Reducing stock investing risk

[steveo73]

When I FIREd 26 years ago, I too thought I had found THE answer, in commercial real estate. Just sit back and let the rental income roll in year after year. No landlord worries, inflation proof, etc. Much like those today who believe an Index Fund and so called SWR will work for them. My initial strategy worked fine until there was a glut of available properties on the market and income started to fall. Time to CHANGE strategy. "Nothing is as constant as change" is a well known phrase and yet another example of a simple reality that people are more than willing to ignore. My strategies have changed quite a few times over the past 26 years. They had to because things keep changing!
http://www.thedailyphilosopher.org/daily/000011.php

What people are looking for of course is SECURITY. They want to know they will not go broke after they FIRE. That their money/investments will last out their lifetime however long that is. They want to KNOW that BEFORE they FIRE. The fact is, NO ONE can know that and no strategy you come up with today can GUARANTEE that.

I basically agree with this however you can put the odds on your side. Have a decent stash. Know how you will withdraw it (for instance a set percentage or a variable amount). Have some buffer (which could be a huge number of things including being prepared to work flipping burgers). Invest rationally.

[OldPro]

That's fine steveo73, but as I have said before, I am absolutely and fundamentally opposed to planning to draw down capital. I prefer to plan to live on the income your capital can generate. My buffer is to re-invest the some of the income, so that the income you then generate continues to be more than you need to live on.

In other words, spend less than you earn. Invest $100. Earn 10%, spend $6 and re-invest the remaining $4 to cover inflation. The capital keeps growing, the income keeps growing, there is no need to draw down capital.

You do NOT need more capital to make this work, you just need to take a different approach to how you invest your capital. IF you say it MUST earn you 10% for example, then you are forced to find ways to get that return on investment. The way to 'put the odds on your side', is to stop thinking you can sit back and eat your capital and start thinking that you need to have your capital earn enough income for you to live on.

[JL13]

The performance of the underlying businesses themselves has not been GREAT. Try looking up Lehman Brothers, Enron or WorldCom to see how the mighty may fall

Yes but I mean American business overall, I didn't say NO businesses ever go under. That's like 4 out of 700 or so.

Try putting yourself in the picture that the reality presented at the time...A drop of 90% on the Dow Jones Average.

You're describing a drop in market value, not a drop in intrinsic value, or even drop in accounting value. How many of the DJIA components actually reported significant losses then? Note, that the P/E ratio never went negative, so overall not very many!

Just imagine you're talking about any other asset. Say every one of your neighbors freaked out and decided to sell their cars for pennies on the dollar? Would you be upset because yours is worth less? Or would you shrug and continue to drive yours without thinking much of it? I would do the later.

It's the actual value of the business that matters, not the most recent quotation of some psychopath selling.

[A Life of FI]

People believe a lot of things without any real logic to their beliefs. A Life of FI wrote, "In relation the economic system reaching a risky level - The risk/market valuations may be more elevated than 2009 years ago but I don't think it is worse than many previous periods in history - 1929 for example - which were fully survivable at a 3.0% WR. Just my opinion."

An admitted opinion which suggests that someone with a 3% WR would have survived the 1929 crash. This is an often repeated 'fact' given by people espousing the SWR.

Oldpro - The statement that 1929 is survivable at a 3% WR - is a fact. The statement that - the risk/market valuations may be more elevated than 2009 but I don't think it is worse than many previous periods in history -is an opinion.

The 3% WR is confirmed based on the actual performance of the market from 1929 onward subtracting out inflation adjusted withdrawals of 3% of the original portfolio amount each year.

What is your logic for believing a 3% rate does not work for 1929 - What do believe the correct SWR is?

[steveo73]

That's fine steveo73, but as I have said before, I am absolutely and fundamentally opposed to planning to draw down capital. I prefer to plan to live on the income your capital can generate.

I have no issues with this for you. I'm not sure that you said that you could beat the market anyway. For me personally though I think I will have to draw down some capital.

You do NOT need more capital to make this work, you just need to take a different approach to how you invest your capital. IF you say it MUST earn you 10% for example, then you are forced to find ways to get that return on investment. The way to 'put the odds on your side', is to stop thinking you can sit back and eat your capital and start thinking that you need to have your capital earn enough income for you to live on.

