The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: justplucky on September 29, 2014, 08:00:19 PM
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Usually after researching a financial topic it's pretty clear to me as to what's the right decision for me at this moment. However, I've been reading about asset allocation and am kind of baffled. Most resources have been recommending having 7%-10% of my retirement savings in bonds at my age (31), but that seems high to me. Here is my current investment mix:
401(k) - 90% of retirement savings (5% in company stock due to the match I get, 67% in an S&P 500 index fund, 28% in an international total index fund)
Roth IRA - 10% of retirement savings (100% in a total stock market index fund)
I'm pretty risk-tolerant as far as market fluctuations are concerned, and understand I am playing the long game. My husband is a bit older than me, and ideally I'd like to retire when he does (in roughly 20-25 years).
Am I crazy for not moving away from 100% stocks right this minute?
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ideally I'd like to retire when he does (in roughly 20-25 years).
Am I crazy for not moving away from 100% stocks right this minute?
20 years? No, you're not crazy at all.
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I think you're fine given your long term view and recognition that your portfolio could drop 30-40%. There are definitely arguments that could be made for why you should have bonds such as lower volatility, dry powder, etc.
My view is that if you have the stomach to continue investing in stocks after losing a substantial amount of your portfolio, 100% stocks will serve you well over the savings and growth part of your life. Once you approach, or enter, the living off your assets stage it's a different story.
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I need to have my portfolio last 60+ years. However, I'm 80% stocks. Why? Simply because another 20% stocks adds a lot of volatility, for very little if any additional performance gains. It's a risk vs rewards question here. I just don't see the point of 100% stocks.
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This is from The Intelligent Asset Allocator*. Standard deviation is a measure of risk.
(http://i.imgur.com/EYDHK1q.jpg)
Each point on the line represents a 5% shift in allocation from stock to bond. The slope of the curve is very small near the 100% stock end of the line, meaning that you can trade a very small amount of return for a relatively large decrease in risk.
A 100% stock allocation obviously has the best absolute return on a sufficiently long time scale, but 20-25 years is probably not that timescale. Downturns can last a long time. Just because we haven't had a decade long bear market recently doesn't mean we won't have one in the future, maybe even in the years right before you want to retire.
With that in mind I think 10%-20% bonds is a pretty reasonable trade off.
The Intelligent Asset Allocator is a really good book, it answers questions like this (and ones you haven't even thought of yet) with models and historical data and math. If you have a local library they almost certainly have it.
*There's a better figure from the book to demonstrate this point, figure 4-1. Unfortunately a previous library patron drew shitty grid lines all over it. That figure uses historical data while this figure uses a probabilistic model. The graphs look basically the same though except the real market has had higher returns than the model.
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Like you, I am 20-25 years from retirement, and like you, I'm currently 100% stocks. Traditionally stocks have had a greater return than bonds, so I'm going for the (hopefully) maximum return. The fact that you say you want to retire in "20-25" years is a good sign that 100% stocks is OK right now. Why? Because not only are you waiting at least two more decades to retire, but you don't have a set date yet, so you have flexibility when it's time to retire. Market crashes 20 years from now? Wait a few years for the market to rebound then retire on the upswing.
Of course, by then, you should have bonds in your portfolio anyway. I know I will :) But for now? As long as you are sure you can stomach a market drop and increased volatility, you should be ok. Just stick to your plan until it's time to retire and you will be fine.
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There are good arguments for why it could make sense to hold a 100% stock allocation forever if you have the stomach for it. See, for example, the discussion in this thread:
http://forum.mrmoneymustache.com/investor-alley/never-reallocating-from-100-equity-with-age/
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My wife and I plan on 100% stocks forever. So I don't think you are crazy at all.
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I plan on 100% stocks for the foreseeable future. I would say as long as your are flexible and can ride the ups and downs stick with it. Most resources are aimed at people who wouldn't be considered mustacian. They assume you need 85% of what you make now in retirement. Most of us live off far less than 85%. And most of us are willing to make cutbacks during a downturn. Yes there is a chance of a 15 year long downturn. But it is highly unlikely and again, most of us are willing to go back to work if we had to.
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This is from The Intelligent Asset Allocator*. Standard deviation is a measure of risk.
(http://i.imgur.com/EYDHK1q.jpg)
Each point on the line represents a 5% shift in allocation from stock to bond. The slope of the curve is very small near the 100% stock end of the line, meaning that you can trade a very small amount of return for a relatively large decrease in risk.
A 100% stock allocation obviously has the best absolute return on a sufficiently long time scale, but 20-25 years is probably not that timescale. Downturns can last a long time. Just because we haven't had a decade long bear market recently doesn't mean we won't have one in the future, maybe even in the years right before you want to retire.
With that in mind I think 10%-20% bonds is a pretty reasonable trade off.
The Intelligent Asset Allocator is a really good book, it answers questions like this (and ones you haven't even thought of yet) with models and historical data and math. If you have a local library they almost certainly have it.
*There's a better figure from the book to demonstrate this point, figure 4-1. Unfortunately a previous library patron drew shitty grid lines all over it. That figure uses historical data while this figure uses a probabilistic model. The graphs look basically the same though except the real market has had higher returns than the model.
Thanks for this post! I already have this book on my reading list. As I'm also seeing elsewhere, there is just no real benefit for the extra percent in stocks.
I want to retire in less than 10 years and don't want a downturn pushing that date back significantly. I also do NOT want to go back to work after FIRE, particularly in a downturn where it's going to be nigh impossible to get a job.
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Thanks for this post! I already have this book on my reading list. As I'm also seeing elsewhere, there is just no real benefit for the extra percent in stocks.
I want to retire in less than 10 years and don't want a downturn pushing that date back significantly. I also do NOT want to go back to work after FIRE, particularly in a downturn where it's going to be nigh impossible to get a job.
There is real benefit in the extra percentage of stocks: higher returns over sufficiently long time periods. It makes sense to have a more conservative allocation if volatility prevents you from sleeping at night, but in my view if your goal is to retire as early as possible then 100% equities is the way to go.
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Thanks for this post! I already have this book on my reading list. As I'm also seeing elsewhere, there is just no real benefit for the extra percent in stocks.
I want to retire in less than 10 years and don't want a downturn pushing that date back significantly. I also do NOT want to go back to work after FIRE, particularly in a downturn where it's going to be nigh impossible to get a job.
There is real benefit in the extra percentage of stocks: higher returns over sufficiently long time periods. It makes sense to have a more conservative allocation if volatility prevents you from sleeping at night, but in my view if your goal is to retire as early as possible then 100% equities is the way to go.
Actually, my rate of return has little affect on my retirement date, as the vast majority of my income between now and my retirement date (more than 80%) will be generated by my salary, not investment returns. This equation totally changes when you're retiring in your early 30's!
I don't want to have everything set to retire at 33 and then have to work 3 more years due to a market downturn. Having some bond allocation will help me reduce the impact of a sudden market downturn.
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I keep half my age in bonds and plan to do that for a long time. (25 currently)
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Had to register for this:
I don't think 20 years is enough to negate the risk of holding stocks. I actually don't think that any period of time is long enough to negate the risk of holding stocks.
The reason is, that even though the annualized return of stocks may converge towards some number (e.g. 7%), it does absolutely not follow that the return of your investments converge. They will actually diverge. Let me shortly explain:
Lets assume the 7% annualized is the "normal" or "expected" return. You invest $10,000, and after 10 years you find out that your annualized return is only 6.5%. You wait, and after 20 years your annualized return is 6.7%. You still wait ten more years, and after 30 years the return is 6.8%. After 40 years it is 6.9%. Everything seems to be going smoothly, and at first glance your return is converging towards the "expected" return.
But what about your actual dollars? After 10 years you will have $18,771. Compared to the 7% return, you are lagging $900. After 20 years, you'll have $36,584, but you will be lagging $2,113 compared to the 7% return. In 30 years you'll have $71,968, but will be lagging $4,155. 40 years and $144,247, but you'll be lagging $5,497.
So while your annualized return is converging towards the "expected" annualized return. Your return may actually be diverging from the "expected" return! (See Table below).
Ret. p.a. Assets ($) Diff. to 7% ret. ($)
10 years 6.5% $18,771 $900
20 years 6.7% $36,584 $2,113
30 years 6.8% $71,968 $4,155
40 years 6.9% $144,247 $5,497
This is of course just an example, but I have seen a paper that shows that the annualized return does not converge fast enough for the return in actual dollars to converge as well (but I can't find it to save my life). One bad year does not hurt too much, but after a bad decade you will have a hard time getting high enough returns fast enough for your dollar return to converge towards your "expected" return. Getting these returns will be even more difficult if you start shifting to bonds when coming closer to retirement. And I doubt that all the possible annualized return will even fall within 0.1 pp from the average of all the returns. If someone has historical data, it would be interesting to see what the possible annualized returns are for 10, 20, 30, 40, 50 years etc. Remember that your investment horizon does not end when you retire, and if you are lagging by then, good luck in catching up if you are holding more bonds and actually living off the returns as well.
I'm not saying that you can't hold 100% stocks. I'm just saying that stocks have a long term risk that you can not wait out. Stocks are risky, and hence you are paid a risk premium to buy them. It's a risk premium, not a patience premium. You can't negate the risk of stocks just by having the stomach not to sell during a bear market. The risk is there, and you have to be aware of both the short- and the long-term risk, especially if you are 100% in stocks. I'm not saying you have to sacrifice all the potential return to avoid risk, but if you can reduce risk (and hence avoid the worst possible long-term outcomes) without hurting your expected return (see graph by pmallory), you should really have a good and thought out reason if you choose not to.
