11. Simulating the Worst Case

11. Simulating the Worst Case

Staying alive in investing matters more than the rate of return.

Who Should Not Be in the Market

Before “should I invest?”, there is a prefiltering step — anyone failing it does not need to learn the “air-raid drills” below; just exit the market:

• People who cannot tolerate a short-term 70–80% drop — please leave the market, don’t enter the stock market. Drop a little and you tense up, tense up enough that you can’t eat or sleep — sooner or later you’ll cut at the low, and that is real ruin.
• Money you need within the next year — cannot be invested. Once invested and the market drops, you are forced to sell at the low and lock in losses prematurely.
• You don’t understand the system at all and just throw money in — that is not investing, that is “passively participating in a gambling game you can’t read,” differing from being scammed only in your consent. If any of the above hits you, please park your money in CDs, short-term Treasuries, or money-market funds — avoid all stock markets, avoid all “wealth management products,” avoid all investment-linked insurance policies. This is not discouragement; this is the most responsible sentence CLEC has said to students in 20+ years. Buffett said the same thing: “People who worry about drops should not invest.” That is not a put-down — it is recognition that risk tolerance differs across people, and the price of mismatch is catastrophic.

Staying Alive Matters More Than Return Rate

Before all investing principles, there is a more fundamental one to put first: staying alive in investing matters more than the rate of return. Meaning — you can earn a little less, but you cannot be forced off the field. You can underperform the “optimal strategy” by 2% a year, but you cannot zero out from one extreme swing. The index fund will come back long-term — provided you are still on the field. The moment you get margin-called, force-liquidated, or fear-sold at the low, you are out of the game. Those out don’t get rebounds — whatever the market does has nothing to do with you. So the following three “questions you must answer before investing” are an entrance exam, not advice.

Three Questions Before You Invest

Before you put a single cent into the stock market, I need you to answer three questions. Not just toss off an answer and move on — seriously, like taking an exam, give your deeply considered response.

Question one: if the money you put in dropped 70% tomorrow, could you still live normally? Not “are you willing to accept that loss” — but: would your daily life — meals, rent, utilities, your child’s tuition — be affected? If the answer is “yes, affected,” then you have invested too much money you shouldn’t have. Question two: if the market falls for three years straight without rebounding, could you completely not touch your investment, not sell a single share for three years? Note: this is not some hypothetical extreme — from 2000 to 2003, the U.S. stock market did fall for three straight years. If your living expenses depend on selling stocks, then at some point in those three years, with cash running low, you will be forced to sell, permanently losing the rebound that follows. Question three: if your portfolio is cut in half, and then cut in half again from that price — that is, down 75% — could you stay calm and do nothing? This question tests not just financial capacity but psychological capacity. Watching your hard-earned $1 million become $250,000 produces a despair outsiders cannot understand. You need to recognize this possibility before you invest, and be sure you can bear it. If any of these three you answered with “not sure” or “can’t do it,” then you are not yet ready to invest. Not “you can never invest” — just that you need preparation work first, then enter. The most important piece of preparation is: build enough emergency cash. For people still working, we recommend setting aside six months of living expenses as emergency cash. This money cannot be invested; it must sit somewhere you can access anytime — bank checking, money-market fund. Its job is to ensure that even if you suddenly lose your job, you have a six-month buffer to find new income, and don’t have to sell investment positions to cover short-term cash needs. For retirees, the bar is higher: three years of living expenses. Why three years? Because the longest continuous downturn in history was about three years (2000–2003). With three years of cash reserves, even if the worst case hits — the market crashes from the moment you retire and falls three straight years — you have enough cash to live without touching your investments. By the time the market rebounds, your position is intact, the compounding engine resumes full speed. I have used mountaineering as an analogy. An experienced climber, before setting out, will always estimate the worst weather: what if I hit a blizzard mid-climb? What if I’m stuck on the slope for three days? He prepares enough food, water, warm clothing, first aid — to last in the worst conditions until rescue. He doesn’t do this because he “thinks a blizzard is certain” — he knows it probably won’t happen — but he knows that mountain weather is unpredictable, and the cost of being caught unprepared by extreme weather may be his life. Investing is the same. You don’t keep emergency cash because you think the market will surely crash tomorrow — you do it because the market will eventually crash, you just don’t know when, how, or by how much. The prepared sail through; the unprepared face annihilation.