I don't like this approach. I'm worried that you are looking for above average returns and that may be hard to get. So what you end up doing is chasing the highest returns and at some point it all goes bust.

I'm personally pretty comfortable retiring on a 5% WR with buffers. Its my buffers that I think will get me through. Even if I say I'm FI for instance I think I will work part-time just to have 5 years of no withdrawls past that point. I can also sell my house and downsize. I should also get inheritance and maybe social security. I also intend to use a variable withdrawal rate. I can easily cut back on expenses if required. That is what gives me confidence not believing that I can consistently get above market returns.

[frommi]

The largest corporations fail to make profits in many years. They can operate at a loss, thanks to banks and investors. Try taking a look at GMs quarterly profits in 2009. They hit negative 55.99% for the quarter ending June 30, 2009. Why do you think they had to get a government bailout? Some companies operate at a loss for years on end and continue in business based on loans and 'investments'.

You are right, you shouldn`t invest in the market without some basic knowledge about the market. When you invested in Enron, GM or Worldcom you deserved this outcome, because with some basic acounting/business knowledge you would have been able to dodge these kind of stocks.

- With a 2% dividend yield on the S&P500 you shouldn`t have to draw down your capital in a 1929-1932 style drawdown when you have 10% of your networth in cash and 90% in an index fund.
- alternatively you can easily create a slightly higher yielding and safer alternative to the S&P500 with highly profitable world class businesses like CL,KO,PEP,PG,Nestle,CHD,XOM,IBM etc. dividendmantra.com is a good start for reading. This is btw. very similar to a low volatility approach and should have comparable drawdowns to low volatility S&P500 funds, for example SPLV.

- Or you go the hard way and try to beat the market with value investing a`la Ben Graham with NCAV stocks. But expect higher volatility and bumpy rides. But this is in no way necessary to achieve a 3% SWR via stocks.

I don`t know a lot about investing in wine, but based on what i know its similar to oldtimers or art. Since its not possible to value these things based on their cashflows you need someone to pay you more to make money. This is based on greater fool theory and surely nothing to base your retirement on. Tulips once belonged to that kind of investment, too. (Maybe with oldtimers you can add some value with repairs)

Investing in real estate without leverage has not beaten the stock market in the past 100 years and probably never will. There are no barriers to entry, so the return on capital will go down to the risk free rate+the amount of labour/resources necessary to maintain your cashflow. In the end its a job not an investment.

And btw. in poker you can only make money in the long run from people that play worse than you. At least to me its easily visible that an edge here is not sustainable against the house/other people, as other people will learn too (and in higher stakes you will mostly play against survivors, while bad players drop out). Its only possible when you constantly find people worse than you as competition will drive down returns. (and has already in the past decade). Of course in the short run you can get a lucky streak. (And will surely equate it to skill)

[OldPro]

How do people manage to read so selectively? How do you mange to tell yourself avoiding what was written or changing what you wrote to something else, is logical?

J_L13, you wrote, " "In what alternative world would the largest American corporations fail to make any reasonable profit over the next 20+ years? " Now you want to change it to, "Yes but I mean American business overall, I didn't say NO businesses ever go under. That's like 4 out of 700 or so." So you can't defend your first statement and think you can just change to saying something else entirely?

Here's how it goes J_L13. First you write, 'OK, I got that wrong. I should have said, ........... '

But let's ignore that an move on to something far more important. In response to my question asking if you actually believe you would sit for 1000 days saying 'don't panic', you respond by suggesting it would be no different from everyone around you selling their car and you would, " shrug and continue to drive yours without thinking much of it". So you are telling me you would watch your $381,000 investment of your life savings drop to $41,000 and just 'shrug without thinking much of it'? Really? I don't think so.

As for market value vs. any other value, the ONLY value that would matter is the market value since that is where your $381,000 would be invested. Yup, you are going to sit there and say, 'that's ok, the bricks and mortar value of the company is still there.' I don't think so.

A LIfe of FI, I find it beyond believe that anyone could try and say that faced with the reality of seeing their life savings disappearing before their eyes, they would sit there arguing that because the MATH says you would survive the 1929 crash, that is proof that YOU would survive it.

