Author Topic: What will the next 10%+ correction look like?  (Read 40157 times)

brooklynguy

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Re: What will the next 10%+ correction look like?
« Reply #50 on: April 18, 2015, 05:40:57 AM »
[more brilliant stuff]

These are all excellent points and should be required reading for every aspiring early retiree.  In addition, although your focus is on the psychological effects on aspiring early retirees still in the accumulation phase, we shouldn't overlook the psychological damage these types of markets can inflict on actual early retirees already in the drawdown phase.  I have to assume that it's even more difficult for an actual retiree to watch the market's value plummet, or slowly erode over time, than it is for the accumulator, because the retiree's portfolio represents not the abstract promise of retirement in the future but the actual, current means of putting bread on the table.  Even grizzled veterans like Nords have talked about how the 2008 crash tested the strength of their steel cojones, so what would have happened to the poor schmuck who early-retired in 1972?  Skyrefuge can pen the tale more colorfully than I, but I think the punchline would be that that hapless retiree would abandon this early retirement idea as a crazy pipe dream even more quickly than the hopeful accumulator.

We should also all keep skyrefuge's sobering reminders about recency bias in mind when, for example, we confidently declare that we have the risk tolerance for a 100% (or near-100%) equity allocation.  If that iron stomach was forged merely over the course of a raging bull market with a short dip or two, it may turn out to be made of jello when and if a prolonged crash arrives.

ender

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Re: What will the next 10%+ correction look like?
« Reply #51 on: April 18, 2015, 07:10:45 AM »
Anyone who is seriously worried about a significant market reduction delaying FI or RE meaningfully early should be sure to include some real estate in their overall retirement plan.

Situations where the market is dropping and stagnating are considerably worse if you have a portion of your income coming from a rental. ARS has written elsewhere that rent rates drop considerably less than the market during crashes.

For most MMM folks, even limited and "lame" part time work if necessary (not to mention legitimate, career related work paying considerably more) combined with a rental will provide a buffer to allow for a much lower than 4% withdrawal rate or to sustain themselves through a period of prolonged market stagnation or declines.

A family spending $30k a year (pretty high by standards here) with $1k/month rental income and $500/month part-time income will only have to drawdown about $12k/year from their other investments. At 4% withdrawal, that's "only" $300k in available investments. This provides a ton of flexibility.

As an aside, scenarios like those being discussed are part of the reason I think man folks prefer paying mortgages off vs investments. It's not optimal, but, it does provide some "insurance" against a long period of non-ideal market performance for an early retiree. This becomes even more true if rental or other part-time work is part of your FIRE plan, as your cashflow required on a yearly basis is lower. This causes market performance to matter less, because a period of stagnation or drop will affect a smaller portion of your cashflow. Someone retiring early only on dividends or portfolio withdrawals is heavily tied to market performance.

For many people, too, all their investments have to do is get them to 60-70 when pensions or SS become enough to sustain their FIRE lifestyle. Most here will have enough in SS payments to cover nearly all expenses in traditional retirement years. And many have some level of pension from previous jobs, even if not a full pension.

Clean Shaven

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Re: What will the next 10%+ correction look like?
« Reply #52 on: April 18, 2015, 07:45:07 AM »
On skyrefuge's repeat of 1972 crash hypothetical -

Has the US government changed its approach to the marketplace since that era? With the 2008 crash, the government took a very active role in trying to stabilize the economy, and it bounced back fairly quickly, at least as far as the stock market is concerned. 

Did we have a policy shift since the 1970s, in order to try to reduce the likelihood of repeating a 10-year period of bad economy (stagflation etc) ?  In other words, is it foolish to expect future recessions to be shorter and recoveries quicker (like 2008), given that the government policy makers have presumably learned something from 1929, 1987, etc.

I don't know the answer. Just throwing it out for discussion.

arebelspy

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Re: What will the next 10%+ correction look like?
« Reply #53 on: April 18, 2015, 08:10:42 AM »
It's funny what we each see (with our own biases) as the more "important" part of the lesson.

Some of you (like sky, original writer of the scenario) see the person losing faith at the end after 9 years of misery in the markets, and that being the key problem.

I don't see that nearly as much of an issue (maybe because I feel like I wouldn't have that issues?) as the extra working time.

Plus savings rate > returns. :D
This. On a short enough timeline, like with the hypothetical investor discussed by skyrefuge, savings rate is king.

Uh, but it's not always.  Definitely not in Sky's scenario.

I mean yeah, saving more is better than not, but the market just dominated him, and made working time to FI 15 years instead of 10.  50% longer working career?  Brutal.  If savings rate was "king," the market wouldn't have that big of an influence.  Savings rate is still super important, don't get me wrong, but if it was king bad returns would add 10% or something, IMO.

That's one of the things I loved about Jacob at ERE - he basically assumed no return during accumulation.

What an optimist.  What if you have negative real returns?
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Aphalite

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Re: What will the next 10%+ correction look like?
« Reply #54 on: April 18, 2015, 08:19:57 AM »
arebelspy was actually wrong; the final year of my hopeless non-retiree where he snapped was not just a throwaway joke. It was meant to illustrate how living through a particular environment can have major and long-lasting effects on your thought-process going forward. You hear the stories of those who grew up during the Great Depression who stayed unnecessarily frugal for the rest of their lives, for example. Heck, the original edition of the otherwise still-excellent Your Money or Your Life thought 30-year Treasury Bonds were the only investment you'd need. Sounded perfectly reasonable at that time, sounds crazy today. My point is that we are all at least partially products of our environment, and sometimes it's helpful to attempt to investigate how those environmental biases could be leading us astray.

All the more reason why people shouldn't just blindly index, do at least the very basic test of comparing earnings yield (http://www.multpl.com/s-p-500-earnings-yield) to treasury yield (http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield). If an investor were to do that back in 1970, he would be holding treasury bonds instead of stocks - why hold stocks if Treasury yield is HIGHER than stock yield? Stocks come with added risk. Now this doesn't mean sell whenever the two converge (you need to think about tax consequences), but it does signal that you should put your additional capital contributions somewhere else for the moment - not stocks

I know these tables are not the most precise or accurate, but just take a look - http://www.multpl.com/interest-rate/table, 10 year treasury was 7.8% in 1970, http://www.multpl.com/s-p-500-earnings-yield/table/by-year, SP earnings yield was 6.34%. You can find a similar story right before each crash and right before each recovery (2001, for example, before the crash, and 2011/2012, for example, before the 30%+ gains)

I just think investors should look at opportunity cost of capital allocation, we already make these decisions (do I buy domestic or international? how much of my portfolio do I dedicate to bonds?) - but somehow we are stuck with the idea that stocks are a golden ticket, and from time to time it's not. Fundamentals do matter, even if the most zealous of stock fanatics deny it. And you need to look at total return rather than just capital gain (or prices on a chart)

@Clean Shaven - Fed targets inflation much more highly now, so the 1970s isn't likely to happen again, I had a post earlier in the thread showing nominal returns in the 13 year period 1972-1985 was +140%, so not terrible, but because of inflation, you end up with Sky's scenario - a very REAL loss of purchasing power, as arebelspy said (expenses go up)
« Last Edit: April 18, 2015, 08:22:21 AM by Aphalite »

Heckler

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Re: What will the next 10%+ correction look like?
« Reply #55 on: April 18, 2015, 09:02:16 AM »
Let's all predict the market's (S&P 500) next 10%+ dip...



I expect it won't look too bad to me, due to not holding 100% VTI.  Instead, I own 25% US, 25% Canadian, 17% EAFE, 3% emerging and 30% fixed income.

mrpercentage

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Re: What will the next 10%+ correction look like?
« Reply #56 on: April 18, 2015, 09:22:40 AM »
(random guess)
It will happen around September 15th following a long overdue interest rate increase. The market will panic and I will sell my car and throw the money into that MF Abyss. When the panic of "We can't buy bonds because rates are increasing, we can buy dividend stocks because everyone will leave to buy bonds, we can't buy growth stocks because they loose value in increasing interest rates" --- yeah, when that bullshit is over, my shit will be gold as I rocket into the stratosphere.

