Following an epic collapse of double bubbles in the stock market and real estate prices, Japan “suffered” 2+ decades of stagnation and deflation.
You would be hard pressed to find somebody who hasn’t at least heard of Japan’s Lost Decade(s.) It’s a popular topic people raise as soon as our early retirement and living off an investment portfolio comes up in polite conversation.
“Oh man, what are you doing to do when the United States (inevitably) experiences it’s Lost Decade(s)?!”
“20 years of 0% investment performance is bound to put a dent in your retirement plans, hehe”
“I want to retire early too but I’m really concerned about a Japan-style financial collapse. What can I do?”
That last question is probably the best – What lessons can we learn from Japan’s challenging times?
Japanese Stock Market Collapse
Japan has experienced one of the most famously drawn out stock market recoveries (or lack thereof.)
On December 29, 1989, the Nikkei 225 peaked at 38,957.44. Thirty+ years later, the index is around 23,500, a total decline of about 40%.
This is not a pretty picture.
Nikkei 225 Performance (data: source)
If we adjust for inflation and reinvest dividends along the way, the decline is slightly improved to (only) -17%. That is an annual return of -0.638% for 30 years.
When you put that number into any retirement calculator, it tells you that you can never retire.
The 4% Rule
The 4% rule is a decent guide for retirement spending for a US person.
But… what would have happened if you had lived/invested in Japan and retired at the end of 1989 with a record high stock market with a high equity allocation, planning on spending 4% for life?
As the iPhone autocorrect says, you would have been royally ducked.
A portfolio of 100% stocks would have failed in 13 years. A 60/40 Japanese stocks/bonds portfolio would have failed in 19 years. By contrast, the worst retirement experiences in US history were fairly tame. (Check out the gory details for 1965 and 2000 and 2008.)
Lessons from Japan
A 4% withdrawal rate failed to survive 30 years in Japan.
So did a 3% withdrawal rate, a 2% withdrawal rate, and all variable withdrawal methods. (A 1.6% withdrawal rate would have worked for 30 years but no more, and an 80%+ bond allocation would have done well.)
So what would have helped? 2 1/2 things:
International Allocation
At the peak in 1989, the Japanese stock market represented ~50% of the world market capitalization. This was with only 15% of global GDP and 2% of world population (and shrinking.) Not bad for an export economy with few internal natural resources.
Today, the numbers for Japan are ~8% of world market cap, ~6% of GDP, and <2% of world population.
Taking an index approach (holding assets in proportion to their global market cap) would have resulted in equity holdings of 50% Japan / 50% Rest of World, which would have made all the difference:
This is part of the reason that we hold international equities.
This is especially crucial for people who live in small market cap countries – we are currently in Taiwan which represents about 2% of global equity market cap. Do I want 100% of my equity allocation in 2% of the world? No, I want 2% in Taiwan, 2% in Australia, 3% in Canada, 5% in the UK, 8% in Japan, etc…
Be Mindful of Valuations
High valuations generally lead to low future returns. At the peak, the Nikkei 225 had a CAPE of nearly 100 (today it is ~22.)
For the equivalent valuation in the US, the S&P500 would need to more than triple overnight. (The US S&P500 CAPE is ~30.)
If that happened, I would be selling US stock and buying bonds and international equities. (See our portfolio.)
Market timing? No. It’s just rebalancing.
Requires superhuman intelligence? No, it’s just standard Modern Portfolio Theory asset allocation.
(MPT states that when one asset in your portfolio grows out of proportion with the other assets, you should sell some of it and buy the others. )
Circa 1989 Japan investors, especially retirement minded investors, should have done the same.
Don’t go 100% cash to 100% stock at extreme valuations
Most of these analyses start the same way… “assume you have $1 million equivalent in JPY at the end of 1989 and retired. What happens?”
But what about the lead up to that date? Did an investor go from 100% cash to 100% equities at the peak? Probably not.
