35/65 portfolio during stock market crashes, 1871-2021

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Ben Mathew
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35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

I use Shiller's dataset to see how a 35/65 portfolio weathered stock market crashes. Shiller's data covers 150 years from 1871 to 2021. I converted Shiller's monthly data to annual data before doing the analysis.

Here's the real growth of $1 in 1871:

Image

Stock is S&P 500 including dividends.
Bond is 10 year US Treasury bond, held for a month and then rebalanced back to 10 year duration every month. Includes interest and price changes.
35/65 portfolio is rebalanced annually.

There are 7 notable stock market crashes over the last 150 years. Cumulative stock market loss

World War I (1916-'20): -41%
Great Depression (1929-'31): -53%
1937 Recession (1937-'41): -39%
Post World War II (1946-'47): -31%
Oil Crisis (1973-'74): -46%
Tech Crash (2000-'02): -39%
Subprime Crisis (2007-'08): -39%

The worst was the Great Depression at -53%.

Cumulative loss of a 35/65 portfolio during these crashes:

World War I (1916-'20): -38%
Great Depression (1929-'31): -4%
1937 Recession (1937-'41): -12%
Post World War II (1946-'47): -25%
Oil Crisis (1973-'74): -25%
Tech Crash (2000-'02): 3%
Subprime Crisis (2007-'08): 1%

Interestingly, the zagging of bonds in a 35/65 portfolio would have erased stock losses during the Great Depression, the Tech Crash and the Subprime Crisis. It would also have reduced the impact of the 1937 recession (-39% reduced to -12%) and the Oil Crisis (-46% reduced to -25%). The worst period for 35/65 was World War I (-38%) when bonds did poorly. Bonds also didn't help much in the post World War II crash (-31% reduced to -25%).

For investors with a balanced 35/65 portfolio, the worst period was not the Great Depression but World War I.

There's also an interesting period from 1977-'81 where the stock market loses only 10%, but 35/65 portfolio does badly (-26%) because of bonds (-35%).

Shillers data is from his spreadsheet "US Stock Markets 1871-Present and CAPE Ratio," available here.
My spreadsheet with this analysis here.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Thesaints »

Interesting. The average return over those 150 years would be about:
6.5% all stocks
3% all bonds
4.6% 35/65

So, with an allocation of less than 50/50 you still would have got about the average return of stocks and bonds. The power of rebalancing, I guess.
Would you be able to calculate the yearly volatilities of the three allocations ?
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Blue456 »

Ben Mathew wrote: Tue May 11, 2021 7:31 pm I use Shiller's dataset to see how a 35/65 portfolio weathered stock market crashes. Shiller's data covers 150 years from 1871 to 2021. I converted Shiller's monthly data to annual data before doing the analysis.

Here's the real growth of $1 in 1871:

Image

Stock is S&P 500 including dividends.
Bond is 10 year US Treasury bond, held for a month and then rebalanced back to 10 year duration every month. Includes interest and price changes.
35/65 portfolio is rebalanced annually.

There are 7 notable stock market crashes over the last 150 years. Cumulative stock market loss

World War I (1916-'20): -41%
Great Depression (1929-'31): -53%
1937 Recession (1937-'41): -39%
Post World War II (1946-'47): -31%
Oil Crisis (1973-'74): -46%
Tech Crash (2000-'02): -39%
Subprime Crisis (2007-'08): -39%

The worst was the Great Depression at -53%.

Cumulative loss of a 35/65 portfolio during these crashes:

World War I (1916-'20): -38%
Great Depression (1929-'31): -4%
1937 Recession (1937-'41): -12%
Post World War II (1946-'47): -25%
Oil Crisis (1973-'74): -25%
Tech Crash (2000-'02): 3%
Subprime Crisis (2007-'08): 1%

Interestingly, the zagging of bonds in a 35/65 portfolio would have erased stock losses during the Great Depression, the Tech Crash and the Subprime Crisis. It would also have reduced the impact of the 1937 recession (-39% reduced to -12%) and the Oil Crisis (-46% reduced to -25%). The worst period for 35/65 was World War I (-38%) when bonds did poorly. Bonds also didn't help much in the post World War II crash (-31% reduced to -25%).

For investors with a balanced 35/65 portfolio, the worst period was not the Great Depression but World War I.

There's also an interesting period from 1977-'81 where the stock market loses only 10%, but 35/65 portfolio does badly (-26%) because of bonds (-35%).

Shillers data is from his spreadsheet "US Stock Markets 1871-Present and CAPE Ratio," available here.
My spreadsheet with this analysis here.
It would be interesting to see 50:50 portfolio.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by TheoLeo »

I wonder if a bit of gold would have helped much in these post war episodes where bonds didnt help.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Thesaints wrote: Tue May 11, 2021 7:41 pm Interesting. The average return over those 150 years would be about:
6.5% all stocks
3% all bonds
4.6% 35/65

So, with an allocation of less than 50/50 you still would have got about the average return of stocks and bonds. The power of rebalancing, I guess.
Would you be able to calculate the yearly volatilities of the three allocations ?
After converting to log returns:

Expected log return:

Stocks: 6.8%
Bonds: 2.7%
35/65 portfolio: 4.5%

Standard deviation of log returns:

Stocks 17.2%
Bonds 8.5%
35/65 portfolio: 8.9%

So, yes, the 35/65 portfolio gave significantly higher return than 100% bonds for just a little bit more volatility. A portfolio with 100% 10 year bonds (non duration matched) was not a good proposition.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Blue456 wrote: Tue May 11, 2021 7:49 pm It would be interesting to see 50:50 portfolio.
Here's the graph for 50/50:

