There Must Be a Limit to Human Pessimism

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Human pessimism must have limits.

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Below is a shared comment and the teacher's replies.

Thank you for sharing. I fully agree with your advice that everyone should keep enough cash to defend against risk. I also have several questions.

Question 1: You said QQQ could fall to zero. Would that mean all 100 large companies go bankrupt? Is this similar to Buffett's nuclear-war example? Do we need to worry about this situation?

Teacher's answer to question 1: A market falling to zero is like Buffett saying, "If the market closed for five years, would your investment still be fine?" As long as the market is closed, I treat it as the market falling to zero. The reason for the closure, and whether the closure is long or short, is not the point. A good asset allocation is one that lets us live calmly no matter how long the market is closed.

Question 2: In video 00462, Jason mentioned placing 50 times assets into time deposits, or you mentioned Treasury bonds, as a safer approach. Is the greater risk of this allocation sudden high inflation, such as in the past two years? Over the past 50-plus years, several episodes of high inflation made 2% spending almost unworkable.

Teacher's answer to question 2: I did not recommend time deposits. For people extremely worried about market volatility, who do not want capital gains and cannot accept principal loss, and who only want stable interest for retirement, long-term Treasury yields are currently decent, nearly 4.3% guaranteed for 30 years. If someone has 50 times annual spending and puts it in 30-year Treasuries, and uses only 2% each year, then 2.3% remains available for reinvestment. Whether that resists inflation over the long term is hard to say. Inflation goes up and down, and historical average inflation around 2.5% is barely acceptable. There is no completely risk-free asset allocation.

Of course, you cannot demand everything with no tradeoffs. Listen carefully to the question and connect it with my answer. The person asking is saying that stock-market volatility is too large and emotionally unbearable. For someone who cannot accept principal loss, this is a reluctant recommendation.

Such a person can only invest in principal-guaranteed Treasuries and live on interest. Whether it beats inflation is no longer the main consideration. Everything involves tradeoffs. You keep what matters relatively more to you and give up what matters relatively less. My answer is personalized based on the type of question and the type of person asking.

If Your Funds Are Too Low Even to Retire With Long-Term Treasuries, You Should Review Whether Your Lifetime Financial Management Went Wrong

Question 3: Since last year, your asset allocation has become more and more complex. Honestly, I feel confused. I understand that you work hard to address people with different asset levels. I would rather accept that I do not have enough assets and keep working. I am a scientist, and I am moved by how scientific your detailed derivations and repeated verification are.

But more than 20 years in science also tells me not to blindly trust numbers to reach conclusions. There are many unknown or unconsidered factors. A Random Walk Down Wall Street also says simulations based on history do not guarantee the same future. A 130% maintenance ratio would go bankrupt; 135% did not go bankrupt in the last history, but may not be truly safe. What if the Fed had not rescued the market in time in 2009 and it fell for another year? Of course, I see the Fed continuously trying to maintain the US market.

Teacher's answer to question 3: This person seems to be the pessimist from question 2 above, or someone afraid of market volatility. Even an allocation that survives stocks going to zero still worries them. They worry about inflation when investing in Treasuries, too. I do not know what else such a person can invest in.

It is not a lack of ability; it is extreme pessimism. Such a person is suited to buying Treasuries. There is no other choice. Even if Treasuries cannot resist inflation, they must accept that. But if the market truly falls to zero, they should also be psychologically prepared that Treasuries may not be immune either.

Such a person probably should not invest in stocks, and perhaps should not invest at all. They should keep working until they believe they can no longer work. Working longer does not necessarily create a better retirement life. One day everyone retires or is forced to retire. At that time, whatever poor retirement life you can afford is the life you will live.

If your funds are too low even to retire with long-term Treasuries, you should review whether your lifetime financial management went wrong.

Follow-up comment:

Thank you for replying. I feel your emotions were somewhat strong. I am still executing the earlier approach of nearly 100% QQQ with six months of emergency reserves. I have not rebalanced because I truly do not understand it. Scientists are not necessarily smarter than others, especially outside their field. I know I know very little and hope to live humbly. I do not know what made you misunderstand me as pessimistic. If you dislike my comment, please delete it. Thank you.

Teacher's reply:

No One Can Answer Something That Is Not a Proposition

Your comment said bonds cannot resist inflation, stocks falling to zero would also make life impossible and cause bankruptcy, and therefore you can only keep working. Is that what you mean?

A person investing 100% in QQQ has, in my view, the highest risk among all asset allocations. The market can fall to zero at any time, and six months of emergency reserves cannot carry you through decades. Our ideal asset allocation should let us live calmly even if stocks fall to zero.

I am explaining that the comment's statement lacks logic. Saying "you cannot completely trust data" is not a logical proposition. We still need logical thinking and need to understand what a logical proposition is.

Fearful imagination and unlimited pessimistic statements are not propositions.

No one can answer something that is not a proposition. I convert the pessimistic statement into a proposition:

"If the market becomes worse than 2009 and continues falling until all stocks go to zero, we will all go bankrupt." That is a falsifiable proposition. A proposition must be capable of being falsified. To prove whether this statement is wrong, we need only give one example showing that even if conditions after 2009 became worse and all stocks went to zero, a certain asset allocation would not go bankrupt. Then the proposition is false.

We can show that the proposition is false. Even if the market kept falling after 2009 until stocks went to zero, we would not go bankrupt. Our asset allocation has a solution.

If you truly understand our investment strategy, there is a solution that will not go bankrupt even if the stock market falls to zero. If you cannot find a worse situation to refute that solution, then logically we should accept that solution as true.

Using scientific calculation and proof is the best way to answer a proposition. Saying "I do not believe data, mathematics, or science" is not logical. Without logical thinking, you cannot find an answer.

I appreciate this question because it shows that many people are still very worried and do not understand our investment philosophy and strategy. This question gives me a chance to answer others with similar concerns.

We Have Several Plans That Still Leave Plenty of Cash Even If Stocks Fall to Zero

Howard Marks wrote in Mastering the Market Cycle that when the market became extremely pessimistic, he explained to clients what they could do if conditions became worse. One client kept asking what would happen if things became even worse. Howard Marks patiently explained that the portfolio still had ways to handle it and even profit. When the client kept asking about worse and worse scenarios, Marks finally said that if the client was truly that worried, they should not be in the meeting; they should go home and sell all their assets.

Human pessimism must have limits. If there are no limits, no strategy can satisfy you.

Our method still has cash available even if the market goes to zero. Is there a better method in the world? If there is a better strategy or asset allocation, we welcome suggestions.

I recommend carefully studying our Excel files instead of imagining problems and frightening yourself.

We have many plans that still leave cash even if stocks fall to zero:

For retirees who are very worried that the market could fall to zero, use scenario 3: in up years, move 50% of the leveraged fund gains to cash through smart rebalancing. In the worst market case, with all stocks going to zero, an initial US$1,000,000 still leaves US$339,242 in cash. Debt is US$229,350, leaving net cash of US$109,892. Cash does not fall when the market falls. With US$3,000,000, the final net cash would be US$329,676. This should be better than keeping six months of reserves and putting the rest 100% in QQQ, which becomes zero in the worst case.

For people not yet retired and not withdrawing from investment assets, use scenario 4-1: 80% QQQ and 20% cash with simple annual rebalancing. In the worst case, if all stocks go to zero, an initial US$1,000,000 still leaves US$145,157 in net cash. No matter how the market falls, cash does not fall, and there is no debt. With US$3,000,000, final net cash would be US$435,471. This should be better than six months of cash and the rest 100% QQQ falling to zero.