In the 7+/– years prior the Nikkei 225 was up 400%+, a return of 26%+ per year. For context, had the US market 7-year return been the same, the S&P500 would currently be around ~7,500 (current value = ~3,000.)
If you estimated that you could retire within 10 years (perhaps based on this data), but you reached your savings target within 3…
… do you proclaim to the world that you are an investing god?
… Or do you practice a small bit of humility, rebalance your portfolio and build a small cash cushion, and carefully consider your timeline?
(See “Be Mindful of Valuations”)
Don’t fall victim to one of the classic blunders – The most famous of which is ‘never get involved in a land war in Asia’ – but only slightly less well-known is this: ‘Don’t invest 100% of your life savings in a single asset class with unprecedented valuation and let it ride.”
“But This Could Never Happen in the US”
I’ve seen this general comment quite a few times: “It couldn’t happen here, because <insert reasons.>”
They are always really good reasons. But, multiple decades of zero return have happened in the US multiple times:
- The Nasdaq from peak in 2000 to start of 2015 has had a real CAGR of -1.9%
- The S&P500 from Oct 1929 to Oct 1943 and from Jan 1966 to Jan 1983 returned 0%
In fact, the reason the 4% rule is not the 5% or 6% rule is because of these historical periods.
Could such a period happen again? Of course.
At present, the US represents:
55% of world equity market cap (CAPE ~31) (Japan 1989: 50%, CAPE ~100)
23.89% of world GDP (Japan 1989: 15%)
4.3% of world population (Japan 1989: 2%)
Before the Great Depression CAPE peaked at ~30. In 2000, it peaked at ~44.
At present, the market is overvalued compared to historical periods and compared to non-US markets. But not nearly to the same degree as Japan in 1989.
Sources & Methodology
To create the Japan 4% rule charts above, I used data from these sources:
Japanese bond returns: 1 year & 9 year
Japan CPI
Nikkei 225 total return (includes reinvested dividends)
Japan “foreign equities” – MSCI ex-Japan index (in USD – convert to JPY.)
USD JPY exchange rates – FRED
Boglehead’s Japan thread (couldn’t connect to same data sources, but reverse engineered for data)
Then, I created an ugly equivalent of cFIREsim for a single start date that allowed me to experiment with different asset allocations (Nikkei 225, Japan bonds (1 or 9 year), ex-Japan index.) All numbers calculated in Japanese yen.
Conclusions
Is the United States and the rest of the world destined to repeat Japan’s 20+ year downturn? Would we be better off investing in ammunition and food rations due to economic collapse? Should we expect multiple decades of 0% investment return?
Probably not. At least not without first having stock markets double or triple whilst earnings remain flat.
But based on the Japan experience, we can take some steps to minimize the already slim chance that it happens “here.”
Hold some international allocation, be mindful of valuations, and follow good portfolio rebalancing practices. Then, even in the worst of times, a well-diversified global portfolio is likely to carry you through. It worked in Japan, afterall.
幸運を祈る.
Great post. Investing with a home bias is a real risk, although for some reason people feel more comfortable with it. Most my stocks allocation is in Vanguard’s total world ETF, VT. So easy these days to be diversified globally.
Cheers!
Well, if you read “The Simple Path to Wealth“, JL argues that by buying into a fund like VTSAX, you’re buying into companies that are international conglomerates by definition, so you’re inherently already diversifying your risk between US and Internationally.
Japanese companies are also international – Sony, Toyota, Honda, Panasonic, Sharp
Historically, for a US investor, holding some amount of international stock increased returns and reduced volatility. See here.
The author later said that he was going to start investing internationally.
Great article and certainly makes me think about when the time is to start getting more global. The USA has been the worlds largest economy since 1871. This makes it hard for some to see a day when the USA is not the economic juggernaut it is today or a time when the US economy actually shrinks. Nothing lasts forever. Global diversification makes sense if the ultimate goal is risk mitigation as opposed to maximizing return.
Historically maximizing returns meant holding some international. It came with lower volatility too.
