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How much Downside Risk are you comfortable with?
Old 07-30-2005, 11:24 AM   #1
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How much Downside Risk are you comfortable with?

I realize everyones circumstances are different, but I am curious about how much downside volatility everyone is comfortable with in relation to their total investments, especially for those that are near retirement or in retirement??

For me, a loss > 5% in any one year would make me lose sleep at night.* I am currently 56 and would like to work another 3 years, but job situation might force RE at any time.* Given this, I am revisiting my retirement portfolio (all $ in IRA) to see if I can setup it up to kickoff 4-5% income annually, while minimizing downside risk to <5%.* Also, do not want to sell any assets to contribute to the income stream.* I am not sure whether this is being too conservative or not, but I just feel it is too hard to make up losses with anything more aggressive.*

Another question,* aside from designing a low volatility portfolio, what sort of stop loss strategy do you have in the event of another 911 or bubble bursting scenario?* Hold or sell.......

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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 11:36 AM   #2
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Re: How much Downside Risk are you comfortable with?

Good question and now that I have FIREd I also prefer to see my withdrawals to come from div/interest only. My income from that would be in the 3% range - and hopefully the divs and some of the interest(TIP) would keep up with inflation.

As for acceptable downside; 10% would hurt a bit (heck; even 1% does and I see it on a daily basis ) but 25% would make me uncomfortable. I would however not change anything/exit - not even in a 911 scenario as it would be too late anyway, and I would be exiting with all the sheeps, while the wolfs would be picking up my stuff at bargain prices.

Your target of 4-5% income from div/interest only with only a 5% downside risk might be a bit hard to manage - even a 100% FI/cash portfolio will have more than a 5% downside.

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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 11:47 AM   #3
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Re: How much Downside Risk are you comfortable with?

-27.325% down counting div stocks would start to make me a little nervious - UNLESS all current yield was above 4- 4.5% - in which case I mght do nothing - my duration on the bond side is about 4-5 years - so movement would be slow and deliberate.
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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 12:08 PM   #4
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Re: How much Downside Risk are you comfortable with?

At the end of each calendar year I go thru an exercise to prepare myself mentally for a drastic drop in equities. I take the massive spreadsheet that I use to track all my investments and I cut the price of all the stocks and stock mutual funds by 25%. The resulting total is something less than 25% below the current total due to my cash and other fixed income assets. Having seen the result, I am less likely to panic and sell equites if a big drop occurs since I know that my SWR will still support the lifestyle I currently have. While I would not be happy if equity markets fell 25%, I would not lose too much sleep over it because I have already gotten a level of comfort with that possibility.

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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 12:33 PM   #5
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Re: How much Downside Risk are you comfortable with?

Sorry all I am the same a DFW, If I lost 5 - 10% it would be a big thing to me. I would rather put up with the inflation loss, than risk too much downside. If I can get 5.5% I am usually happy, even with inflation taking a bite. Taxes are minimal for me so at the end of the day given the recent low inflation, I think if I come our 3% clear, I am happy. That happens to be my withdrawall rate. So my portfolio increases by the amount of inflation every year.

OK not so accurate down to the penny, but so long as I have my tax credits (for another 5 years) I may as well take the concervative approach, at least for now.

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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 12:55 PM   #6
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Re: How much Downside Risk are you comfortable with?

A 50% drop in stocks depending on where it put average div yield would make me 'very, very greedy' - at age 62 - perhaps not Warren Buffett's "like an oversexed teenager in a cat house" - but going 100% stock under such circumstances would be extremely tempting.
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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 01:41 PM   #7
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Re: How much Downside Risk are you comfortable with?

We have stomached a greater than 25% loss in VTSMX in less than a year. We did sell for the tax-loss and exchanged into SPY. We have been carrying forward that loss for 4 years now.

It seems to me that if you believe in index funds or ETFs for your asset allocation, you are pretty much committing to take a 25-35% downturn in stride.
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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 01:56 PM   #8
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Re: How much Downside Risk are you comfortable with?

None.
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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 03:00 PM   #9
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Re: How much Downside Risk are you comfortable with?