You ask, "What is your logic for believing a 3% rate does not work for 1929" The logic is that you are talking about PEOPLE, not a robot. It is not a question of mathematics, it is a question of human behaviour. So try and tell me YOU would sit there for 1000 days saying to yourself, 'the math proves I will survive this', while you watched your $381,000 drop to $44, 000.

[OldPro]

Steveo73, I have never commented on beating the market or not beating the market so you are right in saying you are not sure I ever said so. What I have said is that I do not invest in the market and I did not set my goals based on a WR. I set my goals based on a desired income to be derived by finding a way to generate that income outside of the market.

You wrote, "I'm worried that you are looking for above average returns and that may be hard to get." Above average returns for what? I am not looking for returns from the stock market so you cannot compare what I am looking for to the average returns of the stock market. I am not, "chasing the highest returns and at some point it all goes bust.", as you write. I look for investments that provide the average returns I want to get and do so relatively safely.

For example, as I have already said, I started my FIRE life invested in commercial real estate. At the time it was paying me 10% plus with very little risk whatsoever. I wasn't 'chasing the highest returns' at all. The goal was a return of 10% + with relatively low risk. I found it and invested in it. I was getting the 'average returns' for commercial real estate at that time. I was not chasing the highest returns for real estate. You can't compare apples to oranges and say that if the average for apples is $1 and you are looking for $2 for oranges, you are chasing 'above average apple returns.' The question is what is the average for oranges.

Finally, you wrote, "not believing that I can consistently get above market returns", presumably meaning that I do believe that I can consistently get above market returns. Somehow, everyone seems to always thinks in terms of market returns and either you must be investing in the market to get those average returns OR you are somehow trying to BEAT those returns. Again, you are talking apples and trying to compare their price to the price of oranges.

I don't CARE about the market. Full stop. It does not enter my thinking about investing, other than that it is NOT something I would ever do. That being the case, can you see that I cannot be trying to beat the market, I am trying to get the return on investment that I set as my goal and in as safe a way as possible. Not risk free but as low a calculated risk as I can find. FORGET the market when talking to me, it doesn't exist on my radar in any way, shape or form.

[OldPro]

Frommi, again a mathematical answer to 1929 that ignores the reality of human behaviour.

Also again, you are trying to compare everything to apples when in fact an orange is not comparable to an apple at all. Again, it is not about 'beating' the stock market (apples) at all. It is about finding the oranges that do have the average return you want. That's the hard part, finding the oranges. What's more, oranges may only be the answer today, not tomorrow.

When I FIREd, I found an orange called commercial real estate. Today I may need to find a tangerine called something else that provides the average return I want relatively safely. I am not fixated as so many here seem to be on having to compare everything to the stock market or that the answer is going to be something that lasts forever.

I've written here before that I plan for now, this year. I do not expect and have learned from experience not to expect, to find something that will last beyond that. Something may last several years or may not. The world changes, what works changes and so I must change my strategy to suit the world I am living in.

Anyone who thinks they can stick to a 'works till I die' one time answer, is in for a rude awakening I would say. Find me one person who has been FIREd for say 15 plus years that has not changed how they invest their money and derive their income. Nothing is as constant as change. My investment strategy has changed a dozen times or so in my 26 years since I FIREd. It has never included the stock market.

[frommi]

Anyone who thinks they can stick to a 'works till I die' one time answer, is in for a rude awakening I would say. Find me one person who has been FIREd for say 15 plus years that has not changed how they invest their money and derive their income. Nothing is as constant as change. My investment strategy has changed a dozen times or so in my 26 years since I FIREd. It has never included the stock market.

I can tell you a lot of value investors that have not changed their strategy the past 50 years and have gotten unbelievable rich. If you don`t want to learn about the stock market, its your problem.
How do you realize that your strategy isn`t working anymore, do you abandon your approach after one year when it didn`t work? two years, three years?

[JL13]

J_L13, you wrote, " "In what alternative world would the largest American corporations fail to make any reasonable profit over the next 20+ years? " Now you want to change it to, "Yes but I mean American business overall, I didn't say NO businesses ever go under. That's like 4 out of 700 or so." So you can't defend your first statement and think you can just change to saying something else entirely?

