly be constructed to avoid a big drawdown, but you'll want a very low withdrawal rate with today's low yields and high stock prices.

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Re: On the risk of investing in stocks for the long run

Post by steveo73 » Fri Aug 09, 2019 12:17 am

Lucky C wrote:
Thu Aug 08, 2019 5:59 am
Most people are less comfortable with trying to limit max drawdown while getting high returns, which involves very different allocations at different points in time (sometimes not very diversified), more frequent trades, often going against the crowd, and getting burned by whipsaw price movements.
I'm betting that this approach will significantly under perform a fixed asset allocation.
Lucky C wrote:
Thu Aug 08, 2019 5:59 am
A fixed asset allocation can certainly be constructed to avoid a big drawdown, but you'll want a very low withdrawal rate with today's low yields and high stock prices.
Maybe but you and no one else can predict the future. We might be on the cusp of the biggest bull market of all time. It might crash tomorrow and then go on 20%+ runs year on year.

I don't see anything in this thread that means stocks aren't the best place to invest over the long term. Stocks have outperformed over the long term in the past and that should continue.

FIRE 2018
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Re: On the risk of investing in stocks for the long run

Post by FIRE 2018 » Fri Aug 09, 2019 2:11 pm

Investing in diversified index mutual funds monthly regardless of share price and market conditions is how I FIREd. If I did not, I would still be a slave to work and debt like the masses in the USA.

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Re: On the risk of investing in stocks for the long run

Post by 2Birds1Stone » Fri Aug 09, 2019 2:44 pm

And here we thought you were getting paid by the post.

FIRE 2018
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Re: On the risk of investing in stocks for the long run

Post by FIRE 2018 » Fri Aug 09, 2019 2:57 pm

I should. Care to donate to my GoFundMe account? :lol:

Lucky C
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Re: On the risk of investing in stocks for the long run

Post by Lucky C » Sat Aug 10, 2019 5:58 pm

steveo73 wrote:
Fri Aug 09, 2019 12:17 am
Maybe but you and no one else can predict the future.
Good valuation metrics for the stock market have correlation with subsequent 10-15 year returns with R^2 around 0.8 - 0.9, thus the valuation measure alone explains (or "predicts the future") roughly 64 - 81% of those future returns. What is unpredictable over that long of a time period (economic surprises and market sentiment) is actually plays a more minor role in stock returns.

If you buy a 10-year government bond at 2% and hold it for 10 years, I can predict it will return a nominal 2%, assuming the government doesn't default.

So in a traditional 60/40 portfolio, I can predict about 80% of the future.

In the meantime (<10 years), I seek to limit drawdowns. I wasn't describing any specific strategy. Anything from Buffett's rule of "don't lose money" (while embracing big but safe bets) to trading based on chart analysis. Sometimes you outperform and sometimes you underperform the market. The point is, it isn't impossible to limit sharp drawdowns if that is your goal. But it is harder than passive index investing.

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Re: On the risk of investing in stocks for the long run

Post by steveo73 » Fri Aug 16, 2019 1:22 am

Lucky C wrote:
Sat Aug 10, 2019 5:58 pm
So in a traditional 60/40 portfolio, I can predict about 80% of the future.
I don't think you can. I think that you think that you can. There is a massive difference. I also think that when you try to stop the maximum drawdown you are more likely to lose money and therefore your WR will need to be a lot lower.

I invest on the basis of a couple of facts:-

1. No one can predict the future.
2. The stock market has historically had the best returns over the long term.
3. Stocks are basically buying parcels of businesses. Businesses in aggregate tend to increase in value over time.
4. Diversification across the stock market (or markets) gives you the best chance not to hold to many individual stocks that are going to under perform.
5. Bonds and cash protect you when stocks crash.
6. You need to beat inflation over the long term. Stocks are the only assets that do this.

Taking this approach means that I have the odds in my favour. This is what I want.

I don't think any other approach has the odds in your favour and some including trying to trade your way to lower draw downs have the odds against you.