Well, I didn't sell any stock during the last downturn. I kept buying. My 401k declined for 3 years. Lost about a third of its value. It's recovered now. I am not retired though, so I don't think I would be a calm about it if I were
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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 03:33 PM   #10
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Re: How much Downside Risk are you comfortable with?

Quote:
Originally Posted by DFW_M5
I realize everyones circumstances are different, but I am curious about how much downside volatility everyone is comfortable with in relation to their total investments, especially for those that are near retirement or in retirement??

For me, a loss > 5% in any one year would make me lose sleep at night.* I am currently 56 and would like to work another 3 years, but job situation might force RE at any time.* Given this, I am revisiting my retirement portfolio (all $ in IRA) to see if I can setup it up to kickoff 4-5% income annually, while minimizing downside risk to <5%.* Also, do not want to sell any assets to contribute to the income stream.* I am not sure whether this is being too conservative or not, but I just feel it is too hard to make up losses with anything more aggressive.*

Another question,* aside from designing a low volatility portfolio, what sort of stop loss strategy do you have in the event of another 911 or bubble bursting scenario?* Hold or sell.......
Interesting how no one ever complains about upside volatility!

I can't help with the sleep factor, but you can plug numbers into FIRECalc and then keep reducing the size of the portfolio until the success % becomes unacceptably low. (Bernstein opines anything above 80% is irrelevant but you might pick 90%.) The reduction in the portfolio is the theoretical max volatility that you're comfortable with.

Between late 1999 & Oct 2002 we op-tested -40%. After retirement (June 2002) we rode it out with our two years of cash reserves and didn't replenish until late 2003. If things had dragged on longer then we would have been selling a few tax loss stocks but we wouldn't have had to go back to work. Buying in during the 2003 recovery (also a reversion to the mean!) was one of the foundations that brought us back to all-time highs this year.

I'm much more concerned about inflation than I am about volatility. Downside volatility only matters if you need to sell so we keep a couple years' cash on hand to ride out the majority of those declines. A properly diversified portfolio is much more likely to have winners that can be sold first if the losers are too "precious" to hold onto for a hopeful recovery. Lately we've been replenishing our cash stash from Tweedy, Browne (up another 0.25% on Friday) which also reduces the portfolio's expense ratio.

The price of lower volatility is lower returns. You pay for a low-volatility portfolio by needing to have a bigger one to support your expenses. A portfolio of 25x expenses will theoretically support a SWR for three decades, but invasion of principal will result and inflation will eventually win. If you live too long then you will definitely experience that late-in-life reduced-spending phenomenon that all those (still working) economists have noticed.

A super-safe portfolio would be one where all spending money comes from dividends and the underlying stocks are never sold. (I guess it'd work for bonds too, but they eventually mature.) The key is rising dividends (especially when the yield rises!). The DOW Dividend ETF may be part of such a portfolio but again you'll need to have a much bigger portfolio to support spending without invading principal. But it'll never run out!

I'd hesitate to sell any dividend-paying stock, and as Unclemick has pointed out I'd be tempted to buy more. (For example look at Pfizer.) I occasionally use a stop loss on individual stocks to protect a profit when I'm ready to sell, but I don't often do even that. Today's volatility is high enough to trigger even the most generous stops, and it's too easy for the market-maker to see the stops (despite brokerage assurances to the contrary) which leads to you being stopped out right at the day's low.

The day the stock market re-opened after 9/11, the Bass family was facing mammoth margin calls on their holdings and ended up dumping two MILLION shares of Disney. Everyone's sell stops leaped on that trend and the day's volume was about 10x average. The stock went from ~$24 to as low as $15 and recovered in the following six months. It was one of the best buys we ever made in a declining market...
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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 03:41 PM   #11
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Re: How much Downside Risk are you comfortable with?

I'd probably sweat a bit if I saw a 25% total portfolio loss, but I am pretty diversified by asset class and I don't live off the portfolio yet, so I am in a different place than those og you in drawdown.
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Re: How much Downside Risk are you comfortable with?
Old 07-30-2005, 09:25 PM   #12
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Re: How much Downside Risk are you comfortable with?