I kind of wanted some more explanation in your reply….then I found it here:
https://www.gocurrycracker.com/us-vs-international-investing/
interesting…
sorry meant to link it. Nice example of diversification benefits.
Yeah lets see how this one plays out.. Always so interesting to see recommendations pre, during and then post crisis without survivorship bias coming in and clouding any analysis. I think earning some income will help immensely in these times, either investment bargains or for cash flow.
And good luck to you too =)
Indeed, best of luck sir.
Great read
Did the 4% rule world for a globally diversified portfolio?
2nd chart in this post. After 30 years of 4% withdrawals portfolio is worth ~$600k.
Gcc,
So is your strategy still to stay at 90/10 stocks right now per your prior articles, considering the ~30 CAPE of the S&P? If the CAPE went up to 40, 50, and higher how would you rebalance your allocation and switch to more bonds?
You should rebalance once per year or when the market shifts by 25%. If CAPE were to jump that much, this automatic rebalancing would mean buying bonds.
You should change allocation never (or only under extremely special circumstances.)
Last I checked we are at 85/15 stock/bonds. Will know for sure when I update the allocation post sometime in the next month or so.
The US stock market has been a better investment for many years now. I’m seriously thinking about eliminating our developed international market allocation. It’s small, but it’s a drag on our portfolio.
On the other hand, I still believe in emerging markets. I’ll keep a small allocation there.
BTW, if you started working in Japan in 1989 and invested 100% stocks and keep investing, I bet you’d do pretty well. It’s only flat if you started off with a ton of money.
I could see a Japanese investor in 1988 saying the same thing. Japan has been outperforming for awhile now, I’ll sell all my international and put it in Japan.
Really great piece.
Thank you kindly.
I just picked up some more international stocks today, as my portfolio has been too heavy on the US.
I am wondering, if someone is in their accumulation phase, or 100% stocks and retired like your plan, there would be no re-balancing into bonds. How would the scenario work without bonds?
If not retired, you keep putting more money in per your asset allocation.
If retired, you just have to accept the volatility of a 100% stock portfolio. It probably pays off in the long run.
Great article. You do a great job of putting complicated issues into simpler language. I would request that you spell out some of the acronyms – CAGR, CAPE or link them like you do so much in your pieces. Not all of us who follow your are as familiar with these terms as you. When I do a google search, there are a bunch of things that these acronyms stand for. It’s hard to wade through them to figure out which one is applicable so I can then research what that acronym is measuring. Thanks for all of the articles!
CAPE – cyclically adjusted price-to-earnings ratio – a valuation metric
PE – price to earnings ratio – the price of a stock relative to that companies profits
CAGR – cumulative annual growth rate – the rate of return
I had already figured those out, but thanks for posting. I was thinking more about future articles. I know I am not as well versed as many on here on financial terms, so I know I have to do my reading. I’d just like the full name of something to help get me going. Thanks!
I’ll try to do better. Thanks for the suggestion.
A timely topic after what happened today… You reached conclusions very similar to a write-up of mine on the same topic! https://www.bogleheads.org/blog/2017/02/06/a-short-study-of-the-recent-japanese-crisis/
It’s good perspective for how bad it could be. Efficient markets will ebb and flow, but the US recent historic rise is probably bound for historic drops as well. Over the long run they need to be allowed to just do their thing and the swings won’t be so extreme.
We are accumulating and have been buying continuously for years (including the last two years). Other than the dip at the end of 2018, there has been no “dollar cost averaging” , just more expensive stocks every other week.
Japanese inflation rate:
= (103.7 / 92.9) ^ (1 / (2017 – 1990) – 1
= 0.4%
= ignore.
How to afford 50 years Japanese retirement:
Start with enough cash and don’t invest it.
Japanese average household income:
= ¥ 5,000,000
Initial cash required:
= 50 * ¥ 5,000,000
= ¥ 250,000,000
= $USA 2,500,000
The 2% Rule. Cash only.
Much detested by governments – which prefer moderate imaginary [inflationary] wealth growth which can be taxed alongside real growth to cause investment in profitable and taxable enterprise.
