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Old 09-06-2021, 12:47 PM   #61
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Sure, the risk matrix is the common way of quantifying risk. https://en.wikipedia.org/wiki/Risk_matrix. And no, it doesn't result in a number, because it relies on the probability of a future event, which is not precisely known. Assigning a number would give a false sense of precision.


In a stock market downturn the prudent thing to do is to rebalance (sell stable or appreciated assets and buy more stock at the now lower price), not to sell stocks. On the one hand, this seems obvious, but on the other hand, the lower stock prices are precisely the result of more willingness to sell stocks, even at the lower price which is selling in a downturn.
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Old 09-06-2021, 01:24 PM   #62
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... a quantified measurement for your view of risk? ...
Just for reference, the genesis of the idea that volatility is risk is AFIK Harry Markowitz' 1952 paper, "Portfolio Selection," which was the first inkle of modern portfolio theory (MPT eventually earned him a Nobel). He had failed to find a quantitative measurement for risk and he needed one to do the mathematical analysis he wanted to do. So rather than explaining, he simply postulates: "We next consider the rule that the investor does (or should) consider expected return a desirable thing and variance of return an undesirable thing."

Starting with variance is kind of an odd pathway to "risk" equivalence because variances can be both positive and negative. But for him, an accurate prediction of return was the goal, so variance in either direction was the undesirable thing. (William Sharpe later patched over this up/down thing with his "Sharpe Ratio.")

To me risk is like Justice Potter Stewart's approach to pornography: "I know it when I see it." Risk is Enron, Theranos, Montgomery Ward, GE, Worldcom, Compaq, Kodak, etc. (Many times hindsight tells me that I have looked at risk without seeing it, but that is another thread.)

But @chassis, your implicit point, maybe a challenge, is that measuring risk quantitatively is difficult, maybe impossible. I agree but will be pleased if @SnowballCamper has one.

(@SnowballCamper identified the one place, though, where variance creates risk -- forced selling of volatile assets. SORR, in other words.)
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Old 09-06-2021, 02:58 PM   #63
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@OldShooter risk can be easily quantified. It depends on the definition of risk. It's a very broad topic that can and should be partly quantified. On the contrary, there is no implicit question, unless you manufactured the question yourself. Your posting style seems confrontational, seems to seek conflict and seems to propose words on behalf of others. It's OK, it doesn't bother me, my skin is pretty thick. But definitely something I have noticed and I think others have commented about your posting style as well.

The aspects of risk that I pay attention to in the investing world are in the next sentence.

I like standard deviation of return, max drawdown, downside capture ratio, value at risk and intra-portfolio correlation.

Examples you gave fall into fraud and mismanagement in my view. What about meteors hitting the earth? Serious question. What about airliners flying into tall buildings in a global financial center? What about a global panic lasting nearly 2 years?

Too many scenarios to identify, so let's boil it down to some quantified KPIs.
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Old 09-06-2021, 07:13 PM   #64
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I agree that there are too many high level scenarios to identify. The one scenario that matters to the individual investor is being forced to sell a depreciated asset in order to fund essential spending, or just running out assets in general. I'm not sure how the various KPIs that chassis mentions relate to those two events in a direct manner...even taken as a whole. They seem to me to be in line with "volatility is risk" thinking.

The classical statistical way to quantify a financial risk would be with an expected value (the average of the product of each each $$ outcome and its associated probability) but we quickly realize that single number is not very descriptive of the possible outcomes. Then a more robust approach would be to use the whole distribution of outcomes. But it turns out that we don't really know the distribution in many cases, or make shortcut assumptions so that the math is easier. This making shortcut assumptions is necessary for the individual investor, and indeed it is what everyone who uses FIREcalc does in interpreting the spaghetti graph of historical returns. We assume that the historical returns are an indicator of future results.

So how would snowball measure risk with a number? If forced to use a number, I would abandon the combination of event and probability, as the above paragraph describes the complicating math, and esoteric assumptions. My initial thought of how to measure personal financial risk is in units of $$:

Current Assets (to include vested pension & Social Security streams) - Market realized losses in the last downturn (maybe times 2 if under 50y/o) - Current annual average spending*(100-age)

The resulting number (if negative) is how much gain you need from investments (or work) in order to maintain current spending levels through one market downturn (or two) like the last one, and live to be 100. If the number is positive, then you can give all your market gains to charity.

This is a very crude measure, that ignores a lot, but I think it captures the essential idea of quantifying an individual's risk of running out of money before death. It does so in a most useful way, by telling you how much money you will need to come up with to maintain your current spending until age 100.

