Why the PP is better in accumulation than you think

[Pointedstick]

no doubt ,  but then these folks should not be investors  . you can't blame markets and these same folks may have long bailed out of the pp too by now .

bad investor behavior will always be with us but you can't blame markets for what happens to them . it didn't happen to many of us , self included ..

Nobody is "blaming the markets." The markets have no intentions, they just are. We're simply acknowledging the reality of human nature and psychology. Lots of people make bad decisions when they're scared, including (gasp!) ourselves from time to time.

[mathjak107]

Great post.

I know people that got burned in 2000 and took years to get back into the markets only to get burned again in 2008. They have completely cratered their savings from these experiences. All of these investors would have been much happier in a lower volatility portfolio and would have definitely been further along to their retirement savings program. They got sucked in with promises of high returns but ignored volatility.

Longish quote from our book that discusses this:

Even one year of large losses can be very difficult to recover from (especially for someone who is nearing retirement or already retired).
...
Investors should understand the math involved here because it is not symmetrical. For example, recovering from a 50 percent loss can be very difficult because an investor in that situation will need a 100 percent return just to get back to where he started! Even a 40 percent loss (as happened recently in 2008 to U.S. stocks) requires a 66.7 percent gain to get back to even. Depending on how an investor reacts to these kinds of losses, the recovery could happen in a few years if the investor is patient enough to wait, or it could never happen if the investor bails out due to the stress generated by excessive portfolio volatility.

This problem of large losses hobbling a portfolio potentially for years is why investors want to avoid it. The only way to protect against these kinds of losses is to either take almost no risk (which also means limiting potential gains) or use strong diversification within a portfolio.
...
On one occasion when Craig was working as a network engineer he was discussing network architecture with a very experienced designer, Dr. Jose Nabielsky. Dr. Nabielsky responded to a question about the role of high performance in system design with the following comment: “Speed is fine, just be sure you can take the turns.” The translation is that high performance is only one part of network design; it also has to be reliable at all times to handle inevitable problems.

What does this have to do with investing? A lot. It’s tempting to get enchanted with high performance returns in a portfolio. But, having a portfolio that shows red-hot performance is only one measure you need to consider (and probably not the most important one). Investors also need to know what happens when things don’t go according to plan. Can your investment portfolio take the turns? Or does it go flying off a cliff into a fiery death at the first twist in the road?

Red-hot historical returns are not impressive on their own. It is easy to go into a spreadsheet with historical data and hindsight to come up with a portfolio that outperformed everything else, but that doesn’t mean the portfolio will do that in the future. If investing was that easy there would only be one mutual fund—The Hot Historical Return Fund—and everyone would invest all of their money in it.

Designing a portfolio for high returns alone eventually leads to disaster. Portfolios need the ability to generate growth, but must also have the ability to weather the unexpected storms, including investors’ inevitable bouts of fear when the whole market seems to be falling apart. Portfolios need to take the turns.

but as kitces study teaches us it isn't the drop . it is the recovery time . a moderate drop and long recovery time can be devastating to a retiree. 2008 was a non event , equity's tripled since the low over a very short period of time and the 2008 retiree is right  on track in there with any other retiree from any other time frame that wasn't worse case .

they are doing just fine despite the drop ..

[Xan]

no doubt ,  but then these folks should not be investors  .

You've said that the PP is unsuitable because regular people need the higher returns of much more stock exposure in order to ever have a hope of retiring.  The PP, you said, is for the weirdo elites who save way more money than normal.

Yet now, anybody who might panic when observing his net worth drop by 40% shouldn't be an investor.  What, pray tell, are the "regular people" supposed to do?

[fi50@fi2023]

Tyler - thanks so much for your work.  Your charts are extremely helpful and convincing.  Also, you give Mathjak something to do, which is a nice side benefit.  Thanks to everyone for the great discussion.

[craigr]

but as kitces study teaches us it isn't the drop . it is the recovery time . a moderate drop and long recovery time can be devastating to a retiree. 2008 was a non event , equity's tripled since the low over a very short period of time and the 2008 retiree is right  on track in there with any other retiree from any other time frame that wasn't worse case .

Yeah but you know that now. What were people thinking in late 2008 with near -40% declines in stocks?

So the recovery time is completely unknown and may not happen on an investor's timetable. Bad markets have a nasty habit of coinciding with job losses for instance. So the moment you may need your life savings to tide you over between jobs after a layoff, is the exact time it could be down significantly and your withdrawals are doing the most damage.

Just as one example.

[dutchtraffic]

but as kitces study teaches us it isn't the drop . it is the recovery time . a moderate drop and long recovery time can be devastating to a retiree. 2008 was a non event , equity's tripled since the low over a very short period of time and the 2008 retiree is right  on track in there with any other retiree from any other time frame that wasn't worse case .

they are doing just fine despite the drop ..

The reason WHY they tripled after the drop should scare you the most..