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So while your annualized return is converging towards the "expected" annualized return. Your return may actually be diverging from the "expected" return! (See Table below).
Ret. p.a. Assets ($) Diff. to 7% ret. ($)
10 years 6.5% $18,771 $900
20 years 6.7% $36,584 $2,113
30 years 6.8% $71,968 $4,155
40 years 6.9% $144,247 $5,497
This is of course just an example, but I have seen a paper that shows that the annualized return does not converge fast enough for the return in actual dollars to converge as well (but I can't find it to save my life).
Well yeah, but 900/18,771 > 5497/144,247, so in percentage terms you are converging to the expected return. You are mixing absolute and relative differences.
I'm just saying that stocks have a long term risk that you can not wait out.
I guess it depends how you define it, but I have a hard time seeing how you can't. The worst 30 year period ever for the S&P 500 returned an average 8.5% annually (source (http://articles.chicagotribune.com/2012-07-13/business/sc-cons-0712-started-20120713_1_young-investors-stock-market-double-digit-stock-returns)). What historical evidence is there to say you can't?
Anyway, my take on this topic is that it depends on your goals. If you just want to die with as much money in your account as possible, yes, go for 100% equities. If you do not want the possibility of periods during your retirement being very lean (i.e. going back to work, spending less, etc) then gradually shift into bonds as you near FI and then maintain some bond allocation during retirement.
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I'd suggest 20% in bonds, that way you can enjoy some buy high, sell low rebalancing.
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Just a FYI because I keep seeing things like "Add bonds to reduce volatility & risk without reducing returns." Putting bonds in your portfolio does reduce your return. Even the graph in this thread shows that, and it's being cited as an example of how holding bonds doesn't reduce return. It absolutely does. There are countless sources showing this (again, including the one in this thread). Don't shoot the messenger. It's probably the best idea for the majority of people to hold bonds, just like it's the best idea for the majority of people to invest in index funds, but that doesn't mean you aren't making some amount of sacrifices when it comes to your total return.
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Well yeah, but 900/18,771 > 5497/144,247, so in percentage terms you are converging to the expected return. You are mixing absolute and relative differences.
I'm not. I'm just stating that your return might not converge even though your annualized return does. Therefore you run the risk of not only never achieving the "expected return", but actually fall more and more behind the expected return in actual dollars for every year. This is a definite risk, and it's one you can't necessarily cancel out by waiting.
I'm just saying that stocks have a long term risk that you can not wait out.
I guess it depends how you define it, but I have a hard time seeing how you can't. The worst 30 year period ever for the S&P 500 returned an average 8.5% annually [SNIP!]
How doe's the fact that S&P returned an average of 8.5% annually prove anything? The point is, that if you held stocks for that 30 years, you are lagging behind the expected return of the stock market, and you might never catch up with it (even though it may seem that your annual return is catching up with the expected annual return). So waiting any amount of time (including forever) does not guarantee you the expected return of the stock market. And I'm interested in dollars because we spend actual dollars, not annualized returns.
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Had to register for this:
I don't think 20 years is enough to negate the risk of holding stocks. I actually don't think that any period of time is long enough to negate the risk of holding stocks.
The reason is, that even though the annualized return of stocks may converge towards some number (e.g. 7%), it does absolutely not follow that the return of your investments converge. They will actually diverge. Let me shortly explain:
Lets assume the 7% annualized is the "normal" or "expected" return. You invest $10,000, and after 10 years you find out that your annualized return is only 6.5%. You wait, and after 20 years your annualized return is 6.7%. You still wait ten more years, and after 30 years the return is 6.8%. After 40 years it is 6.9%. Everything seems to be going smoothly, and at first glance your return is converging towards the "expected" return.
But what about your actual dollars? After 10 years you will have $18,771. Compared to the 7% return, you are lagging $900. After 20 years, you'll have $36,584, but you will be lagging $2,113 compared to the 7% return. In 30 years you'll have $71,968, but will be lagging $4,155. 40 years and $144,247, but you'll be lagging $5,497.
So while your annualized return is converging towards the "expected" annualized return. Your return may actually be diverging from the "expected" return! (See Table below).
Ret. p.a. Assets ($) Diff. to 7% ret. ($)
10 years 6.5% $18,771 $900
20 years 6.7% $36,584 $2,113
30 years 6.8% $71,968 $4,155
40 years 6.9% $144,247 $5,497
So what you're saying is that your actual returns may not equal expected returns? I'd hope that's common knowledge.
This is of course just an example, but I have seen a paper that shows that the annualized return does not converge fast enough for the return in actual dollars to converge as well (but I can't find it to save my life). One bad year does not hurt too much, but after a bad decade you will have a hard time getting high enough returns fast enough for your dollar return to converge towards your "expected" return. Getting these returns will be even more difficult if you start shifting to bonds when coming closer to retirement. And I doubt that all the possible annualized return will even fall within 0.1 pp from the average of all the returns. If someone has historical data, it would be interesting to see what the possible annualized returns are for 10, 20, 30, 40, 50 years etc. Remember that your investment horizon does not end when you retire, and if you are lagging by then, good luck in catching up if you are holding more bonds and actually living off the returns as well.
If you have enough to retire, then you have enough to retire. Your returns do not need to "catch up" to anything.
I'm not saying that you can't hold 100% stocks. I'm just saying that stocks have a long term risk that you can not wait out. Stocks are risky, and hence you are paid a risk premium to buy them. It's a risk premium, not a patience premium. You can't negate the risk of stocks just by having the stomach not to sell during a bear market. The risk is there, and you have to be aware of both the short- and the long-term risk, especially if you are 100% in stocks. I'm not saying you have to sacrifice all the potential return to avoid risk, but if you can reduce risk (and hence avoid the worst possible long-term outcomes) without hurting your expected return (see graph by pmallory), you should really have a good and thought out reason if you choose not to.
Yeah, but that graph shows that returns will be higher with all stock. So how are you proposing to reduce risk without hurting returns? That would seem to be an impossibility.
I don't really understand this paragraph at all. Where exactly is the risk? You're saying the risk is that if you're counting on your projection to be 100% accurate that you may be wrong even if you wait a long time?
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This is from The Intelligent Asset Allocator*. Standard deviation is a measure of risk.
(http://i.imgur.com/EYDHK1q.jpg)
Each point on the line represents a 5% shift in allocation from stock to bond. The slope of the curve is very small near the 100% stock end of the line, meaning that you can trade a very small amount of return for a relatively large decrease in risk.
A 100% stock allocation obviously has the best absolute return on a sufficiently long time scale, but 20-25 years is probably not that timescale. Downturns can last a long time. Just because we haven't had a decade long bear market recently doesn't mean we won't have one in the future, maybe even in the years right before you want to retire.
With that in mind I think 10%-20% bonds is a pretty reasonable trade off.
The Intelligent Asset Allocator is a really good book, it answers questions like this (and ones you haven't even thought of yet) with models and historical data and math. If you have a local library they almost certainly have it.
*There's a better figure from the book to demonstrate this point, figure 4-1. Unfortunately a previous library patron drew shitty grid lines all over it. That figure uses historical data while this figure uses a probabilistic model. The graphs look basically the same though except the real market has had higher returns than the model.
Thanks for this post! I already have this book on my reading list. As I'm also seeing elsewhere, there is just no real benefit for the extra percent in stocks.
I want to retire in less than 10 years and don't want a downturn pushing that date back significantly. I also do NOT want to go back to work after FIRE, particularly in a downturn where it's going to be nigh impossible to get a job.
Just a side note, the graph is what many call the Efficient Frontier, it does change over time, in other words its not static.
As for all stocks, I forget who wrote it but it was suggested to never hold less than 20% of bonds or stocks over ones life time, could have been 25%, seems reasonable to me.
With the great run up in the last few years don't get hung up with Regency Bias!
Edit: I thought Rick Ferri's "All About Asset Allocation" book was good read, he did a nice job of laying it out, I don't recall his minimum bond allocation however.
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People also seem to be missing the argument that, over the long-term, the historical data suggest that a 100% equity allocation is LESS risky in the sense that you are ALWAYS better off (assuming that (i) the future is no worse than the past and (ii) you have the willpower to stick to the strategy even during periods of high volatility).
If you play around with cfiresim using sufficiently long-term horizons, you will see that there is no historical period when having any level of bond exposure would have helped your success rate. In every case, with 100% equities, the success rate is equal or better, and the remaining portfolio is higher. Read through the thread I linked to above (and the threads linked to in that thread), especially the posts by Skyrefuge.
If your stash's purpose is to serve you for the rest of your life, and you are able to stick to your strategy with cold Vulcan logic, having a percentage of bond exposure (small or otherwise) does nothing to protect you. What it does do is give you an emotional security blanket to prevent your human emotions from causing you to deviate from the strategy when your portfolio value temporarily plummets.
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I don't really understand this paragraph at all. Where exactly is the risk? You're saying the risk is that if you're counting on your projection to be 100% accurate that you may be wrong even if you wait a long time?
Stocks have a historical expected return. Everyone knows that your actual returns can differ from the historical returns during e.g. one year. The point is, that your actual return can differ a whole lot from the historical return after a long time, and you cant wait this out. In addition one might be fooled by the converging of the annual return if one waits, and confuse that with being able to wait long enough the have a converging actual return. If you calculate an estimate of your expected return, you will have a huge probability distribution around that projection, and the spread will grow larger as time passes, not narrower.