That is my prediction and Im sticking to it.

Neustache

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Re: What will the next 10%+ correction look like?
« Reply #57 on: April 18, 2015, 09:44:21 AM »
What a great read!  Thanks so much for this thread - really good stuff.

I think I'm overly cautious anyways, and that's okay.  Our plan is to have 4 rentals (probably paid in cash...we'll see where the interest rates are at that point) plus sock away a decent sum into the market, plus work part-time for about ten years after our full-time working careers.  We'll semi-retire somewhere around 46, but won't really fully retire until 55, if we decide to fully retire then.   We'll also have a small teacher's pension, an employer contribution pension plan, and social security at some point.  But I'm extremely risk averse, I might loosen this plan up depending on what happens but it seems like during the above scenario we probably would have been fine to keep our plan of semi-retiring at 46 -  both of us cutting down work hours and just bringing in enough to cover our low expenses and waiting out that period of time. 

It was really good for me to read the 1970's stagflation hypothetical returns (and the emotional, but understandable reaction it it). 





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Re: What will the next 10%+ correction look like?
« Reply #58 on: April 18, 2015, 12:31:58 PM »
Plus savings rate > returns. :D
This. On a short enough timeline, like with the hypothetical investor discussed by skyrefuge, savings rate is king.

Uh, but it's not always.  Definitely not in Sky's scenario.

I mean yeah, saving more is better than not, but the market just dominated him, and made working time to FI 15 years instead of 10.  50% longer working career?  Brutal.  If savings rate was "king," the market wouldn't have that big of an influence.  Savings rate is still super important, don't get me wrong, but if it was king bad returns would add 10% or something, IMO.

That's one of the things I loved about Jacob at ERE - he basically assumed no return during accumulation.

What an optimist.  What if you have negative real returns?

I think we are actually on the same page here...we're just sniping at the margins.

Let's use the Jacob/ERE accumulation phase idea. 80% savings rate, getting you to 6.25 years in accumulation. Let's use 100k net income just to keep things clean.

Year 1: $80k invested, 24% drop in the market = $60.8k
And this is assuming all of the 100k hit this 30%, which is probably not a good assumption

Year 2: $80k invested, 34% down = $120k
Again, these are very simple calculations on a year-by-year basis with lump sum inputs

Year 3: $80k invested, 30% up = $236k

Year 4: $80k invested, flat = $316k

Year 5: $80k invested, 11% down = $361k

Year 6: $80k invested, 3% up = $452k

If this investor had achieved 0% returns during this timeframe, her portfolio would now be $400k. A significant difference to be sure, but only around 6 months at this savings rate. The 1972 super-saver still only works 6 months longer (I made it a whole year in the numbers above because I bet 1972 investor would have OM1/2Y syndrome). If we're playing using percentages here, the working career is 10% longer.

So, I think we're saying the same thing...right? Of course the psychology would be terrible and the risks would still be great, because the downslope sequence sucks (up 1% in Year 7, up 13% in Year 8, down 10% in Year 9). But even that terrible downslope isn't THAT bad. Let's see how it goes:

Year 7: $452k portfolio, $20k withdrawal, market up 1% = $436k

Year 8: $436k portfolio, $21k withdrawal due to high inflation only partially offset by cutbacks, market up 11% = $472k

Year 9: $472k portfolio, $23k withdrawal due to continued high inflation and no further cutbacks possible, market down 10% = $448k

Again, my calculations are very rudimentary as they assume 100% S&P 500, lump sums and other nonsense coming from my puny brain. Actual results could be a bit different. However, at the end of this exercise you start to see the wisdom of two ideas: stocks for the long run and savings rates being the crucial ingredient for FIRE seekers. The fun note at the end of this potential scenario is this investor would soon see the greatest bull market in American history. The portfolio would literally explode with wealth, turning our awesome 1972-er into a multimillionaire and philanthropist.
« Last Edit: April 18, 2015, 04:08:12 PM by NICE! »

forummm

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Re: What will the next 10%+ correction look like?
« Reply #59 on: April 18, 2015, 02:18:53 PM »
Was I the only one who read skyrefuge's entertaining scenario and thought that it looked really good? With a savings rate high enough to start from zero and expect FIRE in 10 years (i.e. ~67%), even that market performance wouldn't be enough to delay retirement that much.

I went ahead and did the math, for a $100k earner with a 66% savings rate. At a steady 7% real return, that's a 10-year career to hit his $850k number. Assuming his first 5 years had that steady 7% return, and then the 6th year started the 1973 sequence, he'd have only $516k by his 10th year, and by the 15th year, the end of the sequence I described, he'd still be short at only $812k. His retirement is already delayed at least 50% past his expectation. Maybe a 5+ year delay is not "that much" to someone expecting a 40 year career, but for someone expecting a 10 year career, it's enormous.

Good points. But I guess I see it the other way. Instead of a getting to retire 30 years before everyone else, this mustachian gets to retire 25 years before everyone else. And then gets insanely rich in the 80's and 90's. And his 5 year delay would only be if he were 100% S&P 500. Any international exposure or bonds or small caps or REITs would have helped him out. You have to be diversified. There were a couple years there where small caps went up over 50% per year.

Yes, the mustachian in the 70's didn't know about CAPE, but we all do now. The 5 year delay wouldn't even need to be a delay.

NICE!

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Re: What will the next 10%+ correction look like?
« Reply #60 on: April 19, 2015, 02:39:58 PM »
This won't change my overall opinion re: stocks for the long run, diversification, etc, but I do have a question since I'm having a hard time finding a good source:

What if we all were Japanese and we started this experiment at the market peak in Tokyo? Perhaps our investor already had a couple hundred thousand stashed and continued to plow money into the two and a half decades of misery...what would that look like?

theoverlook

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Re: What will the next 10%+ correction look like?
« Reply #61 on: April 20, 2015, 09:05:02 AM »
It's not a question worth giving an actual answer to, but I think it's a good philosophical question for people to think about for themselves.

Because I've been feeling lately that a lot of people have a subconscious recency bias telling them "a market crash is a deep dive quickly followed by a long and steady bounce back up", just because that's what the last two major market crashes have looked like. The more you believe that, the less likely it will be that the next crash resembles the previous two, because the universe likes to fuck with you like that. Our species has an incredible pattern-recognition processor built-in, but using it on input that had no part in its evolution can lead to some incredibly wrong answers.

I may be reading invisible subtext, but I hear that bias when people talk about hoping for another crash so they can "buy stocks on sale". In general, people just seem to have more confidence in post-crash bounce-backs than they ought to, like a crash is just some "irrational" thing that the market will quickly and inevitably correct.

In 1972, the inflation-adjusted, dividend-reinvested S&P 500 lost ~50% of its value in a 2-year slide, almost identical to the crashes in 2000 and 2007. But the similarities end there, because that time, the post-crash bounce-back stalled after a year. In 1982, seven-and-a-half years after the 1974 bottom, your investment was still down 37% from its 1972 value. You wouldn't have returned to your break-even point until 1985, after a full twelve years in the hole. That's a longer period of time than an entire Mustachian career, so all of your "buying low" wouldn't have done anything to help you retire earlier. Contrast that with the recovery from the 2007 crash, which took only five-and-a-half years.

So I have no idea what the next crash will look like, but I wouldn't bet much money on it looking like the last two.



And look, I didn't even have to invoke Japan!

A tough time to be in the market, but if someone is looking for "cheap stocks" then they're probably still in their accumulation phase.  And the 1973 time frame was not a bad time at all to be in the accumulation phase.  From 1974 to 1985 you were getting an average of 10% returns per year, that's phenomenal.  The people that it would have hurt were those already retired in 1973 - THAT would have been some pain!

Wolf359

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Re: What will the next 10%+ correction look like?
« Reply #62 on: April 20, 2015, 01:43:50 PM »
You may have heard about the infamous August, 1979 Business Week cover story called, "The Death of Equities."  You may want to actually read it if you haven't already.  Put yourself into the mindset of those who had just gone through the 70's bear market, stagflation, the Iran hostage crisis, and the feeling of the twilight of America (which Jimmy Carter actually articulated in a speech around that time.)

http://www.bloomberg.com/bw/stories/1979-08-13/the-death-of-equitiesbusinessweek-business-news-stock-market-and-financial-advice

The irony is that the article mocks the elderly, when in hindsight they knew something the public didn't.  They were staying the course.

brooklynguy

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Re: What will the next 10%+ correction look like?
« Reply #63 on: April 20, 2015, 02:24:42 PM »
You may have heard about the infamous August, 1979 Business Week cover story called, "The Death of Equities."

