My daughter is a millionaire

[Sniper]

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You have zero of risk of loss in the stock market over multiple decades?

i think not...

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I think he meant total loss, ie Risk of Ruin.

[DesertCat]

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You have zero of risk of loss in the stock market over multiple decades?

i think not...

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Nope I meant any loss. Name for me one 20 year period in which a large stock index lost money.

[stinkypete]

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You have zero of risk of loss in the stock market over multiple decades?

i think not...

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Nope I meant any loss. Name for me one 20 year period in which a large stock index lost money.

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name five non-overlapping 20 year periods that resemble today's market and the markets of 50 years from now even remotely closely.

(i don't necessarily disagree with your conclusion, but that's a poor argument imo)

[IdealFugacity]

I'm a very firm believer in indexing and equity investing, as a search of my posts in this forum will very easily show (I am eagerly awaiting my post-college job to start in a few weeks so I can begin saving up emergency savings and my first Roth IRA contribution)

Despite this, I think it is very important for every investor, *especially* those posting advice in a forum which is still at least partially devoted to investing, to recognize that there is no truth to the statement "There is zero risk of loss..." when it comes to equity investing.

I don't feel like I am being nit-picky, either. I don't think it's possible to put a number on the risk of loss in the stock market over the next few decades/centuries, but I know I can rule out "0" and all numbers below it, as well as imaginary numbers [img]/images/graemlins/tongue.gif[/img]

Edit: This isn't to say we can't generalize risks of loss, which we know generally correlate with expected reward. I throw this in to stop off-topic responses questioning my respect or lack thereof for the validity of risk-return estimates people and institutions publish.

[DesertCat]

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[ QUOTE ]
You have zero of risk of loss in the stock market over multiple decades?

i think not...

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Nope I meant any loss. Name for me one 20 year period in which a large stock index lost money.

[/ QUOTE ]

name five non-overlapping 20 year periods that resemble today's market and the markets of 50 years from now even remotely closely.

(i don't necessarily disagree with your conclusion, but that's a poor argument imo)

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Well barring nuclear war I think I'm right. The returns of the stock market aren't a random walk over long periods, they are directly correlated to the profitability of the underlying businesses. It's possible that massive tax code changes (like a huge capital gains tax surcharge) could drive the average PE ratio down to single digits, but then companies would go back to paying large dividends.

Barring the election of Hugo Chavez as the U.S. President, it's hard to envision a country where the majority of people rely on the stock market for much of their pensions and retirement savings would allow tax code changes so severe against both capital gains and dividends that it leads to a negative stock market return over 20 years. The 1970s led directly to Ronald Reagan being elected with a pro market mandate.

For example I could ask for an example of negative stock market returns for a single decade, and someone would probably come up with the Dow Jones from 1929 - 1938, where it fell from 380 to around 100. But that would be ignoring 10 years of dividends over 5% per year that eliminated most of that loss. My guess is that broader indexes performed even better.

[Jeff W]

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[ QUOTE ]
You have zero of risk of loss in the stock market over multiple decades?

i think not...

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Nope I meant any loss. Name for me one 20 year period in which a large stock index lost money.

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Nikkei 225?

Inflation stacks the deck most of the time.

[Sniper]

Cat, isn't the real issue here that annual variance is essentially meaningless when viewed over a 65 year timeframe?

In other words, If it can be demonstrated that avg annual returns over the very long term for an equity index only port will beat avg annual returns for a mixed port, doesn't annual risk become meaningless? (simply because max risk does not create a RoR situation, even to a black swan event)

[DesertCat]

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[ QUOTE ]
[ QUOTE ]
You have zero of risk of loss in the stock market over multiple decades?

i think not...

[/ QUOTE ]

Nope I meant any loss. Name for me one 20 year period in which a large stock index lost money.

[/ QUOTE ]

Nikkei 225?

Inflation stacks the deck most of the time.

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Not yet, right now it's only down about 25% (from 24k to 17.5k) the last 20 years. I'm assuming that doesn't include dividend yield, if so the the last 20 years are likely solidly profitable. But in two years from now (38k in 1989) it's got a good chance of being still in negative territory even including dividends.

[DesertCat]

[ QUOTE ]
Cat, isn't the real issue here that annual variance is essentially meaningless when viewed over a 65 year timeframe?

In other words, If it can be demonstrated that avg annual returns over the very long term for an equity index only port will beat avg annual returns for a mixed port, doesn't annual risk become meaningless? (simply because max risk does not create a RoR situation, even to a black swan event)

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Yes, trying to make the argument that you have zero risk of loss over 20 years is overstating the case, it doesn't matter if the odds are zero or just tiny. Clearly you can never rule out hyperinflation, gross taxation changes, war, etc, all of which can also wreak havoc on bond returns.

The real argument is that beta is not very important over long periods (20 years +), maximizing your return is.

[DcifrThs]

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if so, then you are flat wrong. the main problem goes to how you are thinking about these things. it isn't like you're getting 10% return with equities and 8% return with bonds at the same level of risk. 10% return of equities is higher risk than 8% return of bonds.