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Re: On the risk of investing in stocks for the long run

Post by Seppia » Fri Aug 16, 2019 3:59 am

I would caution being “too sure” about that though.
Context is important.
In 2006 the mantra was “housing never loses money”.
Turned out, at extreme valuations, it does

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Re: On the risk of investing in stocks for the long run

Post by bigato » Fri Aug 16, 2019 4:41 am

steveo73: regarding diversification, the assets inside a single asset class tend to correlate positively about 60% of the time. So if diversification is an important value for you, you may be interested in diversifying across even more classes, specially looking for the ones which are negatively correlated or not correlated.

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Re: On the risk of investing in stocks for the long run

Post by Dream of Freedom » Fri Aug 16, 2019 7:01 am

steveo73 wrote:
Fri Aug 16, 2019 1:22 am

I invest on the basis of a couple of facts:-
.
4. Diversification across the stock market (or markets) gives you the best chance not to hold to many individual stocks that are going to under perform.
5. Bonds and cash protect you when stocks crash.
6. You need to beat inflation over the long term. Stocks are the only assets that do this.

Taking this approach means that I have the odds in my favour. This is what I want.

I don't think any other approach has the odds in your favour and some including trying to trade your way to lower draw downs have the odds against you.
4 Half of the stocks in a total market portfolio will have returns bellow the median. That is a mathamatical fact. It is easy to believe that a s&p index is well diversified given the number of stocks in them, but roughly 40% are in just 2 sectors tech an financials. Hell, 23% is in tech alone. So not that well diversified really.

6 One should always be wary of someone who says that their way is the only way.

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Re: On the risk of investing in stocks for the long run

Post by conwy » Fri Aug 16, 2019 4:20 pm

Two things that I think are overestimated by many people:

1. Inflation.

CPI is calculated extremely broadly and then assumed to be universal. But when I look at the costs of basic goods/services on a frugal lifestyle (living in cheap accommodation, cooking, choosing cheap ingredients, generally avoiding expensive purchases) and as a percentage of the average take-home salary in a given city, I don't see a heck of a lot of inflation. The things that were cheap 5 years ago are still cheap today. The things that were expensive 5 years ago aren't on my shopping list today.

What's cheap and expensive varies across time and location. I'm flexible with both, so I'll pretty much always find a cheap version of whatever I need.

(Even housing. I'm in San Francisco and have managed to find reasonably priced shared accommodation out of the main area of the city. Cheap enough to easily afford on a 3% drawdown of my investments. The key is to be flexible, e.g. willing to share a space with other people, willing to commute, etc.)

2. Unemployment.

I think paid work is an under-appreciated form of financial downside protection.

I find it hard to imagine a severe shortage of jobs in future. To my knowledge, the last time the US had really high unemployment (20%+) was in the great depression when the economy was much less developed than today. I think double-digit unemployment is a thing of the past. If anything, jobs will increase as population growth shrinks and development and wealth increase.

There won't be an AI apocalypse; AI and robots will only ever be good for a sub-set of jobs; the rest will continue to require human beings. If AI ever manages to do everything, then the entire human species will get to retire early.

Even in a recession there's always work to do, as long as you're flexible. For example, in the 2008 recession or even the recent job losses in manufacturing, etc., you could get a new job if you were willing to relocate and/or retrain. Recessions seem to more affect people who ride on bubbles, make bad financial decisions or are inflexible.

If you have the personal traits and capacities required to save 50%+ of your income, it's pretty unlikely that you'll ever not be able to do some kind of paid work. Even if you encounter health issues, it's unlikely that those issues will be so severe as to prevent you from doing any kind of paid work whatsoever, permanently. If they are that severe, well, that's an unusual catastrophe. Catastrophic insurance is a cheap enough way to protect against that downside.

All this being taken into account, I see paid employment as the best form of financial security and downside protection. Whatever happens, and assuming the whole world doesn't go to hell (e.g. WW3), I think most people can always find some kind of paid work.

Since I believe I'll always have employment to fall back on, I'm happy to take the calculated risk of holding mostly stocks.

* If my stocks appreciate, then I'll live off them and do unpaid work that is easy and fun, like volunteering and hobby projects.
* If my stocks don't appreciate, or even collapse, then I'll simply continue to do paid work and find ways to make it easy and fun.