The point is that don't be fooled to think that the return of stocks are somehow guaranteed to come even close to the historical return during your lifetime. The risk of stocks is not just the next bear market. If you have enough to retire, then you have enough to retire. Stocks have an uncertainty even in the long run, so if you can achieve your goals with less risk you should probably do it.
I hope I could find the paper, there the distribution was shown, and calculated from real data (if my memory is not playing tricks on me, it might have been a monte carlo based on statistical parameters, because we don't have that many 50+ year periods of data). I favor being heavy in stocks, but I know I can't rely on them to guarantee anything close to the average even in 30 years. They might even under perform less risky investments (although time does reduce that probability).
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People also seem to be missing the argument that, over the long-term, the historical data suggest that a 100% equity allocation is LESS risky in the sense that you are ALWAYS better off (assuming that (i) the future is no worse than the past and (ii) you have the willpower to stick to the strategy even during periods of high volatility).
If you play around with cfiresim using sufficiently long-term horizons, you will see that there is no historical period when having any level of bond exposure would have helped your success rate. In every case, with 100% equities, the success rate is equal or better, and the remaining portfolio is higher. Read through the thread I linked to above (and the threads linked to in that thread), especially the posts by Skyrefuge.
If your stash's purpose is to serve you for the rest of your life, and you are able to stick to your strategy with cold Vulcan logic, having a percentage of bond exposure (small or otherwise) does nothing to protect you. What it does do is give you an emotional security blanket to prevent your human emotions from causing you to deviate from the strategy when your portfolio value temporarily plummets.
I think having some fixed income protects you from a bad case of sequence of return risk and not just an emotional security blanket, I do agree it's part a emotional security blanket just as an annuity can be. If you retire, the following year the market tanks by 50% and stays their for, pick a number say 5 years what are you going to live on? You have two choices, go back to work or spend down your stock pile at 50% loss. If you are using a 1-2% SWR you would likely be ok but if you are hitting an SWR of 4-5% I'm not so sure it would work out very well.
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People also seem to be missing the argument that, over the long-term, the historical data suggest that a 100% equity allocation is LESS risky in the sense that you are ALWAYS better off (assuming that (i) the future is no worse than the past and (ii) you have the willpower to stick to the strategy even during periods of high volatility).
We don't have that much data. How many independent 30 or 50 year periods do we really have. If the probability of stocks under performing a less risky asset after 30 years is low (e.g. 1%), and a 100 year period only contains about 3 independent 30 year periods, we can have several hundreds, even thousands years of data before we actually encounter this for real. If you have the volatility of different asset classes, you can run simulations, and thus get thousands of outcomes. This will give you another picture than looking at a couple of hundred years of historical data.
Again, I'm not advocating not using stocks. I think it's the best bet out there. I'm just saying it is not a sure thing even in the long run.
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I don't really understand this paragraph at all. Where exactly is the risk? You're saying the risk is that if you're counting on your projection to be 100% accurate that you may be wrong even if you wait a long time?
Stocks have a historical expected return. Everyone knows that your actual returns can differ from the historical returns during e.g. one year. The point is, that your actual return can differ a whole lot from the historical return after a long time, and you cant wait this out. In addition one might be fooled by the converging of the annual return if one waits, and confuse that with being able to wait long enough the have a converging actual return. If you calculate an estimate of your expected return, you will have a huge probability distribution around that projection, and the spread will grow larger as time passes, not narrower.
The point is that don't be fooled to think that the return of stocks are somehow guaranteed to come even close to the historical return during your lifetime. The risk of stocks is not just the next bear market. If you have enough to retire, then you have enough to retire. Stocks have an uncertainty even in the long run, so if you can achieve your goals with less risk you should probably do it.
I hope I could find the paper, there the distribution was shown, and calculated from real data (if my memory is not playing tricks on me, it might have been a monte carlo based on statistical parameters, because we don't have that many 50+ year periods of data). I favor being heavy in stocks, but I know I can't rely on them to guarantee anything close to the average even in 30 years. They might even under perform less risky investments (although time does reduce that probability).
MrMonkeyMustache, your point still really just boils down to "your actual returns may differ from past returns, even over long periods of time." But that doesn't change the fact that stocks give you higher returns. So if the only goal is to retire as early as possible with the lowest likelihood of running out of money, your best bet is the highest equity allocation your stomach can handle. Your statement that "if you can achieve your goals with less risk you should probably do it" is the line of thinking often referred to on this board as "if you've won the game, stop playing." But for most people, the only way to "win the game" with a more conservative allocation is to prolong their working career before pulling the trigger on FIRE.
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I think having some fixed income protects you from a bad case of sequence of return risk and not just an emotional security blanket, I do agree it's part a emotional security blanket just as an annuity can be. If you retire, the following year the market tanks by 50% and stays their for, pick a number say 5 years what are you going to live on? You have two choices, go back to work or spend down your stock pile at 50% loss. If you are using a 1-2% SWR you would likely be ok but if you are hitting an SWR of 4-5% I'm not so sure it would work out very well.
If you stick to the "future being no worse than the past" assumption, this just isn't true. The cfiresim simulations based on historical periods include every scenario where the market tanked immediately after retirement, yet still show a 100% stock allocation coming out ahead.
We don't have that much data. How many independent 30 or 50 year periods do we really have. If the probability of stocks under performing a less risky asset after 30 years is low (e.g. 1%), and a 100 year period only contains about 3 independent 30 year periods, we can have several hundreds, even thousands years of data before we actually encounter this for real. If you have the volatility of different asset classes, you can run simulations, and thus get thousands of outcomes. This will give you another picture than looking at a couple of hundred years of historical data.
Yes, this is a valid point, which is why you have to take the "future being no worse than the past" assumption for what it's worth. But it's the best we have to go on.
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Usually after researching a financial topic it's pretty clear to me as to what's the right decision for me at this moment. However, I've been reading about asset allocation and am kind of baffled. Most resources have been recommending having 7%-10% of my retirement savings in bonds at my age (31), but that seems high to me. Here is my current investment mix:
401(k) - 90% of retirement savings (5% in company stock due to the match I get, 67% in an S&P 500 index fund, 28% in an international total index fund)
Roth IRA - 10% of retirement savings (100% in a total stock market index fund)
I'm pretty risk-tolerant as far as market fluctuations are concerned, and understand I am playing the long game. My husband is a bit older than me, and ideally I'd like to retire when he does (in roughly 20-25 years).
Am I crazy for not moving away from 100% stocks right this minute?
Not at all.
Bond rates are expected to remain lame for the better part of the next decade.
Asset allocation is largely about your risk tolerance. If your tolerance is high, over twenty years statistically you'd be better off 100% stocks. But... can handle seeing your account drop 50% tomorrow without freaking out?
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We don't have that much data. How many independent 30 or 50 year periods do we really have. If the probability of stocks under performing a less risky asset after 30 years is low (e.g. 1%), and a 100 year period only contains about 3 independent 30 year periods, we can have several hundreds, even thousands years of data before we actually encounter this for real. If you have the volatility of different asset classes, you can run simulations, and thus get thousands of outcomes. This will give you another picture than looking at a couple of hundred years of historical data.
Yes, this is a valid point, which is why you have to take the "future being no worse than the past" assumption for what it's worth. But it's the best we have to go on.
I don't think it is. We have some information about the statistical parameters that we can use to run simulations. Assume we flip a coin 50 times and repeat the experiment 100 times. Lets then assume that in none of the 100 50 flip series do we get all heads. The best we can do is not to say "well you can flip heads an awful lot of times, but if you just keep flipping, at some point you will flip tails. The historical data shows it." This would not be the best we could do. The best thing would be to run simulations (or calculate) the probability of flipping 50 heads in a row. Nothing have to change about the coin or the circumstances that will enable us to flip 50 heads. It just has not happened yet. And nothing fundamental would necessarily have to happen to the market for stocks to under perform an less riskier asset over 30 years. It just has not happened yet (don't know where we are with Japanese stocks these days...).
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I don't think it is. We have some information about the statistical parameters that we can use to run simulations. Assume we flip a coin 50 times and repeat the experiment 100 times. Lets then assume that in none of the 100 50 flip series do we get all heads. The best we can do is not to say "well you can flip heads an awful lot of times, but if you just keep flipping, at some point you will flip tails. The historical data shows it." This would not be the best we could do. The best thing would be to run simulations (or calculate) the probability of flipping 50 heads in a row. Nothing have to change about the coin or the circumstances that will enable us to flip 50 heads. It just has not happened yet. And nothing fundamental would necessarily have to happen to the market for stocks to under perform an less riskier asset over 30 years. It just has not happened yet (don't know where we are with Japanese stocks these days...).
Ok, I agree with everything you said here but don't see where you are going with it. Just like with coin flips, once you have sufficient data the empirical evidence should line up nicely with the expected probabilities. Of course it is possible for stocks to underperform bonds for a very extended period, just like it is possible to get 50 heads in a row flipping coins. But it is very unlikely (whether you draw that conclusion based on the historical performance of the markets or using simulations based on statistical parameters).
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I'm just saying that stocks have long term risk. It is an over simplification to just say "20 years? You are fine with 100% in stocks!". I agree that data will line up, but we have no where near enough data to draw conclusions of stocks long term risk by just looking at individual long periods.
It might seem that you can beat 10 heads ("bear markets") by just fliping, and you will eventually end up with tails, but by running simulations we can see that that is just not the case. To us it might seem that we will always end up ahead with 100% stocks, but we really can't draw that conclusion based on our limited historical data.
