As for the discussion about throwing out the old advice, etc. Only time will tell, but it is normal for markets to go through 15 or even 25 year stagnant periods. Going back to the 19th century, you see similar patterns emerge. We peaked in 1999/2000 and prices have been stagnant since. If we go until 2015 or 2025, it’s problematic for investors, but what better alternative is there to asset allocation? I have yet to see one.

In the area of stock investing, Smart Money had a great article with a bunch of old line investment managers that were around for the crash in 1929. They were Ben Graham disciples and their investment discipline has held up over the years. I don’t see a broken system, just a lot of broken portfolios. It’s fairly obvious from the data produced by the 401k industry that most were overpositioned towards equities relative to age.

In working with clients, I would always show a Morningstar report comparing two portfolios. One with more equities exposure and more risk and the other with a little less equities and a lot less risk. The returns were typically within a percent of one another while the risk was usually reduced by one-third. I had not one client pick the riskier portfolio. Often it’s about making educated decisions–something in short supply when times are good. Now that things are in the toilet, I’m hoping more people will get involved with their finances, read blogs, research their investments, and turn off CNBC:)

Great topic

It depends on why an investment lost 20%. One of the primary reasons why people got badly burnt in the last year or so is because they did not strategize on how to protect themselves on the downside. There are times when one must bite the bullet and get their money out to prevent losses. When to do so is perhaps one of the toughest decisions in investing.

Traditional measures of risk are kind of two-dimentional — they tend to be based on the frequency and magnitude of fluctuations. A better model would be three-dimentional, where the extra dimension is price. The higher prices go, the higher the risk.

I used to explain this to clients as being like the risk of falling off a ladder. It’s useful for me to know that there is a 10% risk of me falling off the ladder, but I process that information differently if I am on the first rung or if I am 30 ft. up.

Stocks are clearly a riskier asset class than money market accounts. So, according to the conventional wisdom, stocks should always offer a better long-term return. But, if you perform a regression analysis on the historical stock-return data to determine the likely long-term return for stocks at the top of the recent price bubble, the number you get is a negative number. Money market accounts beat that.

I believe that we need to be rethinking the conventional advice about stock investing in general and about risk in particular. I believe that what investors are really compensated for is for taking on PERCEIVED risk. The real risk of stocks was sky high at the top of the bubble. But stocks were so popular that the perceived risk was just about zero. That’s why stocks were paying a lower long-term return than money markets at the time.

Rob

Thanks for the important reminder.