I fully expect to experience a -20% year or two at a minimum during retirement, and believe we'll take it right in stride using a variable withdrawal strategy similar to what SG outlined several months ago.

Many of out budget items are expenses that only occur every 3, 4, or more years...things such as auto & motorcycle replacement, some home maintenance/redecorating expenditures, Hawaiian vacations, etc. We'll simply defer those (when possible) until portfolio returns are at or above average.

Cb :P
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Re: How much Downside Risk are you comfortable with?
Old 07-31-2005, 10:03 AM   #13
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Re: How much Downside Risk are you comfortable with?

Those risk-profile questionnaires are no substitute for experience.* If there's anything good about the 2000-2003 markets it's that most of us got a real gut check on our tolerances & sleep habits.

I was at a living-trust sales talk seminar in late 2002 and the speaker asked people to approximate their risk profiles by deciding how much of a portfolio drop they could tolerate.

Those who'd been retired before 2000 (and were still retired!) were keenly aware of their risk profiles and exactly how much of a loss they could tolerate.* Most of them felt that they'd exceeded that % already...
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Re: How much Downside Risk are you comfortable with?
Old 07-31-2005, 11:36 AM   #14
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Re: How much Downside Risk are you comfortable with?

I just checked - ballpark -46% down in my individual stocks back in the little 2000- 2002 dip - BUT even that is muddy - cause I suffered a merger/cash spin off rash in the period - jumped a tax bracket involuntarily - AND, AND:

Remodel mania hit - so very little of the cash got put back.

After joining this forum in 2003 - I went back and checked the big dog Vanguard Lifestrategy mod - down -16.5% during the period for one quarter.

It was a hoot - that the market fluctuation was more - current $ wise - than the 200k I started ER(not counting her IRA) with in 1993.

I think the pucker factor dimishes with age. In 2003 - I was somewhat smug that I never hit my precalculated - 22.5% scenario.
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Re: How much Downside Risk are you comfortable with?
Old 07-31-2005, 12:04 PM   #15
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Re: How much Downside Risk are you comfortable with?

I'm 30% stocks, 70% bonds. My downside risk is whatever a 30/70 asset allocation historically dishes out. I don't want to sell stocks while they're down, and I doubt I will.

I retired early and for the past 3 years I've been taking income from dividends only, that's a ~3% withdrawal. I have a huge chunk in Sort Term Bonds which is down 1.5% since purchase, that's a lot of money but I try to look at the portfolio as a whole. The total portfolio is still growing at approx. 7% due to stocks, but I'm not counting inflation. I think I'm a little too chicken to spend more.
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Re: How much Downside Risk are you comfortable with?
Old 07-31-2005, 01:30 PM   #16
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Re: How much Downside Risk are you comfortable with?

Quote:
Originally Posted by Nords
. . .

Those who'd been retired before 2000 (and were still retired!) were keenly aware of their risk profiles and exactly how much of a loss they could tolerate.* Most of them felt that they'd exceeded that % already...
Investment advice always suggests you first determine your risk tolerance. Then invest accordingly. The problem with this advice is that it's hard to truely understand risk till the losses are real and affect you and your portfolio. I thought I understood my risk tolerance prior to 2000. But the experience taught me something about myself. I didn't panic and sell or anything, but I decided that I could afford to be a little more conservative and would feel better about it.
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Re: How much Downside Risk are you comfortable with?
Old 07-31-2005, 02:23 PM   #17
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Re: How much Downside Risk are you comfortable with?

DFW_M5,

Like Nords, I am much more afraid of inflation than I am paper losses--and they ain't real losses until you sell, remember!

Remember Oct, 1987? The world did not come to an end. The markets came back.

Vanguard has a page that I can get to when I log on (but I can't find out how a visitor can get to it) that may help. (See my attempt at a table, below.) It shows how various combinations of stocks and bonds (index funds, of course) have performed over time.