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I'm just saying that stocks have long term risk. It is an over simplification to just say "20 years? You are fine with 100% in stocks!". I agree that data will line up, but we have no where near enough data to draw conclusions of stocks long term risk by just looking at individual long periods.
It might seem that you can beat 10 heads ("bear markets") by just fliping, and you will eventually end up with tails, but by running simulations we can see that that is just not the case. To us it might seem that we will always end up ahead with 100% stocks, but we really can't draw that conclusion based on our limited historical data.
So what's your conclusion then? That we need bonds because there's a slight chance they could outperform over the long term, even though it's never happened? That seems to be dealing with possibilities instead of probabilities.
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If you are going to have 100% stocks, acklowledge the long term risk. Stocks do not become risk free investments over time.
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If you are going to have 100% stocks, acklowledge the long term risk.
I still don't quite follow what you're claiming the long term risk actually is. Are you saying that the long term risk is that it's possible that stocks will under perform bonds over the next 50 years? If so, then I acknowledge that possibility, but think it's not actionable without hurting returns when considering probability.
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You will hurt your expected return if you take risk off the table. But reducing risk is not just paving way for a "smoother ride", it's also guarantee for a smaller spread in outcomes even in the long run.
I'm opposed to the idea that a 20 year timeline automatically would mean 100% stocks are ok without any need for further considerations. A one year period might be suitable for stocks if one wants to maximize the returns and are prepared to take a possible loss.
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You will hurt your expected return if you take risk off the table. But reducing risk is not just paving way for a "smoother ride", it's also guarantee for a smaller spread in outcomes even in the long run.
I'm opposed to the idea that a 20 year timeline automatically would mean 100% stocks are ok without any need for further considerations. A one year period might be suitable for stocks if one wants to maximize the returns and are prepared to take a possible loss.
Yup, I agree.
Back to other posts in this thread, the point is that going 100% vs. 80% stocks, the additional return is miniscule. However, the additional risk increases a lot more. Yes, 100% stocks will give you more return. But it's pretty negligible. A 75/25 or 80/20 portfolio looks like an excellent place to be in the risk/return continuum.
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You will hurt your expected return if you take risk off the table. But reducing risk is not just paving way for a "smoother ride", it's also guarantee for a smaller spread in outcomes even in the long run.
I'm opposed to the idea that a 20 year timeline automatically would mean 100% stocks are ok without any need for further considerations. A one year period might be suitable for stocks if one wants to maximize the returns and are prepared to take a possible loss.
I don't think anyone is claiming that stocks do not have associated risk (even over extended time horizons). Your point makes sense for someone who is in a position to hold a more conservative allocation and still have high enough expected returns to fund their needs. That's why the argument to start dialing back risk once you've won the game makes sense to me (even though personally I'm in the camp of "might as well continue to let it ride" if you've reached the point where your withdrawal rate has become ridiculously safe). But the typical member of this forum who is trying to accumulate enough to declare FIRE (or who has already achieved FIRE using a moderately high withdrawal rate) has not yet won the game and needs the more aggressive allocation if the goal is to achieve FIRE as quickly as possible (or continue to maintain FIRE).
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You will hurt your expected return if you take risk off the table. But reducing risk is not just paving way for a "smoother ride", it's also guarantee for a smaller spread in outcomes even in the long run.
I'm opposed to the idea that a 20 year timeline automatically would mean 100% stocks are ok without any need for further considerations. A one year period might be suitable for stocks if one wants to maximize the returns and are prepared to take a possible loss.
I don't think anyone is claiming that stocks do not have associated risk (even over extended time horizons). Your point makes sense for someone who is in a position to hold a more conservative allocation and still have high enough expected returns to fund their needs. That's why the argument to start dialing back risk once you've won the game makes sense to me (even though personally I'm in the camp of "might as well continue to let it ride" if you've reached the point where your withdrawal rate has become ridiculously safe). But the typical member of this forum who is trying to accumulate enough to declare FIRE (or who has already achieved FIRE using a moderately high withdrawal rate) has not yet won the game and needs the more aggressive allocation if the goal is to achieve FIRE as quickly as possible (or continue to maintain FIRE).
I just ran cFIREsim with my own numbers and used the "compare asset allocation" function. My success rate increased by a negligible amount. 80% vs 100% stocks is really not that different in terms of long-term returns. As I've said before, 100% stocks increases volatility for a very minor increase in returns. IMO it just isn't worth it.
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Obligatory Japan 1989-2013 (25 years) chart:
(http://s22.postimg.org/58ph5zzap/jpn1989_2013.jpg)
How would stocks having a negative return for 25 years affect your plans? Suddenly you're 50 and have significantly less money than expected. Bonds are at their best when taking distributions from the portfolio, planned or not. While you may think this won't happen for many years, after all you're young, there are many scenarios where you might end up needing your portfolio before then. Generally, 100% of anything is not recommended. Here's an insightful post from the Bogleheads forum on this topic:
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Listen, there are two HUGE reasons other than psychology (itself not to be underestimated) to have some bonds:
1) you might need the money during a crash. As in, you get fired or get ill, both for the long term. The forced sale will be devastating and may well be the difference between the poor house and some degree of comfort. Do you really want to trade that in exchange for "more money if stocks do well", a situation in which you're already in good shape?
2) there are no guarantees that stocks rebound after any amount of time. Compare a stock certificate with a Treasury bond, no guarantees in sight for the former. If someone tells you that it's a certainty because of history blah blah, ask them for a written, notarized guarantee backed by THEIR personal fortune. Only then can you rightfully sleep well.
So don't do 100%. Add 20 or 30 percent bonds, which won't hurt your returns too badly and will be there for you when times generous. Unlike others above, I won't qualify this to depend on your worldview or vitamin levels. Just don't.
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http://www.bogleheads.org/forum/viewtopic.php?f=1&t=142825&newpost=2123372#p2120756
This is what the Cfiresim.com calculator tells me, regarding a 1,000,000 portfolio, a 60 year time-horizon, and a 4% withdraw rate:
Using Historical Data, 90% is the peak success rate:
(http://i.imgur.com/WZMaRw2.png)
Using Monte Carlo (randomized) data, between 70-80% is the peak success rate:
(http://i.imgur.com/PfiujWR.png)
Every time you rerun the Monte Carlo, the results are different. Some Cfiresim.com Monte Carlo results are REALLY BAD for 100% equities:
(http://i.imgur.com/js2bzs9.png)
Vanguard's Monte Carlo retirement nest egg calculator (https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementNestEggCalc.jsf) also maxes out the success rate between 70-80% stocks:
With 100 stocks / 0 bonds, a 4% withdraw rate, and a 50 year time horizon, here are the chances of success I get:
80%
79%
80%
When I change to 90 stocks / 10 bonds
81%
81%
82%
80 stocks / 20 bonds
82%
82%
81%
70 stocks / 30 bonds
82%
82%
84%
60 stocks / 40 bonds
81%
82%
80%
(http://i.imgur.com/YRaLdHq.png)
So, to answer your question, of "100% stocks for how long?" I don't think there's ever a good time to be 100% stocks.
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This is what the Cfiresim.com calculator tells me, regarding a 1,000,000 portfolio, a 60 year time-horizon, and a 4% withdraw rate:
Using Historical Data, 90% is the peak success rate:
Dodge, when I plug the same numbers into cfiresim, I get 95% - 100% as the peak success rate.
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Nice post Dodge,
As I noted above it a sequence of return risk story, that's they way I'm looking at it anyway.
If I had 3 times more than I need for a SWR of lets say 4% then 100% stocks, sure why not. But I would think the majority of people don't have 3 times more than they will need to sustain a 4% SWR so what is the flip side? I think Warren and Gates would do ok with 100% stock forever but is that the norm?
To avoid the sequence the of return risk (think Japan) at the start of the draw down you hold some portion of fixed income and as you age and you could ramp it back up if you wish for the simple fact that you don't need to cover as many years.
I don't give to much credence to the data we have from 100 years ago either.
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So don't do 100%. Add 20 or 30 percent bonds, which won't hurt your returns too badly and will be there for you when times generous. Unlike others above, I won't qualify this to depend on your worldview or vitamin levels. Just don't.
If I can jump in here, this thread is fascinating to me.
I'm not sure where I stand either way on this. The numbers seem to argue for 100% stocks.
To Dodge's point above, can someone explain to me with numbers (but not success rate, that's been covered well in this thread) how having that 20 or 30 percent bonds in your portfolio actually helps you in retirement in the event of a catastrophe?
Dodge, you mention it's not certain that the market will recover. While 100% truth, even if you reject the notion that historically the stock market has never been down over a 10 year period, how does a 30% bond allocation actually help you in that situation?
I ask because with a 30% bond allocation in a down market will still lead to an 'unsafe' WR, right? Worst case scenario is you retire and then the market crashes, correct? Assuming I retired with 25x annual expenses, and then the crash occurs, am I not screwed regardless of allocation?
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This is what the Cfiresim.com calculator tells me, regarding a 1,000,000 portfolio, a 60 year time-horizon, and a 4% withdraw rate:
Using Historical Data, 90% is the peak success rate:
Dodge, when I plug the same numbers into cfiresim, I get 95% - 100% as the peak success rate.
Here are the settings I used:
(http://i.imgur.com/aQiznBS.png)
It's because my fee is set to 0.08. When I set the fee to 0.05, I get 90% and 100% stocks as having the same success rate, with 95% being a bit lower.