Image

World War I (1916-'20): -38%
Great Depression (1929-'31): -17%
1937 Recession (1937-'41): -19%
Post World War II (1946-'47): -26%
Oil Crisis (1973-'74): -22%
Tech Crash (2000-'02): -8%
Subprime Crisis (2007-'08): -9%

The Great Depression is now palpable at -17%, though World War I remains the worst at -38%
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

TheoLeo wrote: Tue May 11, 2021 7:54 pm I wonder if a bit of gold would have helped much in these post war episodes where bonds didnt help.
Unfortunately, Shiller's spreadsheet did not have data on gold.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Thesaints »

Well, gold would have been "cash" until 1933 and fixed price until 1971.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by sandan »

Ben Mathew wrote: Tue May 11, 2021 7:56 pm
Standard deviation of log returns:

Stocks 17.2%
Bonds 8.5%
35/65 portfolio: 8.9%

So, yes, the 35/65 portfolio gave significantly higher return than 100% bonds for just a little bit more volatility. A portfolio with 100% 10 year bonds (non duration matched) was not a good proposition.
modern portfolio theory still amazes me no matter how many times I see it. somehow it is also consistent with physics.

this reminds me to keep some stock in various types of tax advantaged accounts.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by dogagility »

Thanks, but did I miss something? Is there a point or a conclusion to this analysis? Trying to understand why the thread was started.
The more flexibility you have the less you need to know what happens next. -- Morgan Housel
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Blue456 »

dogagility wrote: Wed May 12, 2021 4:37 am Thanks, but did I miss something? Is there a point or a conclusion to this analysis? Trying to understand why the thread was started.
150 years of data :)
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ependytis »

dogagility wrote: Wed May 12, 2021 4:37 am Thanks, but did I miss something? Is there a point or a conclusion to this analysis? Trying to understand why the thread was started.
The post lets investors know what losses to expect under the worst case scenarios in the last 150 years. Thanks to the OP. For me, it puts things into perspective. Meaning I should not worry so much if I have enough.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by SquawkIdent »

Thanks OP for doing all that work.

Enlightening...

Maybe why Wellesley (VWINX and VWIAX) is so popular.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Blue456 »

Ben, would it be possible to add 30% or 40% ex-US?
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by tennisplyr »

Thanks for the work.
Those who move forward with a happy spirit will find that things always work out.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

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FinishLine
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by FinishLine »

Great information! I am at 35/65 so this is a nice validation. I generally sleep well at night :-)
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Valuethinker »

Ben Mathew wrote: Tue May 11, 2021 7:31 pm I use Shiller's dataset to see how a 35/65 portfolio weathered stock market crashes. Shiller's data covers 150 years from 1871 to 2021. I converted Shiller's monthly data to annual data before doing the analysis.

Here's the real growth of $1 in 1871:

Image

Stock is S&P 500 including dividends.
Bond is 10 year US Treasury bond, held for a month and then rebalanced back to 10 year duration every month. Includes interest and price changes.
35/65 portfolio is rebalanced annually.

There are 7 notable stock market crashes over the last 150 years. Cumulative stock market loss

World War I (1916-'20): -41%
Great Depression (1929-'31): -53%
1937 Recession (1937-'41): -39%
Post World War II (1946-'47): -31%
Oil Crisis (1973-'74): -46%
Tech Crash (2000-'02): -39%
Subprime Crisis (2007-'08): -39%

The worst was the Great Depression at -53%.

Cumulative loss of a 35/65 portfolio during these crashes:

World War I (1916-'20): -38%
Great Depression (1929-'31): -4%
1937 Recession (1937-'41): -12%
Post World War II (1946-'47): -25%
Oil Crisis (1973-'74): -25%
Tech Crash (2000-'02): 3%
Subprime Crisis (2007-'08): 1%

Interestingly, the zagging of bonds in a 35/65 portfolio would have erased stock losses during the Great Depression, the Tech Crash and the Subprime Crisis. It would also have reduced the impact of the 1937 recession (-39% reduced to -12%) and the Oil Crisis (-46% reduced to -25%). The worst period for 35/65 was World War I (-38%) when bonds did poorly. Bonds also didn't help much in the post World War II crash (-31% reduced to -25%).

For investors with a balanced 35/65 portfolio, the worst period was not the Great Depression but World War I.

There's also an interesting period from 1977-'81 where the stock market loses only 10%, but 35/65 portfolio does badly (-26%) because of bonds (-35%).

Shillers data is from his spreadsheet "US Stock Markets 1871-Present and CAPE Ratio," available here.
My spreadsheet with this analysis here.
Whoosh.

There was a stockmarket crash in the early 1870s.

Grant Cutler went broke. That should be in that data?

The depression thereafter was at least as bad as 1929-33.

Also the period 1966-81 saw negative real returns for stocks of c 40%.

You have to look at real returns not just nominal.

And there was the UK market crash in the mid 70s. -80% real.

And there is of course Japan, if we want to scare ourselves.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

sandan wrote: Tue May 11, 2021 9:15 pm
Ben Mathew wrote: Tue May 11, 2021 7:56 pm
Standard deviation of log returns:

Stocks 17.2%
Bonds 8.5%
35/65 portfolio: 8.9%

So, yes, the 35/65 portfolio gave significantly higher return than 100% bonds for just a little bit more volatility. A portfolio with 100% 10 year bonds (non duration matched) was not a good proposition.
modern portfolio theory still amazes me no matter how many times I see it. somehow it is also consistent with physics.

this reminds me to keep some stock in various types of tax advantaged accounts.
Here's a graph that captures this more fully. Having less than about 30% stocks using this strategy was not attractive from a risk/reward perspective.

