The usual Mantra is BUY and HOLD even if your ass falls off! Then they go into some story about not being able to time the market. Just because YOU can’t time the market doesn’t mean the market isn’t time-able. The story goes “Oh the market fell and then Billy Bob sold, and now the market “recovered” and now he’s at a loss!” This isn’t how you time a market. How you time a market is, the market is high and I’ve made a lot of money, so maybe I should book some profit before the profit is lost.
There is some asymmetry to a market cycle. Early in the cycle there is mostly upside, late in a cycle there is ever increasing potential big time downside. At the end of a 12 year hyper-expansion there is MAJOR downside and not much upside. One thing to understand is as an investor you are really wall street’s sucker. Wall street wants to do one thing, sell you shit no matter what. The world is totally under water and the boobs on CNBC are quacking about green shoots. THAT crowd is paid to sell you shit. The Wall Street Journal is paid to sell you shit. Vanguard is paid to sell you shit and YOU are expected to buy shit no matter the asymmetry of the investment cycle, and no matter whether it’s healthy for your portfolio.
No matter that the rate of change of GDP has been slowing since Q4 of 2018 because that was the quarter acceleration peaked and turned to slow deceleration. It means yes there will be a higher high but a slowing higher high that’s bound and determined to become a major draw down.
We do simple calculations on our money, compounding calculations like this:
Here is a typical retirement portfolio. It starts at 50K, adds 50K/yr compounds at 6% and yields 3M bucks after 25 years. And we think that’s the ticket! 56% of our money comes from compounding. But wait that 6% needs to be in excess of inflation. If inflation averages 3% over the 25 years
Our 3M is really only worth 2M and we made only 33% on our money.
When you have a draw down how you get back to zero follows a formula Y=X + X*A.
Y = back to zero amount
X = starting amount after loss
A = % growth needed to get back to the start
L= % loss
So lets say you loose 10% on $100 how much do you have to compound to get back to $100?
100 = 90 + 90*.111, .111 = L/X = 10/90
So you have to compound an excess of 11.1% total ABOVE INFLATION over some period of time to get back to zero.
Let’s say you loose 30%.
100 = 70 + 70 *.428 to get back even ABOVE INFLATION. To calculate the % increase needed simply divide the starting point (in this case 70) into the % loss in this case 30. In other words L/X = 30/70 = .428. So you have to grow your money almost 43% above inflation to break even. Here is the sad truth
If you have $70 and need to grow it to $100 to break even and you have 3% inflation which yields only 3% of growth, it takes 12 years to get back to zero. Bet you never saw that on buy and hold CNBC. Bet you never saw that on some bogglehead web site. This is what you get with the old “you can’t time the market” mantra. It takes 12 years to get back to zero, with zero drawdown on the principal (say for retirement income). Lets say you correctly exit at a market top, say at $99 and the market falls 30% how long does it take to get back to $100 presuming you can time the market bottom. So the market falls from 100 to 70 and then you stick your 99 back in the market. How long does it take to get back to 100?
In one year you’re already $2 ahead. In the buy and hold case you’re $28 behind in one year
There is a saying
“The enemy of long term compounding is short term draw down.”
This analysis is a variation on a system control called a bang bang control analysis, where you model and optimize abruptly bounded conditions, like what if you loose 30% vs what if you loose 1%, how do you optimize those possibilities, solving for length of time to get back to zero. It assumes a steady 3% over inflation return. But even with those constraints it’s illustrative when Wall Street is trying top sell you FOMO, quick quick buy high it might go higher! Never mind 34M unemployed, never mind several years of projected negative GDP. Remember when you can’t identify the sucker, you are the sucker.