When I set the fee to 0.5, 100% stocks is the best, again when using historical data:
(http://i.imgur.com/hmKrcSw.png)
I prefer using Monte Carlo as my benchmark, as you don't know if the future will resemble the past. And in Monte Carlo, 100% stocks never looks very good, even with the 0.5 fee:
(http://i.imgur.com/FcPZBlS.png)
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So don't do 100%. Add 20 or 30 percent bonds, which won't hurt your returns too badly and will be there for you when times generous. Unlike others above, I won't qualify this to depend on your worldview or vitamin levels. Just don't.
If I can jump in here, this thread is fascinating to me.
I'm not sure where I stand either way on this. The numbers seem to argue for 100% stocks.
To Dodge's point above, can someone explain to me with numbers (but not success rate, that's been covered well in this thread) how having that 20 or 30 percent bonds in your portfolio actually helps you in retirement in the event of a catastrophe?
Dodge, you mention it's not certain that the market will recover. While 100% truth, even if you reject the notion that historically the stock market has never been down over a 10 year period, how does a 30% bond allocation actually help you in that situation?
I ask because with a 30% bond allocation in a down market will still lead to an 'unsafe' WR, right? Worst case scenario is you retire and then the market crashes, correct? Assuming I retired with 25x annual expenses, and then the crash occurs, am I not screwed regardless of allocation?
Play around with this calculator and you'll see how it helps:
http://optimalrebalancing.tk
Let's say you have a typical 3 fund portfolio, and need to withdraw $3,333 for your monthly expenses (4% a year, of a $1,000,000 portfolio). This is what that looks like:
(http://i.imgur.com/3oawmO5.png)
Now let's do a hypothetical...OH NO! The stock market dropped 50%! But you still need to withdraw your $3,333 monthly expenses...what should you withdraw from now, making sure you keep your 80/20 stock/bond allocation?
(http://i.imgur.com/YQx1WV7.png)
As you see, we aren't touching the stock funds at all! We can remove the $3,333 directly from the bond fund. But how long can we do that, before the 80/20 forces us to start touching stocks again? What does it look like after 30 months of withdraws?
(http://i.imgur.com/FH67tNs.png)
Ok, we still haven't touched the stocks yet. Let's reset the number so we can see what our portfolio looks like on that 31st month, assuming stocks are still at 50%
(http://i.imgur.com/m59fyhQ.png)
Finally, in the 31st month, our $3333 monthly withdraw will have to touch some stocks. Even then, only 80% of the withdraw touched the stocks, and it was split among international stocks and domestic stocks. Hopefully that helps show how bonds can help you during a downturn, it gives the stocks room to breathe. While most people would probably have rebalanced during this time, throwing off the numbers, I find it easier to see with the above example.
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Finally, in the 31st month, our $3333 monthly withdraw will have to touch some stocks. Even then, only 80% of the withdraw touched the stocks, and it was split among international stocks and domestic stocks. Hopefully that helps show how bonds can help you during a downturn, it gives the stocks room to breathe. While most people would probably have rebalanced during this time, throwing off the numbers, I find it easier to see with the above example.
Thanks Dodge for the clear examples and good explanation. I highlighted the statement that really stuck out for me.
In that scenario the 20% bonds essentially 'bought' you 30 months for your stocks to breathe; the total portfolio value is at 500,010 after 30 months, whereas obviously 100% stocks allocation would have had a value of 500,000 overnight.
I definitely see the value of even a 20% bond allocation now!
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I don't think it is particular relevant to use a withdrawal calculator for a 31 year old in the accumulation phase.
Making a couple of numbers up. I'm 31, we need $1 million in todays dollars to retire. I have 100K currently, we can save 20K/year. I want to retire in 20 year best case 25 years worse case, what AA historically gives me the best probability of hitting a million? My guess without running the number is 100% equities gives the best chance. Now once you are in the withdrawal certainly adding some bonds(20-25%) reduces volatility, while having only modest impact on either your success rate, or how big an estate you'll leave to your kids But the OP isn't at the stage.
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I don't think it is particular relevant to use a withdrawal calculator for a 31 year old in the accumulation phase.
Making a couple of numbers up. I'm 31, we need $1 million in todays dollars to retire. I have 100K currently, we can save 20K/year. I want to retire in 20 year best case 25 years worse case, what AA historically gives me the best probability of hitting a million? My guess without running the number is 100% equities gives the best chance. Now once you are in the withdrawal certainly adding some bonds(20-25%) reduces volatility, while having only modest impact on either your success rate, or how big an estate you'll leave to your kids But the OP isn't at the stage.
I addressed this in the first part of my initial post:
http://forum.mrmoneymustache.com/investor-alley/asset-allocation-100-stocks-for-how-long/msg413096/#msg413096
Starting from "Obligatory Japan 1989-2013 (25 years) chart:", and ending at the Bogleheads link. Any comments on that part of my post? :)
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Those are some powerful pills, Dodge.
Thanks for the enlightenment. I vacillate between 100% stocks and adding some bonds for safety. I'm nowhere near the withdraw stage, but this was eye-opening.
Also, that re-balancing calculator is awesome!
Cheers,
Grateful
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I addressed this in the first part of my initial post:
http://forum.mrmoneymustache.com/investor-alley/asset-allocation-100-stocks-for-how-long/msg413096/#msg413096
Starting from "Obligatory Japan 1989-2013 (25 years) chart:", and ending at the Bogleheads link. Any comments on that part of my post? :)
I am assuming that the OP has an emergency fund of X number of months. This is really a discussion about saving for retirement and I'm assuming the bulk of their savings is tax deferred. So even if they do have say 20% of their portfolio in bonds, it makes no sense for their bonds to be in a taxable account during the accumulation phas. It is all fine and dandy that in theory you have some money in bonds when the next great recession hits and you lose your jobs and stocks lose 1/3 of their. But from a practical viewpoint there is no difference between having an emergency fund, taxable equity investments, and 401K which is 100% equities and one which is 70%/30%. You only want to tap into a 401K in case of dire emergency, good savers like those on the forum
almost never need to.
As for the safety of the bonds, it's worth keeping in mind that countries like US, Canada, Australia that haven't ever defaulted on their sovereign debt are in a minority. Most countries have either through outright default or hyperinflation have defaulted historically. I am not saying this likely to happen in the next 30 years, but with the tiny real returns they offer, I think Warren Buffett characterization of government bonds now as offering return free, is very accurate.
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I addressed this in the first part of my initial post:
http://forum.mrmoneymustache.com/investor-alley/asset-allocation-100-stocks-for-how-long/msg413096/#msg413096
Starting from "Obligatory Japan 1989-2013 (25 years) chart:", and ending at the Bogleheads link. Any comments on that part of my post? :)
I am assuming that the OP has an emergency fund of X number of months. This is really a discussion about saving for retirement and I'm assuming the bulk of their savings is tax deferred. So even if they do have say 20% of their portfolio in bonds, it makes no sense for their bonds to be in a taxable account during the accumulation phas. It is all fine and dandy that in theory you have some money in bonds when the next great recession hits and you lose your jobs and stocks lose 1/3 of their. But from a practical viewpoint there is no difference between having an emergency fund, taxable equity investments, and 401K which is 100% equities and one which is 70%/30%. You only want to tap into a 401K in case of dire emergency, good savers like those on the forum
almost never need to.
As for the safety of the bonds, it's worth keeping in mind that countries like US, Canada, Australia that haven't ever defaulted on their sovereign debt are in a minority. Most countries have either through outright default or hyperinflation have defaulted historically. I am not saying this likely to happen in the next 30 years, but with the tiny real returns they offer, I think Warren Buffett characterization of government bonds now as offering return free, is very accurate.
Ok, let's review. In response to my following point:
1) you might need the money during a crash. As in, you get fired or get ill, both for the long term. The forced sale will be devastating and may well be the difference between the poor house and some degree of comfort. Do you really want to trade that in exchange for "more money if stocks do well", a situation in which you're already in good shape?
You say we will, "almost never need" this. I agree. You will almost never get fired, or have someone in your family become ill, for the long term..etc. If you, or the OP, find this risk is low enough to not plan for it, and instead value making more money on the chance that stocks do well, go right ahead. But I won't recommend it :)
If you have a large number of X months saved up in a cash emergency fund, well then you aren't really 100% stocks. If you're going to hold that much in cash, might as well put it in bonds. Even in a taxable account.
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Ok, let's review. In response to my following point:
1) you might need the money during a crash. As in, you get fired or get ill, both for the long term. The forced sale will be devastating and may well be the difference between the poor house and some degree of comfort. Do you really want to trade that in exchange for "more money if stocks do well", a situation in which you're already in good shape?
You say we will, "almost never need" this. I agree. You will almost never get fired, or have someone in your family become ill, for the long term..etc. If you, or the OP, find this risk is low enough to not plan for it, and instead value making more money on the chance that stocks do well, go right ahead. But I won't recommend it :)
If you have a large number of X months saved up in a cash emergency fund, well then you aren't really 100% stocks. If you're going to hold that much in cash, might as well put it in bonds. Even in a taxable account.
Lets put in some numbers for two young savers; Balanced Bob, and Equity Ed. Assume both keep 3 months in an emergency fund in money market and CDs. Lets also assume they have 50K in stock index funds. They also have 100K in 401K Ed has all his money in Total Stock Market. Balanced Bob has 2/3 total stock market and 1/3 total bond which he rebalances every year. Over the next 10 years stock return an average 9% and Bonds 4.5% (we are at historically low bond yields).. For simplicities sake we'll forget about additional savings.
