Black Monday

General Discussion on the Permanent Portfolio Strategy

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Jack Jones
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Re: Black Monday

Post by Jack Jones » Tue Aug 25, 2015 3:04 pm

Tyler wrote: Depending on the numbers you look at, the return on your additional risk may not be nearly as high as you may think. Volatility is not simply an emotional drag but a financial one as well.  http://portfoliocharts.com/2015/08/24/a ... trap/ 
Hey, great article, Tyler! Thanks for writing it!
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dualstow
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Re: Black Monday

Post by dualstow » Tue Aug 25, 2015 3:29 pm

From Tyler’s article:
Recently, a 100% stock market investor starting in 2000 experienced 13 years of negative real returns before finally breaking even.
I wish there were a tool out there — and maybe there is — that lets you add in ongoing cash infusions. I didn’t start really investing until 2004. However, I was able to put a significant amount into stocks on really bad days in 2009. Not the absolute bottom, but really bad days.

I have seen tools that let you input regular, automatic investments. Buys at specific prices, though- it gets complicated.
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Tyler
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Re: Black Monday

Post by Tyler » Tue Aug 25, 2015 5:34 pm

mathjak107 wrote: if you want to know about the past you want cagr returns as they account for sequence risk .

if you are projecting forward you want  to use average returns since sequences are unknown .
IMHO, switching measures to the more rosy one looking forward is exactly what gets many investors in trouble and sets them up for disappointment. Years later they'll look back at their returns and say the portfolio no longer works as it was sold to them, when in reality they were using unrealistic projections to begin with.

Since 1900, the compound real return of the S&P500 trails the average real return by 22% per year (6.6% vs. 8.5%).  http://www.moneychimp.com/features/market_cagr.htm  Those choosing to invest in stocks based on average returns would have accumulated (on average) 41% less money than they expected 30 years later.  Most investors would agree that's a big difference but are completely unaware of that fact.  Invest however you please, but ignore the effect of volatility in your own future projections at your own risk.

@Jack Jones -- Thanks!  If you find it helpful, please spread the word.
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Desert
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Re: Black Monday

Post by Desert » Tue Aug 25, 2015 7:02 pm

Tyler wrote:
mathjak107 wrote: if you want to know about the past you want cagr returns as they account for sequence risk .

if you are projecting forward you want  to use average returns since sequences are unknown .
IMHO, switching measures to the more rosy one looking forward is exactly what gets many investors in trouble and sets them up for disappointment. Years later they'll look back at their returns and say the portfolio no longer works as it was sold to them, when in reality they were using unrealistic projections to begin with.

Since 1900, the compound real return of the S&P500 trails the average real return by 22% per year (6.6% vs. 8.5%).  http://www.moneychimp.com/features/market_cagr.htm  Those choosing to invest in stocks based on average returns would have accumulated (on average) 41% less money than they expected 30 years later.  Most investors would agree that's a big difference but are completely unaware of that fact.  Invest however you please, but ignore the effect of volatility in your own future projections at your own risk.

@Jack Jones -- Thanks!  If you find it helpful, please spread the word.
That's a very important point!  Thanks for the reminder.
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mathjak107
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Re: Black Monday

Post by mathjak107 » Tue Aug 25, 2015 7:33 pm

it is so important to understand i will say it again    lol .for looking at things in the past you use cagr returns . projecting in to the future you use average since sequence risk can be big .

vanguard quotes average returns  on their site while morningstar is cagr .

think about it ,  if you go 100%  the first year and down  50% the second year your cagr is zero % return but that could be expressed as a 25% average return .

a sly advisor could get away saying that was a 25% average return even though you got zero
Last edited by mathjak107 on Tue Aug 25, 2015 7:35 pm, edited 1 time in total.
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Re: Black Monday

Post by AnotherSwede » Tue Aug 25, 2015 11:09 pm

mathjak107 wrote: it is so important to understand i will say it again    lol .for looking at things in the past you use cagr returns . projecting in to the future you use average since sequence risk can be big .
Say it again. Louder and slower. I still don't understand what use I have for average returns.
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Re: Black Monday

Post by tennpaga » Tue Aug 25, 2015 11:38 pm

Sequence is extremely important when evaluating overall returns when one is making periodic contributions.