Magrien3 was recently pardoned for his similar transgression, but for your violation of the cardinal rule against failing to read the thread and linking to an article that's already been posted within a 15-post radius in the very same thread, the punishment shall be swift and severe:  I hereby place you under forum citizen's arrest and henceforth banish you from the forums make you feel slightly embarrassed, but then realize that we're all human, and we have a laugh about it over a beer!

MOD EDIT: More appropriate punishment.
« Last Edit: April 20, 2015, 03:00:29 PM by arebelspy »

NICE!

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Re: What will the next 10%+ correction look like?
« Reply #64 on: April 20, 2015, 03:34:46 PM »
This won't change my overall opinion re: stocks for the long run, diversification, etc, but I do have a question since I'm having a hard time finding a good source:

What if we all were Japanese and we started this experiment at the market peak in Tokyo? Perhaps our investor already had a couple hundred thousand stashed and continued to plow money into the two and a half decades of misery...what would that look like?

Anyone willing to do this? My math and internet connection suck.

skyrefuge

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Re: What will the next 10%+ correction look like?
« Reply #65 on: April 20, 2015, 04:03:28 PM »
These are all excellent points and should be required reading for every aspiring early retiree.  In addition, although your focus is on the psychological effects on aspiring early retirees still in the accumulation phase, we shouldn't overlook the psychological damage these types of markets can inflict on actual early retirees already in the drawdown phase.  I have to assume that it's even more difficult for an actual retiree to watch the market's value plummet, or slowly erode over time, than it is for the accumulator, because the retiree's portfolio represents not the abstract promise of retirement in the future but the actual, current means of putting bread on the table.

Yeah, my original thought process was this: the retiree has already locked in his course and chosen his fate, so for better or worse, the act of living through unexpected market performance would have little ability to change his future behavior or relationship with investing. Yes, he'd even more stress than the accumulator, but his investing beliefs would remain intact due to a certain sort of fatalism imparted by a lack of choice. Whereas the accumulator has more "freedom" to abandon his strategy, become psychologically scarred, and never return to it. But now I realize that of course the retiree can abandon his strategy too, by returning to work, or using the remains of his stash to buy a bunker in Nevada, etc.

skyrefuge

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Re: What will the next 10%+ correction look like?
« Reply #66 on: April 20, 2015, 04:21:11 PM »
Did we have a policy shift since the 1970s, in order to try to reduce the likelihood of repeating a 10-year period of bad economy (stagflation etc) ?  In other words, is it foolish to expect future recessions to be shorter and recoveries quicker (like 2008), given that the government policy makers have presumably learned something from 1929, 1987, etc.

Sure, government policy has likely helped prevent the same thing from happening, but it's almost surely done nothing to prevent the next bad thing that no one has seen before and no one expects. Worse, efforts to prevent "the same thing" from repeating could actually be (and often are) the cause of the "the next bad thing". If market risks were so avoidable and predictable, the market would not provide the rewards that it does.

So I'm not saying "don't expect the next crash to look like 2008, because it's going to look like 1973".

I'm saying: "don't expect the next crash to look like 2008, because there's no good reason to expect that. It might look like 2008, it might look like 1973, it might look like 1929, but it's more likely that it won't look like any of those. If you have a strong opinion of what it will look like, that probably means you have an insufficient respect for the risks inherent in the market".

skyrefuge

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Re: What will the next 10%+ correction look like?
« Reply #67 on: April 20, 2015, 04:45:10 PM »
All the more reason why people shouldn't just blindly index, do at least the very basic test of comparing earnings yield (http://www.multpl.com/s-p-500-earnings-yield) to treasury yield (http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield). If an investor were to do that back in 1970, he would be holding treasury bonds instead of stocks - why hold stocks if Treasury yield is HIGHER than stock yield? Stocks come with added risk. Now this doesn't mean sell whenever the two converge (you need to think about tax consequences), but it does signal that you should put your additional capital contributions somewhere else for the moment - not stocks

Huh? This looks like a pretty crappy strategy to me (as I would expect of any market-timing strategy with such a simple ruleset). You buy 10-year treasuries instead of stocks in 1970, so you can't take advantage of the 2.5 year stock run-up before the 1973 crash? Then, 10-year treasury yield beat earnings yield every single goddamn year from 1981 through 2003; someone who avoided stocks and kept buying treasuries through that period based off your advice would have wanted to kill you. So if you still think that metric is a good crash-indicator, I've got an awesome stopped clock I'd like to sell you!

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Re: What will the next 10%+ correction look like?
« Reply #68 on: April 20, 2015, 05:32:51 PM »
Yes, the mustachian in the 70's didn't know about CAPE, but we all do now. The 5 year delay wouldn't even need to be a delay.

Again, it's not a question of whether that 70s Mustachian knew about CAPE. It's whether he trusted it to hold any meaning. Even, if, like you, he was fully convinced in 1970 that CAPE was some immutable part of the fabric of the universe, by 1982, he had changed his mind. Just as Issac Newton would have changed his mind about his supposed law of gravity if he had subsequently seen a feather falling faster than a bowling ball hundreds of times and year after year.

There is stuff that we think we "know" that future will tell us we were wrong about. In some cases it will be because our current understanding is revealed to be incorrect/incomplete. In other cases, it will be because our understanding was actually correct, but reality diverged from our model for a period longer than we expected it to. Only in the latter case would that 70s Mustachian be "correct" in relying on CAPE to retire on a lower-than-expected stash. In the former case, where CAPE was discovered to just be a bad metric, he'd be a fool to rely on it. After seeing low-CAPEs for years with no positive results, two gas crises, and inflation getting worse and not better, I think it would be quite rare even for an optimistic-Mustachian to say "oh, yeah, I feel totally comfortable retiring with a 6.6% WR, because that CAPE is low!"

Aphalite

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Re: What will the next 10%+ correction look like?
« Reply #69 on: April 20, 2015, 05:55:57 PM »
Huh? This looks like a pretty crappy strategy to me (as I would expect of any market-timing strategy with such a simple ruleset). You buy 10-year treasuries instead of stocks in 1970, so you can't take advantage of the 2.5 year stock run-up before the 1973 crash? Then, 10-year treasury yield beat earnings yield every single goddamn year from 1981 through 2003; someone who avoided stocks and kept buying treasuries through that period based off your advice would have wanted to kill you. So if you still think that metric is a good crash-indicator, I've got an awesome stopped clock I'd like to sell you!

Hmm, you're definitely right about that,  712% from 1981 to 2003 for SP500 (no dividend reinvestment), 1475% with dividend reinvestment, whereas with 10 year treasury, if you swapped everytime you could get a higher interest rate (in 1982, and 1995) or whenever your 10 year duration ran out (in 1992), you would end up with 1057% - that's equivalent to 400K worse if your initial investment was 100K. And this is assuming only an initial investment, not DCA, where SP500 would blow treasuries out of the water

           10 Year    Hold            1,000.00
1981   12.57%   12.57%    1,125.70
1982   14.59%   14.59%    1,289.94
1983   10.46%   14.59%    1,478.14
1984   11.67%   14.59%    1,693.80
1985   11.38%   14.59%    1,940.93
1986   9.19%   14.59%    2,224.11
1987   7.08%   14.59%    2,548.61
1988   8.67%   14.59%    2,920.45
1989   9.09%   14.59%    3,346.54
1990   8.21%   14.59%    3,834.80
1991   8.09%   14.59%    4,394.30
1992   7.03%   7.03%    4,703.22
1993   6.60%   7.03%    5,033.86
1994   5.75%   7.03%    5,387.74
1995   7.78%   7.78%    5,806.90
1996   5.65%   7.78%    6,258.68
1997   6.58%   7.78%    6,745.61
1998   5.54%   7.78%    7,270.41
1999   4.72%   7.78%    7,836.05
2000   6.66%   7.78%    8,445.70
2001   5.16%   7.78%    9,102.77
2002   5.04%   7.78%    9,810.97
2003   4.05%   7.78%    10,574.26

I am curious tho, if you could have gotten a 30 year treasury bond (from my quick and dirty research I did not see a 30 year offered back then) yielding 14.59% in 1982, would you have taken it?