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Over multiple decades the risk is the same. Because you have zero risk of loss with both approaches and don't have to use any leverage.

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to avoid this problem, you can simply leverage bonds to get to the same risk/return tradeoff as equities and thus get the diversification without sacrificing any of the returns.


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I can't do this, and wonder how you can.

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see my other post, but you can easily obtain leverage via the futures/forward market. you can less easily obtain leverage through the repo market.

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Specifically where can you borrow margin cheaper than the yields on the bonds you buy with it?

And even if you can overcome this obstacle, this approach has other problems. To max returns you have to stay heavily margined. So you are taking a huge risk of a black swan (an event outside your expected volatility ranges) hitting your windshield as you are driving 100 mph, and wiping you out.

Even if you can avoid this, you have the psychological problem that occurs when the market turns and your leveraged assets decline in value, increasing your leverage substantially. Even if your porfolio is built to ride out that storm (because it falls within historical volatility ranges), many investors can't deal with the stress and will sell their portfolio at the point of maximum losses.

Essentially LTCM (long term capital management) was built using similar theories (by guys who helped write those theories) and it worked for a few years until they hit a black swan and wiped out.

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wow, leverage to you must be avery very dirty word...or at least one you don't use often.

answer me this, what is more risky:

a) the Dow index

or

b) US 5 year Nominal bonds leveraged 2:1?

answer is a.

leverage doesn't equal RISK!!!!! there are two vastly different readings of leverage, 1) accounting leverage, and b) economic leverage.

i think you, and most people, get stuck on accounting leverage (aka, having more exposure to an asset than cash invested in that asset). economic leverage though is by far more important. a leveraged short duration bond, is less risky than the equity market. (by economic leverage, i mean taking into account the total amount of actual risk you are exposed through the use of acheiving a higher exposure to a security than the total amt of cash invested int hat security)

similarly, a leveraged 10 yr inflation linked bond is less risky than a nominal 30 yr bond (this is less clear b/c you don't accrue double inflation via a repo'd 10yr but it is still the case in terms of variation of total return)

these two examples reference economic leverage. not accounting leverage.

the event that falls out of historical volatility ranges that you draw parrallel to a huge bug htiting your windshield at 100mph is just not true. leverage by itself does not automatically increase your exposure to a black swan. what if i leverage a nominal bond 1.05:1? (this can be done by investing 100% of $X into a bond, then repo'ing that bond and taking the remaining cash and buying the same duration bond in a fund for 5% and taking the 95% of borrowed money- at the repo rate- and investing it in cash. NOTE: i've ignored some small costs here like the haircut & fees etc. but it is essencially the same)

in this case, this leveraged instrument is VASTLY less risky than a stock investment. and it isn't remotely close.

responsible use of leverage can REDUCE your exposure to black swan type events by diversifying your portfolio into economic buckets based on the basic drivers of the prices of risky assets, inflation and growth. you need leverage to give equal risk weight to the assets in the less easily acheivable buckets (high growth, high inflation; low growth, high inflation; high growth, low inflation; low growth, low inflation). this can be done at a fairly low cost...but you need leverage to do it.

LTCM was not responsible leverage. they had like 25 positions where LESS THAN a 1 standard deviation event would cripple the fund. they were gambling at the end, pure and simple. they had the same bet throughout their portfolio: holding risky assets & selling risk free assets (i.e. betting spreads would converge) accross every single market in every single section of their portfolio. what wiped them out was risk aversion. it just happened to come in the form of a black swan (asian criss + russian default caused huge drive to purchase treasuries & sell riskier bonds).

that could have occurred in many different forms and LTCM would have been wiped out.

that doesn't even mention the fact that they were massively invested in completely illiquid merger arb bets that they didn't have an expertise in.

i know it is easy to say with hindsight that LTCM was "asking for it." but many people there acknowledge that their risk controls were simply not there. any rudimentary VAR analysis would have concluded that they had too much invested via massive leverage in far too many positions. that wasn't done though for a number of reasons.

whew, SORRY for getting off on a massive tangent there but your point that leverage is dangerous by itself just gets to me (again, i apologize). intelligent and responsible use of leverage protects you, not hurts you.

basically, you'll never be more than 1.5-2:1 levered at any point. and you're only levering LESS RISKY assets to bring them to the EXACT SAME level of risk as the risky assets you hold (i.e. equities). you can adjust your portfolio to bring equities DOWN to the same level of risk as nominal 10 yr govt bonds and have the exact same portfolio, just lower returns but lower risk. by using leverage and a diversified portfolio, you can acheive the same risk target with way higher returns, OR the same return target with lower risk.

sorry again for the long post, and i know i babbled a lot but this is obviously a sore spot for me since i've had similar arguments with actual ignorant people (rather than you guys who are smart) and they never got it.

if i've been too harsh or unclear i promise to come back to this point soon and hash it out point by point since you all have been helpful to me.

i do hope that this post provides some base though from which we can work off w/o the harshness [img]/images/graemlins/blush.gif[/img]

again, im sorry. obviously nothing personal.

take care,
Barron