Author Topic: Unreliability of long run stock market returns  (Read 7190 times)

SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #50 on: September 13, 2017, 03:22:23 PM »
When I simply put numbers in cfiresim (the way I always did) to look at %chance of FIRE, I saw such variability in outcomes.

Isn't the unreliability a given ?  1966-1983 was a pretty bad period for stocks.

I think it is a given. And, David, if you've always "gotten" that you are way ahead of many who mistakenly believe that one can use "time" to diversify away a bunch of the risk! (Good job!)

Some people intuitively get this. And some people don't.
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SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #51 on: September 13, 2017, 03:38:10 PM »
I think I agree with DrF.

Two tangential comments... One, there are great resources at the www.portfoliocharts.com website. I love it! But as an author I'm always alert about not stepping over the fair use boundary and violating an author's copyrights. (I.e., Tyler's copyrights.) He can share his work. But we should be careful about showing his charts, I think.

Second comment:I know I said earlier in this thread that what I'm talking about here is sequence of returns risk. But after more thought, I realize it's not really.

Don't we think that sequence of returns risk refers to situations like this:

Guy #1 earns 4% for the first 15 years of retirement and then 8% for the second 15 years.

Guy #2 earns 8% for the first 15 years of retirement and then 4% for the second 15 years.

Both of these guys earn about a 6% IRR or actually 5.9811%. And sequence of returns risk refers to weirdness that even though they get the exact same average annual return, the first guy gets limited in what he can draw because he gets the bad returns early.

The variability in outcomes issue is that even if the average run 6%, lots of people will get 4% or 5%... lots will actually get 7% or 8%... and some outliers will for good or bad get even more extreme results.
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DavidAnnArbor

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Re: Unreliability of long run stock market returns
« Reply #52 on: September 13, 2017, 04:24:44 PM »
Another actionable insight: If this variability is "new" to someone's financial thinking and strategic planning, I wonder if someone doesn't want to maybe use a different asset allocation... maybe one with less risk and less return but possibly a narrower range of likely outcomes...
Tyler would often express this point and became the reasoning behind developing portfolio charts.

gerardc

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Re: Unreliability of long run stock market returns
« Reply #53 on: September 13, 2017, 06:17:05 PM »
Most of the time, when authors produce these charts, they talk about how the tail of the chart narrows over time. But something else is true, too, which is the tail never compresses to a single value.

Are you talking about the tail after a predefined period, e.g. 30 years? If so, this is trivially true. If not, please provide proof. I seriously doubt that's the case.

Gerardc,

I may not understand your comment, but I'm thinking you're asking for proof there's tons more variability in outcomes than many people commonly believe. So I'm going to address that issue... try to "provide proof"... I'm also going to break this response out into sections so people can choose a method of proof that meshes with the way they like to process information.

For People Who Know How to Use cFIREsim and Microsoft Excel:

In message response #12 above, I provide the steps for using the cFIREsim online calculator to calculate the average, worst and best case returns historically for a given retirement savings plan. I also describe how to use Microsoft Excel to quickly calculate the average annual returns for the investor who experienced the worst case scenario, the average scenario, and the best case scenario.

Going through the steps of using cFIREsim takes less than a minute (I just timed myself)...  And this exercise will provide proof.

For People With Good Spatial Reasoning and Chart Reading Skills


Another pretty easy way to prove this to yourself is to look at any--any--funnel chart you see in books or on websites talking about long return returns.

What you will see is that the worst case and best case scenario returns never converge to a single percentage. The charts always show a gap between the worst and best case. Always, always the charts show this.

Well, the charts stop at 30 or so years, so obviously the gap won't vanish entirely. The point is that it gets smaller and smaller as the period increases, which is the definition of convergence (assuming it can get as close to 0 as you wish).

Your argument is like saying, 2 ^ -x doesn't converge to 0 as x -> infinity, with the proof that "draw a chart from 0 to 10, and you'll see the curve NEVER reaches 0".

Long term market returns probably converge to a single value by the central limit theorem, i.e. after throwing a large number of random outcomes, the standard deviation of the empirical mean approaches 0. It's always a question of how long you wait. Of course, in an investing lifetime of ~50 years, the standard deviation of the mean is not necessarily small or negligible, which is trivial IMO.

Tyler

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Re: Unreliability of long run stock market returns
« Reply #54 on: September 13, 2017, 09:34:44 PM »
One, there are great resources at the www.portfoliocharts.com website. I love it! But as an author I'm always alert about not stepping over the fair use boundary and violating an author's copyrights. (I.e., Tyler's copyrights.) He can share his work. But we should be careful about showing his charts, I think.

Thank you for being conscientious about that.  For the record, I don't approve of people using Portfolio Charts images for profit but I have zero problem with anyone using them (with proper attribution) in blogs and forum discussions. 

Another actionable insight: If this variability is "new" to someone's financial thinking and strategic planning, I wonder if someone doesn't want to maybe use a different asset allocation... maybe one with less risk and less return but possibly a narrower range of likely outcomes...
Tyler would often express this point and became the reasoning behind developing portfolio charts.

That's exactly right.  Lots of traditional investing advice comes down to maximizing tolerable risk, while I personally prefer to think about it in terms of meeting your important life goals with minimum uncertainty.  Different portfolios (paired with the right savings rate) can get you to where you need to go but with a much more pleasurable ride along the way. 
« Last Edit: September 13, 2017, 11:04:36 PM by Tyler »
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Mr Mark

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Re: Unreliability of long run stock market returns
« Reply #55 on: September 14, 2017, 05:58:09 AM »
Most of the time, when authors produce these charts, they talk about how the tail of the chart narrows over time. But something else is true, too, which is the tail never compresses to a single value.

Are you talking about the tail after a predefined period, e.g. 30 years? If so, this is trivially true. If not, please provide proof. I seriously doubt that's the case.

Gerardc,

I may not understand your comment, but I'm thinking you're asking for proof there's tons more variability in outcomes than many people commonly believe. So I'm going to address that issue... try to "provide proof"... I'm also going to break this response out into sections so people can choose a method of proof that meshes with the way they like to process information.

For People Who Know How to Use cFIREsim and Microsoft Excel:

In message response #12 above, I provide the steps for using the cFIREsim online calculator to calculate the average, worst and best case returns historically for a given retirement savings plan. I also describe how to use Microsoft Excel to quickly calculate the average annual returns for the investor who experienced the worst case scenario, the average scenario, and the best case scenario.

Going through the steps of using cFIREsim takes less than a minute (I just timed myself)...  And this exercise will provide proof.

For People With Good Spatial Reasoning and Chart Reading Skills


Another pretty easy way to prove this to yourself is to look at any--any--funnel chart you see in books or on websites talking about long return returns.

What you will see is that the worst case and best case scenario returns never converge to a single percentage. The charts always show a gap between the worst and best case. Always, always the charts show this.

Well, the charts stop at 30 or so years, so obviously the gap won't vanish entirely. The point is that it gets smaller and smaller as the period increases, which is the definition of convergence (assuming it can get as close to 0 as you wish).

Your argument is like saying, 2 ^ -x doesn't converge to 0 as x -> infinity, with the proof that "draw a chart from 0 to 10, and you'll see the curve NEVER reaches 0".