Edit: That is actually really sloppy math, I'm assuming I can reinvest the principal at the original rate - total return is probably closer to 700% instead of 1057% - also forgot to include a growth assumption in the SP500 where there is none for treasury bonds when comparing the earnings yield for each - embarrassing!
« Last Edit: April 20, 2015, 06:45:20 PM by Aphalite »

Roland of Gilead

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Re: What will the next 10%+ correction look like?
« Reply #70 on: April 20, 2015, 06:58:55 PM »
On the original question what will the next 10% correction look like, I think it will be extremely short, with the market recovering in less than 6 months and then reaching new highs.

There is still a lot of money on the sidelines from the last crash, waiting to come into the market.   They will come in on a 10% pullback even though they missed the previous 90% gains from the low.

The other reason it will be short is simply the state pension funds require market gains to remain above water without significant tax increases or cuts to pensions.   The path of least resistance is to manipulate the market higher such that these gains are realized.


bigchrisb

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Re: What will the next 10%+ correction look like?
« Reply #71 on: April 20, 2015, 08:48:33 PM »
Some interesting observations on this issue from the Reserve Bank of Australia, if you want a more economics-y view.
http://www.rba.gov.au/speeches/2015/sp-gov-2015-04-21.html

My take-homes for this were:
- There has been a reduction in the levels of liquidity.  This means markets are going to move faster, I suspect both on the way down and the way up.
- The divergence between financial and real world risk taking, along with already high levels of leverage make monetary policy fairly weak - so central banks won't be able to do much to help.  I guess the other way to look at this is that rates are already super low, and the money supply has been significantly expanded already through QE in many countries.  The other observation from this is that the equity premium is unusually high at the moment, comparing earnings yields against the "risk free"rates, being 5%-6%
- There is limited political will (and capability?) for fiscal policy. 
- There is a large amount of money invested across borders chasing a yield arbitrage.  Panic repatriation of this in a fairly il-liquid market will have some significant exchange rate issues.
- Central banks are trying to be maintain easy monetary policy for the long haul (with a few exceptions such as NZ (raising rates) and the US (telegraphing raising rates in the future)).

So, how is this actionable?  I don't know.  What I do know is that:
- These observations seem to indicate that markets may move savagely when they do.  Probably not a good time to be highly leveraged.  I'm going to work down my margin and callable debt.
- Anything going into cash/ "risk free" assets is losing 5-6% per year compared to the earnings yield.   Central banks are trying to maintain stability for a period of years.  I'm not prepared to risk 6% annually in the potential of a crash.
- My aim: Reduce gearing to a neutral level.  When markets are evidently on sale next, consider re-introducing some conservative gearing.

Wolf359

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Re: What will the next 10%+ correction look like?
« Reply #72 on: April 21, 2015, 07:36:15 AM »
You may have heard about the infamous August, 1979 Business Week cover story called, "The Death of Equities."

Magrien3 was recently pardoned for his similar transgression, but for your violation of the cardinal rule against failing to read the thread and linking to an article that's already been posted within a 15-post radius in the very same thread, the punishment shall be swift and severe:  I hereby place you under forum citizen's arrest and henceforth banish you from the forums make you feel slightly embarrassed, but then realize that we're all human, and we have a laugh about it over a beer!

MOD EDIT: More appropriate punishment.

My apologies.  I missed that previous link and comment my first time through the thread.  Sorry, it came from speed-reading the forum at the office.

As penance, and to continue moving the thread, may I instead suggest reading "The Great Depression - A Diary" by Benjamin Roth.  It literally provides the mindset of an investor (well, someone keenly interested in investing, but has no money to invest) throughout the Great Depression.  It continues over the decade.  At one point he even stops the diary in 1935 because he intended to journal from the beginning of the depression to its end, and it ended.  And then he picks up because he realized that it didn't. 

Ben Roth doesn't give up on the markets in the end.  He develops an investment philosophy that sounds like the Bogleheads.  But during most of the Depression he's watching other people lose and make fortunes (and lose them again) while he's forced to stay on the sidelines due to lack of cash.  His big lesson -- cash is king.  Multiple times he stated that if he had lived below his means to accumulate some savings prior to the Depression, he could have been set for life.  Once the economy tanked, professionals like lawyers and doctors were living hand-to-mouth. 

If there are severe economic dislocations, you don't want to have any margin, and you don't want to own real estate (if rents fail to come in, you still have to maintain the property, pay taxes, and pay a mortgage. You have no flexibility in expenses short of razing your building to reduce the tax obligation and maintenance costs.)  His conclusion was that diversified blue chip stocks, government bonds, cash on hand for buying opportunities, and a very long time perspective were the best choices to survive financially.

brooklynguy

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Re: What will the next 10%+ correction look like?
« Reply #73 on: April 21, 2015, 07:49:57 AM »
My apologies.  I missed that previous link and comment my first time through the thread.  Sorry, it came from speed-reading the forum at the office.

I accept your penance, but next time (lenient-moderator-intervention notwithstanding) it's the guillotine!!!

Quote
His conclusion was that diversified blue chip stocks, government bonds, cash on hand for buying opportunities, and a very long time perspective were the best choices to survive financially.

To skyrefuge's point, for every monkey-wrench-avoidance lesson history teaches us, the future will find a new kind of monkey-wrench.

skyrefuge

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Re: What will the next 10%+ correction look like?
« Reply #74 on: April 21, 2015, 10:25:47 AM »
Hmm, you're definitely right about that,  712% from 1981 to 2003 for SP500 (no dividend reinvestment), 1475% with dividend reinvestment, whereas with 10 year treasury, if you swapped everytime you could get a higher interest rate (in 1982, and 1995) or whenever your 10 year duration ran out (in 1992), you would end up with 1057% - that's equivalent to 400K worse if your initial investment was 100K. And this is assuming only an initial investment, not DCA, where SP500 would blow treasuries out of the water

I think just looking at this Morningstar Growth of $10k chart is the easy way to do the math. The S&P 500 investment grew ~1400%, while the intermediate government bond benchmark (I don't know of an actual fund that covers that period) grew ~500%.

I am curious tho, if you could have gotten a 30 year treasury bond (from my quick and dirty research I did not see a 30 year offered back then) yielding 14.59% in 1982, would you have taken it?

Normally I would say "I have no idea", since I recognize that I would always be a product of my environment, and without living in that 1970s/1980s environment (as an investor), I cannot know how it would have shaped my decisions. But in this case, I think I can say "yes, assuming I could not see the future, I probably would have taken a 14.59% 30-year treasury", simply because that's what the 'Your Money or Your Life' author did (or at least recommended), and if it seemed like a good idea to him at the time, it probably would have seemed like a good idea to me too.

Of course, time then revealed that, while not a terrible choice, that wasn't the optimal choice. Just as time is likely to reveal that my current choice of a stock-heavy index fund portfolio is unlikely to be the optimal choice.

(FYI, the 30-year treasury was 14.22% in January 1982, so close enough to the 14.59% of the 10-year.)

To skyrefuge's point, for every monkey-wrench-avoidance lesson history teaches us, the future will find a new kind of monkey-wrench.

Said much more pithily than my version!
« Last Edit: April 21, 2015, 10:29:31 AM by skyrefuge »

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Re: What will the next 10%+ correction look like?
« Reply #75 on: April 21, 2015, 03:02:58 PM »
This thread made me think of a book I heard about recently:

http://en.wikipedia.org/wiki/The_Wisdom_of_Crowds

In this case, the crowd not only knows what the correction will look like, but will actually decide when and how much!

Cookie78

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Re: What will the next 10%+ correction look like?
« Reply #76 on: April 21, 2015, 03:30:54 PM »
Great thread. Important lessons.

