kitchen table math, the sequel: A loss is a loss

Sunday, September 27, 2015

A loss is a loss

x = opening balance, index fund
y = monthly deposit to index fund
z = 1 - % by which market has declined. (For example, if the previous balance was $100, and the market was down by 2%, z would equal 0.98.)



I mentioned a couple of weeks ago that Ed and I were trying to figure out what to do about our 401(k).

What we're told to do, and what we did do during the 17-month bear market of 2007-2009, is nothing.

That's John Bogle: "Don't do something. Just stand there."

That's what we did.

We stood there for the entire 17 months.

Worse than that: we continued to contribute money.

Ed finally took a close look at his Vanguard statement last week. Seven years later. He found that for the first several months of the bear market, his balance stayed the same.

Which meant that every penny he and NYU were putting into the fund, month after month after month, was instantly burned up in the market. Every penny. Not one survived.

Then at some point, presumably in October 2008, the account balances started going down. Which meant that not only was every new penny being burned up, but now the old pennies were being disappeared as well.

17 months of this.

We're not doing that again.


A paper loss is a real loss

The money we lost didn't come back.

New money came in.

That may sound like a distinction without a difference, but it's not.

The reason the market made such huge gains after 2011 was that the Fed did quantitative easing. If the Fed hadn't done quantitative easing, there was no reason for stocks to go back up. The Bank of Japan didn't do quantitative easing when they hit zero, and Japan's stock market declined for two decades, losing 3/4 of its value in that time.

This is America, and the Fed did do quantitative easing, so all things equal I assume they'll do it again if need be.

But I don't assume they'll do it before the market loses more than it has already. The Fed obviously wants, desperately, to tighten money, and tight money is bad for markets.

If, at some point during those 17 months, Ed and I had redirected his monthly deposits to a money market, we would be far ahead of where we are now.

We couldn't have timed the move exactly, of course. We would have sustained losses for a few months going into the bear market, and we would have missed the return of the bull market for a couple of months on the other side.

Doesn't matter. We'd still be far ahead because when we got back in we'd have had lots more to invest than we did when we got out. We've have had all the money we'd protected by putting it in a money market instead of the stock market.

The trend is your friend

The reason people like us are told to put our money in index funds and forget about it is that people like us can't time the market.

(I used to think no one could time the market, but a friend of mine, whose money is managed by Neuberger Berman, tells me she's been earning 1% above market returns, after fees, for years.)

It's true that I can't time the market.

But there's no trick to timing a market that goes down 17 months and loses 56% of its value. That's not a blip. It's a trend.

My new rule: if the trend is up, we're in the market. If the trend is down, we're not in the market. If the market is moving "sideways," which is more or less what it's doing now, we're also not in the market, but we're paying attention so as not to miss too much of the bull market when the bull market returns.

My Fed watching hobby helps with all this, needless to say.

Because the Fed is a monetary superpower.

5 comments:

Anonymous said...

"If, at some point during those 17 months, Ed and I had redirected his monthly deposits to a money market, we would be far ahead of where we are now.

We couldn't have timed the move exactly, of course. We would have sustained losses for a few months going into the bear market, and we would have missed the return of the bull market for a couple of months on the other side.

:

But there's no trick to timing a market that goes down 17 months and loses 56% of its value. That's not a blip. It's a trend."

If everyone knew at the beginning that the market was going to go down 56% in 17 months, it would be easy to know when to get out (and when to get back in).

Folks have looked for formulas for getting out and getting in for decades (if not centuries). Very few people have found a formula that works for future stock market activity.

If you *REALLY* want to know that your approach to getting out at the beginning of a downturn works (and that your approach to getting back in soon after the market goes back up), you'll want to create a formula/procedure/whatever (e.g. get out after a 10% dip, stay out until the market goes back up 10% from whatever low it hits) and then backtest it. This is more work than just looking back in hindsight and saying, "I could have done better." But it is much more rigorous.

My prediction is that if you don't go in knowing how things are going to play out, you won't be able to find a procedure that worked well for the last 50 years. Which means that your approach will do fine if we replicate the 2007/8 crash, but won't necessarily do well if the future doesn't look like that crash.

Good luck, because no matter what you do you are playing with real money!

-Regards,
Mark Roulo

linsee said...

What Mark said.

What you did is market timing in hindsight; you can't do it either at the beginning of a big slide or the beginning of a big rise, because you don't know it was the beginning (of either) until months later.

Try running your calculation with number of shares instead of dollar value, for what you actually did.

Then formulate a strategy for getting out and getting back in -- percent down and percent up, say -- and run that same number-of-shares calculation with that strategy. Make sure to try it with several different time frames; why 17 months? because (with hindsight) you know that was the relevant period. In 2007, you didn't know. For that matter, why start with 2007? Try your strategy starting in different years. For comparison, make sure to try it for comparable periods when interest rates are high and low.

Then do the whole exercise again with a dozen different strategies, and see which one is best.

(You could also try different mixes of mutual funds, and different currencies, but I suspect the point will have been made.)

I was teaching in Shanghai in 1987, when the Dow fell 500 points in a day -- from 2,200 to 1,700 -- and I couldn't do anything about it, so I just left things as they were. That was right, and it has continued to be right.



Catherine Johnson said...
This comment has been removed by the author.
Catherine Johnson said...

The other issue is that you're telling me to 'back test' and create formulas etc etc.

Nobody needed a formula for the Great Recession, which was a once-in-a-lifetime financial crisis, and that we knew was a once in a lifetime financial crisis as it was happening.

History can't be predicted via backtesting & formulas.

We were in an absolute disaster, and there was no reason to assume that the market was going to "snap back."

In fact, we didn't assume the market was going to snap back.

We knew we were losing money -- though we didn't realize how much -- and just thought there was a 'rule' that that's what we had to do.

Catherine Johnson said...

So are you seriously saying that each and every month, as we watched every penny we put into our index fund disappear the moment it hit the markets, we should have **put more in?**

That makes no sense whatsoever.

And, by the way, people *have* done these series & created stop-loss rules.

People like us just never hear about them.

The rule of thumb people who actually know what they're doing seems to be to sell after a 10% loss.

Which is exactly what we should have done.