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Crash math
Old 03-07-2017, 08:37 AM   #1
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Crash math

Has anyone actually calculated if or when you should turn everything to cash based on some informal probabilities? I read predictions that a correction would come in March, by the end of the year, and even next year. So, if you figure on the worst case scenario (being in cash for the longest time) and assume it's next year and you wait another month to liquidate and stay liquid for a year, then reinvest at some low point of your choosing, would you likely lose money? The assumption is that there will be a correction in that year's time. Your mission is to guess how low it will be when you reinvest and whether you'll likely save or lose money by doing this.
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Old 03-07-2017, 08:50 AM   #2
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At a first approximation: each year in cash 'costs' about 6%, assuming equities outperform by that amount typically. There is some historical evidence that supports this (long term return).

That puts the bar for going to cash pretty high. A typical correction is only 10%, so that's two years waiting time. Stay out for more than 5 years and well .. there you go. If you *know* equities will go negative within a year there is no other rational option than to go cash.

That's not how I look at it though: there is emotional regret factors, there are bonds and CDs, TIPS, peace of mind etc ..

What I do use currently as a 'panic' indicator is the inverted CAPE (currently about 3.3%) minus current inflation (2.5% last check). If that hits zero, I reduce equity exposure. So we're close, but not really there. It's short term indicator, and I'm still not 100% convinced it is fit for this purpose.
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Old 03-07-2017, 09:28 AM   #3
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At a first approximation: each year in cash 'costs' about 6%, assuming equities outperform by that amount typically. There is some historical evidence that supports this (long term return).

That puts the bar for going to cash pretty high. A typical correction is only 10%, so that's two years waiting time. Stay out for more than 5 years and well .. there you go. If you *know* equities will go negative within a year there is no other rational option than to go cash.

That's not how I look at it though: there is emotional regret factors, there are bonds and CDs, TIPS, peace of mind etc ..

What I do use currently as a 'panic' indicator is the inverted CAPE (currently about 3.3%) minus current inflation (2.5% last check). If that hits zero, I reduce equity exposure. So we're close, but not really there. It's short term indicator, and I'm still not 100% convinced it is fit for this purpose.
If you "know" equities will crash and when then put your money to shorting the market and make it grow. However, no one "knows" that as far as I'm aware.
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Old 03-07-2017, 09:31 AM   #4
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Originally Posted by Boho View Post
Has anyone actually calculated if or when you should turn everything to cash based on some informal probabilities? I read predictions that a correction would come in March, by the end of the year, and even next year. So, if you figure on the worst case scenario (being in cash for the longest time) and assume it's next year and you wait another month to liquidate and stay liquid for a year, then reinvest at some low point of your choosing, would you likely lose money? The assumption is that there will be a correction in that year's time. Your mission is to guess how low it will be when you reinvest and whether you'll likely save or lose money by doing this.
Well, first off you'd have to have suitable reasons for thinking a crash is going to happen. The "assumption" of a crash within a year is based on speculation and as such, isn't really worth anything. Even if it was a certainty because a time-traveler came and gave an investor a heads up without divulging any other information, the investor would still have to miraculously figure out the "bottom" on their own, which experience tells us is unlikely (based on the people who bailed and waited years into recoveries before putting their money back in the market). So, are they getting in at a "low" point or near the next high?
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Old 03-07-2017, 10:22 AM   #5
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Has anyone actually calculated if or when you should turn everything to cash based on some informal probabilities?
Yes. Never. Market timing does not work. You have to know when to get out and also when to get back in. You might get lucky sometimes but it is a long term loser.
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Old 03-07-2017, 10:40 AM   #6
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If the possibility of a stock crash worries you, keep enough of a "cash bucket" to covers a few years of expenses, then don't sell stocks until prices recover. A cash bucket is insurance against market crashes.
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Old 03-07-2017, 10:54 AM   #7
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I'm no expert, but looked into some classical signals a couple of years ago after much research online. I immediately realized that the recent FED zero interest rate policy (ZIRP) had distorted all the indicators. ZIRP created an artificial environment which didn't respond in normal ways to stimuli. Periods of cheap money and low inflation like we've seen have been very rare. We are expecting a return to normalcy, with the Fed's announcement of multiple rate increases later this year, but we heard the same thing last year. Until the Fed loosens their grip on the economy, none of the classical signs have any value as predictors.