For fun, I grabbed 34 years of S&P annual returns (1981-2014) from the moneychimp site Tyler mentioned. The CAGR is 11.3%. The assumption here is that you deposit everything before year 1, and withdraw at the end of year 34.

However, if instead, you start with $0, but deposit $1000 at the start of each year, the final value is $320,000, and corresponding the IRR (internal rate of return) is 10.8%. Note that this is slightly lower than the CAGR.

Keeping the $1000 per year deposit, but now sequencing the annual returns from lowest to highest, the final value is $1,702,000, which is 18% IRR. 

On the other hand, if the returns are sequenced from highest to lowest, the final value is only $162,000, which is 8% IRR.

All from the same 11.3% CAGR!
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Re: Black Monday

Post by tennpaga » Wed Aug 26, 2015 12:07 am

Of course, you can see the effect of sequence in an even simpler example.

Consider a 100% return followed by a -50% return.  The CAGR is 0%, of course, over these 2 years.

With this sequence, if you add $1000 at the start of each of the 2 years, you'll have $2000 at the end of year 1, and $3000 at the start of year 2 (once you add the $1000), but $1500 at the end of year 2.  This is equivalent to a -17.7% IRR.  That is, if you deposit $1000 at the start of each year, and the return is -17.7% each year, you'll have $1500 at the end of year 2.

Now consider a -50% return followed by a 100% return.  Again, the CAGR is 0%.  But you'll have $500 at the end of the first year, $1500 at the start of the second year, and $3000 at the end of the second year.  This is equivalent to a 30.2% IRR.
Last edited by tennpaga on Wed Aug 26, 2015 12:09 am, edited 1 time in total.
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Re: Black Monday

Post by Tyler » Wed Aug 26, 2015 1:51 am

Tyler wrote: Those choosing to invest in stocks based on average returns would have accumulated (on average) 41% less money than they expected 30 years later. 
Following up, I wanted to point out that after more research this part of my previous statement is likely incorrect.  Volatility drag is absolutely real, but that particular factoid is from an inappropriately simplified calculation. 

Also, Mathjak's point about future returns and averages is not unfounded but does require a caveat.  Long story short:  Looking at history (where the order of returns is certain) compound returns always trail the average and are the more useful measure of performance.  Projecting into the future (where order of returns is unknown), averages are helpful because they are order of returns neutral.  However, volatility still matters.  Volatility does not mean you will always earn less than the historic average (you could get lucky and hit a hot run), but higher volatility does lower the median endpoint, reducing your odds of an enjoyable outcome.

Ain't math fun?  ;)
Last edited by Tyler on Wed Aug 26, 2015 2:50 am, edited 1 time in total.
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Re: Black Monday

Post by mathjak107 » Wed Aug 26, 2015 3:48 am

also the less volatile the asset the less the spread . the spread between cagr and average  is greater for the s&p 500 vs a balanced fund , vs bonds vs cash .

even the mix of the portfolio matters so like the pp volatile assets can be tempered down to a point the spread is reduced  far more than the assets reflect .

that is why it is hard to use cagr for projecting out .
Last edited by mathjak107 on Wed Aug 26, 2015 3:54 am, edited 1 time in total.
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Re: Black Monday

Post by dualstow » Wed Aug 26, 2015 8:49 am

Tyler, as I wrote in my PM reply, I am really taken with the Hurricane calculator at portfoliocharts. Thanks for mentioning it!
The Max and Min are good enough, so forget about the wrestling Really Bad Days data.
Also....from the results of the hurricane calc, it looks like I'm going to be rich when I'm old. Huzzah!
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Re: Black Monday

Post by lordmetroid » Wed Aug 26, 2015 9:19 am

It would be cool if the hurricane calculator could show how many paths ended up as positive and how many ended up negative relative to the starting value
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