In Which I Predict the Stock Market for the Next Five Years

No, really.

Apologies for the clickbait headline. But I thought I would run an experiment. No one can actually predict the stock market as if they could they would be richer than everyone else on the planet! You might as well just roll some dice. So that’s exactly what I did.

With the market being so high I am a bit concerned that we are too invested in stocks and that maybe we should convert some stocks to cash and then reinvest into some slightly more secure items.

Here is the methodology I was considering. If our portfolio goes up in a month, take half that rise and convert to cash. So say the portfolio rises by $10,000 then convert $5000 into cash. If the market continues to rise then after a few months we should have a decent cash reserve to reinvest.

We would also use that cash reserve to pay for monthly expenses outside of passive income.

So here is my simulation of the stock market and cash conversion using that system.

Methodology.

Over the long term i’m assuming the market will rise by 5% a year. In order to simulate this I took two dice, a black one and a white one. On the white one I customized it by turning the 1 into another 2. So the white dice now has 22 pips rather than 21 pips. So there is a touch under 5% more pips.

Each month, the dice is rolled, each pip is equal to a 0.5% change in the stock market. So a white 6 would be equal to a 3% rise. A black 4 would be a 2% drop etc. This means that overall if 12 white 6s are rolled in a row, then we would be looking at a 36% rise (actually a bit more due to compounding). Twelve black 6s in a row would be a 36% drop. This seemed to be a reasonable set of annual boundary conditions.

For cash purposes I started with a $10,000 reserve and an assumption of spending $3,000 a month.

So starting with a hypothetical $2,000,000 portfolio (invested totally in stocks) and a stock market at 10,000 here is the results of the simulation.

Month One

Uh oh a black 4. So the market drops 2% in month 1. So I can’t take out any cash. The market drops from 10,000 to 9,800 the portfolio loses $40,000. The cash reserves drop from $10,000 to $7,000 as we need to spend $3,000.

Months Two & Three

Another black! This time a 3. So another 1.5% drop in the market. The market is down to 9653 and we lose another $29,400. Cash reserves are now perilous as we are down to $4000.

In month three finally a white roll, a 3. So the market claws back last months losses and ends the month at 9798. The portfolio is up $28,959 so we can convert half of that into cash ($14,479). So at end of month three our cash reserves are up at $15,480 which is enough to keep us going for a while. However the stock portfolio is down by over $50,000 after 3 months.

Year One

After a full year of this I ended up rolling more blacks than whites. The overall market was down 9.3% after a full year, very close to an official correction. The overall portfolio was down $250,000 (12.5%). Cash reserves now sit at $43,500.

Years Two – Five

Year 2 was another down year for the market (1.8%), overall down 10.9% since the high. Portfolio now sits at $1,610,000 (down 19.3% since high) and cash reserves at $110,500.

Year 3 down another 6%! Most of which occurred in the final two months of the year when I rolled 2 black 6s in a row! Overall market sits at 8361 and is down 16.4% from the high 3 years ago. Portfolio sits at $1,450,000, down over 27% from the high three years ago. Cash reserves now sit at $150,000.

Year 4, are you kidding me, down another 5%. Market at 7976, overall 4 year loss 20.2%. Portfolio at $1,327,000 down 34% from high. Cash reserves at $170,000.

Year 5, finally the market recovers by 6%. So market is up to 8449, showing an overall 5 year drop of 15.5%. Portfolio is at $1,312,000 down 1% for the year, but cash reserves are up to $229,000.

Hypothetical Stock Market Performance Over 5 Years

 

Commentary

So after 5 years, we end up with a good chunk of cash but the overall portfolio of stock plus cash is down 23% off of a 15.5% drop in the market (of course we did also spend $3,000 a month or $150,000). If we hadn’t spent the cash then our drop would have only been 14% so we would have smoothed out some of the overall loss.

It’s interesting that even though I “loaded” the dice to program in a 5% rise I ended up creating a stock market correction (not quite a crash though!). I’m not sure that spending half the cash rise is a valid methodology to convert to cash, but for me it was certainly an interesting experiment.

If nothing else rolling dice is as good a way to predict the stock market as any other!

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Frankie
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Great experiment! Definitely as good as any other means of prediction! Would be interesting to see if you ran the same simulation 1,000 times, whether you’d get to your average 5% per annum return 🙂

I’ve literally just written about my own strategy for dealing with these markets highs – definitely a topic front of mind for most investors…