Yeah, although in this case, I think I'm trying to highlight the need for "expectational flexibility" in addition to the "operational flexibility" that we normally talk about around here. Because operationally, my hypothetical accumulator didn't do anything wrong, until he finally snapped. And the reason he snapped is because he had failed to mentally prepare for the reality he experienced; it had not been included within the range of his expectations. He had read all the MMM cheerleading, never dug much deeper than a glance at an S&P500 price chart from 1995-2015, and wholly bought into the idea that a crash is inevitably a good thing for a Mustachian accumulator in his position.

If he had instead read my post illustrating the 1972 crash, his expectations for the outcome of a crash would have covered a broader range, and that might have given him the "expectational flexibility" to better tolerate the unpleasant outcome. Someone who is told that there might be some harrowing shit in their military training exercise is less-likely to snap when the electric-eel attack starts at 3am than someone who is just expecting the exercise to be a relaxing day at the lake.

So my post was just intended to expand the range of possibilities for some people who might be suffering from recency bias;  not to make them more "scared" of a crash, but to help give their psyches the ability to bend rather than break on the rare chance that the eels show up.

This was a really striking thought for me, as a noob, and I thank you. But I still really hope I don't end up working an extra 5 years!!

TGod

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Re: What will the next 10%+ correction look like?
« Reply #77 on: April 21, 2015, 05:05:14 PM »
Back to the initial question...I hope it is soon. I gave the government a nice fat interest free loan last year and they are hopefully about to pay me back the principle. I need to invest it, but things seem a bit high at the moment for a big buy.

NICE!

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Re: What will the next 10%+ correction look like?
« Reply #78 on: April 22, 2015, 12:58:12 AM »
So...we keep talking about the US in the 70s. Again, does anyone want to consider Japan or another country during a really bad period of returns?

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Re: What will the next 10%+ correction look like?
« Reply #79 on: April 22, 2015, 06:41:09 AM »
So...we keep talking about the US in the 70s. Again, does anyone want to consider Japan or another country during a really bad period of returns?

Where the US is now, is very different than where Japan was then. A lot would have to happen before the US could get to a place where the Japan-style lost decades would occur due to similar causes. The US could experience flat return for a long time, but different factors would have to drive that.

But it's an important risk for people to think about, and why I think it's unwise to be 100% US.

dragoncar

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Re: What will the next 10%+ correction look like?
« Reply #80 on: April 22, 2015, 07:54:18 AM »
For those who still think accumulation during the 70s sounds nice, don't assume constant real savings.  Likely your salary won't keep up with inflation (assuming you keep your job):



About once a week I actually have something to say, but most of my time on the forum is just mindless drivel.

Oh, hello there.  Fancy meeting you here.


I sympathize with the posts that periodically pop up questioning whether the commitment some of us have to this forum starts to border on unhealthy addiction


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Re: What will the next 10%+ correction look like?
« Reply #81 on: April 22, 2015, 08:25:28 AM »
So...we keep talking about the US in the 70s. Again, does anyone want to consider Japan or another country during a really bad period of returns?

This is the third time you've asked that, along with these two:
This won't change my overall opinion re: stocks for the long run, diversification, etc, but I do have a question since I'm having a hard time finding a good source:

What if we all were Japanese and we started this experiment at the market peak in Tokyo? Perhaps our investor already had a couple hundred thousand stashed and continued to plow money into the two and a half decades of misery...what would that look like?

Anyone willing to do this? My math and internet connection suck.

Given that, it seems like the answer to the above bolded question is "no."

Just didn't want you to keep feeling ignored.  :)
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Johnez

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Re: What will the next 10%+ correction look like?
« Reply #82 on: April 22, 2015, 03:02:40 PM »
Remarkable thread.  I thought it was going to be all puff and fun stuff, yet so many well formed thoughts and questions came pouring out.

Now, what to do about the impending correction?  So far I have gleaned this:

-Every recession is different.  2008 and subsequent bounce back is anomalous.
-Optimism in the market during the mid-'70s was WORTHLESS.  It can happen again.

For now, none of my plans have changed, even given so much to chew on in here.  I plan on becoming an electrician, pouring my money into my Roth and 401k, and buying a house.  I feel nothing can grant freedom like a pile of cash/investments, paid off home, no debt, and the ability to generate cash at will/need.  We'll see if 1974 happens again tomorrow or 15 or so years from now...
« Last Edit: April 22, 2015, 03:04:26 PM by Johnez »

NICE!

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Re: What will the next 10%+ correction look like?
« Reply #83 on: April 23, 2015, 03:03:51 PM »
Given that, it seems like the answer to the above bolded question is "no."

Just didn't want you to keep feeling ignored.  :)

It appears so. Thank you for not ignoring me. I don't quite understand how the question isn't interesting or relevant to the discussion, so I guess I don't belong here.

arebelspy

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Re: What will the next 10%+ correction look like?
« Reply #84 on: April 23, 2015, 03:07:13 PM »
My guess is people would be willing to discuss if you did the work and posted conclusions, but don't find it compelling/interesting enough to do the work themselves.
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brooklynguy

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Re: What will the next 10%+ correction look like?
« Reply #85 on: April 23, 2015, 03:31:28 PM »
My guess is people would be willing to discuss if you did the work and posted conclusions, but don't find it compelling/interesting enough to do the work themselves.

Yeah - NICE, I'm definitely interested and have been patiently waiting for someone else to take up the challenge of answering your question, but I'm too lazy to attempt to do it myself, primarily because we already know the answer, in broad strokes:

Question:

What if we all were Japanese and we started this experiment at the market peak in Tokyo? Perhaps our investor already had a couple hundred thousand stashed and continued to plow money into the two and a half decades of misery...what would that look like?

Answer:

As bad as, or worse than, skyrefuge's tale of woe upthread.

JamesAt15

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Re: What will the next 10%+ correction look like?
« Reply #86 on: April 24, 2015, 12:58:23 AM »
My guess is people would be willing to discuss if you did the work and posted conclusions, but don't find it compelling/interesting enough to do the work themselves.

Yeah - NICE, I'm definitely interested and have been patiently waiting for someone else to take up the challenge of answering your question, but I'm too lazy to attempt to do it myself, primarily because we already know the answer, in broad strokes:

Question:

What if we all were Japanese and we started this experiment at the market peak in Tokyo? Perhaps our investor already had a couple hundred thousand stashed and continued to plow money into the two and a half decades of misery...what would that look like?

Answer:

As bad as, or worse than, skyrefuge's tale of woe upthread.

Hmm, I might have a go at it, with the understanding that it should be read for entertainment purposes only and any resemblance to real returns would be almost entirely coincidental.

My first quick read at the lower posts of this thread provoked my irritated "you can't compare to Japan, that's apples to sweet potatoes" kneejerk, but going back and reading the rest, I think I have a better idea what you were getting at. The thoughts about how an investor's feelings and reactions would be affected after such a long stretch of bad returns sounds very plausible. Very interesting thread so far.

OurFirstFire

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Re: What will the next 10%+ correction look like?
« Reply #87 on: April 24, 2015, 07:15:10 AM »
All the more reason why people shouldn't just blindly index, do at least the very basic test of comparing earnings yield (http://www.multpl.com/s-p-500-earnings-yield) to treasury yield (http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield). If an investor were to do that back in 1970, he would be holding treasury bonds instead of stocks - why hold stocks if Treasury yield is HIGHER than stock yield? Stocks come with added risk. Now this doesn't mean sell whenever the two converge (you need to think about tax consequences), but it does signal that you should put your additional capital contributions somewhere else for the moment - not stocks

Huh? This looks like a pretty crappy strategy to me (as I would expect of any market-timing strategy with such a simple ruleset). You buy 10-year treasuries instead of stocks in 1970, so you can't take advantage of the 2.5 year stock run-up before the 1973 crash? Then, 10-year treasury yield beat earnings yield every single goddamn year from 1981 through 2003; someone who avoided stocks and kept buying treasuries through that period based off your advice would have wanted to kill you. So if you still think that metric is a good crash-indicator, I've got an awesome stopped clock I'd like to sell you!

