Tag Archive: diversification

How Low Can the Stock Market Go?

A theme that runs on this blog is to not take anything for granted in terms what will happen while investing. In particular, I often mention the idea that any asset can fall in price very steeply at any time and for a multitude of reasons. Stocks in particular have had a very storied history in this regard.

Wade Pfau made a post aggregating the worst stock market losses by country over the past 100 years:

How Low Can the Stock Market Go?

Here are some excerpts from his post. Check the link to see the rest:

Australia 1970-74  -66%
Finland   1917-21  -85%
1943-48  -74%
1989-91  -60%
France    1943-50  -88%
Germany   1914-31  -84%
1948     -91%
Ireland   2007-08  -75%
Italy     1913-21  -68%
1944-45  -85%
1974-77  -75%
Japan  1946     -86%
1940-47  -98%
1990-02  -70%
US        1929-31  -60%
UK        1973-74  -71%

Some of these numbers were the result of WWI or WWII for certain, but others were clearly not. There is no guarantee the markets are going to perform on anyone’s particular timetable so you gotta stay diversified. I think this chart also illustrates the fallacy of time diversification in some respects as well. The fallacy of time diversification was discussed in John Norstad’s paper:

Fallacy of Time Diversification

In essence, holding stocks for a long time does not make them “safer” as commonly stated. Just because you held a stock for 20 years does not mean it can’t drop steeply on year 21 and stay there for a really long time. Investors taking a lot of stock risk and expecting quick market recoveries after these kinds of falls can be in for a nasty surprise. If an economy turns into another Japan (-70% from 1990-2002) and they need that money for retirement there could be big trouble. You gotta stay diversified!

Hat tip to Taylor Larimore on the Diehards forum for posting the link. And thanks to Wade Pfau for posting this interesting data in one place.



Callan Periodic Table of Investing Returns 2011

I love the Callan Periodic Table of Investing Returns. This chart shows major asset classes and how they’ve done from 1992-2011. It shows very vividly the unpredictable nature of the markets and why holding a diversified investing portfolio is a good idea. It doesn’t show gold and long-term bonds that the Permanent Portfolio also uses, but the general idea still comes across.

Callan Periodic Table of Investing Returns

Thanks to the people at Callan for putting this together.

The Misleading Stocks for the Long Run Chart


I see this chart posted from Jermy Siegel’s book Stocks for the Long Run from time to time to defend why owning lots of stocks is the way to go and why owning gold is some kind of chump move.

Well I think this chart is misleading for several reasons. Gold is useful in a diversified portfolio along with stocks and bonds. It should not be 100% of a portfolio just as stocks shouldn’t be nor bonds.

First let’s explain a few things about this gold line you see here. We must understand that for the first 130 or so years of the founding of the United States gold and the dollar were the same thing (aka. the Gold Standard). With that, let’s look at this chart with this gold standard in mind:

1) From 1802-1913 the value of the dollar was strongly linked to gold and there was slight deflation over this time. There was essentially no inflation except for the period around the Civil War when Lincoln printed a lot of money to pay for things. That’s the blip you see in the early 1860s. Gold went “up” simply because the dollar was going “down.”

2) In 1933 FDR broke the gold standard. He raised the price from $20.67 an ounce to $35 an ounce to deliberately try to cause inflation. This was done after prohibiting Americans from owning gold. That’s the rise in gold price you see in that year and also when the dollar started to rapidly decline in value. A gold convertible currency prior to that keeps paper currency honest because if people think the government is printing too much money they could turn in their paper dollars for gold specie and drain the Treasury. After 1933 that was no longer possible. This was a stupid idea that achieved nothing but allow the inflation genie out of the bottle and send the dollar on a downward trajectory from that day forward.

3) In 1971, after nearly four decades of artificially low gold prices due to government price controls, Nixon broke the last of the gold standard for foreign holders of dollars. Dollars could now be converted to gold by nobody. You see the gold price spike the first couple years as it adjusted for the prior price controls. After that, I believe it was simply responding to the very high inflation. The dollar also this year begins a very big decline. By the end of the 1970s the dollar bought about only 50% of what it did in the early 1970s. By today it’s lost something around 80% of its purchasing power.

4) Gold is not volatile. It’s a piece of metal. It is only volatile against the currencies it is priced in which are the real culprits. Price spikes in gold are more of a reflection in the value of the dollar than anything. Gold is a form of money and people buy it when they think the dollar is going to have problems keeping its value.

Now back to the chart in general. This chart is misleading for several reasons:

1) The data going back to 1802 is suspect to me. Nobody could have invested that way if they wanted to even if the data is accurate (which is another debate). This chart is what stock bugs use to justify why you only need to own stocks. It’s as bad as when a gold bug shows you a chart of gold vs. the dollar and insists you only need to own gold. No, you need to own a variety of assets like the Permanent Portfolio. Concentrating your bets in any one asset is a bad idea.

2) Nobody lives for 200 years. An investor’s timeline is like 30-40 years before they need the money. Stocks have had extended periods of bad performance in the past and this makes total returns very time dependent on the individual level.

3) Gold doesn’t have interest and dividends. This is a statement of the obvious. But it has much different risks than stocks and bonds and that means it is still useful in a portfolio. The same economic factors that are horrible for stocks and bonds can be quite good for gold and vice versa. That simply means you own gold as part of a diversified portfolio and not 100%.

4) This chart also shows that over 200 years gold has had a remarkably good record of stability in terms of preserving purchasing power. This is quite remarkable when you consider the history of the US, the wars, the booms, the busts, etc. that have happened. How many companies from 1802 are still around today?

5) Gold in a diversified portfolio can increase returns, decrease volatility, decrease risk, and provide protection under serious currency problems. All good things in my book.

This chart doesn’t make the case that gold shouldn’t be owned to me. It basically makes the case that owning a lot of different assets with different risk profiles is a really good idea. Stocks can be very powerful when the economy favors them, but when it doesn’t they can languish with big losses or zero real returns for protracted periods. A portfolio with stocks, bonds, cash and gold however can weather just about anything the economy is throwing at it. Diversification is your friend.