Even if the signals were accurate, the timing would still be imprecise. You may miss out on large gains (like the last 3 months) or not know when the correction is actually underway and lose more than you want. You should adjust now, in a balanced manner, to keep your hand in and also protect somewhat against any downside. Hedges might be a good idea, but I don't really understand them well enough to risk anything on them.
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Old 03-07-2017, 10:59 AM   #8
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Sorry , my Crystal Ball cracked in the last market crash. Tried super glue, no luck.

So I just buy shares of Goldman on the dips, and sell some when I get nervous. Nearest thing to a money machine I have found.
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Old 03-07-2017, 12:03 PM   #9
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Last time I tried this, in 2007, I went to about 33% cash from all equities. The markets continued to rise 10% after that. I started buying back in when the market was down 20%. And -25% and -30% and -35% and -40% and a little at -50%. I didn't get a full buy at -50% because the market quickly rose above my target price and I was a little slow. At that point I was able to ride the market up, though after 6 months or so I had to start selling a little bit to raise cash for living expenses. Fairly successful overall, but I only captured a small part of the possible gains, and with only 33% of my portfolio. That was a lot of work for a little extra portfolio boost.

So yeah, you can do it. It works really well if you can recognize the exact top and bottom of what you're buying and selling. I was generally happy to hit tops and bottoms to within 15%, back when I tried. The easiest way to hit the bottom was to buy more each time the price dropped by 15% and then sell the excess on the way back up. I did that quite a bit, with some success, except when it didn't work, like Worldcom.

Large scale timing like that has its pluses and minuses, just like anything else. I'm pretty sure I did OK with it, but it wasn't a big jackpot that allowed me to RE. Now it seems like too much work to fuss with.
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Old 03-07-2017, 12:42 PM   #10
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And with taxes on capital gains I think the strategy really is a loser unless you do it all within your retirement account, in which you're gambling long term money on a short term strategy. Doesn't seem wise. Every study seems to suggest the better strategy is picking your asset allocation and rebalance to that once or twice a year ... and if a crash rebalances for you, history shows that time will also help
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Old 03-07-2017, 03:29 PM   #11
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In March of 2009 I was selling stuff...at the bottom.

In February of 2016 I was buying stuff...at the most recent near term bottom.

I like my older self better than my dumbass younger self.
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Old 03-07-2017, 04:13 PM   #12
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If you "know" equities will crash and when then put your money to shorting the market and make it grow. However, no one "knows" that as far as I'm aware.
Well, unless you're really, really good at rock, paper, scissors.
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Old 03-08-2017, 07:41 AM   #13
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No, market timing is a looser's game for most of us. I do wonder at what point after an irrationally exuberant rise it would make sense to call it a win and take a bunch of equities off the table. Lets say a trillion dollar infrastructure program coupled with a trillion dollar+ tax cut has a Keynsian effect and equities shoot up 50%+ over the next 12 months. For those of us who would find that less than half our portfolios would fund our needs for the foreseeable future would it be time to set up a TIPS ladder or equivalent and just set and forget the rest in equity indexes for our heirs? Rises greater than that occurred in 1999 and I suspect a lot of folks nearing retirement wish they had done something along those lines. Very hard recognizing when you have really won.
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Old 03-08-2017, 07:52 AM   #14
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No way. Been through too many market cycles. Whatever genius called the top or the bottom of one market typically never gets it right again.