Image

Note that this conclusion only applies to holding bonds in this way -- i.e. not inflation-adjusted or duration matched so there is still risk in bonds. Holding 100% duration matched TIPS would be okay. The annual bond returns would still show volatility, but there would be no consumption risk because price changes would exactly offset yield changes.
Last edited by Ben Mathew on Wed May 12, 2021 12:55 pm, edited 1 time in total.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Blue456 wrote: Wed May 12, 2021 6:28 am Ben, would it be possible to add 30% or 40% ex-US?
Unfortunately, Shiller does not have ex-US data. I don't think there is any ex-US data that goes that far back. If there is a reliable source, I would be interested as well.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Thanks.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Blue456 »

Ben Mathew wrote: Wed May 12, 2021 11:28 am
Blue456 wrote: Wed May 12, 2021 6:28 am Ben, would it be possible to add 30% or 40% ex-US?
Unfortunately, Shiller does not have ex-US data. I don't think there is any ex-US data that goes that far back. If there is a reliable source, I would be interested as well.
Rational Reminder podcast not to long ago had an episode on rolling 30 year returns of single country vs total world between 1900-2020. That’s the best info I got.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Valuethinker wrote: Wed May 12, 2021 7:59 am You have to look at real returns not just nominal.
Yes, these are all real returns.
Valuethinker wrote: Wed May 12, 2021 7:59 am There was a stockmarket crash in the early 1870s.

Grant Cutler went broke. That should be in that data?

The depression thereafter was at least as bad as 1929-33.
The nominal price shows a 36% decline from 1873-1877. But that is mostly offset by the 29% deflation during the same period. Dividend yields were about 7% per year. So that's about 35% in real dividends over the period. Between the deflation and the dividends, the real return ended up being 28%.
Valuethinker wrote: Wed May 12, 2021 7:59 am Also the period 1966-81 saw negative real returns for stocks of c 40%.
The data shows a 20% decline from 1966-81. This period includes the 1973-74 crash of 46% that I included in the list of crashes.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Valuethinker »

Ben Mathew wrote: Tue May 11, 2021 7:31 pm I use Shiller's dataset to see how a 35/65 portfolio weathered stock market crashes. Shiller's data covers 150 years from 1871 to 2021. I converted Shiller's monthly data to annual data before doing the analysis.

Here's the real growth of $1 in 1871:

Image

Stock is S&P 500 including dividends.
Bond is 10 year US Treasury bond, held for a month and then rebalanced back to 10 year duration every month. Includes interest and price changes.
35/65 portfolio is rebalanced annually.

There are 7 notable stock market crashes over the last 150 years. Cumulative stock market loss

World War I (1916-'20): -41%
Great Depression (1929-'31): -53%
1937 Recession (1937-'41): -39%
Post World War II (1946-'47): -31%
Oil Crisis (1973-'74): -46%
Tech Crash (2000-'02): -39%
Subprime Crisis (2007-'08): -39%

The worst was the Great Depression at -53%.

Cumulative loss of a 35/65 portfolio during these crashes:

World War I (1916-'20): -38%
Great Depression (1929-'31): -4%
1937 Recession (1937-'41): -12%
Post World War II (1946-'47): -25%
Oil Crisis (1973-'74): -25%
Tech Crash (2000-'02): 3%
Subprime Crisis (2007-'08): 1%

Interestingly, the zagging of bonds in a 35/65 portfolio would have erased stock losses during the Great Depression, the Tech Crash and the Subprime Crisis. It would also have reduced the impact of the 1937 recession (-39% reduced to -12%) and the Oil Crisis (-46% reduced to -25%). The worst period for 35/65 was World War I (-38%) when bonds did poorly. Bonds also didn't help much in the post World War II crash (-31% reduced to -25%).

For investors with a balanced 35/65 portfolio, the worst period was not the Great Depression but World War I.

There's also an interesting period from 1977-'81 where the stock market loses only 10%, but 35/65 portfolio does badly (-26%) because of bonds (-35%).

Shillers data is from his spreadsheet "US Stock Markets 1871-Present and CAPE Ratio," available here.
My spreadsheet with this analysis here.
https://en.wikipedia.org/wiki/Panic_of_1873

something wrong. The depression which followed the 1873 stock market crash was at least as bad as 1929-1933.

There's an issue with the data.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Valuethinker wrote: Wed May 12, 2021 12:11 pm https://en.wikipedia.org/wiki/Panic_of_1873

something wrong. The depression which followed the 1873 stock market crash was at least as bad as 1929-1933.

There's an issue with the data.
See post above for why the data is not showing a decline in 1873-77

You can see the nominal data with the recession highlighted at FRED. It's the same data source that Shiller uses (Cowles).
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Valuethinker »

Ben Mathew wrote: Wed May 12, 2021 12:24 pm
Valuethinker wrote: Wed May 12, 2021 12:11 pm https://en.wikipedia.org/wiki/Panic_of_1873

something wrong. The depression which followed the 1873 stock market crash was at least as bad as 1929-1933.

There's an issue with the data.
See post above for why the data is not showing a decline in 1873-77

You can see the nominal data with the recession highlighted at FRED. It's the same data source that Shiller uses (Cowles).
Thank you. Sorry that I missed your reply.

I do think the experience of a nominal fall in the market (which is moderated by price deflation) is a different one than that of a real fall in the market (which is moderated by higher inflation).

A major reason, besides psychological, may be that liabilities are denominated in nominal terms. You still owe what you owe. So a -60% fall in the nominal level of something, which is only -40% in real terms, is going to hurt like a -60% fall in something.

Conversely the 1970s bear market was largely about treading water in stocks (but with plenty of volatility) whilst the world went to heck and a handbasket in other ways. Eventually leading to a total loss of confidence in stocks (and in bonds).
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by ShaftoesSpreadsheet »

Nice work, thanks for sharing.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Thesaints »

Valuethinker wrote: Wed May 12, 2021 12:39 pm A major reason, besides psychological, may be that liabilities are denominated in nominal terms. You still owe what you owe. So a -60% fall in the nominal level of something, which is only -40% in real terms, is going to hurt like a -60% fall in something.
That is true only for liabilities already incurred, of course.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by jginseattle »

This is of particular interest to me because I'm very close to the 35/65 allocation.