Long term market returns probably converge to a single value by the central limit theorem, i.e. after throwing a large number of random outcomes, the standard deviation of the empirical mean approaches 0. It's always a question of how long you wait. Of course, in an investing lifetime of ~50 years, the standard deviation of the mean is not necessarily small or negligible, which is trivial IMO.

Isn't there the problem that we only have historical returns data for a limited period of ~150 years (and for many asset classes a lot less), so as the period of averaging increases the number of data points gets smaller. Plus the dataset gets progressively biased to earlier time periods when conditions are less and less likely to be similar to 'now'.

Monte Carlo/sequential Gaussian simulation can address that, if you trust the assumptions are valid. But for your OP purposes 30 years does seem a totally reasonable length of savings years to test, and your conclusion is clear - don't count on getting a guaranteed CAGR of 7% real compounded growth in the market!

Does this then point to the value of adding other asset classes? IE Real estate, small businesses, forestry? One of the things I like about my little forest of pine trees is that the growth is natural regardless of the DJIA or bond prices because they are plants and plants grow. Insure for fire, naturally. Final ROI will be a function of taxes levied, log prices, residual value of the land and costs when we harvest. Still has risks of disease, drought and pests tho'...
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Re: Unreliability of long run stock market returns
« Reply #56 on: September 14, 2017, 06:37:55 AM »
I think I get your point:  Some people get lucky saving up for retirement (if their accumulation years match up with good market returns - particularly their earlier years of savings).  Some people get unlucky saving up for retirement.  And I agree that this happens.

Exactly. We are on the same page.

In simple terms, I am still missing what causes the "lucky" high returns vs "unlucky" low return results in the models? Why is there so much variability?

DrF

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Re: Unreliability of long run stock market returns
« Reply #57 on: September 14, 2017, 07:47:12 AM »
Seattle and I are already on the same page, but I thought this was a better visual to aid everyone in seeing why this matters.

EDIT: I realized that the first chart was slightly incorrect, I've removed the previous one and inserted the new and bolded the text that changed as a result.

Based on prior returns, if one wants to have enough to retire in 30 years you would need to save 24% of your income. It will take you 30 years to save enough based on the worst case returns in the portfoliocharts database. If you happen to start saving in the best year possible, it would only take you ~19 years. A whole 11 year spread from best to worst.


Quote
But, we're mustachians right? So, if you save more of your income you are less exposed to this front end sequence of return risk. Same AA, but vastly different results when you save more of your income. By saving 75% of your income, you're guaranteed to have enough in 10 years (based on the portfoliocharts data). Best case scenario you would have enough in just 4-5 years. This is a spread of only 5-6 years, which reduces your exposure to sequence of return risk.



DrF

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Re: Unreliability of long run stock market returns
« Reply #58 on: September 14, 2017, 08:13:50 AM »

In simple terms, I am still missing what causes the "lucky" high returns vs "unlucky" low return results in the models? Why is there so much variability?

Root, it's easy to look back at the charts and explain this.

Let's take 2 people, Mary and Jane. Mary starts saving $12,000 per year ($1000/month) starting in January of 2004. While Jane is a few years younger and starts saving $12,000 per year ($1000/month) starting in January of 2009.

Mary hasn't done too badly. portfoliovisualizer

She's had annual returns between 8-10.3% depending on her AA.



But Jane's returns have been far better!! portfoliovisualizer

Jane's returns have been between 9.6-13.8% depending on AA.



So, Jane got "lucky" because she started a few years after Mary. Mary may also be more unlucky if we have another recession in the next few years because she has more money invested.

brooklynguy

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Re: Unreliability of long run stock market returns
« Reply #59 on: September 14, 2017, 08:30:41 AM »
The issue I'm trying to highlight is those funnel charts and popular thinking at places like Bogleheads say you bear less risk if you invest for a long time... like for decades. And that's not true.

As always, when discussing "risk" (a word we tend to use too loosely), it is important to define precisely what we mean.  If risk means "exposure to an adverse possibility," we should be clear about which specific adverse possibility or possibilities we are referring to (or, alternatively, that we are broadly referring to the entire universe of conceivable adverse possibilities).

In this thread, you appear to be referring primarily to the risk that future long-term stock returns will underperform an investor's expectations or historical averages (which may have informed the investor's expectations).  As maizeman nicely illustrated in this post, it makes little sense to focus on that risk in isolation. 

Undoubtedly, investors should be aware that stock market returns are uncertain, with significant variability in outcomes even over extended time periods--which, I believe, is the only point you were trying to make in starting this thread.

But no matter how you define risk, I don't see how the above quoted claim can be accurate.  It's certainly the case that the specific "variability of outcomes" risk you're referring to goes down over time, as the funnel charts clearly illustrate.

SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #60 on: September 14, 2017, 10:44:41 AM »
Well, the charts stop at 30 or so years, so obviously the gap won't vanish entirely. The point is that it gets smaller and smaller as the period increases, which is the definition of convergence (assuming it can get as close to 0 as you wish).

Your argument is like saying, 2 ^ -x doesn't converge to 0 as x -> infinity, with the proof that "draw a chart from 0 to 10, and you'll see the curve NEVER reaches 0".

Long term market returns probably converge to a single value by the central limit theorem, i.e. after throwing a large number of random outcomes, the standard deviation of the empirical mean approaches 0. It's always a question of how long you wait. Of course, in an investing lifetime of ~50 years, the standard deviation of the mean is not necessarily small or negligible, which is trivial IMO.

Gerard, I'm not sure if we agree or disagree. And I agree the visual gap between the worst and best cases narrow if you look further into future.

However, if your understanding is that either the two cases "coverge" to a single value or as a practical matter tighten into a very tight range that means individuals get nearly the same outcome, your understanding differs from my understanding.

Two or three hopefully constructive comments:
1. Even tiny differences compounded over long periods of time result in large differences in the final "future values."
2. The history surely shows that wide variability has occurred in past.

I sort of hesitate to veer into the weeds about this--I'm far more concerned about new investors understanding this point than about experienced investors polishing their expertise, but I think a monte carlo simulation someone can play with on their own perhaps moves the discussion forward in a helpful way.

Accordingly, I constructed a simple century long monte carlo simulation with Excel that looks at a 1000 simulations of the case where someone invests $1,000 when they're born into the stock market and then lets that investment compound for a century. Just to keep things simple but reasonably accurate, I used a 10% nominal rate of return and then also a 10% standard deviation.

With those inputs, I get the following results after 100 years:

StatisticDollarsReturns
Mean$14,017,736.7910.019%
Median$9,271,956.099.565%
St. Dev.$14,868,015.08NA
Minimum$433,632.936.260%
Maximum$134,498,934.1712.535%

Three features I'd like to point out:
1. Though the mean and median nominal returns are very close to each other, after a century of compounding, even that small half a percent difference produces a really large difference in the future value.
2. Wide variability in nominal rates of returns and future values occurs even with a century of "evening out" or "averaging out".
3. Anyone looking at this data needs to really take note of the fact that these values are nominal values (so greatly, greatly inflated after a century of inflation.)