I've got a solution to this argument:  Let's buy both stocks and bonds! (and some other stuff).  It's called asset allocation (http://www.mrmoneymustache.com/2012/02/17/book-review-the-intelligent-asset-allocator/), and is the answer to most of the hand wringing on this thread about 1973.   Applying a "Coffee House Portfolio" AA strategy, here are your yearly returns during this time period with yearly rebalancing:

1972   11.6%
1973   -9.4%
1974   -10.7%
1975   28.8%
1976   27.4%
1977   9.6%
1978   10.7%
1979   18.1%
1980   19.2%
1981   6.0%
1982   21.4%
1983   20.4%
1984   9.6%
1985   27.1%
1986   18.9%

It turned a 17 year slump into a 3.5-year slump.  If you retired on 1 Jan 1973 with $1MM and a modified 5% withdrawal rule, by 1985 you'd have $2.6MM.  Play around with the backtesting speadsheet on Bogleheads for more info: http://www.bogleheads.org/wiki/Simba%27s_backtesting_spreadsheet

Of course there's no guarantee that the next drop will work out so well for a good asset allocation strategy, but it's much better than worrying about the return of the S&P (or the Nikkei for that matter) in isolation.

JamesAt15

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Re: What will the next 10%+ correction look like?
« Reply #88 on: April 24, 2015, 07:21:35 AM »
Our story begins as we approach the end of the 1980s. Japan's wonder economy has stunned the world. American firms study Japanese management practices, hoping to duplicate their successes, lest they be overrun by Japanese firms producing higher-quality products increasingly respected as first class brands, even superior to American stalwarts. Business leaders and economists grumble about how Japan's governmental ministry of trade and industry allows them to align government and business interests and development, while American firms thrash about without a guiding hand and clear national goals.

Our protagonist, Hiroyuki Yamashita, finds himself making a pretty good salary at one of the bigger Japanese banks. His position is a relatively boring one supporting consumer products and accounts. The guys making crazy money are the ones over in equities and business lending. He hears stories, but those departments are handled in the main office over near Ginza. Still, the company is doing well... very well. Company bonuses have been hefty for the past several years, adding the equivalent of several months' salary to his yearly pay. Hiro and his wife Yoshimi are frugal, even by traditional Japanese standards, and these bonuses have been stashed away in an investment account, growing as shares of mutual funds tracking the Nikkei 225 index. Hiro checks his balance amazedly in January of 1989 - the Nikkei has hit 30,000 points, up almost 9000 points since last year. Hiro has about 30 million yen invested, or about $240,000 US at the current exchange rate of 125yen/$. Hiro keeps an eye on the exchange rate because of his crazy dream - saving up a ton of money and retiring to Hawaii. He's only 30, so that's a long ways off still, but if the Nikkei keeps up this rocket ride to the stratosphere, who knows? Japan may have bought Hawaii outright by then.

Hiro doesn't think the Nikkei can keep up these crazy gains, though.  Stock prices seem too high to him. He quietly hopes for a pullback so he can buy more shares at lower prices, as he's read about in the books on market investing he reads to practice his English. He knows Japan is still producing the best cars, electronics, and high tech products on the market, so when the market recovers he'll make an even bigger profit. Giddy coworkers have tried to convince him, using candlestick charts and other advanced analysis, that there's a lot of growth still to come, but he hopes to get some purchases in at fire sale prices to really benefit. Hiro decides to stick with his plan and invest about half of his 8 million yen (about $56,000) salary yearly, plus his bonuses, in his Nikkei funds. His crazy dream doesn't really consider retiring early... but if he and his wife get REALLY rich, who knows?

  • Jan 1990: Nikkei is at 37,000, down slightly from its peak at around 39,000. Is this the start of the pullback? Not sure yet. Still up 23% for the year. Retirement account at almost 44 million yen ($306,000 at 144yen/$).
  • Jan 1991: Nikkei is at 23,200 (down 38%). Hiro has felt like it was in freefall for the last year. Japan is now the one who has been stunned, as their giddy dreams and free-flowing champage has disappeared with a loud POP! of the bubble that no one wanted to acknowledge while the party was still going. Hiro is thankful his banking job is one of the more boring ones - some of his high-flying friends from the Ginza office have disappeared amid rumors and whispers of debts unpaid. Yakuza-looking gangsters loitering around their homes and offices have put many on edge. Hiro tells himself that he's buying stocks cheaply and will be in great shape as the economy recovers.  His bonus has dropped to about one month's salary. He doesn't know yet that it will barely budge from this value for the next two decades. Retirement account is about 31.5 million yen ($233,000 at 135yen/$)
  • Jan 1992: Nikkei is at 23,000 (about even). Hiro thought he saw the beginnings of a recovery in March when it got back up to 26,000, but it dropped back and struggled the rest of the year. Companies and banks struggled as they found that much of their assets were based on real estate values for their properties that were massively inflated from the bubble economy. Some companies have failed, and many banks juggle loans they have made to firms who now have no way to repay. Retirement account is about 36 million yen ($288,000 at 125yen/$).
  • Jan 1993: Nikkei is at 17,000 (down 26%). Recovery? Where's the damn recovery?! Hiro is starting to worry. Japanese companies are still struggling. Some have failed. Some are even talking about restructuring, even layoffs. The thought sends a chill down his spine. Hiro has, like most Japanese, thought of his employment as a lifelong contract. Japanese companies have essentially never laid off employees. If they're forced to start now, what other unthinkable changes may be coming up? Retirement account is about 29 million yen ($232,000 at 125yen/$).
  • Jan 1994: Nikkei is at 17,500 (up a trifle). Still no sign of a recovery. Firms in trouble have juggled to avoid layoffs, but "restructuring" and layoffs have started. Hiro's job is thankfully fairly safe, but other banks have not been in good shape with many uncollectable loans on their books. Retirement account is about 33 million yen ($295,000 at 112yen/$).
  • Jan 1995: Nikkei is at 19,000 (up 8.5%). It doesn't feel like a recovery, with the Nikkei at only half its peak value. Hiro begins to feel like this is just how it's going to be. Retirement account is about 40 million yen ($392,000 at 102yen/$).
  • Jan 1996:  Nikkei is at 20,000 (up 5%). Retirement account is about 47 million yen ($447,000 at 105yen/$).
  • Jan 1997: Nikkei is at 19,000 (down 5%). Retirement account is about 51 million yen ($428,000 at 119yen/$).
  • Jan 1998: Nikkei is at 15,500 (down 18%). Retirement account is about 52.5 million yen ($404,000 at 130yen/$). Hiro often muses that if he'd have just put his funds in a savings account earning .1% interest, he'd have been closer to 66 million yen by now. More than that if he'd have mixed in some Japanese government bonds at around 1%, as most Japanese seem to do. It didn't seem that bad a couple years ago if he used dollars instead of yen, but that's changed as well. Maybe he should get into foreign stocks too? He's read that the S&P500 has had good returns the last few years, but then he'll have to worry about the exchange rate as well…
  • Jan 1999: Nikkei is at 14,000 (down 10%). Retirement account is about 51 million yen ($443,000 at 115yen/$). Hiro is ready to throw in the towel and give up his crazy dream. It's been ten years. The Nikkei seems to be going nowhere, if not stumbling downward. His kids are getting older and starting to get more expensive as they begin juku cram schools and try to get into better private junior high and high schools in hopes of getting into a good university. It's not that bad, he reflects. His job is stable. Japan has no inflation to speak of, so prices for most goods barely change, and sometimes go down. National health care is universal and price-controlled. Most Japanese seem to rely on the national pension system for their incomes in retirement, supplemented with savings in plain savings accounts, government bonds, maybe some foreign currency bonds and similar exotic items. Few others seem to have significant savings invested in equities, and who can blame them after the economy blew up, disappearing all that wealth with no sign that it will be coming back? Hiro's family can plan out what their expenses will likely be for the next several decades and save accordingly. Getting rich in the stock market and retiring to island paradise was a nice dream though…

brooklynguy

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Re: What will the next 10%+ correction look like?
« Reply #89 on: April 24, 2015, 10:18:05 AM »
Of course there's no guarantee that the next drop will work out so well for a good asset allocation strategy

The quoted portion of your post has been the theme (and the point) of the discussion in this thread.  Sure, your Coffee House Portfolio would have been the better bet for the 1972-investor.  But if you expand your dataset to include the entire historical record instead of that cherry-picked period of stock-investing calamity, then a stock-heavy (100% or close to it) allocation would have been your best bet.  As long as you're using history as a guide, diversifying your asset allocation to include conservative assets actually decreased your chances of portfolio success (in addition to leaving you with a smaller portfolio ending value).  But the whole point is that you can't necessarily use history as a guide (even though we may have no better option), because who the hell knows what will happen in the future?