I definitely agree that you made a good point - it's a bad idea to invest your life savings into one company. I'm not sure I follow why my statements are contradictory? My first statement said "largest American corporations" and the second statement said that about 700 corporations are in included in "the largest American corporations". There are some 1.7 million C corporations alone in the US. I'm pretty sure the US stock market is a pretty good proxy for the largest American corporations?

So you are telling me you would watch your $381,000 investment of your life savings drop to $41,000 and just 'shrug without thinking much of it'? Really? I don't think so.

I am an accountant by trade. I spend much more time reading 10K than I do market quotations. If the financial statements were painting a grim picture, I might start to panic. If the financials were still telling a good story, I would probably sell everything not tied down to buy some more. I'm not so sure market quotations alone would cause me to panic. There are many, many irrational things other people do around me that do not influence my behavior. Not everyone responds the same way to social pressure.

[OldPro]

I realize it isn't working when it will no longer provide the return I want it to provide frommi. I would have thought that was pretty simple to understand. It's time to change. When will someone who is using a WR and index funds know it is time to change with their method?

I agree that value investors such as Irving Kahn have done well over time. Which index fund follows his method of investing? None that I know of.

M_L13, aaahh an accountant. That explains a lot. I won't waste any more of my time trying to explain to you that human behaviour does not follow mathematical formulas when it comes to watching their life savings disappear.

[Scrubby]

The discussion with OldPro is pretty much just a repetition of this one: http://forum.mrmoneymustache.com/welcom ... #msg637952

If you think you can repeat what he says he's done in the message I've linked to with the same result then go ahead.

[A Life of FI]

A LIfe of FI, I find it beyond believe that anyone could try and say that faced with the reality of seeing their life savings disappearing before their eyes, they would sit there arguing that because the MATH says you would survive the 1929 crash, that is proof that YOU would survive it.

You ask, "What is your logic for believing a 3% rate does not work for 1929" The logic is that you are talking about PEOPLE, not a robot. It is not a question of mathematics, it is a question of human behaviour. So try and tell me YOU would sit there for 1000 days saying to yourself, 'the math proves I will survive this', while you watched your $381,000 drop to $44, 000.

Oldpro - The numbers you are quoting above are for a portfolio of 100% equities - which is the highest risk asset class. No one here is saying that anyone/everyone should hold a 100% equity portfolio.

A portfolio of 50% equities and 50% debt decreased from 1929 to 1931 by about 25% before it started to climb in value. Thus the reduction in value is much less and the interest and dividend distributions from the portfolio during the period from 1929 to 1931 would have been more that 3%, so I don't see a reason for someone panic and sell. Also this portfolio would allow for a 3% WR for someone Firing in 1929 or any other year over the last 100+ years.

But if someone is worried about market drops, even better than just externally holding a 50%/50% standard allocation of equities and debt is to shift these allocations considering the pricing in the market and point in the economic cycle.

For example I generally I do not own equities at any time when price you need to pay for every dollar of earnings (the P/E ratio) is very high and the economy has just experienced a long expansion. Thus I did not own any publicly traded equities at the time of the 2000 or 2008 market drops, when, similar to 1929, the prices you needed to pay for equity securities where very high and the economy had just experienced several years of strong growth.

At these times I owned government debt. Government debt increases in value at the time when the stock market drops as interest rates go down. So for me when the stock market was dropping the last thing I wanted to do is sell my investments - as they are continuing to grow in value. It was not about panicking but rather watching my investments grow in value, waiting for the point when equities/real estate became cheap enough and then selling my debt positions and buying publicly trade equities/real estate at significantly reduced valuations.

This is just my approach though and of course is not right for everyone. Some people prefer the permanent portfolio or a 50% equity/50% debt allocation as its lower maintenance and the portfolio value is more stable over time, others hold all equities all the time as they have built-up large capital gains and don't want to reduce their portfolio by selling and having to pay the taxes on gains, others stay in cash except for when the market is really cheap as they already have enough money through pensions, social security, upcoming inheritances etc. and don't see any utility in taking on any significant risk to make more money which they don't need in the first place. All of these approaches make sense it just depends on the financial situation, age, physiology etc. of the investor.