At the end of the ten years they both have $118K in taxable brokerage account. Ed has 237K in his 401k. Bob only has 206K ,69K in bond fund 137K in stocks. A recession and bear market hit, Ed and Bob lose their and job and the market drops 30%, while bonds remain flat.
In addition to their 3 month emergency fund they both have roughly 83K in the stock market. Add in unemployment benefits they probably have two years to find a job before they have tap into their 401K, suffer the 10% penalty etc. But lets say they do need to tap into their 401K. After the 30% bear market hair cut Ed has only $165,715, but Bob is in even worse shape with $164,882.
So Bob actually came out worse despite his more conservative AA.
Now obviously, we can change assumption on returns or have the recession happen early and Bob will come out ahead. But a couple things in the event of bear market the difference between 100% equities and 75-80% equities isn't the much money for folks in the accumulation phase. You'd be hard pressed to find a scenario where is going to devastating or It is a different story when you got a million or two saved up for us retires.
Second, the main reason to have bonds in portfolio is to reduce volatility. For a retiree volatility is your enemy which is why you want bonds in your portfolio. However for a person in the accumulation phase volatility is your friend due to dollar cost averaging. However if volatile markets cause you to lose sleep and you constantly want to sell during scary markets, by all means have some bonds. In the case of the OP that didn't seem to be the case and he was focused more on being able to retire in his 50s.
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I like your example Clipf, it introduces 'some' of the complexity and nuance whereas many people like to boil this down to, 100% stock will give me the highest return. In the 'real world', money is moving into the 401k and, if you lose your job during a recession, money may move out again. People are also known to freak out when individual, household company names are worth a fraction of what you bought them at, and you wake up to Bear Sterns being closed down by the government and Congress is throwing hundreds of billions of dollars at the problem with no real plan on how TARP will be spent and if it is enough, and your neighbor lost their job and homes are going in to foreclosure and are underwater. You really do wonder if your stocks will ever 'recover'.
I will admit, for the past 18 years, I have been 100% equities in my 401k. I started to diversify into muni bonds and a small allocation to TIPS in taxable (they're not available in my 401k) in my late 30's. I'm 40 and I like the option to retire in the next 0 - 10 years, plus I just 'feel' like stocks are overvalued and I want to have plenty of safety margin if stocks go in to free-fall anytime in the next 50 years. It also doesn't hurt that I'm FI, so I don't need to play the game the same way I used to. I might be in the distribution phase if I use a 72(t), so I moved my 401k to a rebalanced target date fund (still 80% equities).
I'll leave off with a bit of theory, because it's impossible to capture all the permutations when you start adding money during accumulation and moving / withdrawing funds during a downturn, but the best possible thing, if we knew the sequence of returns, would be to add as much to equities as possible when they are 'undergoing low returns / undervalued' and withdraw less when they are 'undergoing high returns / overvalued'. The first part is a battle of emotion, forcing yourself to buy something that no-one else wants (and may never want, more companies go bankrupt in a recession than a boom...) The second part is a cake walk, equities easily outpace the 3 - 4% SWR during a bull market.
The following image shows a hypothetical portfolio starting with $10k. No money is added or withdrawn. The puke green line is a static 7% RoR. Dark green is actual SoR, Purple is the S&P return in reverse chronological order. Blue is a theoretical ordering of the highest returns first and lowest at the end, and Orange is the reverse. If someone gave you this picture and told you that were on the blue line at the apex, would you choose to stay 100% equities? Hopefully you can see, we can all have a different answer and be right, the important thing is to 100% understand what you are doing and STAY THE COURSE (Bogleheads motto).
(http://escapevelocity2020.com/wp-content/uploads/2014/10/Hypothetical-performance-of-lump-sum-investment.png)
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Tons of recency bias. There have been SO MANY years that bonds have outperformed equities. And when they do, you rebalance sending that money into equities. And vice-versa. You make money off of both of them by rebalancing the overperformers to the underperformers. A portfolio isn't static. Bonds also help hedge against the psychological impact of stocks taking a hit in a given year. And that hit doesn't matter much because chances are your bonds will do well and that money will get funnelled into equities.
Does anyone here think they're smarter than the attached chart? I know I'm definitely not/
Please read the below:
"Why Diversify? Because Winners Rotate."
https://www.franklintempleton.ca/en-ca/public/commentary/why-diversify.page (https://www.franklintempleton.ca/en-ca/public/commentary/why-diversify.page)
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Now obviously, we can change assumption on returns or have the recession happen early and Bob will come out ahead. But a couple things in the event of bear market the difference between 100% equities and 75-80% equities isn't the much money for folks in the accumulation phase. You'd be hard pressed to find a scenario where is going to devastating or It is a different story when you got a million or two saved up for us retires.
Second, the main reason to have bonds in portfolio is to reduce volatility. For a retiree volatility is your enemy which is why you want bonds in your portfolio. However for a person in the accumulation phase volatility is your friend due to dollar cost averaging. However if volatile markets cause you to lose sleep and you constantly want to sell during scary markets, by all means have some bonds. In the case of the OP that didn't seem to be the case and he was focused more on being able to retire in his 50s.
Agreed again, if things moving forward look like they did in the past, then there is a negligible difference between going 100% stocks, and diversifying into bonds, during the accumulation phase. As you said, we can come up with examples where Balanced Bob comes out ahead of Equity Ed, but that wouldn't be useful. While your example didn't include extra savings, luckily Cfiresim.com can. Let's see what Cfiresim gives me for a 10 year portfolio, starting at $100,000 and adding $30,000 a year using historical data:
80/20:
(http://i.imgur.com/ZA9Ie3n.png)
100/0:
(http://i.imgur.com/GdWIrLi.png)
Not a big difference at all. If you're really just starting out with saving, your asset allocation is less important than your savings rate. So why not diversify? Why bet big on stocks outperforming bonds (doesn't always happen!) during the specific years you need them to? Why bet on the future looking like the past? That bet can really come back to bite you, and can add complexity as you approach FIRE (in terms of when you start sliding to bonds). In my opinion, it's not worth the risk, and I recommend against it.
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This is a great thread; subscribing.
I live in Australia, where shares pay a lot higher dividends than the US.
And the federal Govt is economically well managed by the public service - a recession was adeptly avoided in 2008. A lot less economic vandalism by politicians.
It is very easy in Australia to get your 4%SWR in dividends alone. And franking credits add more on top of that when you are in a low income tax bracket in retirement.
So, I am 100% shares forever.
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This is a great thread; subscribing.
I live in Australia, where shares pay a lot higher dividends than the US.
And the federal Govt is economically well managed by the public service - a recession was adeptly avoided in 2008. A lot less economic vandalism by politicians.
It is very easy in Australia to get your 4%SWR in dividends alone. And franking credits add more on top of that when you are in a low income tax bracket in retirement.
So, I am 100% shares forever.
I'm Australian as well and the way I see it is own my home, super at whatever level you get too and then 100% shares plus a cash buffer. I figure the cash buffer should be about 10-20 % of the non-super wealth. If you are risk averse you should make it 20% otherwise make it 10%.
The last thing I save for though is the cash buffer. I don't think it is as important as the non-super stock portfolio.
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One thing I definitely learned in this thread is I should play with cfiresim it has more capabilities that FIRECalc. My take away from looking at the 10 years numbers is that the median and average number for 100% are significantly bigger than a 80/20 and worse case is only marginally worse..
I think we can agree that if your goal is to retire as soon as practical say by 50 than 100% equities is the way to go. If your goal is to make you sure you can retire by say 60, having some bonds will give you a smoother more reliable path.
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I think we can agree that if your goal is to retire as soon as practical say by 50 than 100% equities is the way to go. If your goal is to make you sure you can retire by say 60, having some bonds will give you a smoother more reliable path.
Nope, don't agree. More like, if you are young and putting money in a 401k that you won't touch for 10+ years come hell or high water, 100% equities is a good allocation for it. And If you have twice your target retirement funds (i.e. 2% SWR at retirement), 100% equities has historically been the best allocation if you don't mind losing half at some point and staying the course (no longer me).
For the rest of us, we need to optimize, and 100% equities is not optimal for most people most of the time. It's one thing to use a simulator, but life never quite turns out the way you expect...
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One thing I definitely learned in this thread is I should play with cfiresim it has more capabilities that FIRECalc. My take away from looking at the 10 years numbers is that the median and average number for 100% are significantly bigger than a 80/20 and worse case is only marginally worse..
I think we can agree that if your goal is to retire as soon as practical say by 50 than 100% equities is the way to go. If your goal is to make you sure you can retire by say 60, having some bonds will give you a smoother more reliable path.
The median for 100% is $14,000 better, and the lowest is $17,000 worse. In percentages, the median is about 2.5% better, and the lowest is about 6% worse.
If your goal is to retire as soon as possible, and things end up exactly the same as in the past, and you don't have any personal situations which require early withdrawl during a market crash (the time when early withdrawls are most likely), and equities don't crash for 25 years at exactly the wrong time, and bonds don't outperform...etc, then sure, you might shave a few months off your FI date, but you're risking adding years if things don't go your way.
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Not a big difference at all. If you're really just starting out with saving, your asset allocation is less important than your savings rate. So why not diversify? Why bet big on stocks outperforming bonds (doesn't always happen!) during the specific years you need them to? Why bet on the future looking like the past? That bet can really come back to bite you, and can add complexity as you approach FIRE (in terms of when you start sliding to bonds). In my opinion, it's not worth the risk, and I recommend against it.