I've attached a skinny-ed down version of the Excel spreadsheet. Note four things... First, the 1000 scenarios version of the spreadsheet is too big to attach so the one people can download only does a 100 scenarios. Second, someone can expand the 100 scenarios version to a 1000 scenarios version by copying the range CK16..ALM16 into the range CK17..ALM114. Third, you can press the F9 key to recalculate the spreadsheet's values and run another simulation. Fourth, the MAX function, if it gets too large, returns the #NUM error. Sorry...
« Last Edit: September 14, 2017, 11:14:03 AM by SeattleCPA »
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SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #61 on: September 14, 2017, 10:48:29 AM »
I think I get your point:  Some people get lucky saving up for retirement (if their accumulation years match up with good market returns - particularly their earlier years of savings).  Some people get unlucky saving up for retirement.  And I agree that this happens.

Exactly. We are on the same page.

In simple terms, I am still missing what causes the "lucky" high returns vs "unlucky" low return results in the models? Why is there so much variability?

The variability reflects the randomness. Or, to give an accurate but pretty unsatisfying answer, good luck bumps returns up and bad luck bumps returns down.

I don't want to be pedantic, but just because readers with a wide range of investment experience are looking at these points... This variability (this risk) is the reason we get more from stocks than we do from bonds.
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SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #62 on: September 14, 2017, 10:54:03 AM »
Isn't there the problem that we only have historical returns data for a limited period of ~150 years (and for many asset classes a lot less), so as the period of averaging increases the number of data points gets smaller. Plus the dataset gets progressively biased to earlier time periods when conditions are less and less likely to be similar to 'now'.

Monte Carlo/sequential Gaussian simulation can address that, if you trust the assumptions are valid. But for your OP purposes 30 years does seem a totally reasonable length of savings years to test, and your conclusion is clear - don't count on getting a guaranteed CAGR of 7% real compounded growth in the market!

Does this then point to the value of adding other asset classes? IE Real estate, small businesses, forestry? One of the things I like about my little forest of pine trees is that the growth is natural regardless of the DJIA or bond prices because they are plants and plants grow. Insure for fire, naturally. Final ROI will be a function of taxes levied, log prices, residual value of the land and costs when we harvest. Still has risks of disease, drought and pests tho'...

Mr Mark,

You and I are on the same page here.

BTW, regarding doing monte carlo simulations, I attached a simple Excel spreadsheet to my last response to Gerard. People can use that, I think, to get a further understanding of how the variability doesn't change even if we stretch out the investment horizon to a century.

Regarding using additional asset classes, I think that works at least a little. (That's what I think I'm doing with the Swensen allocation.) But to me it seems like the two biggest steps we can take (and encourage others to take) are (a) get the savings thing working well and (b) plan for the some variability.
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SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #63 on: September 14, 2017, 11:09:42 AM »
The issue I'm trying to highlight is those funnel charts and popular thinking at places like Bogleheads say you bear less risk if you invest for a long time... like for decades. And that's not true.

As always, when discussing "risk" (a word we tend to use too loosely), it is important to define precisely what we mean.  If risk means "exposure to an adverse possibility," we should be clear about which specific adverse possibility or possibilities we are referring to (or, alternatively, that we are broadly referring to the entire universe of conceivable adverse possibilities).

In this thread, you appear to be referring primarily to the risk that future long-term stock returns will underperform an investor's expectations or historical averages (which may have informed the investor's expectations).  As maizeman nicely illustrated in this post, it makes little sense to focus on that risk in isolation. 

Undoubtedly, investors should be aware that stock market returns are uncertain, with significant variability in outcomes even over extended time periods--which, I believe, is the only point you were trying to make in starting this thread.

But no matter how you define risk, I don't see how the above quoted claim can be accurate.  It's certainly the case that the specific "variability of outcomes" risk you're referring to goes down over time, as the funnel charts clearly illustrate.

If I understand the meaning of your statements above, I think the statements reflect an incorrect interpretation of the charts. And I say this not to be a jerk. For a long time, I made the exact same assumption you may be making above.

FWIW, the funnel chart contributes to my past and perhaps your current misunderstanding because it graphically shows a tightening band of returns. But the band never converges to a single value of course and it doesn't even tighten into a band so narrow that what we're talking about here doesn't matter.

Look at it this way: Say the band out at year 50 is a tight range from 5% to 7% with the average return at 6%. Someone who earns 5% ends up with slightly more than $100K. Someone who earns 6% earns up with nearly $200K. And someone who earns 7% ends up with nearly $300K. Those will be big differences at retirement.

And then these points (which I apologize for making again and again)... first, the range is wider than 5% to 7% because we all use an annuity to accumulate (regular monthly or annual savings) and not a single one-time investment... second, some of the data we have for this analysis misses some really bad and some really good patches of financial history.

P.S. People can very rightly criticize the simplistic monte carlo spreadsheet I attached to my respond to Gerard's last comment, but it'll let someone experiment with how variability doesn't really change over time. Also if someone wants to improve that spreadsheet with a smarter way to make the simulation calculations, hey, you have my blessing and thanks.

P.P.S. I did look at the maizeman comments you helpfully referenced. I would say the situation I'm talking about is when one person is rolling the dice with a Scenario A reality and the another person is rolling the dice with a Scenario B reality.
« Last Edit: September 14, 2017, 11:13:14 AM by SeattleCPA »
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PizzaSteve

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Re: Unreliability of long run stock market returns
« Reply #64 on: September 14, 2017, 11:11:57 AM »
Yup.  Its a sequence of returns plus compounding of returns effect.  The returns for front loaded years outweigh, over time, the benefits of a converging to average return rates in the long run.

it is even worse if one flirts with bad market timing choices.  A friend went to all cash in 2009 out of fear and desire to buy a home. He is still out of the markets and priced out of the housing options he wants.   He will never recover those 2009 to 2017 bull years vs savings account interest rates of 1-2%.  He is priced out of housing due to cost increases above inflation and i feel for him, as he is a normal, typical family guy who saves at a decent rate.
« Last Edit: September 14, 2017, 11:17:56 AM by PizzaSteve »
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brooklynguy

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Re: Unreliability of long run stock market returns
« Reply #65 on: September 14, 2017, 11:56:37 AM »
If I understand the meaning of your statements above, I think the statements reflect an incorrect interpretation of the charts. And I say this not to be a jerk. For a long time, I made the exact same assumption you may be making above.

I'm not sure what assumption you think I'm making, but my point is that the following statement is simply not true:

variability doesn't really change over time

It most certainly does, which is why the funnel charts have a funnel shape with a gap that narrows along the x-axis, and which is why it was incorrect to have stated:

The issue I'm trying to highlight is those funnel charts and popular thinking at places like Bogleheads say you bear less risk if you invest for a long time... like for decades. And that's not true.

The risk of underperforming expected returns/historical average returns (the risk you seem to be focused on) is drastically reduced as you move from the short term to the long term, as are other (more significant) risks, such as the risk of capital loss.

What is true (and what I think is really the only point you've been trying to make) is that, in stock investing, variability of outcomes remains significant even over long time horizons (though not as significant as it is over short time horizons). 

SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #66 on: September 14, 2017, 12:26:20 PM »
If I understand the meaning of your statements above, I think the statements reflect an incorrect interpretation of the charts. And I say this not to be a jerk. For a long time, I made the exact same assumption you may be making above.