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Re: On the risk of investing in stocks for the long run

Post by steveo73 » Fri Aug 16, 2019 6:14 pm

Dream of Freedom wrote:
Fri Aug 16, 2019 7:01 am
4 Half of the stocks in a total market portfolio will have returns bellow the median. That is a mathamatical fact. It is easy to believe that a s&p index is well diversified given the number of stocks in them, but roughly 40% are in just 2 sectors tech an financials. Hell, 23% is in tech alone. So not that well diversified really.

6 One should always be wary of someone who says that their way is the only way.
These points are completely irrelevant to the discussion.

You buy a broad index and you will get the index returns. That is the best that you can do. The comment "You need to beat inflation over the long term. Stocks are the only assets that do this." is simply factual. It's not me or my or a personal opinion. It's a fact based on how markets and inflation have performed over time.

You can invest in Gold/cash/bonds/property etc but the only asset class that has consistently beaten inflation over time and has long term data to back it up are stocks. I'm sure there may be some tweaks here in relation to stocks (I mean picking other asset classes or special plans) but those tweaks won't be realistic for the vast majority of people to invest in and obtain the predicted returns. This means that you think you are special. When you are data mining as well you may see patterns that don't exist. This is a key point.

It's everyone's own personal choice but betting with the odds on your side is smart. If you don't have a large chunk (say 50%) of your portfolio in broad based stock indexes you are making the choice that you can somehow beat the odds over time. I wouldn't bet my money on that.

This thread is actually a classic example of seeing patterns that don't exist. Sure stocks are risky. They are going to go down and up and maybe the expected returns over the next 5-10 years will be less (this is a maybe not a definite). The problem is that you have to look at the alternative options. I don't see any better alternative option but I do see worse alternative options. So not investing in broad based stock indexes will more than likely mean that you under perform the market.

I should add that I don't have what I consider the most rational portfolio. The most rational portfolio in my opinion is the broadest world stock index and a domestic bond index based on your risk profile. I do have this but I also have a domestic stock index tracker and my buffer is all in domestic shares (mostly gifted to me from my job). Domestic shares give me some tax benefits and I'm hoping I get tax rebates when I retire.

So my advice is play a little bit if you want too but don't play too much. You probably can't predict the future so don't bother trying. Invest as rationally as possible and don't believe the stories you tell yourself.

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Re: On the risk of investing in stocks for the long run

Post by Dream of Freedom » Fri Aug 16, 2019 6:50 pm

So, you don't think real estate beats inflation? The appreciation alone matches inflation. Then you add the rent payments. Junk bonds beat inflation. See Edward Altman's work. There is no hard list of what is considered an asset class, but generally if they have less than a 0.7 correlation with other investments they are considered separate. That is why private equity, venture capital, and some hedge funds such as merger arbitrage and long short funds are often considered separate, even when they own equity both long and short, debt, and often other things. They often beat inflation. And don't think that retail investors can't access this stuff either. For instance merger arbitrage can be accessed through the etf MNA, junk bonds JNK, and there are many long/short ETFs out there.

I'm not saying you should buy individual stocks or exotic ETFs if you aren't inclined to, but why the hostility to anyone who is willing to do more with their portfolio?
It's everyone's own personal choice but betting with the odds on your side is smart. If you don't have a large chunk (say 50%) of your portfolio in broad based stock indexes you are making the choice that you can somehow beat the odds over time. I wouldn't bet my money on that.
You could just as easly we looking to lower risk as increase returns. You are projecting your motives on to others.
Last edited by Dream of Freedom on Fri Aug 16, 2019 7:16 pm, edited 1 time in total.

The Old Man
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Re: On the risk of investing in stocks for the long run

Post by The Old Man » Fri Aug 16, 2019 7:04 pm

steveo73 wrote:
Fri Aug 16, 2019 6:14 pm
The comment "You need to beat inflation over the long term. Stocks are the only assets that do this." is simply factual. It's not me or my or a personal opinion. It's a fact based on how markets and inflation have performed over time.
Stocks are not an inflation hedge. The 4% rule failed (using a stock/bond portfolio) due to the comparatively high inflation rates experienced in the 1960s-1970s.