Thanks!
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Kevin K »

Thanks OP for this very interesting thread.

While the 10 year Treasury bond is a benchmark I've always read that 5 year ITT's have historically offered the optimum risk:return. On the other hand, using the 10's puts the duration pretty close to what Wellesley uses for its corporate bond holdings.

Since both gold and Wellesley have been mentioned I thought I'd share this chart on the historical performance (albeit only since 1970) of 80% Wellesley, 20% gold. The CAGR, drawdowns and safe withdrawal rates are impressive. That said, it sure seems like the 40 year tailwind for bonds is over and I can't imagine any portfolio with 60% or more in bonds offering remotely similar returns or downside protection going forward.

https://www.gyroscopicinvesting.com/for ... 96#p206084
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Volando »

I want to ask a question about this but I'm not sure if I can articulate what I'm trying to ask. I'll give it a go anyway. I've been trying to get into the mindset of someone who starts adding bonds early on during accumulation (relevant to another ongoing thread too). There's several rules of thumb that would cause some to consider adding bonds, even if its a bare minimum of 25%, at earlier stages of life. Looking at this data as well as some scenarios I've run in portfolio visualizer with different allocations, it seems that the person who chose to start at 100% equities is better off, even in the worst case scenario. The worst drop listed was the great depression, with a drop of 53% in stocks while the 35/65 almost negated that loss. However, for someone who started early at 100/0 they still had more money left over than the person who experienced less loss but had less to begin with. I noticed this same trend when comparing the history of vanguard's total stock market with various bond allocations in the total bond market fund (see here: Portfolio Visualizer). In this data, comparing 100% total stock market with 60/40 (TSM and total bond fund). In this scenario, even between 2007-2009 at the worst draw-down the total remaining amount was about the same.

So my question: For those in accumulation (**NOT** for those who already have substantial wealth to preserve), what benefit did those bonds provide that were added in early? Even in the event that one would have to start spending that money due to a personal catastrophe, the 100/0 would still have either more or a similar amount of money as someone who added bonds in early. So it doesn't appear to me that they would have been any better off adding those bonds in. Then, if they're able to hang on through the storm and come out the other end, their opportunity for growth is substantially more if they held on to a 100/0 portfolio.

I'm sure that I'm oversimplifying here and missing huge parts of this discussion so let me know where I'm wrong!
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by secondopinion »

Volando wrote: Thu May 13, 2021 12:56 pm So my question: For those in accumulation (**NOT** for those who already have substantial wealth to preserve), what benefit did those bonds provide that were added in early? Even in the event that one would have to start spending that money due to a personal catastrophe, the 100/0 would still have either more or a similar amount of money as someone who added bonds in early. So it doesn't appear to me that they would have been any better off adding those bonds in. Then, if they're able to hang on through the storm and come out the other end, their opportunity for growth is substantially more if they held on to a 100/0 portfolio.
Matching liabilities and having superior principal protection are conflicting goals when it comes to bonds.

In the former case, most people in early accumulation are not retiring before even a 30 year bond matures; liability matching is just not going to be helpful. To the risk adverse, the latter is the only acceptable alternative. To those not risk adverse, 100% stocks is perfectly acceptable if the investment timeframe is greater than 30 years. Different recommendations based on how many there is assumes that the person will retire earlier and have a shorter investment timeframe (but some stocks are recommended since some of the portfolio is for expenses more than 30 years away).

When liabilities can start being matched, then bonds acquire their second use. At this point, bonds have a strong argument to be included. But those who can shift their timeframe further out (that their liabilities are optional) can afford to take more risk.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Volando wrote: Thu May 13, 2021 12:56 pm Looking at this data as well as some scenarios I've run in portfolio visualizer with different allocations, it seems that the person who chose to start at 100% equities is better off, even in the worst case scenario. The worst drop listed was the great depression, with a drop of 53% in stocks while the 35/65 almost negated that loss. However, for someone who started early at 100/0 they still had more money left over than the person who experienced less loss but had less to begin with.
This depends on how you estimate the relevant probabilities. Here's a graph showing 30 year returns of stocks vs bonds using the above data:

Image

Stocks outperformed bonds every single time.

So what can we conclude about the probability (P) of bonds outperforming stocks ? If you conclude that P=0 because it never happened in this data, then it makes sense to conclude that for goals with horizon >= 30 years, there is no reason to hold bonds. Stocks will always outperform.

But the problem is that this is not a lot of data points. 150 years is still only 5 separate 30 year periods. The profusion of dots you see are coming off the same underlying annual data. Each period is just slightly different from the period before and after it. So maybe bonds will actually outperform once in a while. It simply may not have shown up in our data.

So then is there any other way of estimating the probability the bonds will outperform stocks over 30 years? Indeed there is. If you are willing to assume that the annual returns are independent, you could simulate thousands of paths using the 150 annual draws that we have. And some of those paths will be very very bad for stocks. If you are unlucky enough, you can get stocks doing as badly as the worst year of the great depression every single year. So averaging across all these simulations, we will get some nonzero probability that stocks will do really badly, and bonds helped tremendously. That gives you the reason to hold bonds over long horizons.

Some math can show that if returns are independent and you have constant relative risk aversion, you will want to hold the same fixed allocation across all horizons. So for example, if you're risk averse, you'll hold say a 30/70 allocation over both your 5 year and your 50 year goals. And if you're less risk averse, you'll hold say 60/40 for both horizons. The allocation you choose depends on your risk aversion, but not the horizon.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by abuss368 »

I was surprised that World War 1 was lower than the Great Depression.

