I’ve posted Entry #40 to my weekly Beyond Buy-and-Hold column at the Out of Your Rut site. It’s called You Should Be Rooting for Stock Prices to Fall.
Juicy Excerpt: Small changes in the patterns by which stock returns play out can make all the difference. Few of today’s investors know this and it is in my view one of the most important realities of stock investing.
In 1980, we saw a return of 15.76 percent. In 2008, we saw a return of a negative 39.29 percent. What if the returns for those two years were switched? What effect do you think that would have had on your goal of accumulating $1 million in assets before you turned 65?
Such a change wouldn’t have any effect on the 30-year annualized return at all. That number is 7.39 percent in both scenarios.
But experience the big loss in the early days of the 30-year time-period rather than in the later days of the 30-year time-period and you meet your $1 million portfolio goal easily rather than coming up $100,000 short. $1,611,164. That’s the final portfolio balance in the scenario where you take your big loss -early and one of your many nice gain years late.
what says
Your math is wrong wrong wrong. If the CAGR is 7.39 over 30 years the sequence does not matter. Calculating CAGR or annualized return does not even have input parameters for per year return sequences, it just needs start and end value.
After nearly a decade of mental masturbation one would assume you could figure that out…
Rob says
I think it would be fair to characterize your response as an emotional one, What. That should give you pause. Perhaps you are overlooking something.
You are correct that the sequence of returns makes no difference if you are dealing with a lump sum of money. I point that out in the article.
But few investors invest a lump sum and then never add to their portfolios. If you buy more stocks over time (as most of us do), the price you pay for those stocks obviously affects the result you obtain, regardless of what 30-year return applies.
You should do the math for yourself, What. I have done it many times during the days when the calculator was being developed and I had people with serious numbers skills check it out. If you have two scenarios in which the same 30-year annualized return applies but in which the returns sequence differs, you will get different end-point portfolio values if the investors are making annual contributions to their portfolios. The portfolio with early losses will do better, sometimes by a very large amount.
This is math, What. There are right and wrong answers. You are wrong.
Rob
what says
Uh ya, if you take a massive loss right before you end a time period it works that way. I am not sure what your point is. People cannot control when they start or stop working/saving. However, one would guess that if people took conventional/sane approach that they would own far less stocks at the end of a 30 year sequence of returns (as they are nearing retirement). Their loss would not be anywhere near 40% – maybe 20%. So…again I am not sure if you have a point at all.
If you can profess to predict when there will be a 40% drop in the market then please do so publicly on your site so we can all avoid it. All I have seen is random ‘the sky is falling’ nonsense here.
Rob says
I am not sure what your point is.
The point is that most investors (all except those close to retirement) should be rooting for price drops, not price gains.
Buy-and-Holders root for price gains. That’s Get Rich Quick thinking. You get that temporary thrill but it delays your retirement by many years.
I oppose Get Rich Quick, What. I oppose Buy-and-Hold. I favor data-based, research-supported strategies. I advocate Valuation-Informed Indexing.
Rob
Rob says
one would guess that if people took conventional/sane approach that they would own far less stocks at the end of a 30 year sequence of returns (as they are nearing retirement).
It depends, What.
What if stocks are selling at reasonable prices or at low prices? You wouldn’t want to lower your allocation too much in those circumstances, would you? We have never seen poor long-term results starting from low or moderate prices. So what purpose would that serve?
I certainly agree that you would want to lower your allocation if stocks were priced insanely high. But wouldn’t you want to lower your stock allocation when they were priced to crash even if you were not close to retirement? You could buy a lot more stocks after the crash, no?
Rob
Rob says
If you can profess to predict when there will be a 40% drop in the market then please do so publicly on your site so we can all avoid it.
That’s what The Stock-Return Predictor is all about, What. There’s a link to it under the “PassionSaving.com” banner to the left. It’s an amazing tool.
Rob
Rob says
All I have seen is random ‘the sky is falling’ nonsense here.
Huh?
The historical data and the academic research show that following Valuation-Informed Indexing strategies lets you retire five to ten years sooner than you could following Buy-and-Hold strategies. Those who retire early feel that the sky is falling? Not in my experience. My experience is that most people who learn how to retire early feel pretty darn good about it.
Leave it to a Buy-and-Holder to see things just the opposite of how they are!
It’s the Get Rich Quick mumbo jumbo that is making millions of people feel that the sky is falling. You know why? Because the sky really is falling for them. We should be providing those people with accurate and honest and realistic and life-affirming investing advice and doing all that we can to put this economic crisis behind us.
Get Rich Quick is not the answer, What. Get Rich Quick is the problem.
I’m sure of it!
Rob