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Re: On the risk of investing in stocks for the long run

Post by black_son_of_gray » Fri Aug 16, 2019 8:20 pm

steveo73 wrote:
Fri Aug 16, 2019 6:14 pm
The comment "You need to beat inflation over the long term. Stocks are the only assets that do this." is simply factual. It's not me or my or a personal opinion. It's a fact based on how markets and inflation have performed over time.
@steveo73 Of all the posters on this forum, I find you to be one of the most interesting, in large part because I find myself disagreeing with a lot of your posts—particularly, these "statement of facts" kinds of posts—so strongly that I start to question my own reaction. But these posts do get me to thinking about why I disagree and how people frame certain topics and questions. And if nothing else, they get me to run a sanity check through my own logic, which is probably worthwhile more often than not.

So let's look at some of your facts:

You need to beat inflation over the long term. Unless I'm mistaken, the ultimate concern for the FIRE crowd is running out of capital. Inflation is important, sure, but you don't have to "beat" it (I'm assuming you mean real returns > 0). For example, your purchasing power can be slowly eaten away by inflation (i.e. you don't "beat" it) but if you die before you run out of money, it doesn't matter. In real terms: if Jacob has 140X expenses and lives another 80 years, he can lose up to 60X expenses (!) to inflation and still be fine. Or, I suppose I could restate all this as: if you need to beat inflation, it is because you are undercapitalized. Isn't that simply factual? I showed my math and everything.

Stocks are the only assets that do this. So I guess you haven't played around with Portfolio Charts (h/t Tyler9000) enough? What do you call long term? Ten years? Eighty years? The distinction matters. Because there are plenty of examples of real total returns of major national indices having negative returns for 10+ year spans (see below). So stocks aren't always able to keep up with inflation, even for long periods of time. And other assets have long stretches (decades) of beating inflation. For example, see US bond bull market that has lasted well over 30 years! You may be right in arguing that stocks have the highest real return of any asset class since the late 1800s, but that is cold comfort when there are stretches within that time span—stretches longer than entire investment careers—where stocks underperform.

Stocks consistently "beat" inflation?
In major markets where stocks are denominated in currencies that are relatively stable against the dollar – such as the euro, the yen, the Chinese renminbi, the pound sterling, and the Canadian dollar – we discover a universe that has been a shitty long-term investment.

Currency matters when we look at other markets, because, for example, the stock market in Venezuela has shot to astronomical highs simply because the currency those stocks are denominated in has totally collapsed due to hyperinflation.

I also exclude from this comparison countries like India whose currency has lost close to 50% against the dollar over the time frame.

So here are the biggest non-US markets denominated in currencies that are relatively stable against the US dollar. Starting with Asia:

In China, the Shanghai composite is now back where it had first been over 12 years ago, and it’s down 53% from its peak in Oct 2007.

Japan’s Nikkei index is back where it had first been in 1986, and is down nearly 50% from the peak in 1989. That was 30 years ago. And the index is also down from two years ago.

In Germany, the DAXK which is comparable in its structure to the S&P 500, is back where it had first been in 1999.

In the UK, stocks reached a new high in May 2018 but have since fallen off. Currently, the index is just 7% above where it had first been in December 1999. So it made 7%, not per year, but over the course of two decades.

The French stock index is back where it had first been in 1999 and is down 24% from its peak in 2000.

Italian stocks are still down 60% from their peak in 2000.

Spanish stocks are down 45% from their peak in 2008 and are below where they’d first been in 1999.

The Canadian stock index, the TSX, is up about 10% from its prior peak in 2008, with a huge plunge in between. So that’s a gain of less than 1% a year. Not even keeping up with inflation.
Source: https://wolfstreet.com/2019/08/08/is-th ... -ripe-yet/ (Interesting take on FU money in the rest of this article)

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Re: On the risk of investing in stocks for the long run

Post by steveo73 » Fri Aug 16, 2019 10:10 pm

The Old Man wrote:
Fri Aug 16, 2019 7:04 pm
Stocks are not an inflation hedge. The 4% rule failed (using a stock/bond portfolio) due to the comparatively high inflation rates experienced in the 1960s-1970s.
That is right. It's not a fail safe. I get it. There isn't going to be a perfect portfolio.I don't expect a 100% fail safe via my investment portfolio decisions assuming that I have a chunk of stocks in my portfolio. There will be other ways to get ahead but this is to my the safest way to approach long term investing.

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