They say we like to scare ourselves. When it comes to our finances I doubt that’s true, but there are still times when Mr Market slashes at our investments like Freddy Krueger at a couple of horny teenagers.

It’s time to face our fears. The best way to stop yourself panicking like a hapless American virgin on a camping trip is to know just how bad things can get.

Our recent investigations into risk tolerance tell us how much carnage we think we can take.

But how much might we have to take?

Let’s roll the tape and take a look at investing’s scariest horror shows.

Scream!

The UK stock market’s biggest bloodbath was a real return loss of -71% from 1972 to 1974. It wasn’t until 1983 – 10 years later – that the market recovered its former value.

If that seems like ancient history, well, the FTSE All-Share was cut down by -33.4% in 2008.1 Recovery took a mercifully short two years.2

And you only have to go back a few more years before that for A Nightmare on Threadneedle Street 3: the -40% loss between 1999 and 2002.3 Recovery took three years.

Hellraisers

There’s no denying the that the 1972-74 UK stock market crash was horrendous. But we can find even worse if we look at the returns from other markets around the world.

Japan lost -98% between 1943 and 1947. Recovery took 26 years. That’s an investing lifetime.

More infamously, Japan sunk -71% from 1990 to 2002, and it has yet to recover.

The biggest non-war shocker? That would be Spain’s -84%, between 1974-1982. It took them 22 years to finally get back to square one in 1996.

Meanwhile the Great Recession hacked -75% from the Irish stock market between 2007 and 2008. Recovery ongoing.

The longest ever recovery was the 89 years it took Austria to come back from its -96% 1914 to 1925 trauma. The breakthrough finally came in 2003. The great-grandchildren must have been delighted.

The worst fright visited upon the US was a comparatively mild -60% during the first leg of the Great Depression, 1929 to 31. It took seven years to recover.

The US took another -57% hit 2007 to 2009 and went down -49% in 2000 to 2002.

But perhaps none of that is as scary as the slow torture inflicted on UK bonds over 27 years from 1947 to 1974. The total real return loss: -73%.

The recovery date? 1993, a spine-chilling 46 years later.

The ultimate horror is of course the total wipeout of Russian stock and bond holders in 1917 and Chinese investors in 1949. There was no coming back from that.

Scream too

Thankfully the bogeyman doesn’t lop huge chunks out of us that often.

In the UK, the historical returns data shows we took heavy losses in calendar years about one year in every ten between 1899-2014:4

• 10 years have ended with a decline of over 20%.
• Four years have ended with a loss of over 30%.
• One year ended with a loss of over 50%.

The frequency of losses of 20% or more rises to one in seven years in the US, according to passive investing demon-slayer, Larry Swedroe.

Even a portfolio diversified across the developed world will be gored frequently according to this analysis of the biggest falls from the monthly peak in the MSCI World Index from 1970-2016 by Ben Carson.

Date	Loss
1970	-19%
1973-74	-40%
1982	-17%
1987	-20%
1990	-24%
1998	-13%
2000-02	-45%
2007-09	-54%
2011	-26%
2015-16	-20%
Average bear market	-28%

Source: A Wealth Of Common Sense

By the light of the historical record, it’s clear we’re going to take pain every few years. In any given year, global equity returns have only been positive 60% of the time.5

Even a global portfolio, balanced 50/50 between equities and bonds, was splattered -61% in the wartime period 1912 to 1920.

And a balanced UK portfolio was shredded by -58% between 1973 and 1974, taking nine years to recover.

Is nowhere safe?

While locking the doors or calling the sheriff rarely seems to hold the darkness at bay, time usually provides the silver bullet.

The annualised return averaged over the last 116 and 50 years has been:

Selected countries	Last 116 years	Last 50 years
UK	5.4%	6.4%
US	6.4%	5.3%
Sweden	5.9%	8.7%
South Africa	7.3%	7.9%

Source: Credit Suisse Global Investment Returns Yearbook 2016, 1900-2015

But here comes the baddie back from the dead one last time:

• Austrian equities averaged a hideous 0.7% gain over the last 116 years.