[mathjak107]

well we always think this is time is different and things aint coming back no matter what our allocation is but the golden rule of investing is turn off the noise and stay the course .  as i pointed out the morningstar small investor returns on conservative fund returns are no better for the small investor then the growth fund returns are .

so in the end if you were going to run for the exit in a fire it really didn't matter what your allocation is .  everything is relative to ones pucker factor and to a gun shy person being down 10% is just as horrible of a  feeling as being down 40% to an aggressive investor and the odds of bailing are the same .

you had folks bailing out of the pp because it was down .

what is interesting though about market fear is , we all fear the losses but once they happen we are okay with it and just wait for the gains .

this was shown to be fact in jason zwiegs book using modern brain imaging gear .  the fear of loss was horrible with horrible stresses but once the drop happened the stresses ended for the most part .

there ias no guarantee when rates rise  on bonds that the pp won't sustain moderate prolonged losses over an extended period of time if gold and bonds take a hit and its investors bail at losses . .

in the end all of us are betting on an out come that may not happen .

[iwealth]

there ias no guarantee when if rates rise  on bonds that the pp won't sustain moderate prolonged losses over an extended period of time if gold and bonds take a hit and its investors bail at losses . .

Just a minor correction above.

You do make a good point though about drawdown tolerance. Taking it a step farther, if one's drawdown tolerance decreases as they move from aggressive to conservative portfolios, then it is likely they'll run for the exit at some point no matter what. Someone able to withstand a 25% drawdown in equities may freak out about a 3% drawdown in the PP.

Also, the PP won't sustain losses because its investors are bailing. That implies it's like an individual small cap stock or something.

[mathjak107]

i mean if pp investors bail out at a loss they will lose money like anyone else .  pp investors have even a smaller tolerance for volatility so even smaller drops will send some running . in fact i have had direct messages from fiolks here telling me they were bailing out of the pp and sustaining losses .

[mathjak107]

there ias no guarantee when if rates rise  on bonds that the pp won't sustain moderate prolonged losses over an extended period of time if gold and bonds take a hit and its investors bail at losses . .

Just a minor correction above.

You do make a good point though about drawdown tolerance. Taking it a step farther, if one's drawdown tolerance decreases as they move from aggressive to conservative portfolios, then it is likely they'll run for the exit at some point no matter what. Someone able to withstand a 25% drawdown in equities may freak out about a 3% drawdown in the PP.

Also, the PP won't sustain losses because its investors are bailing. That implies it's like an individual small cap stock or something.

the morningstar small investor returns  compared to the fund returns shows this is exactly what is happening .  getting wounded by a grenade vs wounded by a bullet strikes the same fear .

chances of survival may be better with one over the other but fear does not differentiate . morningstar returns show investors bail out of conservative funds just the same as growth funds  when volatility picks up .

[MachineGhost]

50/50 never got destroyed and has a 100% success rate up to 4% .  i only need about 3% anyway .

Wrong?

Pure 4% withdrawals for a retirement starting in 1965 were a disaster, with the portfolio dropping to $0 in about 25 years.  This occurred regardless of asset allocation.  A portfolio of 50% stock / 50% bonds failed just as surely as a portfolio of 100% stock

[img width=800]http://www.gocurrycracker.com/wp-conten ... llapse.png[/img]

[mathjak107]

well i show never has 50/50 failed out to 30 years and a 96% success rate out to 35 years  .  50% s&p 500 and 50% intermediate gov't bonds .  maybe you left out  dividends

according to michael kitces , Whether the retiree started at the beginning of the Great Depression, entering into the stagflationary recession of the late 1960s and 1970s, or the credit crisis and panic of 1907 and the slow economic growth that followed, an initial withdrawal rate below 4.5% was both necessary and sufficient for the portfolio to survive for 30 years.



in fact here is the exact data


suppose you were so unlucky to retire in one of those worst time framess ,what would your 30 year results look like :

1907 stocks returned 7.77% -- bonds 4.250-- rebalanced portfolio 7.02- - inflation 1.64--

1929 stocks 8.19% - - bonds 1.74%-- rebalanced portfolio 6.28-- inflation 1.69--

1937 stocks 10.12 - - bonds 2.13 - rebalanced portfolio -- 7.24 inflation-- 2.82

1966 stocks 10.23 - -bonds 7.85 -- rebalanced portfolio 9.56- - inflation 5.38

but the portfolio outcomes are determined in the  first 15 years .

so here are the 15 year results


1907--- stocks minus 1.47%---- bonds minus .39%-- rebalanced minus .70% ---inflation 1.64%

1929---stocks 1.07%---bonds 1.79%---rebalanced 2.29%--inflation 1.69%

1937---stocks -- 3.45%---bonds minus 3.07%-- rebalanced 1.23%--inflation 2.82%

1966-stocks minus .13%--bonds 1.08%--rebalanced .64%-- inflation 5.38%

[MachineGhost]

The reason WHY they tripled after the drop should scare you the most..