% stocks avg rtn yrs w/ loss best yr worst yr
0% 7.2% 5 31.1% -8.1%
20% 8.1% 5 28.6% -8.2%
30% 8.5% 5 27.4% -8.4%
40% 8.9% 6 26.1% -11.3%
50% 9.2% 8 27.8% -14.1%
60% 9.5% 11 29.6% -17.0%
70% 9.8% 12 31.3% -19.8%
80% 10.1% 12 33.2% -22.7%
100% 10.6% 12 38.5% -28.4%


I recommend that you go to this URL:
http://www.coffeehouseinvestor.com/
and read everything there (doesn't take long). This guy also has a small book out that has a few graphs that show how US markets have performed since the age of coal that will give you some perspective, too.

Here is my recent experience. I have not put anything into my big pot for years, so the numbers are unadulterated by new investment. From 12/01 to 03/03, the value dropped 21%. From 03/03 until today, it is up again +78% (or +41% from 12/01). I am 100% in stock by way of mutual funds, mostly index funds at Vanguard. My overall ratio of US/international (all accounts) is roughly 58%/42% (target 50/50, but I move slow).

All my stuff is in tax-deferred accounts. If any were in taxable accounts, I would be quite happy selling into losses for the tax deduction but turning right around and buying something very similar (be careful--there are rules about this) immediately. Fortunately, :P I don't have to worry about this problem.

If your funds are tax-deferred and for retirement, don't panic. You already have a long-term persective. The folks who lost big in Oct '87 (some in my family) were those who panicked, sold at the bottom and waited too, too long to get back into the market.

The US market has been under water for only a few periods as long as 10 years in a row. The real risk is being out of the market when it turns up again.

(Note: We are talking about "The Market" = S&P 500 index. If you put it all in Enron and Qualcom, or bought the lists of "Ten Stocks for the Next Millenium" [a real portfolio that was published in a financial magazine--true financial pronography--that lost ~75% of its value within the next year and never recovered], then God have mercy on you, bro, and we'll meet in the bread line.)

Not many start out with the nerve that it takes, and it takes a while to pick it up. It took me almost too long.

Be brave. Read more and gain confidence.

(Damn! I could charge for this advice!)

El Gitano,
Still offering faith-based investments--give your money to me and pray you can get it back.
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Re: How much Downside Risk are you comfortable with?
Old 07-31-2005, 02:25 PM   #18
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Re: How much Downside Risk are you comfortable with?

I would almost welcome a market drop right now. There will undoubtedly be market ups and downs. I'm still at the beginning of my investment career. If the market went down now, I could buy in the market at cheaper prices, allowing more growth long term. That being said, I would still lose a lot of money if the market drops. Drops of 40-50% wouldn't worry me, but would be looked at as a buying opportunity.

My long term strategy remains dollar cost averaging into a diversified portfolio of low cost funds.
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Re: How much Downside Risk are you comfortable with?
Old 07-31-2005, 06:51 PM   #19
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Re: How much Downside Risk are you comfortable with?

Thanks for the replies.* Just remember I was referring to downside risk for your "entire total portfolio", not just equities or individual asset classes/stocks.* I fully understand the impact of the up years, but I surely don't have the comfort that some of you have to weather so much downside deviation.* A 25% reduction in my total port in any one year would have me scurrying back to work; LOL!!!
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Re: How much Downside Risk are you comfortable with?
Old 07-31-2005, 08:33 PM   #20
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Re: How much Downside Risk are you comfortable with?

Quote:
Originally Posted by DFW_M5
Thanks for the replies.* Just remember I was referring to downside risk for your "entire total portfolio", not just equities or individual asset classes/stocks.* I fully understand the impact of the up years, but I surely don't have the comfort that some of you have to weather so much downside deviation.* A 25% reduction in my total port in any one year would have me scurrying back to work; LOL!!!
Very risk averse. However, if we lost 100% of our portfolio (not including residences)
and DW quit working, we could still make it work indefinitely. It's simple. Rent or sell
one residence and reverse mortgage the other. Then sit back and collect the SS.
A no=brainer! "Back to work"? Surely you jest.

JG
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