Reacting to Price Drops: Middle Years

I examined what happens to a 100% stock investor after a 50% loss spread over two years. I assumed that starts out with $100000. I assumed that he would cut his stock allocation to 20% after such a blow.

Scenario Surfer Runs

I started out with 100% stocks. I cut back to 20% stocks whenever I suffered a 50% loss over two years. I invested entirely in stocks and 2% TIPS. I started with a $100000 balance. I selected P/E10=26 Bear Market. I made no deposits and no withdrawals. Here are the Year 15 balances. I did not vary allocations in accordance with valuations.

Run 1.
Years of Change: 5.
20% rebalanced: 147,354.
50% rebalanced: 158,140.
80% rebalanced: 156,469.
100% Stocks initially: 96,270.

Run 2.
Years of Change: never.
20% rebalanced: 133,887.
50% rebalanced: 128,246.
80% rebalanced: 117,599.
100% Stocks initially: 108,202.

Run 3.
Years of Change: never.
20% rebalanced: 141,897.
50% rebalanced: 148,213.
80% rebalanced: 148,469.
100% Stocks initially: 145,226.

Run 4.
Years of Change: never.
20% rebalanced: 132,544.
50% rebalanced: 122,722.
80% rebalanced: 106,160.
100% Stocks initially: 92,465.

Run 5.
Years of Change: never.
20% rebalanced: 137,702.
50% rebalanced: 138,553.
80% rebalanced: 134,640.
100% Stocks initially: 129,442.

TIPS Baseline:2% TIPS, no stocks: 134,585.

Data Summary

Here are the ordered Year 30 balances:

145,226.
129,442.
108,202.
96,270 (change in Year 5).
92,465.

TIPS Baseline: 134,585.

Analysis

Only once did the balance fall far enough to pass the two year 50% price drop threshold. For other conditions, prices typically dropped well below the starting balance, but recovered later. Switching to a 20% allocation locked in failure.

The TIPS-only baseline did better than 100% stocks in 4 out of 5 cases.

Conclusion

Over the next 15 years, the outlook is dreary for the 100% stock investor with a sizeable account. It gets worse if he cuts back his stock allocation right after a severe price drop.

Have fun.

John Walter Russell
June 3, 2008