I'm not sure what assumption you think I'm making, but my point is that the following statement is simply not true:

variability doesn't really change over time

It most certainly does, which is why the funnel charts have a funnel shape with a gap that narrows along the x-axis, and which is why it was incorrect to have stated:

The issue I'm trying to highlight is those funnel charts and popular thinking at places like Bogleheads say you bear less risk if you invest for a long time... like for decades. And that's not true.

The risk of underperforming expected returns/historical average returns (the risk you seem to be focused on) is drastically reduced as you move from the short term to the long term, as are other (more significant) risks, such as the risk of capital loss.

What is true (and what I think is really the only point you've been trying to make) is that, in stock investing, variability of outcomes remains significant even over long time horizons (though not as significant as it is over short time horizons).

Look, though, at those charts you reference... see how they don't converge to a single value? I.e., see how they don't ever compress down into a single thin line... There is still a gap between high and low. That gap is what we're talking about.

Losing .5% a year over a 100 years or losing 1% over 50 years makes a really enormous difference in the outcome.

Can I suggest something that takes about a minute of your time? Follow the instructions given in message #12 in the first part of this thread to use cFIREsim to calculate the range of returns that occurs for a given common investment scenario. The instructions suggest 30 years of accumulation which may be too short for you... but try that first... and then jack the accumulation time to 40 or 50 years.

You will see what I'm talking about. You may still disagree. But you'll understand what I'm pointing to in the data.

P.S. If you would be comfortable running a monte carlo simulation, you can also grab that spreadsheet I attached to a message in this thread and run a few thousand simulations.

P.P.S. Harry Sit, who blogs as the finance buff, sent me this link to a great little academic discussion of this issue we're discussing. The bar chart in the writer's "appendix a" shows the chart he thinks does a better job of visually highlighting the variability in outcomes: http://www.norstad.org/finance/risk-and-time.html

« Last Edit: September 14, 2017, 12:31:09 PM by SeattleCPA »
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Telecaster

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Re: Unreliability of long run stock market returns
« Reply #67 on: September 14, 2017, 12:31:05 PM »
The issue I'm trying to highlight is those funnel charts and popular thinking at places like Bogleheads say you bear less risk if you invest for a long time... like for decades. And that's not true.

As always, when discussing "risk" (a word we tend to use too loosely), it is important to define precisely what we mean.  If risk means "exposure to an adverse possibility," we should be clear about which specific adverse possibility or possibilities we are referring to (or, alternatively, that we are broadly referring to the entire universe of conceivable adverse possibilities).

In this thread, you appear to be referring primarily to the risk that future long-term stock returns will underperform an investor's expectations or historical averages (which may have informed the investor's expectations).  As maizeman nicely illustrated in this post, it makes little sense to focus on that risk in isolation. 

Undoubtedly, investors should be aware that stock market returns are uncertain, with significant variability in outcomes even over extended time periods--which, I believe, is the only point you were trying to make in starting this thread.

But no matter how you define risk, I don't see how the above quoted claim can be accurate.  It's certainly the case that the specific "variability of outcomes" risk you're referring to goes down over time, as the funnel charts clearly illustrate.

If I understand the meaning of your statements above, I think the statements reflect an incorrect interpretation of the charts. And I say this not to be a jerk. For a long time, I made the exact same assumption you may be making above.

FWIW, the funnel chart contributes to my past and perhaps your current misunderstanding because it graphically shows a tightening band of returns. But the band never converges to a single value of course and it doesn't even tighten into a band so narrow that what we're talking about here doesn't matter.

Look at it this way: Say the band out at year 50 is a tight range from 5% to 7% with the average return at 6%. Someone who earns 5% ends up with slightly more than $100K. Someone who earns 6% earns up with nearly $200K. And someone who earns 7% ends up with nearly $300K. Those will be big differences at retirement.

And then these points (which I apologize for making again and again)... first, the range is wider than 5% to 7% because we all use an annuity to accumulate (regular monthly or annual savings) and not a single one-time investment... second, some of the data we have for this analysis misses some really bad and some really good patches of financial history.

P.S. People can very rightly criticize the simplistic monte carlo spreadsheet I attached to my respond to Gerard's last comment, but it'll let someone experiment with how variability doesn't really change over time. Also if someone wants to improve that spreadsheet with a smarter way to make the simulation calculations, hey, you have my blessing and thanks.

P.P.S. I did look at the maizeman comments you helpfully referenced. I would say the situation I'm talking about is when one person is rolling the dice with a Scenario A reality and the another person is rolling the dice with a Scenario B reality.

I think you are using the word "risk" in a different manner than they are at Bogleheads.

In academia they typically define risk as volatility (like in the Sharpe ratio), and use it to calculate risk adjusted returns and the like.  I don't think that is a useful definition of risk at all.  In my view, risk is the chance of the permanent loss of capital. 

If our holding period is one year, there is very real chance of a 50% loss.  There have been several years with losses that bad or nearly that bad.  If the holding period becomes 10 years, then there have only been one or two losing periods, and then a couple percent.  If the holding period is 20 years, there have been no periods with losses.   That's why at Bogleheads they say the longer the holding period, the lower the risk. 

You seem to be using "risk" to mean "chance of below average performance."   I suppose that is a type of risk, but I don't get to choose my sequence of returns.  I simply have buy and hold long enough.   


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Re: Unreliability of long run stock market returns
« Reply #68 on: September 14, 2017, 12:36:17 PM »
I think you are using the word "risk" in a different manner than they are at Bogleheads.


I'm trying not to use the word risk. Instead I've been trying to use the phrase "variability in outcomes."

Sorry if I muddied the water by letting that word slip into my comments.

BTW, if I run a quick 20 year calculation with cFIREsim and say I start with $1,000,000, you are correct that no historical example exists of someone losing money.

But lots of people, I am pretty sure, would be surprised to calculate that the worst case scenario is someone after twenty years ends up with just over $1,000,000. The value $1,030,210 to be precise.

Here's the outputs from cFIREsim. They show the variability in outcomes I keep referring tooo.

Average:   $3,980,810
Median:   $3,511,622
St. Dev.:   $2,116,713
Highest:   $10,686,290
Lowest:   $1,030,210

P.S. I won't repeat the comments I made above in Reply #51, but I don't think what we're talking about here is sequence of returns risk. I know I agreed with someone earlier in this thread when they said that. But it isn't the sequence of the returns that's the issue here. Someone who first gets 4% for 15 years and then 8% for 15 years ends up with the same outcome as someone who first gets 8% for 15 years and then 4% for 15 years. These two folks would have different withdrawal rates with those returns.
« Last Edit: September 14, 2017, 12:44:00 PM by SeattleCPA »
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Re: Unreliability of long run stock market returns
« Reply #69 on: September 14, 2017, 02:06:34 PM »
Hopefully people are investing some each year, and the investments in the bad years would grow and make up for an overall low rate of return 20 year period.

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Re: Unreliability of long run stock market returns
« Reply #70 on: September 14, 2017, 07:29:59 PM »
As mustachians, how can you try to use that variability to our advantage? Or what can we do to hopefully pursue that FIRE goal as soon as possible?

Invest more, more often? Review our asset allocation?