[Hankaroundtheworld]

I went thru the related MMM thread as well (thanks @Scrubby), just to be sure I was not missing anything that might be of value. The point of @OldPro is that he is focusing on investments that he knows more about, and by doing so, he feels he has a good (intelligent) handle on the risks involved, and so far he has proven right in beating the average returns (some call this luck, but OldPro of course not, like he said on MMM, as an example, he had some insight information on the Greek bonds). Furthermore, he does not want to settle with the "average" like many perhaps do with Index-based investing. Problem is that, statistically speaking, we cannot verify if let's say 1000 people would follow this investment strategy, the majority would be successful. So far not many have advocated this successful approach on ERE or MMM, so perhaps not many did succeed. I compare this strategy of OldPro with being an entrepreneur/investor in a field of business that you know a lot about. Typically, those people will not bet on "one" horse, but let's say 10 business investments, and hope that at least 2 will pay off. There is no guarantee of success, even if you have a lot of knowledge of the investment domain (or have insight info that nobody else seems to have), hence you need to take on multiple investments to spread the risk. For instance, like suggested here, bet on "retirement homes". Yes, with the knowledge that we have today, this seems a reasonable assumption, and for sure, invest in it, perhaps good chance of success, but will this be the ONLY horse that you are betting on? Even with all the knowledge of the world (as of today), it still remains a gamble if it will pay off because you cannot predict changes in the world. No wonder, people like to diversify, and spread risks (even if your risks are lowered by intelligence or insight info).

I think, this discussion can go on forever. One thing is for sure: if you do start your ERE, you do have more time to invest in finding good investment opportunities (so this "keep on looking" of OldPro, I agree with), but there is also more in life than finding and learning about investment opportunities, so choosing "average risks with average return" is not so bad, especially if you can afford this strategy

[OldPro]

Scrubby, the idea is not to repeat what someone else has done, but to find your own path. Obviously, you could not repeat exactly what I did as the circumstances are no longer the same today. So what do you think you are really saying when you suggest 'if you think......'?

What are all those planning to follow the index fund and SWR path doing, other than looking for an answer that they all can follow. A one size fits all answer. I'm advocating thinking for yourself and finding what works for you rather than believing that one answer will fit everyone. What I have done is find MY path and what I am saying is that is what others can look at repeating is just that, finding their OWN path and not buy in to the, there is ONE path that will work for everyone as long as they are robots with no emotions.

A Life of FI, I'm talking about people and their behaviour. You want to argue mathematics. I used a simple example, not because the reality can't be more complex than that but because I think it makes the human factor quite clear to anyone with some common sense. The point is that people do not act like robots, we are all far more susceptible to fear, anxiety, what if, etc. and we then act based on our emotions. Unless you hand over all decision making power to a computer, you cannot remove emotion from the equation.

In your own case and the others you outline, you are not talking about people investing in the most often suggested (here) strategy of putting their money in index funds and using a WR of X%. You are in fact talking about exactly what I am advocating, do what works for you based on your own knowledge, skills, aptitudes, etc. It those who read here and think they can blindly follow a 'buy index funds and use a 3% WR, end of story, who I am trying to get to understand that unless they can remove being human from the equation, their index fund and WR strategy may work fine, right up until something happens that triggers an emotional response. Then their strategy will go out the window.

Hankaroundtheworld, you wrote, "Problem is that, statistically speaking, we cannot verify if let's say 1000 people would follow this investment strategy, the majority would be successful. So far not many have advocated this successful approach on ERE or MMM, so perhaps not many did succeed."

You are right. It is also equally right that you cannot find 1000 people here who have followed an index fund and WR strategy to statistically verify that doing so has been successful for the majority either. So far many have advocated it but not many (any?) have posted here or on MMM to say they have succeeded with it for 25 years.

Not having statistics to prove something does not disprove whatever it is. It only means you do not have statistics, end of story. So if we are not going to accept a strategy unless we can find statistical proof, where does that leave you? And before anyone says the math proves SWR works, poppycock. The math proves it theoretically works, the math does not prove it will work for people. Only people having done it can prove it will work for people.

So without actual proof a strategy will work, how are you supposed to decide what to do? Well you can take the easy answer of, 'this is what people are all buying in to, so I'll go with that'. OR you can think for yourself and go with what you KNOW. Use your own knowledge, skills, experience, aptitudes, common sense, etc. and find a path that you believe will give you the best chance of success. And my biggest piece of advice would be to run, don't walk, away from anyone and anything that says, 'this one size fits all.'