DavidAnnArbor

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Re: What will the next 10%+ correction look like?
« Reply #90 on: April 24, 2015, 10:29:08 AM »
Between FrugalExpat and JamesAt15's posts, geographic and asset diversification seems to be the key.
I also appreciate the visceral experience of going through stock market collapses as provided in skyrefuge's post.
« Last Edit: April 24, 2015, 10:49:42 AM by DavidAnnArbor »

brooklynguy

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Re: What will the next 10%+ correction look like?
« Reply #91 on: April 24, 2015, 11:07:29 AM »
Our story begins as we approach the end of the 1980s...

That was an excellent, thoroughly enjoyable read.  Thanks for putting it together!  No one can doubt your commitment to Sparkle Motion.

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Re: What will the next 10%+ correction look like?
« Reply #92 on: April 24, 2015, 01:10:39 PM »
Our story begins as we approach the end of the 1980s...

That was an excellent, thoroughly enjoyable read.  Thanks for putting it together!  No one can doubt your commitment to Sparkle Motion.

Yeah, nice work James!  Definitely a worthwhile read.

OurFirstFire

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Re: What will the next 10%+ correction look like?
« Reply #93 on: April 24, 2015, 07:45:48 PM »
Of course there's no guarantee that the next drop will work out so well for a good asset allocation strategy

The quoted portion of your post has been the theme (and the point) of the discussion in this thread.  Sure, your Coffee House Portfolio would have been the better bet for the 1972-investor.  But if you expand your dataset to include the entire historical record instead of that cherry-picked period of stock-investing calamity, then a stock-heavy (100% or close to it) allocation would have been your best bet.  As long as you're using history as a guide, diversifying your asset allocation to include conservative assets actually decreased your chances of portfolio success (in addition to leaving you with a smaller portfolio ending value).  But the whole point is that you can't necessarily use history as a guide (even though we may have no better option), because who the hell knows what will happen in the future?
Actually, it seems that was supposed to be the theme of this thread, but it changed paths into worrying about past crashes.

But to the rest of your post, I challenge the assumption that 100% stocks has outperformed across the historical record.  Virtually any intelligent asset allocation strategy (all with bond holdings in excess of 20%) has yieled a CAGR of between 8%-11% from the 1970s to today (see http://mebfaber.com/2013/07/31/asset-allocation-strategies-2/).  A Coffeehouse allocation has yielded 10.54%.  The S&P has yielded 10.48%.  Asset allocation has outperformed in the crashes but still makes (a bit less) money in the bull runs.

However, I agree that if your goal is to make the most investing, then a stock heavy allocation is your best bet, you will probably have some good bull markets in the mix that will peak above a more conservative mix.  The present day bull market is an example of that, where the S&P average is about 1% higher than the average AA strategy.  But, if your goal is to retire soon and live off investment income, then you need to smooth out the crashes, because volatility will kill your portfolio just as much as poor average returns when you are making regular withdrawals, which is the opposite of dollar-cost averaging.

Yes, I already made the point about how history doesn't guarantee the future, but most of this thread has been about worrying about history.  You needn't worry about retiring in 1973 or 2001 if you have a good AA strategy, but you do have to worry about them if you have 100% stock strategy. 

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Re: What will the next 10%+ correction look like?
« Reply #94 on: April 25, 2015, 02:22:56 AM »
James,

I was literally about to throw in the towel and make the Japan post, but you did far better than I ever would've done. Thank you for the numbers and the narrative!

The lesson I take from that is, though it would be an extremely difficult ride, the dude still about doubled his NW in 10 years. His returns were atrocious, of course, but the lesson that I mentioned earlier still holds - if you save aggressively, you can weather almost all storms.

I'm going to provide an extension to your story, with much less narrative. Again, I'm assuming the same salary ($56,000) and savings rate (50%), but I am eliminating any bonuses. Basically I'm saying that this guy never moves up because the older generation refuses to retire and that salaries languish. I'm also not going to play with exchange rates.

Jan 2000 (up 35.2%): Hiro (my favorite Japanese name, btw) and his wife's portfolio sits at $627,125. Is this a bubble or will tech change the world?
Jan 2001 (down 27.2%): The family portfolio takes yet another major hit and Hiro has now decided it will never truly recover. $484,547
Jan 2002 (down 23.5%): Hiro has definitely left the Hawaii dream in the dustbin, but his home is now mortgage-free, his kids are doing well in school, and he still has a job. Furthermore, after the 9/11 attacks in the US and the subsequent market correction there, Hiro counts his blessings and keeps chugging along, despite the Japanese stock market misery. $398,678.
Jan 2003 (down 18.7%): Continued misery. $352,125.
Jan 2004 (up 24.5%): The American recovery continues and Hiro thinks that perhaps a Japanese recovery is beginning, too. $466,396.
Jan 2005 (up 7.6%) It isn't the 10% he hopes for, but it is definitely a positive. $515,115. The family's NW is recovering. $494,397.
Jan 2006 (up 40.2%): "JACKPOT," screams Hiro. His Hawaii dreams are back on the table! $721,144. A massive increase in NW and the highest NW yet achieved by the family.
Jan 2007 (up 7.5%): Hiro continues planning the possible Hawaii move since his children are out of college and off on their own. Perhaps his perseverance will be rewarded? $803,299.
Jan 2008 (down 8.3%): Is this a small correction? The American market has cooled somewhat and in a few months there will be a historic rescue of a firm called "Bear Sterns." Hiro continues researching visas and housing in Hawaii. $764,561.
Jan 2009 (down 42.2%): "Those fucking Americans and their profligate ways," Hiro exclaims. "There are damn strawberry farmers with $300,000 homes and Wall St fat cats are gambling with other people's money and government-insured deposits." Hiro is angry, but somehow he continues to be a consistent Nikkei investor. $469,916.
Jan 2010 (up 17.3%): "We will need a lot more than this to get to Hawaii," Hiro states, pensively. $579,212.
Jan 2011 (down 3.0%): Hiro sighs. $589,835.
Jan 2012 (down 17.3%): Hiro's wife wonders if the American book, Stocks for the Long Run, that Hiro loves was right. $515,794.
Jan 2013 (up 22.9%): Hiro thinks that this is probably just another tease before a major correction. $661,911.
Jan 2014 (up 56.7%): "WE ARE MILLIONAIRES (in USD)," exclaims Hiro. Hiro decides that he needs OMY before he and his wife will be reclining on a beach in Hawaii. $1,065,214.
Jan 2015 (up 7.1%): $1,168,844. Hiro and his wife decide that they've saved enough. This portfolio, which they will now transition to a much more conservative allocation (60/30/10), will give them a retirement income of over $45k/year, before even considering their pensions.

Furthermore, they'll rent their paid-off home to one of their children for a reduced rate, since he is a grade-school teacher in Tokyo. This will give them $800/month in income and they won't have to worry about property management since their son is the most responsible person they know. He is extremely grateful for their generosity and even makes improvements to the property without them knowing, increasing its value.

Hiro and his wife realize that they are nowhere near as rich as they had envisioned, but they're still where they want to be. Their children are happy and well-adjusted. Their son is married with a grandchild on the way and their daughter lives with her longtime partner. The Americans in Hawaii are incredibly friendly, so they've made a ton of friends.

If they could do it again, they would've owned some bonds and had some more international diversification. But, through savings and dedication, they achieved their goal despite the difficulties.

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Re: What will the next 10%+ correction look like?
« Reply #95 on: April 25, 2015, 06:56:00 AM »
Thanks for the kind words about my Japanese investor post. I hope it was useful. Sorry about the length - I tend to ramble on once I get started.