The only stake in the chest against that kind of dire performance to diversify your portfolio globally.

Global equities have earned a 5% average annualised return over the last 116 and 50 year periods.

And while they’ve only earned a 1.6% average over the last 16 years, a 50/50 global portfolio would still have returned 3.8% on average, over the same timeframe.6

It’s behind you!

The difference between a scary movie and the investor gore I’ve cited above is that those investment returns returns are real. (And after inflation, too, not nominal).

But understanding the monsters that can stalk your portfolio is your best defence against doing the wrong thing in such terrifying situations.

None of these work:

• Running away through the woods at night.
• Calling a priest.
• Emotional sex in a flimsy tent after your best friend was eviscerated.
• Selling up when the market bottoms out.

Take it steady,

The Accumulator

p.s. The recovery times can be a bit misleading. Reality can be kinder. If you keep buying assets as they fall in price and rebound then you will personally recover more quickly (because you bought more assets at cheaper prices) than the market overall. However if you are forced to sell assets during the downturn then your portfolio will take longer to recover its previous value (as you have fewer assets that must now rise further to reach the previous peak). Bear markets (a loss of 20% or more) across global markets (Jan 1980-2016) took an average of 798 days to recover (or just over two years and two months) according to Vanguard.

1. Barclays Equity Gilt Study 2015 [↩]
2. Smarter Investing, 3rd edition, Tim Hale [↩]
3. Smarter Investing, 1st edition, Tim Hale, page 291. I know it’s the Bank of England that sits on Threadneedle Street but the London Stock Exchange is on Paternoster Square and that’s not going to work. [↩]
4. Barclays Equity Gilt Study 2015. The use of calendar years probably masks some big falls where the market recovered before year end but these stats are the best I have. [↩]
5. Smarter Investing, 1st edition, Tim Hale, page 286 [↩]
6. Not taking into account costs or taxes. Credit Suisse Global Investment Returns Yearbook 2016, 1900-2015. [↩]

Good reads from around the Web.

Tons of links this week, so I’ll just kick things off with a Bloomberg piece about bear markets and robo-advisers.

Bloomberg notes:

The rise of these robots and their automated investment strategies has largely coincided with a multi-year bull run in stocks, which means the nascent industry could face a big test if markets were to turn.

A bear market would represent a challenge that the ranks of robo-advisers haven’t encountered yet, and it would be the ultimate test of just how crucial, or irrelevant, working with actual humans is to good, long-term investing.

It seems the tech-savvy Millennials who were first to adopt these passive and automated robo-strategies aren’t really paying much attention to the markets, compared to previous generations.

As Monevator regulars will know, such wilful ignorance will likely see them earning superior long-term returns.

The question is: Would a market crash that’s severe enough to cause ripples even inside their streamed flat white flooded artisanally crafted investing goldfish bowls (figuratively speaking) prompt them to dig out their robo-account passwords to meddle with their portfolios at exactly the wrong time?

We’re not in Kansas anymore

Pull back the curtain on all the grand mysteries of investing, and you’ll discover – nowadays especially – that simple can be most effective.

It’s easy to construct a passive portfolio. You can do it with a robot service or by investing in as few as two ETFs.

Rebalancing isn’t hard, either, whether you’re DIY-ing it or having a robot (or a blended offer like Vanguard’s LifeStrategy funds) take the strain.

The difficult part is learning why most people should take a passive approach in the first place.

And then to have the knowledge to stick with it during the tough times.

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Good reads from around the Web.

Last week’s Weekend Reading was about fund fees, but the comments became a – um – spirited discussion about currency risk in post-retirement portfolios.

It was an argument caused by different perspectives as much as about the facts.

A similar thing often happens when we talk about investing risk.