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Re: 35/65 portfolio during stock market crashes, 1871-2021

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Ben Mathew wrote: Tue May 11, 2021 7:56 pm So, yes, the 35/65 portfolio gave significantly higher return than 100% bonds for just a little bit more volatility. A portfolio with 100% 10 year bonds (non duration matched) was not a good proposition.
Correct. Ergo, to the extent that investors expect the future to resemble the past, an AA close to 35/65 (maybe 25/75) should be considered the most conservative logical allocation.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by abuss368 »

jginseattle wrote: Wed May 12, 2021 2:48 pm This is of particular interest to me because I'm very close to the 35/65 allocation.

Thanks!
This is the allocation my folks retired with and have maintained. In reality it has been closer to 40% stock and 60% bonds. The Target Retirement fund from Vanguard settles at 30% stock and 70% bond.

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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Volando »

Thank you for this. It was informative and gave me more to ponder. I'm wondering about a few things you mentioned. Had a long day so some of this may not be as coherent as I'd like. I hope none of this comes across as anti-bond or anti-conservative portfolio. I'm just trying to understand what was presented and challenge my own assumptions.
Ben Mathew wrote: Thu May 13, 2021 7:51 pm But the problem is that this is not a lot of data points. 150 years is still only 5 separate 30 year periods. The profusion of dots you see are coming off the same underlying annual data. Each period is just slightly different from the period before and after it. So maybe bonds will actually outperform once in a while. It simply may not have shown up in our data.
I can see how 150/30 = 5. But in reality wouldn't you have a much larger number of 30 year periods if you delved a little deeper? I believe the chart you shared has 121, 30 year periods. Further is this data only limited to annual data or can we get down to months? If you delved even deeper by going into specific months, say starting from May 1871- 1901 compared to June 1871 - 1901 you'd have even more 30 year periods to evaluate. From my basic understanding of all of this I can imagine that starting at different points in time would yield different results. What would constitute a large enough set of data points to be sufficiently confident in the assertion that a majority(or entirely) stock portfolio will continue to outperform one with less?
Ben Mathew wrote: Thu May 13, 2021 7:51 pm So then is there any other way of estimating the probability the bonds will outperform stocks over 30 years? Indeed there is. If you are willing to assume that the annual returns are independent, you could simulate thousands of paths using the 150 annual draws that we have. And some of those paths will be very very bad for stocks. If you are unlucky enough, you can get stocks doing as badly as the worst year of the great depression every single year. So averaging across all these simulations, we will get some nonzero probability that stocks will do really badly, and bonds helped tremendously. That gives you the reason to hold bonds over long horizons.
Regarding this point I think I see what you're saying. My stats skills are rusty but here goes: There's a whole range of possible outcomes that could have occurred within this time frame and some could have had stocks doing very poorly, and even consistently doing very poorly. Correct? However, would there not be a range in which the majority of our outcomes would fall which are reasonably represented by what we have seen in the historical data? I'm thinking of a probability distribution where the bulk of the outcomes fall within a certain range, while the extreme outcomes fall on the edges. Although it is possible for there to be repetitive poor outcomes for stocks, isn't it reasonable to assume that the behavior of stocks and bonds will continue to result somewhat similarly to what we have already seen over 150 years? The extremes strike me as so remote and would require such profound shifts in our world that I'm not sure any asset allocation would survive very long, making it more academic than practical.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

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abuss368 wrote: Thu May 13, 2021 7:54 pm I was surprised that World War 1 was lower than the Great Depression.

Tony
Yes, we don't hear much about the WWI crash. But the fact that stocks and bonds crashed together seems to have created a tough situation for 35/65.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

willthrill81 wrote: Thu May 13, 2021 7:54 pm
Ben Mathew wrote: Tue May 11, 2021 7:56 pm So, yes, the 35/65 portfolio gave significantly higher return than 100% bonds for just a little bit more volatility. A portfolio with 100% 10 year bonds (non duration matched) was not a good proposition.
Correct. Ergo, to the extent that investors expect the future to resemble the past, an AA close to 35/65 (maybe 25/75) should be considered the most conservative logical allocation.
Yes, about 30/70 seems to be the most conservative reasonable allocation with this bond strategy. People wishing to go more conservative would need to duration match inflation indexed bonds.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Volando wrote: Thu May 13, 2021 9:09 pm
Ben Mathew wrote: Thu May 13, 2021 7:51 pm But the problem is that this is not a lot of data points. 150 years is still only 5 separate 30 year periods. The profusion of dots you see are coming off the same underlying annual data. Each period is just slightly different from the period before and after it. So maybe bonds will actually outperform once in a while. It simply may not have shown up in our data.
I can see how 150/30 = 5. But in reality wouldn't you have a much larger number of 30 year periods if you delved a little deeper? I believe the chart you shared has 121, 30 year periods. Further is this data only limited to annual data or can we get down to months? If you delved even deeper by going into specific months, say starting from May 1871- 1901 compared to June 1871 - 1901 you'd have even more 30 year periods to evaluate. From my basic understanding of all of this I can imagine that starting at different points in time would yield different results.
Even though there are 121 30 year periods, they are not truly distinct data points. The 1871-1901 period is almost the same at the 1872-1902 period. If the former was a good draw, the latter will almost certainly be a good as well. So they are not independent draws. They are highly correlated (serial correlation). You would have to go out to 1901-1931 to get a truly new data point. In that sense there are only 5 completely independent data points here:

1871-1901
1901-1931
1931-1961
1961-1991
1991-2021

Imagine that these 5 independent draws happened to be good. Now all the other 116 periods will be forced to be exceptionally good on average. Take for example 1920 -1950. It's about two thirds 1901-1931 and one thirds 1931-1961. So it can't be too bad given that the latter two were good.
Volando wrote: Thu May 13, 2021 9:09 pm What would constitute a large enough set of data points to be sufficiently confident in the assertion that a majority(or entirely) stock portfolio will continue to outperform one with less?
There are ways to calculate standard errors and so on with serial correlated data. With enough data points, those standard errors would become tight. I haven't gone down the route of calculating this. The simulations from annual returns are easier to understand and can tell us what we need to know, which is the probability of stocks doing really badly over 30 years.
Volando wrote: Thu May 13, 2021 9:09 pm
Ben Mathew wrote: Thu May 13, 2021 7:51 pm So then is there any other way of estimating the probability the bonds will outperform stocks over 30 years? Indeed there is. If you are willing to assume that the annual returns are independent, you could simulate thousands of paths using the 150 annual draws that we have. And some of those paths will be very very bad for stocks. If you are unlucky enough, you can get stocks doing as badly as the worst year of the great depression every single year. So averaging across all these simulations, we will get some nonzero probability that stocks will do really badly, and bonds helped tremendously. That gives you the reason to hold bonds over long horizons.
Regarding this point I think I see what you're saying. My stats skills are rusty but here goes: There's a whole range of possible outcomes that could have occurred within this time frame and some could have had stocks doing very poorly, and even consistently doing very poorly. Correct? However, would there not be a range in which the majority of our outcomes would fall which are reasonably represented by what we have seen in the historical data? I'm thinking of a probability distribution where the bulk of the outcomes fall within a certain range, while the extreme outcomes fall on the edges. Although it is possible for there to be repetitive poor outcomes for stocks, isn't it reasonable to assume that the behavior of stocks and bonds will continue to result somewhat similarly to what we have already seen over 150 years? The extremes strike me as so remote and would require such profound shifts in our world that I'm not sure any asset allocation would survive very long, making it more academic than practical.
This comes back to the previous point of how many independent 30-year data points are actually there in 150 years. If we go the route of simulating thousands of 30 year returns from annual returns, then we can directly see if the probability of stock underperformance is so unlikely that bonds will not be useful. My guess is that stocks will have a significant probability of very poor performance, and that the average investor will need to hold bonds over long horizons.

Note also that if stocks will definitely outperform bonds over long horizons like 30 years, there would be an arbitrage opportunity in issuing noncallable debt over 30 years and investing in stocks--i.e. people and institutions should be infinitely leveraged over long horizons. That's not what we see, and so that itself suggests that the risk of stock underperformance is non-negligible.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Volando »

Ben Mathew wrote: Fri May 14, 2021 8:55 am
Volando wrote: Thu May 13, 2021 9:09 pm
Ben Mathew wrote: Thu May 13, 2021 7:51 pm But the problem is that this is not a lot of data points. 150 years is still only 5 separate 30 year periods. The profusion of dots you see are coming off the same underlying annual data. Each period is just slightly different from the period before and after it. So maybe bonds will actually outperform once in a while. It simply may not have shown up in our data.
I can see how 150/30 = 5. But in reality wouldn't you have a much larger number of 30 year periods if you delved a little deeper? I believe the chart you shared has 121, 30 year periods. Further is this data only limited to annual data or can we get down to months? If you delved even deeper by going into specific months, say starting from May 1871- 1901 compared to June 1871 - 1901 you'd have even more 30 year periods to evaluate. From my basic understanding of all of this I can imagine that starting at different points in time would yield different results.
Even though there are 121 30 year periods, they are not truly distinct data points. The 1871-1901 period is almost the same at the 1872-1902 period. If the former was a good draw, the latter will almost certainly be a good as well. So they are not independent draws. They are highly correlated (serial correlation). You would have to go out to 1901-1931 to get a truly new data point. In that sense there are only 5 completely independent data points here:

1871-1901
1901-1931
1931-1961
1961-1991
1991-2021

Imagine that these 5 independent draws happened to be good. Now all the other 116 periods will be forced to be exceptionally good on average. Take for example 1920 -1950. It's about two thirds 1901-1931 and one thirds 1931-1961. So it can't be too bad given that the latter two were good.
Volando wrote: Thu May 13, 2021 9:09 pm What would constitute a large enough set of data points to be sufficiently confident in the assertion that a majority(or entirely) stock portfolio will continue to outperform one with less?
There are ways to calculate standard errors and so on with serial correlated data. With enough data points, those standard errors would become tight. I haven't gone down the route of calculating this. The simulations from annual returns are easier to understand and can tell us what we need to know (probability of stocks doing really badly over 30 years).
Volando wrote: Thu May 13, 2021 9:09 pm
Ben Mathew wrote: Thu May 13, 2021 7:51 pm So then is there any other way of estimating the probability the bonds will outperform stocks over 30 years? Indeed there is. If you are willing to assume that the annual returns are independent, you could simulate thousands of paths using the 150 annual draws that we have. And some of those paths will be very very bad for stocks. If you are unlucky enough, you can get stocks doing as badly as the worst year of the great depression every single year. So averaging across all these simulations, we will get some nonzero probability that stocks will do really badly, and bonds helped tremendously. That gives you the reason to hold bonds over long horizons.
Regarding this point I think I see what you're saying. My stats skills are rusty but here goes: There's a whole range of possible outcomes that could have occurred within this time frame and some could have had stocks doing very poorly, and even consistently doing very poorly. Correct? However, would there not be a range in which the majority of our outcomes would fall which are reasonably represented by what we have seen in the historical data? I'm thinking of a probability distribution where the bulk of the outcomes fall within a certain range, while the extreme outcomes fall on the edges. Although it is possible for there to be repetitive poor outcomes for stocks, isn't it reasonable to assume that the behavior of stocks and bonds will continue to result somewhat similarly to what we have already seen over 150 years? The extremes strike me as so remote and would require such profound shifts in our world that I'm not sure any asset allocation would survive very long, making it more academic than practical.
This comes back to the previous point of how many independent 30-year data points are actually there in 150 years. If we go the route of simulating thousands of 30 year returns from annual returns, then we can directly see if the probability of stock underperformance is so unlikely that bonds will not be useful. My guess is that stocks will have a significant probability of very poor performance, and that the average investor will need to hold bonds over long horizons.