It doesn't rely on assumptions about market returns. But it does take into account the individual's portfolio performance in the last downturn. People tend to be slow to change behavior...

It does require the user to make assumptions in order to determine current assets, and about future spending, surely not too much of a cognitive load.

So this is just what I came up with in the last six hours since Oldshooter expressed interest. I make no claims about its validity, reliability, accuracy, etc. It was a nice thought experiment for me ;-)
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Old 09-07-2021, 09:07 AM   #65
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... So this is just what I came up with in the last six hours since Oldshooter expressed interest. I make no claims about its validity, reliability, accuracy, etc. It was a nice thought experiment for me ;-)
I think that's very insightful. I often argue that talking about AA without knowing the overall financial condition and goals of the investor is a bad idea. You're really adding that concept to the idea of risk. Makes sense to me. DW and I could take a pretty significant $$ risk without there being any practical risk of ruining us financially. Others maybe not so much.

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... Your posting style seems confrontational, seems to seek conflict and seems to propose words on behalf of others. It's OK, it doesn't bother me, my skin is pretty thick. ...
Sorry. I took the tone of your question as implying that you did not think quantifiable risk measures existed. I thought I was agreeing with you.

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... I like standard deviation of return, max drawdown, downside capture ratio, value at risk and intra-portfolio correlation.
I dunno. To me all of those are just riffs on the theme of volatility as risk.

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... Examples you gave fall into fraud and mismanagement in my view. What about meteors hitting the earth? Serious question. What about airliners flying into tall buildings in a global financial center? What about a global panic lasting nearly 2 years? ...
If I invest in a loser, I really don't care whether its demise was due to fraud, mismanagement, or its being taken out in some other way. Limiting the discussion to stocks, it would be very nice to have an algorithm that goes into alarm when it suspects fraud or mismanagement. It would also be interesting to see a study that tested whether measuring volatility was of any use in detecting stocks where investors lost a lot of money.
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Old 09-07-2021, 11:03 AM   #66
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@OldShooter I think risk as the term has been used on this site is too broad.

I have listed risk measures I like. They are mainly related to equity portfolio construction.

An infinite array of other risk kpis can be developed from the likelihood of slipping on a bar of soap in the shower, to remaining life expectancy to anything else you can think of.

What quantified measure do you like for risk?
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Old 09-07-2021, 02:45 PM   #67
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@OldShooter I think risk as the term has been used on this site is too broad.

I have listed risk measures I like. They are mainly related to equity portfolio construction.

An infinite array of other risk kpis can be developed from the likelihood of slipping on a bar of soap in the shower, to remaining life expectancy to anything else you can think of.
The question few ask or answer is, "Risk of what?" What adverse event do your KPIs measure the risk of? I looked them up on investopedia and such, but it isn't obvious to me.
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Old 09-07-2021, 03:36 PM   #68
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... What quantified measure do you like for risk?
I don't know that there is one or even a suite of several. That's why Markowitz had to pick a poor one. Maybe there could be test battery including one tool where volatility was used in identifying high fliers nearly certain to crash. One time for Tesla I made up a back-of-envelope business scenario that assumed a $700 stock price, existing # of shares outstanding, reasonable product margins, and a reasonable P/E. That produced a sales volume number requiring that Tesla have 100% worldwide market share in cars and light trucks. Playing with Ben Graham fundamentals numbers like that, maybe a Monte Carlo approach, might result in a predictive tool or tools.

But it's pretty clear that no one has a magic tool to identify and avoid risky stocks, including Markowitz. If someone did, they would be consistent winners in the markets year after year. And we donít see that. (Or maybe it is happening in secret. We can never rule that out.)

Absent a tool to identify risk, our best option is to diversify individual stock risk away and just accept market risk while riding on the long-term upwards market trend. IOW to ignore risk.

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The question few ask or answer is, "Risk of what?" ...
I would say that risk is choosing an investment that has an above-50% probability of losing significant money over a buy-and-hold time period, years. That's a little simplistic vs formal risk/probability/cost-to-mitigate type risk analysis but I think it's useful. P/E is often used as a tool to identify this kind of risk.
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Old 09-07-2021, 03:51 PM   #69
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If you have started "decumulation", just withdraw from each equity to bring it into balance again. No additional rebalancing needed.
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Old 09-07-2021, 03:54 PM   #70
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If you have started "decumulation", just withdraw from each equity to bring it into balance again. No additional rebalancing needed.
Just withdrawing annual expenses may not be enough to get back to the target AA.
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Old 09-07-2021, 03:57 PM   #71
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Just withdrawing annual expenses may not be enough to get back to the target AA.
then withdraw over a two year period.
OR consider the "three bucket" approach to retirement funds.
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Old 09-07-2021, 04:03 PM   #72
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then withdraw over a two year period.
OR consider the "three bucket" approach to retirement funds.
I don't see how that solves the problem.