Often when people say one investment is less or more risky than another, what they’re really describing is transforming risk from kind into another.

In the currency debate, I noted the shortened time horizons of a retired person and the need to spend your pot in your domestic currency to meet your day-to-day living costs made currency risk more important at 65, say, than when you’re saving into a pension at 30 and can take a sanguine long-term view.

I suggested a greater allocation (note: not 100% or anything like it) to your home stock market might therefore make sense, as might hedging a portion of your overseas exposure (again, not all, just a portion to dampen the swings).

The other side bridled at the consequent higher costs – even if those costs were just a hypothetical 0.25% extra annual charge applied to just a bit of the portfolio.

The 0.25% cost was a nailed-on expense to be paid every year of retirement, they pointed out, whereas the impact of currency risk was unknown. Better to risk a bigger hit to your retirement income from currency swings than to guarantee a modest hit by paying that charge every year.

For richer or poorer

How often do we get into similar disagreements when debating finances?

(Okay, not very often if you’re a normal person into football or Facebook – I mean us personal finance nerds!)

Paying down your mortgage versus investing, whether or not you should buy an annuity in retirement or to stay in shares and bonds – they’re not really arguments with the “right” answer, because they depend so much on your risk tolerance, your circumstances, even your philosophy of life.

Sticking with the retirement theme, retirement researcher Wade Pfau posed one of these eternal questions directly this week in his article: Which is better for retirement, insurance or investments?

Pfau wrote:

There are two fundamentally different philosophies for retirement income planning, which I call probability-based and safety-first.

Those philosophies diverge on the critical issue of where an individual is best served to place their trust: in the risk/reward trade-offs of an equity portfolio, or on the contractual guarantee of insurance products.

The fundamental question is about the type of strategy that can best meet the retirement income challenge for how to combine retirement income tools to meet goals and manage risks.

Those favoring investments rely on the notion that the market will eventually provide favorable returns for most retirees […] There is also a general unease about relying on the long-term prospects of insurance companies or bond issuers to meet contractual obligations.

Perhaps not fully understanding the implications of how sequence-of-returns risk differs from market risk, the belief is that in the rare event that the performance for the equity portfolio does not materialize, it would imply an economic catastrophe that would sink insurance companies as well.

Meanwhile, those favoring insurance believe that contractual guarantees are reliable and that an over-reliance on the assumption that favorable market returns will eventually arrive is emotionally overwhelming and dangerous for retirees […]

Even if there is a low probability of portfolio depletion, each retiree gets only one opportunity for a successful retirement.

This is the annuity versus income-portfolio-in-drawdown debate taken back to first principles.

At different times one approach might have an edge – when annuity rates are low, say, or stock markets scarily high.

But ultimately it’s a matter of philosophy and risk.

For better or worse

Coincidentally, Michael Kitces also published a really huge article comparing a whole bunch of different retirement strategies.

Again the same issue comes up:

What seems like a relatively simple question – which retirement income strategy is the best – is actually remarkably difficult to determine.

Because as it turns out, which is “best” depends heavily on how you measure what “best” really means in the first place.

This is a really in-depth article with some excellent graphs, and while it’s written from a US perspective there’s a lot to think about wherever you’re retiring.

Kitces also produced a table showing how the various strategies perform very differently across a range of outcomes:

Now, if you’re having a debate with someone who is most interested in (potentially) maximizing their final wealth, putting forward a strategy where at least some modest success is the top priority will cause some friction – unless maybe you both take a look at this table before you start your argument!

Retirement solved – and sold

You can also see from the table how the financial industry is able to spin the same problem into half-a-dozen different products for sale.

And that’s fine, if they’re providing different solutions for different needs.

But it can also be a misleading spin that says their favoured solution gets rid of the Worst outcome of some other hateful strategy – without pointing out the downsides of their own approach.

Remember, there are no free lunches in investing. Especially when you’re paying!

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