One of the things I was trying to hint at was that the Japan lost decades scenario is unlikely to occur in the US because Japan is different in a lot of ways. Japanese investors are generally much more risk-averse. Japanese society seeks stability. We've had negligible inflation, if not outright deflation, as long as I can recall. Et cetera. I think most people here understand this without even knowing the details, but sometimes you see a post (on some other message board) that reads, "yeah, but what about JAPAN, man?!" and gears kinda grind.

The point is still valid that we don't know what bad scenarios may play out in the future. I agree that diversification is important, even if we sacrifice a bit of gain in order to reduce volatility. We also need to be as learned in our opinions and our asset allocations as we can, because a bad time will really try us, and we will probably need to be unreasonably sure of ourselves to stay the course we have chosen.

My Japanese protagonist invested 100% in equities is really, really rare, for example. I did a quick poke around to see if my impressions were way off, and after finding some articles like this link, I don't think I am. The average Japanese household's retirement savings is only about 6% in equities, compared with 32% for the US. They hold about 3% in bonds, and 55% (!!) in cash and deposits (earning maybe 0.1% annually).

So Hiro is a bit of a freak to begin with, and after a few years of horrid returns, his doubts about his plan are going to be very strong. If he makes the mistake of telling his parents and in-laws about his family's investments, they will gasp in shock. They will equate it with gambling their life savings on foreign exchange day trading. They will begin pressuring him to give up his crazy plan of buying so many stocks, for their daughter's sake, for their grandchildren's sake. He and his wife's resolves may falter, and they may decide that stock trading is best left for the professionals and switch their investments to cash savings, time deposits, some Japanese government bonds, and life insurance policies. Like everyone else.

Of course we know that he would do better to stay the course. Or even better, switch to a diversified plan with some bonds, some real estate, and some foreign stocks, and trust that the additional complexity and new risks will work out well for him. But he will want to be very, very quiet about what he is doing, and very, very sure of himself.
« Last Edit: April 25, 2015, 04:34:34 PM by JamesAt15 »

Pooperman

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Re: What will the next 10%+ correction look like?
« Reply #96 on: April 25, 2015, 07:46:56 AM »
1972 was a bad time to retire, as were the years in the mid/late 1960s. The biggest fear I have with investing is having a repeat of the flat (negative real) 20 years from 1965 to 1985.

As for the original purpose of the thread: 1-3 years until next downturn (2016-2018). I don't foresee it being as insane as 2008/2009 was. something akin to 1990 or 1987.

Current things that could set it off: healthcare, student loans, commercial real estate, social media.

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Re: What will the next 10%+ correction look like?
« Reply #97 on: April 25, 2015, 10:18:31 AM »
I challenge the assumption that 100% stocks has outperformed across the historical record.  Virtually any intelligent asset allocation strategy (all with bond holdings in excess of 20%) has yieled a CAGR of between 8%-11% from the 1970s to today (see http://mebfaber.com/2013/07/31/asset-allocation-strategies-2/).  A Coffeehouse allocation has yielded 10.54%.  The S&P has yielded 10.48%.  Asset allocation has outperformed in the crashes but still makes (a bit less) money in the bull runs.

Just looking at the effect of stock/bond mix on portfolio performance for a standard retirement drawdown strategy, there hasn't been a retirement-length (30-year+) period in the entire history of the markets in the U.S. where an extremely stock-heavy portfolio (100% or near-100% stocks) did not outperform bond-heavier allocations both in terms of avoision of portfolio failure (depletion to zero) and in terms of achievement of higher terminal portfolio value.  This can be confirmed by examining the historical data using cFIREsim.com.

Admittedly, this analysis is limited to U.S. markets and ignores international exposure.  But with that limitation in mind, holding bonds has never been helpful for investors having long enough time horizons, even accounting for the "reverse dollar-cost averaging" effect of regular withdrawals (except to the extent that holding bonds "helped" in the sense their stabilizing effect on volatility psychologically enabled the investor to avoid abandoning the plan and stay the course--which is to say, they never outperformed an extremely-stock-heavy plan as long as the extremely-stock-heavy plan was actually followed).

This has been discussed here a bunch of times at length; see, e.g.:

http://forum.mrmoneymustache.com/investor-alley/why-would-i-be-in-anything-other-than-100-stocks/

And subsequently Go Curry Cracker put together what I now consider the definitive post on the topic:

http://www.gocurrycracker.com/path-100-equities/

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Re: What will the next 10%+ correction look like?
« Reply #98 on: April 25, 2015, 10:30:37 AM »
Thanks for the kind words about my Japanese investor post. I hope it was useful. Sorry about the length - I tend to ramble on once I get started.

One of the things I was trying to hint at was that the Japan lost decades scenario is unlikely to occur in the US because Japan is different in a lot of ways. Japanese investors are generally much more risk-averse. Japanese society seeks stability. We've had negligible inflation, if not outright deflation, as long as I can recall. Et cetera. I think most people here understand this even knowing the details, but sometimes you see a post (on some other message board) that reads, "yeah, but what about JAPAN, man?!" and gears kinda grind.

The point is still valid that we don't know what bad scenarios may play out in the future. I agree that diversification is important, even if we sacrifice a bit of gain in order to reduce volatility. We also need to be as learned in our opinions and our asset allocations as we can, because a bad time will really try us, and we will probably need to be unreasonably sure of ourselves to stay the course we have chosen.

My Japanese protagonist invested 100% in equities is really, really rare, for example. I did a quick poke around to see if my impressions were way off, and after finding some articles like this link, I don't think I am. The average Japanese household's retirement savings is only about 6% in equities, compared with 32% for the US. They hold about 3% in bonds, and 55% (!!) in cash and deposits (earning maybe 0.1% annually).

So Hiro is a bit of a freak to begin with, and after a few years of horrid returns, his doubts about his plan are going to be very strong. If he makes the mistake of telling his parents and in-laws about his family's investments, they will gasp in shock. They will equate it with gambling their life savings on foreign exchange day trading. They will begin pressuring him to give up his crazy plan of buying so many stocks, for their daughter's sake, for their grandchildren's sake. He and his wife's resolves may falter, and they may decide that stock trading is best left for the professionals and switch their investments to cash savings, time deposits, some Japanese government bonds, and life insurance policies. Like everyone else.

Of course we know that he would do better to stay the course. Or even better, switch to a diversified plan with some bonds, some real estate, and some foreign stocks, and trust that the additional complexity and new risks will work out well for him. But he will want to be very, very quiet about what he is doing, and very, very sure of himself.

I completely agree and you're welcome. I just noticed that you're posting from Tokyo - so that's pretty cool.

Obviously I was choosing a worst case scenario and I definitely did not mean to say that it is something in the cards for American equities. I also agree that 100% equities is exceedingly rare. I'm taken aback by how few equities Japanese investors own - wow. I'm torn between being impressed and depressed by the American numbers. As you stated, people probably have real estate, some bonds, maybe REITs, etc. Hiro's portfolio would've looked way better and weathered the storm to a much greater degree had he been, say 80/20 and we included his home that I conveniently added at the end of the story.

Again, please rest assured that I wasn't playing the Japan card in the way that some people may have thought. I only wanted to pick yet another worst-case and recent scenario to test our collective psychology on dealing with prolonged downturns. Honestly, I think that if we get a 3+ year downturn we'll even see 'death of equities' posts around forums like this one, bogleheads, and others.

dungoofed

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Re: What will the next 10%+ correction look like?
« Reply #99 on: April 25, 2015, 06:46:43 PM »
One point about the Japan scenario, 55% in cash would likely have included Japanese housewives borrowing yen at zero interest rates to sell and purchase mainly AUD plus maybe a few other currencies (NZD/ZAR/TRY/etc). There have been several times since 1990 where a carry trade has paid massive returns if you were well-leveraged.

Also, until the introduction of the NISA product two years ago, Japan has not really had a good option for tax-sheltered investing. My question is, how much of the stock market "growth" in the US/Canada/Australia/UK/etc has been respectively due to schemes like IRAs/RRSPs/Superannuation/ISA/etc causing money to pile in?