Cash is part of fixed income. If you withdraw more than your expenses, you are rebalancing.
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Old 09-07-2021, 04:08 PM   #73
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I donít. The only thing I did recently is redo my Traditional IRAs and Roth IRAs to make sure that mostly all the stock funds are in the Roth and mostly all the bond funds are on the Traditional.
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Old 09-07-2021, 04:21 PM   #74
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I donít. The only thing I did recently is redo my Traditional IRAs and Roth IRAs to make sure that mostly all the stock funds are in the Roth and mostly all the bond funds are on the Traditional.

Iím similar but I have a secondary goal of achieving a specific split between Roth and traditional (I donít want to do Roth conversions). It takes a while but Iím close.
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Old 09-07-2021, 04:39 PM   #75
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The question few ask or answer is, "Risk of what?" What adverse event do your KPIs measure the risk of? I looked them up on investopedia and such, but it isn't obvious to me.
There is risk having to much cash, there is risk with to high of percent of equity. There is risk to being in the markets and there is a risk not being in the markets. I do agree "risk of what" and each person risk or what risk they feel is a risk to them.
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Old 09-07-2021, 04:50 PM   #76
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I don’t want to do conversions either but my FA said sometimes it makes sense to do the harder thing. I wanted to just start taking money from our traditional IRA’s.

He wants us to use our cash to live on until we take SS at age 70 ( we are 65 and 67) and do the Roth conversions while our income is low.
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Old 09-07-2021, 06:01 PM   #77
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I like to balance the cost of being conservative. For example: $1M portfolio of 50/50 versus 60/40. Assume stock performs 10% a year versus 7% a year for bonds which is a difference of 3%. The difference between $500K/$500K and $600K/$400K portfolio is $100K. Multiple $100K by 3% = $3000 a year of underperformance. The question is: Is sacrificing $3,000 a year of underperformance worth the additional safety of 50/50 versus 60/40? Over 10 years this is $30,000 which is the cost for a new midsize sedan. Are the benefits of being conservative worth it? Only the investor can answer that but at least the investor has a number to dwell in his decision making.
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Old 09-07-2021, 06:13 PM   #78
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Rebalancing is a way to manage risk. When it comes to investing there are really only two things we can control. One is portfolio expense and the other is risk.

Rebalancing does not lead to higher returns but it can contribute to a reduction in portfolio volatility, and this improves the portfolio survival rate. For many of us that is critical.
...I was waiting for someone to say this. I'm not into rebalancing quarterly or in a compulsive way as I can certainly stomach a fair amount of fluctuation from my desired allocation. And I don't re-balance as a "cheat" to time the market.

However, I think it's a matter of fooling yourself to act as though rebalancing hurts your "performance". To not rebalance is to keep whipping a runaway horse...stocks tend to outperform bonds over time so generally a portfolio will become higher in stocks and become riskier over time. So yes, if you don't rebalance you'll make more money but the point of it is to control risk by slowly selling/taking your "winners" off the table.

So yes, I'm likely sacrificing a bit of money - but supposedly to stabilize the risk I didn't originally want based on my original asset allocation I set for myself. If you want more stocks then ..."be honest" and get it the right way rather than letting your horse run at a full gallop.
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Old 09-07-2021, 07:49 PM   #79
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^^^
Without rebalancing, you could end up with a very high percentage in equities when you are 80 years old. If the market takes a big drop, or a long decline; what are the odds you would live long enough to see you equities regain their value?

I rebalance for that reason, though I'm not yet that old.
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Why rebalance in retirement?
Old 09-07-2021, 09:30 PM   #80
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Why rebalance in retirement?

See, now yíall have made me pull up Portfolio Visualizer to show that, as far back as that siteís data go, rebalancing or not rebalancing doesnít make hardly a dimeís worth of difference.

Blue line is a 60/40 portfolio thatís never rebalanced. Red line is a 60/40 balanced mutual fund that rebalances practically daily.

[ATTACH]
Currently, and very recently, stocks are on a run, but that could reverse the two lines back to even at any moment.
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