In the CLEC system we have a concept called “air-raid drill.” It means periodically simulating the worst case and checking whether your current allocation can withstand extreme stress. How? Take your current portfolio, assume tomorrow’s market drops 70%, and compute on paper: what is your pledge maintenance ratio? How long does your emergency cash last? Do you have any large near-term expenses (mortgage, tuition) coming up? If after a 70% drop your maintenance ratio falls below the bank’s safety line, your pledge ratio is too high — lower it. If after 70% your emergency cash doesn’t cover three years of living, you have invested too much — adjust. You don’t need to do this daily, but do it at least every six months. Like a fire drill: at the time it feels pointless, but once a real fire breaks out, those who have drilled are calmer, more organized, and less likely to make fatal mistakes. In investing, “fire” is the market crash. When the market drops 10% in a day, 20% in a week, 40% in a month, your emotions will be hammered. If you have never imagined this scenario, the probability you make a wrong decision (like panic-selling) in the panic is very high. But if you have already simulated it in air-raid drills — and know how thick your safety cushion is, know you need to do nothing, know that every such crash in history has fully recovered — you will have one more measure of composure than the average person, one less measure of panic. Of course, even with air-raid drills, when a real crash hits you will still be afraid. CLEC’s founder freely admits that even after 30–40 years of investing, in every big crash he still has to “hypnotize himself” and steel his conviction. Don’t think knowledge and experience immunize you from fear — fear is a human instinct, you cannot eliminate it, only manage it. The point of an air-raid drill is not to feel nothing in a crash, but to make the right decision while feeling the fear — namely, do nothing. If you absolutely cannot bear the psychological pressure of investment losses, that’s fine too. Be honest about your risk tolerance, don’t force it. You can park your money in CDs and live peacefully — there’s no shame in that. Investing is not a required course in life, not a game everyone must play. But if you do decide to play, you must be prepared for the worst. Anyone who charges into the market without preparation is the real gambler.

Fifteen Years Underwater: The Risk Retirees Should Really Fear

Finally, a section specifically for friends already retired or about to retire. For you, the worst case is not “down 70%” — it is “after the drop, you wait 15 years to break even.” We showed earlier the real curve from 1999 to 2026: QQQ rose from ~$53 to ~$672, annualized about 10%. But if you were unlucky enough to retire at the very 2000 dot- com peak and put your entire portfolio in lump-sum into an index fund, then:

• 2000 → 2002: QQQ down ~85% from peak; your account shrinks to under 20%.
• 2003 → 2007: slow climb, still below 2000 highs.
• 2008: global financial crisis, another 50% drop.
• 2009 → 2015: continuous rise — until around 2015, when you finally claw back to your starting point.

A full 15 years, your account stays underwater. If during these 15 years you relied on “selling stocks for cash” to live, with high probability somewhere in the middle you would have been forced to sell at a low due to broken cash flow, permanently losing the rebound that follows. People who retire at a peak and have no continuous cash inflow are the ones the market truly “cleans out” in a 15-year underwater stretch. This is why CLEC’s discipline for retirees is much stricter than for working people:

1. Three years of cash living expenses — at all times your account has three years of money sitting still, untouched. Three years is the historical length of the longest 2000–2002 continuous bear.
2. Pledge ratio not exceeding 20% — even with a 70% drop, your remaining net is well above your debt; no forced liquidation.
3. Never sell — the key in a 15-year underwater stretch is not “account balance” but “behavior.” A paper loss waits for you to break even as long as you do not sell; once you sell, it becomes a real loss. Read this section three times. Retired people cannot “afford to lose and try again” like young people — your time window is short; you need structural safety, not higher potential return. Three years of cash + 20% pledge cap + never sell on the core position — these are the three lines of defense this book gives retirees.

Key Points

One, three questions before you invest: down 70%, can you live normally? Three straight down years, can you not sell? Cut in half then cut in half again (75% down), can you stay calm and do nothing? Any one you can’t answer, you’re not ready. Two, emergency cash is the most basic safety cushion. Working people: six months. Retirees: three years. This money is not for investing; it ensures that even in the most extreme market and personal-life shock, you are never forced to sell investment positions. Three, the “air-raid drill” habit, at least every six months: simulate a 70% drop, check pledge maintenance ratio, emergency cash, near-term expenses. The drill is not to eliminate fear — fear is human — but to ensure that in fear you still make the right decision: do nothing.