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Re: Unreliability of long run stock market returns
« Reply #71 on: September 14, 2017, 08:23:23 PM »
As mustachians, how can you try to use that variability to our advantage? Or what can we do to hopefully pursue that FIRE goal as soon as possible?

Invest more, more often? Review our asset allocation?
The knowledge is not actionable, in that you can't control return outcomes. It is actionable in terms of whether the knowldege can help you set up your personal plan and returns/investment timeline expectations.
« Last Edit: September 16, 2017, 07:37:37 AM by PizzaSteve »
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Re: Unreliability of long run stock market returns
« Reply #72 on: September 14, 2017, 11:36:59 PM »
As mustachians, how can you try to use that variability to our advantage? Or what can we do to hopefully pursue that FIRE goal as soon as possible?

Invest more, more often? Review our asset allocation?
Dollar cost averaging is already a very effective method for dealing with it. So invest more more often is a good way of handling it.

I decided to emphasize more volatile and poorly correlated asset classes such as small company stocks and international stocks especially emerging markets to address this. I invest only (so far) in long term bonds, and a small amount in gold miner equity. Asset allocation and diverification can potentially be effective in dealing with it. Other options may include a glide path and reverse glide path, which are currently being discussed elsewhere on the first page. Bernstein suggests a form of market timing by switching a percentage of your assets to safe bonds (not more than 40% based on my reading) in one big chunk as soon as you have enough money to say you won the game.

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Re: Unreliability of long run stock market returns
« Reply #73 on: September 15, 2017, 06:37:56 AM »
As mustachians, how can you try to use that variability to our advantage? Or what can we do to hopefully pursue that FIRE goal as soon as possible?

Invest more, more often? Review our asset allocation?

When I started really writing about this variability in outcomes stuff a few months ago, I came up with the idea that in addition to that retirement plan "A" which we all have as our main plan, we should also have a retirement plan "B" for that pretty realistic scenario where the retirement plan "A" scenario falls short.

Note: The first blog post I wrote about this appears here: Retirement Plan B: Why You Need One.

At the end of the little series I did, I tried to come up with a dozen tips for building a retirement plan here. The full discussion appears at another blog post here, Retirement Plan B Tips, but let me quickly summarize the ideas I had:

1. Don't be in denial about this.
2. Use tools like cFIREsim and FIREcalc to size up the problem.
3. Assess how impactful the problem is to us personally.
4. Consider adjusting asset allocation.
5. Consider adjusting income allocation.
6. Bump savings during a bad patch of returns.
7. Avoid Roth-style accounts.
8. Cut investment costs.
9. Work another year or two or three.
10. Shorten the number of years you plan to work.
11. Double-check your retirement plan "A" to make sure it's robust.
12. Don't forget about the retirement plan "C" option.

For what it's worth, I think the most important and an immediate first step people need to take is to understand this variability in outcomes occurs. That is huge. And it'll probably almost let people address the issue subconsciously.



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Re: Unreliability of long run stock market returns
« Reply #74 on: September 16, 2017, 06:42:27 AM »
Bernstein suggests a form of market timing by switching a percentage of your assets to safe bonds (not more than 40% based on my reading) in one big chunk as soon as you have enough money to say you won the game.

I could never make such a drastic move to my portfolio, that would mean selling hundreds of thousands of dollars of equities and putting them in bond funds. I don't think I can do that.

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Re: Unreliability of long run stock market returns
« Reply #75 on: September 16, 2017, 07:51:13 AM »
As mustachians, how can you try to use that variability to our advantage? Or what can we do to hopefully pursue that FIRE goal as soon as possible?

Invest more, more often? Review our asset allocation?

When I started really writing about this variability in outcomes stuff a few months ago, I came up with the idea that in addition to that retirement plan "A" which we all have as our main plan, we should also have a retirement plan "B" for that pretty realistic scenario where the retirement plan "A" scenario falls short.

Note: The first blog post I wrote about this appears here: Retirement Plan B: Why You Need One.

At the end of the little series I did, I tried to come up with a dozen tips for building a retirement plan here. The full discussion appears at another blog post here, Retirement Plan B Tips, but let me quickly summarize the ideas I had:

1. Don't be in denial about this.
2. Use tools like cFIREsim and FIREcalc to size up the problem.
3. Assess how impactful the problem is to us personally.
4. Consider adjusting asset allocation.
5. Consider adjusting income allocation.
6. Bump savings during a bad patch of returns.
7. Avoid Roth-style accounts.
8. Cut investment costs.
9. Work another year or two or three.
10. Shorten the number of years you plan to work.
11. Double-check your retirement plan "A" to make sure it's robust.
12. Don't forget about the retirement plan "C" option.

For what it's worth, I think the most important and an immediate first step people need to take is to understand this variability in outcomes occurs. That is huge. And it'll probably almost let people address the issue subconsciously.
Agree a good strategy is to have scenario-based alternative plans.

I would recommend multiple plans or strategies (one for average returns, one for 'good luck' returns and one for 'bad luck' returns because the funnel goes both directions).

The list of strategies seems a bit random and kind of mixes up the impact of sequence of returns risk with asset allocation decisions meant to reduce volatility of earnings.  It may confuse some people.  Volatility can be reduced somewhat.  Sequence not so much.  The funnel exists regardless of your asset allocation, though one can impact the curves with allocations.  Most asset class returns are correlated with the overall economic situation of your 30 year time, which is an unknown.

Under the bad luck scenario it all pretty much boils down to spend less, save more (sing to tune from Hamilton...talk less, smile more), or vary your retirement date.

Final comment.  Im not sure i agree with your plan B tips, like why avoid Roth's?  Most if these tips are good advice even under ideal return scenarios. Roth tax benefits would seem to help regardless of your sequence of returns (despite your comment above, this is basically sequence of returns risk). Maybe rethink whether these tips apply to this topic.
« Last Edit: September 16, 2017, 08:04:46 AM by PizzaSteve »
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Re: Unreliability of long run stock market returns
« Reply #76 on: September 16, 2017, 07:52:58 AM »
As mustachians, how can you try to use that variability to our advantage? Or what can we do to hopefully pursue that FIRE goal as soon as possible?

Invest more, more often? Review our asset allocation?
Dollar cost averaging is already a very effective method for dealing with it. So invest more more often is a good way of handling it.

I decided to emphasize more volatile and poorly correlated asset classes such as small company stocks and international stocks especially emerging markets to address this. I invest only (so far) in long term bonds, and a small amount in gold miner equity. Asset allocation and diverification can potentially be effective in dealing with it. Other options may include a glide path and reverse glide path, which are currently being discussed elsewhere on the first page. Bernstein suggests a form of market timing by switching a percentage of your assets to safe bonds (not more than 40% based on my reading) in one big chunk as soon as you have enough money to say you won the game.

Definitely agree that dollar cost averaging is good... Also, though it's easier theory than practice, I too try to have my portfolio constructed in a way that means I'm applying the lessons of modern portfolio theory (so uncorrelated asset classes)...  These things will possibly dampen the volatility, will possibly bump return, and maybe (fingers crossed) do both... But these things don't eliminate the variability in long run stock market returns. Or the variability in the long return returns in an MPT-y portfolio.

Not sure I understand enough and have thought enough about issues in the thread started by Mr. Green about reverse equity glide path to comment.