Yield chasing behavior?  I'm sure we can handle another 50% drop in equities after the last two.  Please don't tell me you believe that Kool Aid about "printing money" flowing into the stock market.

[mathjak107]

well i am only in the high 40's as far as my allocation at the moment so we are looking at a drop a lot less than that . even less if bonds reflect a flight to safety since more than 1/2 are bonds .  not a problem at all .

[MachineGhost]

1907--- stocks minus 1.47%---- bonds minus .39%-- rebalanced minus .70% ---inflation 1.64%

1929---stocks 1.07%---bonds 1.79%---rebalanced 2.29%--inflation 1.69%

1937---stocks -- 3.45%---bonds minus 3.07%-- rebalanced 1.23%--inflation 2.82%

1966-stocks minus .13%--bonds 1.08%--rebalanced .64%-- inflation 5.38%

Sure seems to me like you just proved that chart?  How can you support a 4% SWR with inflation at 5.38% and portfolio only generating .64%?  No wonder it goes to zero.

I suspect whatever amount of gold makes that 1965+ period keep the 4% SWR working is what a portfolio should have as minimum.  Do you disagree?

[mathjak107]

wrong .

answer , that is only the first 15 years . the 30 year time frame was  not bad at all . if the first 15 years were not so bad the safe withdrawal rate would have been higher .

here is the full 30 years

1966 stocks 10.23 - -bonds 7.85 -- rebalanced portfolio 9.56- - inflation 5.38

spin again  ,  ha ha ha  , did you miss the part those numbers were only the first 15 years not 30 .

[MachineGhost]

spin again  ,  ha ha ha

I'll spin again too: the 50/50 portfolio WENT TO ZERO IN 22 YEARS @ 4% SWR starting in 1965.  The disastrous first 15-years seems to prove why this happened.  Do you disagree?

[Pointedstick]

answer , that is only the first 15 years . the 30 year time frame was  not bad at all . if the first 15 years were not so bad the safe withdrawal rate would have been higher .

here is the full 30 years

1966 stocks 10.23 - -bonds 7.85 -- rebalanced portfolio 9.56- - inflation 5.38

spin again  ,  ha ha ha  , did you miss the part those numbers were only the first 15 years not 30 .

LOL! After 15 years of withdrawing 4%, the balance is all gone! There's nothing to grow! The 30 year-results are irrelevant because after 15, you have nothing to get you through the next 15!

[mathjak107]

not at all ,  back to the drawing board for you .  it depends on how the sequences came in . averages don't count when spending down . 
in fact the first 10 years all you lost in real return was about 3.50% annualized  not counting any bond interest

[Pointedstick]

not at all ,  back to the drawing board for you .  it depends on how the sequences came in . averages don't count when spending down .

Yes, exactly. If you start in 1966, the sequence-of-returns for that portfolio are very bad such that after 15 years of withdrawing 4%, you have no money left, so the 30-year return of that portfolio starting in 1966 is irrelevant because that portfolio would cease to exist by 1981. You wouldn't have any money left to grow dramatically for the next 15 years.

Do I have this wrong?

[MachineGhost]

not at all ,  back to the drawing board for you .  it depends on how the sequences came in . averages don't count when spending down .

You seem to be denying that the 1965 sequence goes to ZERO?  If that chart is wrong, why?

[mathjak107]

yes you are wrong . equities the first 10 years lost only an average of 3.41% real return average per year  from 1965 to 1975  and that is not even counting the interest yet  from 1/2 the portfolio . once interest is figured it is even less than that .

1965 to 1980 real returns were positive .68 % per year on the s&p 500 plus interest .

you can do it right here .  it is a fact the 4% safe withdrawal rate survived 1965/1966 . that is why it is the basis for a bench mark .

starting in year 16 to year 30 real returns were more than 9% after inflation , almost 155 before inflation . .

http://dqydj.net/sp-500-return-calculator/

[mathjak107]

yearly returns mean near nothing by themselves when spending down . you need to go by sequence of returns  and inflation each year while deducting the spending .

believe me the 50/50 did not FAIL.    you can see that just by the fact there was less than a 3-1/2% negative real return the first 15 years not including interest in that negative real return , followed by 15 years of almost 15% average returns nominal and 10% returns adjusted by inflation , plus some of the highest interest rates  not included yet .

[MachineGhost]

Okay, I double checked in my own spreadsheet and I get .44% real CAGR for 50/50 from 1965 until the end of 2014.  At no time did it ever reach zero.  That chart from Go Curry that you linked to is obviously wrong.

[mathjak107]

see ,  i am correct .    kiss the ring but don't get it wet .  ha ha  ha   

there are things that just don't make logical sense and running out of money the first 15 years was one of them .  that was the whole point of basing the 4% withdrawal rate on 1965/1966 .

it was the most they could extract and pass .

i don't know much but i do know  quite a bit about what safe withdrawal rates represent and the research leading up to them . .

but that is what these forums are for , not to argue but to learn from each other . .