Note also that if stocks will definitely outperform bonds over long horizons like 30 years, there would be an arbitrage opportunity in issuing noncallable debt over 30 years and investing in stocks--i.e. people and institutions should be infinitely leveraged over long horizons. That's not what we see, and so that itself suggests that the risk of stock underperformance is non-negligible.
Thank you for the further clarification.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by abuss368 »

Ben Mathew wrote: Fri May 14, 2021 8:07 am
abuss368 wrote: Thu May 13, 2021 7:54 pm I was surprised that World War 1 was lower than the Great Depression.

Tony
Yes, we don't hear much about the WWI crash. But the fact that stocks and bonds crashed together seems to have created a tough situation for 35/65.
I would agree. Usually bonds provide the safety and dry powder.

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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by DB2 »

TheoLeo wrote: Tue May 11, 2021 7:54 pm I wonder if a bit of gold would have helped much in these post war episodes where bonds didnt help.
In the 70s, gold did remarkably well.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by JBTX »

Ben Mathew wrote: Thu May 13, 2021 7:51 pm
Volando wrote: Thu May 13, 2021 12:56 pm Looking at this data as well as some scenarios I've run in portfolio visualizer with different allocations, it seems that the person who chose to start at 100% equities is better off, even in the worst case scenario. The worst drop listed was the great depression, with a drop of 53% in stocks while the 35/65 almost negated that loss. However, for someone who started early at 100/0 they still had more money left over than the person who experienced less loss but had less to begin with.
This depends on how you estimate the relevant probabilities. Here's a graph showing 30 year returns of stocks vs bonds using the above data:

Image

Stocks outperformed bonds every single time.

So what can we conclude about the probability (P) of bonds outperforming stocks ? If you conclude that P=0 because it never happened in this data, then it makes sense to conclude that for goals with horizon >= 30 years, there is no reason to hold bonds. Stocks will always outperform.

But the problem is that this is not a lot of data points. 150 years is still only 5 separate 30 year periods. The profusion of dots you see are coming off the same underlying annual data. Each period is just slightly different from the period before and after it. So maybe bonds will actually outperform once in a while. It simply may not have shown up in our data.

So then is there any other way of estimating the probability the bonds will outperform stocks over 30 years? Indeed there is. If you are willing to assume that the annual returns are independent, you could simulate thousands of paths using the 150 annual draws that we have. And some of those paths will be very very bad for stocks. If you are unlucky enough, you can get stocks doing as badly as the worst year of the great depression every single year. So averaging across all these simulations, we will get some nonzero probability that stocks will do really badly, and bonds helped tremendously. That gives you the reason to hold bonds over long horizons.

Some math can show that if returns are independent and you have constant relative risk aversion, you will want to hold the same fixed allocation across all horizons. So for example, if you're risk averse, you'll hold say a 30/70 allocation over both your 5 year and your 50 year goals. And if you're less risk averse, you'll hold say 60/40 for both horizons. The allocation you choose depends on your risk aversion, but not the horizon.
The problem with those who may assert stocks always best bonds over 30 years so one should be 100% stocks is after a certain point the investment time frame becomes less than 30 years.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by esteen »

Am I reading that 100% bond line correctly... That from a period of around 1930-1982 (50+ yrs) there was zero gain in purchasing power? Ouch...

If our 40 year "golden age" of bonds (1982-now) is at its end (that of course is debatable), then we could possibly have something like 1930-1982 for the rest of our investment lifetimes. :shock:
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

esteen wrote: Fri Jun 04, 2021 11:36 pm Am I reading that 100% bond line correctly... That from a period of around 1930-1982 (50+ yrs) there was zero gain in purchasing power?
Yes, you're reading that right. $1 invested in 1941 in 10 year Treasury bonds would have been reduced to $0.45 by 1982 after adjusting for inflation.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Blue456 »

Ben Mathew wrote: Fri Jun 04, 2021 11:51 pm
esteen wrote: Fri Jun 04, 2021 11:36 pm Am I reading that 100% bond line correctly... That from a period of around 1930-1982 (50+ yrs) there was zero gain in purchasing power?
Yes, you're reading that right. $1 invested in 1941 in 10 year Treasury bonds would have been reduced to $0.45 by 1982 after adjusting for inflation.
That's why William Bernstein always prefers to avoid the duration risk and instead take the risk on the equity side.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

JBTX wrote: Fri Jun 04, 2021 11:24 pm The problem with those who may assert stocks always best bonds over 30 years so one should be 100% stocks is after a certain point the investment time frame becomes less than 30 years.
The investor who believes that stocks always beat bonds over 30 years should, at the 25 year mark, feel that if stocks have underperformed over the last 25 years, then it should do really well over the next 5 years (to catch up and beat bonds). Conversely, if stocks have done well over the last 25 years, the should feel that bonds won't do so well over the next five years. So it implies market timing.

The idea that stocks can't be beaten over 30 years when it can be beaten over 5 years requires significant mean reversion in stocks. Studies have found mean reversion in stock returns, though I don't think the results are robust enough to hang one's hat on. I haven't calculated the probabilities, but my guess is that small or moderate mean reversion would still not drive that the probability of stocks underperforming bonds over 30 years to negligibly low levels. You would likely need high levels of mean reversion.