Regarding Bernstein's comment "if you've already won the game, why keep playing," that logic to me absolutely reflects deep understanding of this variability in returns we're talking about in this thread.

Regarding Bernstein's comment, I wonder if personal situation factors into that. E.g., someone in their 70s like Dr. Bernstein is (I think) probably bears less inflation risk than someone who FIREs in their 40s or 50s. That to me argues against bonds. Or another example, someone with a really big portfolio may be in a situation where even a catastrophic bear market means they aren't losing their house, they're downsizing from a 4 bedroom to a 2 bedroom or dumping the second vacation home. Someone right on the edge can't bear that risk.

I come back again and again to the very simple conclusion that we need to be smart in our investing... and then also be alert to the risk variability in outcomes possible and have some cushioning built into our plans and a willingness to show flexibility if it's needed.

This is maybe off on a tangent, but obviously when you engineers build a bridge, you don't build it in way that means it'll only "work" for an average sized vehicle... that would mean the bridge collapses anytime an over-sized vehicle tries to cross. You build it so there's lots of extra capacity just in case.

We can't as individuals build portfolios that handle extreme conditions. But we can/should build portfolios that fail something less than 50% of the time.
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Re: Unreliability of long run stock market returns
« Reply #77 on: September 16, 2017, 08:03:00 AM »
Agree.  Engineer to max load is a good analogy for my personal strategy, however that will never be popular with some groups on this site.  It is a good plan for high earning members of the forum, but would dramatically push back FIRE dates for some of our younger, more aggressive members (who are just the folks that need this understanding the most).  if they accept the risks, their lifestyle will need to flex accordingly, whether positively or negatively.

I am optimistic we will all succeed, so i wouldn't overthink it too much.  This crowd is resilient.
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Re: Unreliability of long run stock market returns
« Reply #78 on: September 16, 2017, 08:09:19 AM »
Agree a good strategy is to have scenario-based alternative plans.

I would recommend multiple plans or strategies (one for average returns, one for 'good luck' returns and one for 'bad luck' returns because the funnel goes both directions).

The list of strategies seems a bit random and kind of mixes up the impct of sequence of returns risk with asset allocation decisions meant to reduce volatility of earnings.  It may confuse some people.  Volatility can be reduced somewhat.  Sequence not so much.  The funnel exists regardless of your asset allocation, though one can impact the curves with allocations.  Most asset class returns are correlated with the overall economic situation of your 30 year time, which is an unknown.

Under the bad luck scenario it all pretty much boils down to spend less, save more (sing to tune from Hamilton...talk less, smile more), or vary your retirement date.

Final comment.  Im not sure i agree with your plan B tips, like why avoid Roth's?  The tax benefits seem to help regardless of your sequence of returns risk (despite your comment above, this is sequence of returns risk).  Is there a source for these?

PizzaSteve, we are probably mostly on the same page here. (The list of tips may appear a little less random on the actual blog post referenced... but the list does reflect a certain "and then throw in the kitchen sink too" quality.)

Regarding my suggestion to not use a Roth, I've written a lot about why I think that choice doesn't make sense: Are Roth-IRAs and Roth-401(k)s Really a Good Deal, Worst Case Scenarios for Roth Style Accounts, and then The Only Times You Should Use a Roth-style Account.

I think those posts pretty thoroughly describe the situation, but as a general comment, a Roth-style account is a bet your or my marginal rate will go up in retirement. The bad case scenarios would, it seems to me, all be situations where one's marginal rate had gone down.

As generality, I think one doesn't need to worry too much about taxes in retirement: Why You Don't Need to Worry about Taxes in Retirement.

Finally, yup, agree people can't work with "civil engineering" levels of confidence. None of us can afford that. That would be the "never retire" approach for many...
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PizzaSteve

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Re: Unreliability of long run stock market returns
« Reply #79 on: September 16, 2017, 08:22:05 AM »

I think those posts pretty thoroughly describe the situation, but as a general comment, a Roth-style account is a bet your or my marginal rate will go up in retirement. The bad case scenarios would, it seems to me, all be situations where one's marginal rate had gone down.

As generality, I think one doesn't need to worry too much about taxes in retirement: Why You Don't Need to Worry about Taxes in Retirement.

Agree we are on the same page.  Thanks for the links.  I read the links and agree each person should run the numbers to decide whether to roth or not.

The key is to understand the tools and use them well.  I mostly have not used Roth vehicles, for precisely the reasons in your links.  However, my yearly backdoor Roth conversions of after tax money are in effect gaining tax free future earnings at no cost but IRS paperwork. Also, a timely Roth conversion after a market crash can yield all sorts of benefits.  Friends saved millions converting their 401ks in 2009.  To say 'avoid Roths' out of context, i think tends to send the wrong message.

« Last Edit: September 16, 2017, 02:41:13 PM by PizzaSteve »
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Re: Unreliability of long run stock market returns
« Reply #80 on: September 16, 2017, 01:43:43 PM »
 Remember that all our investment projections are based on history, not irrefutable laws of the universe, such as gravity. Looking at longer timeframes does not change this.  To paraphrase Mark Twain, "(investing) History doesn't repeat itself but it often rhymes."
So, we need to:
1. Control what you can control: savings rates, investment fees, balanced asset allocation, etc.
2. Expect variability from historical assumptions.  Be prepared to adjust.








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Re: Unreliability of long run stock market returns
« Reply #81 on: September 16, 2017, 03:13:22 PM »
What is true (and what I think is really the only point you've been trying to make) is that, in stock investing, variability of outcomes remains significant even over long time horizons (though not as significant as it is over short time horizons).

I am sorry, but I missed this important statement of yours in my earlier response.

The above makes me think we probably see the situation as very similar. Not identical... but very similar. Apologies for not reading your comments more carefully.

E.g., if one plays with that crude monte carlo simulation Excel workbook I attached to a message in this thread, the worst to best annual return spread after 5 years is, in one simulation, -4% to 22%. And if you look at the worst to best annual return spread after 100 years in that same simulation, 6% to 12%.

Note: These are nominal returns... not real returns. But I think we both agree that something like this narrowing shows up in the returns.

And what I thought we were talking about is the worst to best dollar outcomes... which in that same simulation range goes from $800 to $2700 dollars at year 5 and from $400,000 to roughly $139,000,000 at year 100.

Note: These are inflated dollars and based on an initial $1,000 investment. But the ever increasing dollar range thing is what I've been trying to communicate.

Again, sorry for not better reading your full response.

« Last Edit: September 16, 2017, 03:28:27 PM by SeattleCPA »
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SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #82 on: September 16, 2017, 03:14:27 PM »
Remember that all our investment projections are based on history, not irrefutable laws of the universe, such as gravity. Looking at longer timeframes does not change this.  To paraphrase Mark Twain, "(investing) History doesn't repeat itself but it often rhymes."
So, we need to:
1. Control what you can control: savings rates, investment fees, balanced asset allocation, etc.
2. Expect variability from historical assumptions.  Be prepared to adjust.

+1
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Re: Unreliability of long run stock market returns
« Reply #83 on: September 16, 2017, 05:36:33 PM »
This is all interesting however I suppose that the other side of the equation is that if you are saving in a down period you are probably more likely to get an up period in retirement.