But the "specific years" you need stocks to outperform bonds are not the years between investment and the commencement of retirement, but the entire remainder of your life. Even during the accumulation phase when you're working towards the goal of accumulating enough to pull the trigger on retirement, the time horizon for your investments is the rest of your life (not your retirement date).
And If you have twice your target retirement funds (i.e. 2% SWR at retirement), 100% equities has historically been the best allocation if you don't mind losing half at some point and staying the course (no longer me).
I would argue the reverse; if your stash is large enough to support a very low withdrawal rate, that's when you can afford to use a more conservative allocation. You don't need the higher returns of a 100% equity portfolio to fund your needs. In other words, you've already won the game, so you can stop playing. But if you want to stop working before you are able to amass a portfolio that can support such a low withdrawal rate, that's when you need a more aggressive allocation.
For the rest of us, we need to optimize, and 100% equities is not optimal for most people most of the time. It's one thing to use a simulator, but life never quite turns out the way you expect...
Can you elaborate on what you mean by "optimize"? I would characterize it the opposite way; based on history, 100% stocks is optimal, because it allows you to retire earlier and end up with more money (or use a higher withdrawal rate). But the argument being made to support having some bond exposure seems to be that the costs of using a sub-optimal allocation are worth paying (because the benefits of a 100% stock allocation are minimal, while the consequences could be severe if you end up needing to access funds unexpectedly at the wrong time).
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I don't think that 100% equities necessarily allows you to retire earlier. (Full disclosure, I'm at ~90/10 right now aged 33).
The problem with a big stocks allocation is that a recession can last 5 years. If you plan to retire in say 2020, but a recession hits in 2018, you're definitely not going to retire then. However, I'd argue that no matter what allocation you use, that you shouldn't retire within a year or two of a recession anyways.
As an accumulator, I'd say that 100% stocks makes sense AT LEAST up until 3-5years from retirement. After that, I'd resign to the phrase "Once you've won the game, why continue to play it?" and put some of your allocation into bonds for the withdrawal period, as to not "lose the game". Though, historical data will tell you that you're not going to get a benefit going less equities than 60/40 stocks/bonds. In fact, over a 30yr period @ 4%WR, Any less than 60% equities INCREASES the chance of failure.
For draw-down, this is an album of different allocations across a 30yr time period (4%WR) and how the success rate changes over time: http://imgur.com/a/ql03L
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Some examples of how bonds can outperform stocks over a very long period:
1994-2014 (20 years) - Vanguard Long Term Bond Index vs S&P 500
(http://i.imgur.com/JgSPJU1.png)
1973-2014 (41 years) - Vanguard Long-Term Investment-Grade vs S&P 500
(http://i.imgur.com/LTOsDU4.png)
(Sorry for the inclusion of the active fund, couldn't find any other bond funds at Vanguard that went back that far)
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Some examples of how bonds can outperform stocks over a very long period:
1994-2014 (20 years) - Vanguard Long Term Bond Index vs S&P 500
(http://i.imgur.com/JgSPJU1.png)
1973-2014 (41 years) - Vanguard Long-Term Investment-Grade vs S&P 500
(http://i.imgur.com/LTOsDU4.png)
(Sorry for the inclusion of the active fund, couldn't find any other bond funds at Vanguard that went back that far)
Do note that the performance of a single $10k investment over a long time period is very different from a nest egg in which you are actively withdrawing from year after year. But, I get your point.
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I don't think that 100% equities necessarily allows you to retire earlier. (Full disclosure, I'm at ~90/10 right now aged 33).
The problem with a big stocks allocation is that a recession can last 5 years. If you plan to retire in say 2020, but a recession hits in 2018, you're definitely not going to retire then. However, I'd argue that no matter what allocation you use, that you shouldn't retire within a year or two of a recession anyways.
As an accumulator, I'd say that 100% stocks makes sense AT LEAST up until 3-5years from retirement. After that, I'd resign to the phrase "Once you've won the game, why continue to play it?" and put some of your allocation into bonds for the withdrawal period, as to not "lose the game". Though, historical data will tell you that you're not going to get a benefit going less equities than 60/40 stocks/bonds. In fact, over a 30yr period @ 4%WR, Any less than 60% equities INCREASES the chance of failure.
For draw-down, this is an album of different allocations across a 30yr time period (4%WR) and how the success rate changes over time: http://imgur.com/a/ql03L
If we go with the assumption that the future will be no worse than the past, then a 100% equity allocation DOES allow you to retire earlier, as a matter of fact, not opinion (which we can easily determine thanks to your cfiresim calculator -- thanks so much for your efforts!).
Still sticking with the historical performance assumption, over decades-long periods, the 100% stock portfolio will fare just as well or better than the portfolio with some bonds mixed in, even in the scenario where a big crash hits right after retirement.
Valid arguments are being made that despite this, it still makes sense to have some bond exposure, but those arguments are based on the rationale that history may not accurately predict the future, and that one may have to deviate from one's expected withdrawal rate due to unexpected events (NOT the rationale that the historical data indicate that some bond exposure reduces failure rates).
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I'd suggest 20% in bonds, that way you can enjoy some buy high, sell low rebalancing.
Agree. DH and I are 10% bonds because when a dip does occur, I want money available to put into stocks, in addition to our normal savings. Also helps DH sleep at night.
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As for all stocks, I forget who wrote it but it was suggested to never hold less than 20% of bonds or stocks over ones life time, could have been 25%, seems reasonable to me.
[/quote]
It is from Benjamin Graham's The Intelligent Investor. He proposes moving your % of bonds between 25% and 75%, depending on whether stocks are "expensive" or "cheap". But the movement is 100% based on market conditions, not your personal age.
Using that along with Buffett's 90/10 stocks vs. bonds in his estate plan, I think the overall feeling is to have some bonds as a cushion. For some people, maybe it's cash or CD's instead of bonds. If a cushion is not necessary (due to monthly pension payments, real estate income, social security), that's a personal choice that has sound logic behind it.
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This is a great thread; subscribing.
I live in Australia, where shares pay a lot higher dividends than the US.
And the federal Govt is economically well managed by the public service - a recession was adeptly avoided in 2008. A lot less economic vandalism by politicians.
It is very easy in Australia to get your 4%SWR in dividends alone. And franking credits add more on top of that when you are in a low income tax bracket in retirement.
So, I am 100% shares forever.
No matter what country you're in, you can come up with reasons why your situations is different. It's not. I read a story that said the default idea of investing for many Australian investors is 300% stocks. Despite a good portion of them being wiped out during recessions.
I'm sure Japan felt the same way ;)
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The question is what the best AA to get to a retirement in 20 years. I chose to address the case where you get laid off and were force to dip into your retirement after 10 years. I'd argue that nether median higher value of $14,000 for 100% equities nor the $17,000 worse case for 80/20 is particularly significant a few additional months. It is pretty unlikely to occur for this crowd (not the lay off, those happen but burning through all of your saving before find a new job.)
The OP wanted to know the best AA to hit that goal.
So I used to cfiresim to get an answer for 100k initial portfolio, 30K a year savings.
100% equities
Analysis for: Ending Portfolio Yearly Withdrawals Total Withdrawals
Average $1,640,295.25 $0.00 $0.00
Median $1,602,298.86 $0.00 $0.00
St. Dev. $681,355.93 $0.00 $0.00
Highest $3,807,022.93 $0.00 $0.00
Lowest $586,504.47 $0.00 $0.00
80/20 AA
Average $1,474,151.96 $0.00 $0.00
Median $1,416,274.38 $0.00 $0.00
St. Dev. $509,464.19 $0.00 $0.00
Highest $3,097,199.81 $0.00 $0.00
Lowest $585,004.46 $0.00 $0.00
I don't see how you can spin these results and arrive at a conclusion other than if you are trying to maximize your chances to retire in 20 years, than 100% equities is the right AA. If your retirement goal is $1.6 million (in today's dollars) 50% of the time you'll hit with 100% AA after 20 years. You'll have to work 21.5 years to have 50% chance of hitting your number with an 80/20. In no case will you have less money with 100% stocks than with 80/20 AA. In the good case a bull market like I was fortunate enough to experience, you can retire really early 39 like I did.
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I'll add another point to this discussion. If I am still working and therefore saving each year isn't it better to be 100% or at least a really high stock allocation. If stocks decrease I am still earning and buying more stocks. I don't see the need to re-balance my portfolio in this situation.
Its why I think I might get to a 5% WR and then work part-time for a couple of years during which time I will increase my cash component or buy more stocks if the market crashes. Worst case is that this time period will continue for a few more years. Best case I get to slowly move towards retirement whilst taking a pretty safe approach. I think this approach will avoid an early drawdown which could threaten your retirement.
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I'll add another point to this discussion. If I am still working and therefore saving each year isn't it better to be 100% or at least a really high stock allocation. If stocks decrease I am still earning and buying more stocks. I don't see the need to re-balance my portfolio in this situation.
Its why I think I might get to a 5% WR and then work part-time for a couple of years during which time I will increase my cash component or buy more stocks if the market crashes. Worst case is that this time period will continue for a few more years. Best case I get to slowly move towards retirement whilst taking a pretty safe approach. I think this approach will avoid an early drawdown which could threaten your retirement.