I monitor my allocation and try and weed out poor performers regularly. A crash like the last one will hurt, especially since I'm not putting new money in, but I have the resources to wait it out.
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Old 03-08-2017, 08:19 AM   #15
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If the possibility of a stock crash worries you, keep enough of a "cash bucket" to covers a few years of expenses, then don't sell stocks until prices recover. A cash bucket is insurance against market crashes.
+1

This is my strategy. I have enough in cash to cover 5-7 years of withdrawals and avoid being forced sell stocks to meet my expenses. Sure I miss some investment gains to have that much in cash and not invested, but I just see that as the price of the insurance.
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Old 03-08-2017, 08:23 AM   #16
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I currently have a stop loss sell order under 1 of my stocks that has a PE of 60 Does that count as moving to cash? It is up nearly 100% with the dividend reinvestment. I also am looking at ways to protect a portfolio that has performed pretty nicely in the last 2-3 years.

The problem as I see it with not market timing somewhat is you can loose huge amounts of money during corrections. When your retired your withdrawal needs don't go down with the market.

So if you retire with $1,000,000 and a 4% withdrawal rate, you need $40,000 per year. If the market corrects 30% in year 1 and stays down for 2 years before moving back up. You will be retired on about $630,000 going into year 4 of retirement, with 26 years to go.

But then again others have said you have to be right twice to make it work.
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Old 03-08-2017, 09:11 AM   #17
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Rather than trying to outguess Mr Market's next move, I have a mental Stop Loss Order about 10% below the current price. If the SP500 drops 10% over the course of a week or two.....chances are there's been a shift in overall sentiment. A Chart with 50-day and 200-day Moving Average overlays is a helpful visual aid. The 10% figure keeps you from getting whip-sawed in and out.

I have a big chunk of my Equity Allocation in FSTVX, it can move to cash with one click. I call it our swing fund, and my AA can swing 30% if needed. DW owns some Blue Chip Stocks that are so far above her entry point that they good ballast for our overall portfolio.

The Trick is to build up gains such that a 10% give-back doesn't kill you.
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Old 03-08-2017, 10:59 AM   #18
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Rather than trying to outguess Mr Market's next move, I have a mental Stop Loss Order about 10% below the current price. If the SP500 drops 10% over the course of a week or two.....chances are there's been a shift in overall sentiment. A Chart with 50-day and 200-day Moving Average overlays is a helpful visual aid. The 10% figure keeps you from getting whip-sawed in and out.

I have a big chunk of my Equity Allocation in FSTVX, it can move to cash with one click. I call it our swing fund, and my AA can swing 30% if needed. DW owns some Blue Chip Stocks that are so far above her entry point that they good ballast for our overall portfolio.

The Trick is to build up gains such that a 10% give-back doesn't kill you.
So if I understand your strategy correctly, you sell at a 10% correction? Have you tried this in reality? I would be curious about the results.
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Old 03-08-2017, 11:23 AM   #19
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If you can successfully time the tops and bottoms with any level certainty, you need to start a fund, use other people's money so you can do it in a big way, and collect "2+20" for the effort. To exnavynuke's point, use leverage/options/shorts to really drive the gains.

History suggests you cannot do this, however. To the contrary, history suggests that at best you will under perform and more likely you will get trashed along the way. I'd suggest you tape a "do not click" sticker your mouse that reminds you to step away before you place the sell order to time the top.

If you need to scratch this itch, pull a small part of the portfolio to the side, bless it as gambling money and have at it. Just remember that successfully rolling a hard 8 doesn't mean you're better at craps than the next guy nor does it mean you should double you risk the next time you bet on the hard 8. its still a sucker's bet even if it pays off once in a while.

Good luck.
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Old 03-08-2017, 02:46 PM   #20
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I wouldn't suggest "timing" the beast. But instead of trying to predict the future moves of a random market......have an exit strategy if things get really ugly. I haven't had to go DefCon-1 lately. but I did avoid a substantial part of the 2008 haircut. Last February I had some money in transit from Vanguard to Fido so I was partially sheltered from that downturn as luck would have it.
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