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Re: Unreliability of long run stock market returns
« Reply #84 on: September 17, 2017, 10:34:33 AM »
This is all interesting however I suppose that the other side of the equation is that if you are saving in a down period you are probably more likely to get an up period in retirement.
Hard to know for sure.  It is an over used example, but my personal plan is greatly influenced by colleagues from my work in Japan from 1988-1991.  I had colleagues in their prime work years (30somethings to 60somethings) face roughly 0% returns in equities, bonds and real estate (crash followed by stagnant recovery).  If they were not internationally diversified they were hosed unless saving to a 2% withdraw rate.  0%mortgages helped those underwater RE assets, but yuck!   Other smaller countries have had similar eras.
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Re: Unreliability of long run stock market returns
« Reply #85 on: September 17, 2017, 11:50:48 AM »
Actionable items for those of you advising the next generation, as this is primarily about accumulation:

1) Encourage them to take a statistics class or 8. At heart this isn't a discussion about personal finance as much as a discussion about elementary statistics

2) Encourage them, if they plan on retiring, to consider a plan that is not tied to a specific date, but instead a specific stash-to-retirement-expenses ratio, unless they are getting a sweet deal (e.g. after 20 years can retire with free healthcare for life). If they are focused on a # then all of this is way less important. At that point it only really affects asset allocation choices, and in an optional way. Of course they still need to understand that variability exists as they make choices. That is, asset allocation matters, but variability in outcomes matters more if you're limited by something other than your outcome, in terms of $ amount. The higher their savings rate the less any of this matters too as our OP pointed out.   

3) Flexibility and saving more money than you think you need are important. The more you have and the more flexible you are the less important small things like this are once you turn the corner from accumulator to withdraw-or.

Thought related to this:
There is so much uncertainty in life that over-optimizing personal finance is honestly kind of a waste of time, except inasmuch as "Plans are nothing, planning is everything."

a) Humanity scratches and claws and breaks and reforms the rules all of the time because evolution has built us to behave that way. We're all kind of gambling that society keeps working like it has. We're taking the best bet we can by putting our money in the hands of businesses who can change and adapt and usually are the driving force behind changes anyway. That doesn't mean the system will look remotely the same in future though. Private equity could leave just the shitty companies available on the public stock market, a solid gold asteroid could calmly land in the ocean and quintuple the amount of gold in the market, UBI could get figured out and enable most mustachians to retire overnight, long run average stock returns could drop to 1% indefinitely etc. and make all of this consternation not worth much at all. The haves could take it away or the have-nots could burn down the digital records of banks/stocks or effectively do so through wealth-leveling. I still like our odds, but they are just odds not iron law.

b) 150 years of stock market returns with wildly differing operational definitions year to year are not really enough data for meaningful prediction, and people often greatly overstate the importance of "statistics of personal finance" in one's life anyway, using a small amount of bad data to focus on such a small part of your overall happiness in life. For me, people should burn #3 above into their brains and just not worry too much about the details of things because society can change all the time and we really can't predict personal finance meaningfully enough anyway. E.g. your personal health, climate change, technology, war, politics removing the notion of personal property/assets, a million things could happen that make your amount and ratio of stocks/bonds/real estate way less important to your actual life and happiness than you might think. If I'm advising people I'm getting them down the right path as far as personal finance then honestly moving on to helping them get the rest of their life happy.
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Re: Unreliability of long run stock market returns
« Reply #86 on: September 17, 2017, 05:47:55 PM »
The Only Times You Should Use a Roth-style Account
You don't address the case where someone is unable to take advantage of pre-tax contribution/deduction, so they backdoor their way into the Roth account.
The choices for that person are "post-tax brokerage account with no unique tax benefits" vs. "Roth account with tax-free growth".  Contributions are the same in both cases, no penalty is being paid to get dollars into the Roth account.

That seems like a valid time in which you should use a Roth style-account.

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Re: Unreliability of long run stock market returns
« Reply #87 on: September 17, 2017, 06:44:38 PM »
The Only Times You Should Use a Roth-style Account
You don't address the case where someone is unable to take advantage of pre-tax contribution/deduction, so they backdoor their way into the Roth account.
The choices for that person are "post-tax brokerage account with no unique tax benefits" vs. "Roth account with tax-free growth".  Contributions are the same in both cases, no penalty is being paid to get dollars into the Roth account.

That seems like a valid time in which you should use a Roth style-account.

You are right. I agree. I am talking in those posts about people comparing something like a traditional IRA and then a Roth-IRA... if one compares a Roth-IRA and a regular taxable account, that math works differently.

Good point.
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Re: Unreliability of long run stock market returns
« Reply #88 on: September 17, 2017, 06:55:10 PM »
...3) Flexibility and saving more money than you think you need are important....


The above, I think, pretty well summarizes what I propose should be the BIG takeaway from this discussion. Especially the importance of flexibility.

Most likely (like 2/3rds of the time) someone's long run annual return will run between 5% and 7%.. and of course even that requires some flexibility. But there's a 1/3-ish chance, someone's experience might be above or below this. And that will require more flexibility. Or more cushioning in either money or earnings.
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shuffler

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Re: Unreliability of long run stock market returns
« Reply #89 on: September 17, 2017, 07:00:26 PM »
You are right. I agree. I am talking in those posts about people comparing something like a traditional IRA and then a Roth-IRA... if one compares a Roth-IRA and a regular taxable account, that math works differently.
No worries.  I'm aware of your posts around here, so I was certain I wasn't telling you anything you didn't already know.
Maybe just a bit of feedback about that context not being clear in the text of the blog posts.  Nor in your simple bullet-list retirement tips.  Maybe "choose traditional over Roth", rather than the more absolute "avoid Roth".

SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #90 on: September 18, 2017, 11:36:46 AM »
This discussion has probably run its course by now... but I realize (belatedly) that this is the chart I should have included in the original message:



It shows the actual, adjusted for inflation dollar values someone gets if they experience the average, worst and best case outcome over 5 year, 10, years, 15 years, etc, all the way up to 40 years. (So a little longer than the first chart showed.)

My message would have been far more understandable had I included this the first time. (I actually blog about this and include the chart in today's post:

https://evergreensmallbusiness.com/myth-long-run-stock-market-return-chart/

And the point is, the range of outcomes widens...

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max9505672

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Re: Unreliability of long run stock market returns
« Reply #91 on: September 18, 2017, 09:30:12 PM »
This discussion has probably run its course by now... but I realize (belatedly) that this is the chart I should have included in the original message:



It shows the actual, adjusted for inflation dollar values someone gets if they experience the average, worst and best case outcome over 5 year, 10, years, 15 years, etc, all the way up to 40 years. (So a little longer than the first chart showed.)

My message would have been far more understandable had I included this the first time. (I actually blog about this and include the chart in today's post:

https://evergreensmallbusiness.com/myth-long-run-stock-market-return-chart/

And the point is, the range of outcomes widens...
Thnaks again for posting this thread. It has been really helpful for me, and I'm sure it has helped many others.