We could see CAPE ratios go sky high if the “E” in the P/E ratio goes way down due to an prolonged economic slowdown. A 20% hit to companies top lines could result in an 80% hit (or greater) to their bottom lines. All of the sudden stocks across the board that have lost 30% in value are still really expensive based on their ratios, but the markets are forward looking so maybe it’s just a blip. Hopefully this whole Coronavirus thing is just a blip.
This is really interesting, I’ve always been curious about this topic but never got around to looking into Japan’s economy. Currently I am VTSAX and VTI all the way and have subscribed to JLCollins methodology of most US businesses are already international so no exposure is necessary. I play around with the idea of going 90/10 in 5 years when I retire but I still lean more toward just straight 100% stocks. I’m curious though what you think of the effect the US has on the global economy. Just like in 2008-2009, when we crashed we took a lot of other economies with us (including China to a degree). In a short term collapse I don’t imagine that the rest of the world would fare much better these days. Although I do believe that a protracted decline like Japan would offer opportunity to begin transferring funds to the economies that start picking up the slack from the US. How would you assess the risk of staying exclusively US based during the accumulation phase and avoiding the slower growth but more stabilizing International exposure?
Best Regards,
Robert
P.S. Well done with the Princess Bride Reference.
*slow clap*
*raises a glass of champagne*
International isn’t slower growth. Read more.
Thanks for this article and the information you are consistently providing. After reading this one in particular, I’m realizing I should be diversified in an international index fund. My brokerage account was 100% invested in an s&p500 index fund and then I did some tax loss harvesting and now have both s&p500 and vtsax. I have more losses I would like to harvest and I was thinking maybe I could exchange them into an international index fund? Is there any reason why that wouldn’t be a good idea? Thanks again!
It would be changing your asset allocation, which would change the behavior of your portfolio. That could be considered a bad idea by some if what you really want is US only exposure.
But if that is something that you want to do, then no, I don’t see a downside. Diversification is generally a good idea.
With years of nice gains and now a quick sharp pullback why not consider using a strategy buying PUTS and/or LEAPS to hedge and protect your cash nest egg through the extreme volatility?
What’s the downside?
Great post. I’d been wanting to investigate the this question, but I’ve been too lazy. Thanks for doing the work for me. I’ve said for a while that Japan is the reason I am heavy on international equities.
Crazy to see mister 100% stocks result this month !!!!!
That’s Mr 90% stocks to you.
Instead of being an anonymous asshat on the Internet, see what you can do to help the millions of people who woke up today without a job (restaurant workers, retail, etc…) Thanks for caring.
You should know that I’ve been noodling the whole INTR exposure question for ages. I like JL but something in kept nudging me to diversity. This post (and your other one) pushed me over the edge. I’m now 65% US and 15% INTER (10 vxus 5 vwo) .
Good time to be re-balancing anyway. WELL DONE! (now i need to go wash my hands. AGAIN)
How does exchange rate factor in, if at all? The fluctuations there would seem to cause the returns to be worth less in Japan than you would need at the suggested withdrawal rate. See https://fxtop.com/en/historical-exchange-rates.php?YA=1&C1=USD&C2=JPY&A=1&YYYY1=1990&MM1=01&DD1=01&YYYY2=2020&MM2=03&DD2=30&LANG=en
All of this is in JPY. Exchange rate is included.
I have to point our one substantial error. You stated “The S&P500 from Oct 1929 to Oct 1943… returned 0%.”
A 14-year recovery. Looks pretty grim. However, if you account for inflation and reinvested dividends, the recovery time was actually closer to 4.5 years (see NYT Article: https://www.nytimes.com/2009/04/26/your-money/stocks-and-bonds/26stra.html)
It’s a nice NYT article, but including inflation and reinvested dividends from Oct 1929 to Oct 1943 the SP500 returned -5% (-0.4% per year.)
Use this calc and check the math.
Great thoughts. Agree with rational rebalancing and occasionally looking at the big picture. Love your stuff.