"No mean reversion" is the more conservative assumption when it comes to financial planning--you may overestimate future uncertainty, but that's better than underestimating it. It also leads to simpler strategies that don't require market timing. So that's the assumption I favor in my financial planning--it's simple and conservative.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by Ben Mathew »

Blue456 wrote: Sat Jun 05, 2021 6:27 am
Ben Mathew wrote: Fri Jun 04, 2021 11:51 pm
esteen wrote: Fri Jun 04, 2021 11:36 pm Am I reading that 100% bond line correctly... That from a period of around 1930-1982 (50+ yrs) there was zero gain in purchasing power?
Yes, you're reading that right. $1 invested in 1941 in 10 year Treasury bonds would have been reduced to $0.45 by 1982 after adjusting for inflation.
That's why William Bernstein always prefers to avoid the duration risk and instead take the risk on the equity side.
Yes, I think removing duration risk and inflation risk from bonds by using duration matched TIPS is a good idea, particularly in a bond heavy portfolio.
Last edited by Ben Mathew on Wed Jun 16, 2021 10:41 am, edited 1 time in total.
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Re: 35/65 portfolio during stock market crashes, 1871-2021

Post by qwertyjazz »

Ben Mathew wrote: Fri May 14, 2021 8:55 am
Volando wrote: Thu May 13, 2021 9:09 pm
Ben Mathew wrote: Thu May 13, 2021 7:51 pm But the problem is that this is not a lot of data points. 150 years is still only 5 separate 30 year periods. The profusion of dots you see are coming off the same underlying annual data. Each period is just slightly different from the period before and after it. So maybe bonds will actually outperform once in a while. It simply may not have shown up in our data.
I can see how 150/30 = 5. But in reality wouldn't you have a much larger number of 30 year periods if you delved a little deeper? I believe the chart you shared has 121, 30 year periods. Further is this data only limited to annual data or can we get down to months? If you delved even deeper by going into specific months, say starting from May 1871- 1901 compared to June 1871 - 1901 you'd have even more 30 year periods to evaluate. From my basic understanding of all of this I can imagine that starting at different points in time would yield different results.
Even though there are 121 30 year periods, they are not truly distinct data points. The 1871-1901 period is almost the same at the 1872-1902 period. If the former was a good draw, the latter will almost certainly be a good as well. So they are not independent draws. They are highly correlated (serial correlation). You would have to go out to 1901-1931 to get a truly new data point. In that sense there are only 5 completely independent data points here:

1871-1901
1901-1931
1931-1961
1961-1991
1991-2021

Imagine that these 5 independent draws happened to be good. Now all the other 116 periods will be forced to be exceptionally good on average. Take for example 1920 -1950. It's about two thirds 1901-1931 and one thirds 1931-1961. So it can't be too bad given that the latter two were good.
Volando wrote: Thu May 13, 2021 9:09 pm What would constitute a large enough set of data points to be sufficiently confident in the assertion that a majority(or entirely) stock portfolio will continue to outperform one with less?
There are ways to calculate standard errors and so on with serial correlated data. With enough data points, those standard errors would become tight. I haven't gone down the route of calculating this. The simulations from annual returns are easier to understand and can tell us what we need to know, which is the probability of stocks doing really badly over 30 years.
Volando wrote: Thu May 13, 2021 9:09 pm
Ben Mathew wrote: Thu May 13, 2021 7:51 pm So then is there any other way of estimating the probability the bonds will outperform stocks over 30 years? Indeed there is. If you are willing to assume that the annual returns are independent, you could simulate thousands of paths using the 150 annual draws that we have. And some of those paths will be very very bad for stocks. If you are unlucky enough, you can get stocks doing as badly as the worst year of the great depression every single year. So averaging across all these simulations, we will get some nonzero probability that stocks will do really badly, and bonds helped tremendously. That gives you the reason to hold bonds over long horizons.
Regarding this point I think I see what you're saying. My stats skills are rusty but here goes: There's a whole range of possible outcomes that could have occurred within this time frame and some could have had stocks doing very poorly, and even consistently doing very poorly. Correct? However, would there not be a range in which the majority of our outcomes would fall which are reasonably represented by what we have seen in the historical data? I'm thinking of a probability distribution where the bulk of the outcomes fall within a certain range, while the extreme outcomes fall on the edges. Although it is possible for there to be repetitive poor outcomes for stocks, isn't it reasonable to assume that the behavior of stocks and bonds will continue to result somewhat similarly to what we have already seen over 150 years? The extremes strike me as so remote and would require such profound shifts in our world that I'm not sure any asset allocation would survive very long, making it more academic than practical.
This comes back to the previous point of how many independent 30-year data points are actually there in 150 years. If we go the route of simulating thousands of 30 year returns from annual returns, then we can directly see if the probability of stock underperformance is so unlikely that bonds will not be useful. My guess is that stocks will have a significant probability of very poor performance, and that the average investor will need to hold bonds over long horizons.

Note also that if stocks will definitely outperform bonds over long horizons like 30 years, there would be an arbitrage opportunity in issuing noncallable debt over 30 years and investing in stocks--i.e. people and institutions should be infinitely leveraged over long horizons. That's not what we see, and so that itself suggests that the risk of stock underperformance is non-negligible.
The first limited liability law was written in New York in 1811. So any concept of investing in modern corporations (stocks or bonds) has to date after that. That limits you to 6-7 independent 30 year time frames.
A rule of thumb in stats is for each ten data points you can look at one variable (of course there are issues with that). So one could argue that you do not have enough data to loo at any full retirement. This of course assumes stability in the process you are modeling. Investing in stocks was very different for a small investor 80 years ago let alone 160.
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