DavidAnnArbor

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Re: Unreliability of long run stock market returns
« Reply #92 on: September 19, 2017, 07:06:34 PM »
my personal plan is greatly influenced by colleagues from my work in Japan from 1988-1991.  I had colleagues in their prime work years (30somethings to 60somethings) face roughly 0% returns in equities, bonds and real estate (crash followed by stagnant recovery).  If they were not internationally diversified they were hosed unless saving to a 2% withdraw rate.  0%mortgages helped those underwater RE assets, but yuck!   Other smaller countries have had similar eras.

I think this is a crucial point. It's my main reason for some international diversification.

SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #93 on: September 20, 2017, 01:55:57 PM »
my personal plan is greatly influenced by colleagues from my work in Japan from 1988-1991.  I had colleagues in their prime work years (30somethings to 60somethings) face roughly 0% returns in equities, bonds and real estate (crash followed by stagnant recovery).  If they were not internationally diversified they were hosed unless saving to a 2% withdraw rate.  0%mortgages helped those underwater RE assets, but yuck!   Other smaller countries have had similar eras.

I think this is a crucial point. It's my main reason for some international diversification.

Agreed. And with yet another apology to everyone just terribly tired at hearing me say this: Though not in recent US financial history, in the not too distant past, there are some extended stretches of pretty poor US investor portfolio returns too.

P.S. to max9505672... thanks for compliment... but also I think this thread really reflects a group effort where both the people asking the questions and the people trying to come up with the answers help everybody think more clearly... even when we don't always totally agree in the end.
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Mr Mark

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Re: Unreliability of long run stock market returns
« Reply #94 on: September 21, 2017, 12:36:38 AM »
my personal plan is greatly influenced by colleagues from my work in Japan from 1988-1991.  I had colleagues in their prime work years (30somethings to 60somethings) face roughly 0% returns in equities, bonds and real estate (crash followed by stagnant recovery).  If they were not internationally diversified they were hosed unless saving to a 2% withdraw rate.  0%mortgages helped those underwater RE assets, but yuck!   Other smaller countries have had similar eras.

I think this is a crucial point. It's my main reason for some international diversification.

I'm with JHCollins and others that the modern USA equity market intrinsically contains a lot of effective international diversification compared to pre-1970s for example. The advantage of staying US based is there is more liquidity and (argably) better governance. I still don't see a lot of alternatives to the US dollar and US treasuries as safe havens in a crisis. In those 'risk on' situations overseas equities and currencies tend to get hit even harder than US.

I also think there is a lot of potential for overseas growth from many US companies where their brand and reputation will be a boon to business (companies like J&J, DowDupont, Amazon, etc) as in many emerging markets the local companies are no where near the sophistication of developed companies. As a foreigner it strikes me that many US mid-sized and small caps have hardly bothered with overseas markets because the US/NAFTA market is so huge they haven't needed to to go further afield to grow.

So I'm in the main sticking to good ol' VTSAX and VTBSX with just a light sprinkle of explicit international equities.
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SeattleCPA

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Re: Unreliability of long run stock market returns
« Reply #95 on: September 21, 2017, 07:19:13 AM »
my personal plan is greatly influenced by colleagues from my work in Japan from 1988-1991.  I had colleagues in their prime work years (30somethings to 60somethings) face roughly 0% returns in equities, bonds and real estate (crash followed by stagnant recovery).  If they were not internationally diversified they were hosed unless saving to a 2% withdraw rate.  0%mortgages helped those underwater RE assets, but yuck!   Other smaller countries have had similar eras.

I think this is a crucial point. It's my main reason for some international diversification.

I'm with JHCollins and others that the modern USA equity market intrinsically contains a lot of effective international diversification compared to pre-1970s for example. The advantage of staying US based is there is more liquidity and (argably) better governance. I still don't see a lot of alternatives to the US dollar and US treasuries as safe havens in a crisis. In those 'risk on' situations overseas equities and currencies tend to get hit even harder than US.

I also think there is a lot of potential for overseas growth from many US companies where their brand and reputation will be a boon to business (companies like J&J, DowDupont, Amazon, etc) as in many emerging markets the local companies are no where near the sophistication of developed companies. As a foreigner it strikes me that many US mid-sized and small caps have hardly bothered with overseas markets because the US/NAFTA market is so huge they haven't needed to to go further afield to grow.

So I'm in the main sticking to good ol' VTSAX and VTBSX with just a light sprinkle of explicit international equities.

If one believes, as I do, that modern portfolio theory works, one tries to construct a portfolio that includes either uncorrelated asset classes or imperfectly correlated asset classes . Pretty clearly, that means including whenever possible other distinct asset classes like international stocks and REITs. And using riskless assets like treasuries.

This should either bump returns or dampen volatility.

BTW if someone only dampens volatility that should bump your SWR... a point explored a little bit at www.portfoliocharts.com.

P.S. I spent a bit of time looking for it and couldn't locate, but there's a great blog post where Mr Money Mustache politely debates the merits of modern portfolio theory with Jim Collins. (If someone can locate that, it's really worth reading.)
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Mr Mark

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Re: Unreliability of long run stock market returns
« Reply #96 on: September 21, 2017, 09:22:28 AM »
I understand. I just don't agree that international equities in general are poorly correlated with U.S. equities  as much these days. Just lower upside and larger downside.

So I prefer some types of real estate and forestry and hyperlocal businesses for example.
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Re: Unreliability of long run stock market returns
« Reply #97 on: September 21, 2017, 12:40:37 PM »
I see no fault in the logic of keeping it all in the US market.  But for the anti-correlation reason, I do  keep about 12% of my port in international equities.   It has been kind of a dog for the last few years, but this year it has been red hot, mostly because the dollar is sliding against the Euro.  As a SWAG I'd say it will continue to be hot for a while as Europe recovers, and I'd guess we'll enter the next recession before them. 

That's mostly just speculation on my part though.  I'm not suggesting or recommending anyone do the same thing. 

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Re: Unreliability of long run stock market returns
« Reply #98 on: September 22, 2017, 07:06:35 AM »
I understand. I just don't agree that international equities in general are poorly correlated with U.S. equities  as much these days. Just lower upside and larger downside.

So I prefer some types of real estate and forestry and hyperlocal businesses for example.

This post replies both to Mr Mark and sort of to Telecaster...

Okay, agree there's poor correlation. But even with a (say) .9 correlation between US stocks and developed markets or a .8 correlation between US stocks and emerging markets, aren't we still getting reduction in the portfolio variance?

https://www.portfoliovisualizer.com/asset-class-correlations

I think so. BTW, usual stipulations that correlations change over time and aren't predictable so we can't construct the perfect portfolio going forward (only looking backwards)... also that everything correlates in a worst case scenario.

So this is a bit of a "Pascal's Wager" for me... have faith in modern portfolio theory because I don't think there's any real downside. And if MPT does really work, you either bump returns, dampen volatility or both.

« Last Edit: September 22, 2017, 07:08:26 AM by SeattleCPA »
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Rubic

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Re: Unreliability of long run stock market returns
« Reply #99 on: September 22, 2017, 07:25:53 AM »
So this is a bit of a "Pascal's Wager" for me... have faith in modern portfolio theory because I don't think there's any real downside. And if MPT does really work, you either bump returns, dampen volatility or both.

Heh.  I don't believe in Hell in the afterlife or MPT, but appreciate an apt analogy.  ;-)

Great discussion all around and I like the recently posted chart.