[Scrubby]

Scrubby, the idea is not to repeat what someone else has done, but to find your own path. Obviously, you could not repeat exactly what I did as the circumstances are no longer the same today. So what do you think you are really saying when you suggest 'if you think......'?

I think you've just lucked out, definitely with the housing investment and most likely with the bonds. As they said in the other thread, it's extremely unlikely that you were better at evaluating the risk than everyone who manages huge sums of money and spend all their time getting as much information as possible. It's easy to confuse luck with skill, especially if you've lucked out several times in a row.

[Hankaroundtheworld]

Like I said, this discussion can go on forever. I think, @OldPro made his point, use your brain and only invest in what you know. Great, it has worked for him, and we will never know if it was just luck or skill, or a mix. It also does not mean that others do *not* think, but some like to use investment studies that have analyzed the results based on the past/history, and yes, everyone knows that is also not a guarantee for the future, but there is no harm in using Analysis-Data and mix it with your own understanding/knowledge, and find your own unique path in this (like many do, see the journals). My decision is not to bet on "one" horse at a time. Good luck all

[steveo73]

Like I said, this discussion can go on forever. I think, @OldPro made his point, use your brain and only invest in what you know. Great, it has worked for him, and we will never know if it was just luck or skill, or a mix. It also does not mean that others do *not* think, but some like to use investment studies that have analyzed the results based on the past/history, and yes, everyone knows that is also not a guarantee for the future, but there is no harm in using Analysis-Data and mix it with your own understanding/knowledge, and find your own unique path in this (like many do, see the journals). My decision is not to bet on "one" horse at a time. Good luck all

Its a different kind of thinking isn't it. I reckon we all get to choose our own paths.

[OldPro]

I agree this has now run its course and is starting to repeat. Do as you want guys, hear what you want, ignore what you want.

I would like to make a comment though on the 'luck' comment by Scrubby. It's easy for you to voice an opinion that I just got lucky Scrubby. It's like asking someone to 'prove a negative'. It's as easy for me to say, prove it was just luck. But the proof is always in the pudding. How many times can you say someone was just lucky before having to admit they've made decisions that turned out right too many times for it to just be chance? If they do so more often than not, luck alone cannot account for that.

I'll also comment on this remark Scrubby. "it's extremely unlikely that you were better at evaluating the risk than everyone who manages huge sums of money and spend all their time getting as much information as possible." What makes you think that someone else whoever it might be, would have more information than I would? That is a huge assumption on your part Scrubby. Have I not said repeatedly, invest in what you KNOW about? You are assuming that a person did not KNOW about whatever it was they were looking at investing in. That may be true for you, it is not true for me. I invest based on what I KNOW about something.

Here is a simple example of the difference. Two people decided to open a bar in a busy tourist area of a country that both of the people were new to. One took 2 years to get a license to open. The other got a license in 8 weeks. I was the one who got a license in 8 weeks Scrubby. So what was the difference between that other guy and me? He had bad luck and I had good luck? Do you really think that is likely to be the only thing at play? The bar I opened is still in business today (I sold out). The bar the other guy opened didn't even last a year before he left and went home broke. That wasn't just luck Scrubby. That was the difference between someone who did not KNOW what they were doing and someone who did KNOW.

But this may clarify for you what KNOW means. Did I know all there was to know about getting through the bureaucracy to get a license and know all there was to know about running a successful bar in that country? The answer is, no I did not. But what I did know is that I didn't know what I needed to know to get where I wanted to be. That knowing what I did not know was the difference between the other guy and I Scrubby.

There is what is supposedly an old arab proverb. " “He who knows not and knows not he knows not: he is a fool - shun him. He who knows not and knows he knows not: he is simple - teach him. He who knows and knows not he knows: he is asleep - wake him. He who knows and knows he knows: he is wise - follow him.”

What knowing I didn't know enough told me, was that I needed a teacher. So I KNEW what I needed and went about getting it. That came in 2 forms. First a partner who knew the bar business and had a record of success. Second, a 'consultant', who knew all the right palms to grease to get a license. If I had not been able to find a way to get the knowledge I needed, I would not have opened a bar.

You always know something, even if it is only that you don't know enough. Or at least you do unless you fall into the first category in the old proverb, 'he who knows not and knows not he knows not.'