Exactly correct, you want a bad market or at least a volatile market while working. You get an opportunity to buy stocks cheap because of dollar cost averaging. William Bernstein in his book the Ages of the Investor points to academic research that shows for a young person, ideally you want >100% equities, borrowing cheap money, mortgage, student loan, or even margin loan and invest in the market. Based on personal experience, even though I have high risk tolerance, the use of margin during a bear market isn't for the faint of heart.
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I'll add another point to this discussion. If I am still working and therefore saving each year isn't it better to be 100% or at least a really high stock allocation. If stocks decrease I am still earning and buying more stocks. I don't see the need to re-balance my portfolio in this situation.
Its why I think I might get to a 5% WR and then work part-time for a couple of years during which time I will increase my cash component or buy more stocks if the market crashes. Worst case is that this time period will continue for a few more years. Best case I get to slowly move towards retirement whilst taking a pretty safe approach. I think this approach will avoid an early drawdown which could threaten your retirement.
Exactly correct, you want a bad market or at least a volatile market while working. You get an opportunity to buy stocks cheap because of dollar cost averaging. William Bernstein in his book the Ages of the Investor points to academic research that shows for a young person, ideally you want >100% equities, borrowing cheap money, mortgage, student loan, or even margin loan and invest in the market. Based on personal experience, even though I have high risk tolerance, the use of margin during a bear market isn't for the faint of heart.
I don't believe in borrowing money although I have a massive mortgage (its getting close to being paid off) however this makes complete sense to me. Save into equities first and let that grow then worry about your buffer or safety margin.
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This is why I like the idea of 100 % stocks.
1) Why are we in the stock market? We are in the stock market to see our money grow and we have been told that stocks are the best way to ensure that your savings are not eroded by inflation.
So...If going out in to the stock market and buying stocks is the way to do that, then why are we buying bonds? If buying bonds was good, then why are we in stocks at all? I understand that if stocks don't work out, then at least bonds will be something to fall back on. But if we are so scared of stocks not working out, then why are we buying them? I just see buying bonds or doing anything else to "hedge our bet" is distracting us from our original choice. It is almost like choosing to marry someone but taking along another person you've had your eye on just in case it doesn't work out. If you have to take that other person with, then why are you marrying this person? Why not just marry the other person if your feelings are not strong enough?
That i just my gut instinct.
If I wasn't a MMM, I probably wouldn't feel this way. In my opinion, I don't think I need my retirement account. I can live off a part time job FOREVER once my house is paid for. To me, buying 100 percent stocks is me seeing where this original path goes. I get a IRA so let's see what it does. Let's not debase it with all these "what if" scenarios.
If you can't stand the heat, why are you in the kitchen type of thing?
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I am sorry, but having a 100% allocation to any asset class is just STUPID, regardless of desire to take on risk.
The only free lunch in investing (and this is mathematically demonstrated as part of the Efficient Market Hypothesis) is diversification. By holding assets with a low correlation, the act of reallocation every year or so will ensure you're moving assets out of over-valued asset classes and into under-valued (on a relative basis) asset classes. You significantly reduce portfolio volatility without sacrificing much in the way of potential (not to mention actual) returns.
For a small portfolio, target date funds are fine.
If you still think you want more risk than blended portfolio, buy some riskier components within the portfolio. Maybe the stock portion of your portfolio should be weighted towards small caps. Buy some Emerging Market funds. In your non-equity allocation, add some real estate (VNQ is a good starting point) and junk bonds.
You can still target a highly-risky portfolio without having all of your money in a single asset class.
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The question is what the best AA to get to a retirement in 20 years. I chose to address the case where you get laid off and were force to dip into your retirement after 10 years. I'd argue that nether median higher value of $14,000 for 100% equities nor the $17,000 worse case for 80/20 is particularly significant a few additional months. It is pretty unlikely to occur for this crowd (not the lay off, those happen but burning through all of your saving before find a new job.)
The OP wanted to know the best AA to hit that goal.
So I used to cfiresim to get an answer for 100k initial portfolio, 30K a year savings.
100% equities
Analysis for: Ending Portfolio Yearly Withdrawals Total Withdrawals
Average $1,640,295.25 $0.00 $0.00
Median $1,602,298.86 $0.00 $0.00
St. Dev. $681,355.93 $0.00 $0.00
Highest $3,807,022.93 $0.00 $0.00
Lowest $586,504.47 $0.00 $0.00
80/20 AA
Average $1,474,151.96 $0.00 $0.00
Median $1,416,274.38 $0.00 $0.00
St. Dev. $509,464.19 $0.00 $0.00
Highest $3,097,199.81 $0.00 $0.00
Lowest $585,004.46 $0.00 $0.00
I don't see how you can spin these results and arrive at a conclusion other than if you are trying to maximize your chances to retire in 20 years, than 100% equities is the right AA. If your retirement goal is $1.6 million (in today's dollars) 50% of the time you'll hit with 100% AA after 20 years. You'll have to work 21.5 years to have 50% chance of hitting your number with an 80/20. In no case will you have less money with 100% stocks than with 80/20 AA. In the good case a bull market like I was fortunate enough to experience, you can retire really early 39 like I did.
I was thinking about my earlier statement, "you might shave a few months off your FI date, but you're risking adding years if things don't go your way." and thought I'd run a fun experiment. What would happen to a 100% US Stock portfolio, vs a 3 fund portfolio (essentially the Vanguard Life Strategy fund without international bonds), if stocks dropped by 50%, stayed flat for 10 years, then doubled? US stocks have fallen 50% in the past, and stocks have had negative growth for 10 years, but it's never happened together. Not yet.
In both scenarios, you started with $100,000 and saved $30,000 a year. The year you are set to retire, after accumulating $1,000,000, disaster strikes! The US stock market drops 50%, and you lose your job! During this scenario, bonds continue to appreciate at 4% a year, and international stocks are unfazed, if not a little depressed, growing at 6% a year. To keep the math simple, I'm using the following to calculate returns:
(http://i.imgur.com/sP2UAIS.png)
https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations
(http://i.imgur.com/yEckfjz.png)
(http://i.imgur.com/MxpeRlS.png)
http://www.investor.gov/tools/calculators/compound-interest-calculator
This is our starting point, just after the 50% drop:
3 fund portfolio (total $752,897)
(http://i.imgur.com/5fpFSOY.png)
100% stock portfolio
(http://i.imgur.com/IjvuNge.png)
After 10 years of joblessness, and withdrawing $400,000 from our portfolio, here's how our 3 fund portfolio looks (total $556,282):
(http://i.imgur.com/KUsJvG8.png)
During this entire time, we didn't have to sell any US stocks! Let's check in on the 100% stock portfolio:
(http://i.imgur.com/26X8dMt.png)
And now, after 10 years of pain, the 11th year sees the US stock market double! We also find a job, and didn't have to withdraw anything this year :)
(http://i.imgur.com/5tpnFu1.png)
3 fund portfolio total: $862,513
(http://i.imgur.com/LpO10dN.png)
100% stock portfolio total: $298,996
You either believe equities can lose 50% and not recover significantly from those "new normal" levels during your effective investing lifespan, or you don't. It doesn't matter if it's never happened in (recent, US, etc.) history; it only has to happen once for it to affect you.
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I was glad to see pmallory's post.
The only thing I have to personally add is that the Intelligent Asset Allocator book by Bernstein is fantastic. I highly recommend it. It's a pretty easy read too.
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Let me present you all with this situation:
Right now I am 28 years old and 100% stocks split the following:
22k in a taxable account in VTI
34k in a Roth IRA in VTI
135k in my 401k S&P 500 fund (HBIDX) with a 0.56% expense ratio
If I wanted to reallocate to 80/20 I would need to convert about 35k to bonds.
Here's the question:
I could convert my entire Roth IRA to BND and its .08% expense ratio. That would be the "cheapest" option nominally (no taxes, no transaction fees) however I never know how to view post tax Roth dollars vs pretax 401k dollars.
The other option is to covert 35k from my 401k to one of the available bond funds...all have expense ratios between 1.1% and 1.3%.
Or I could just keep on going 100% for another few years and then make a decision then.
What would you do?
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Jags - in my opinion, it is best to have your highest potential growth dollars in your Roth account since you have already paid taxes on it. (Stocks) that is why I keep my bonds in my 401k or traditional IRA.
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Let me present you all with this situation:
Right now I am 28 years old and 100% stocks split the following:
22k in a taxable account in VTI
34k in a Roth IRA in VTI
135k in my 401k S&P 500 fund (HBIDX) with a 0.56% expense ratio
If I wanted to reallocate to 80/20 I would need to convert about 35k to bonds.
Here's the question:
I could convert my entire Roth IRA to BND and its .08% expense ratio. That would be the "cheapest" option nominally (no taxes, no transaction fees) however I never know how to view post tax Roth dollars vs pretax 401k dollars.
The other option is to covert 35k from my 401k to one of the available bond funds...all have expense ratios between 1.1% and 1.3%.
Or I could just keep on going 100% for another few years and then make a decision then.
What would you do?
Short answer: I'd choose the Roth IRA 0.08% over the 1.1% 401k, but you should make a new thread for this question :)
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Jags - in my opinion, it is best to have your highest potential growth dollars in your Roth account since you have already paid taxes on it. (Stocks) that is why I keep my bonds in my 401k or traditional IRA.
Good point! Not sure how I'd judge it when the 401k option is 1.1+% ER though. Definitely deserves it own thread.
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The scenario you created is about as realistic as me finding a unicorn in my backyard.
Yup
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Lets put in some numbers for two young savers; Balanced Bob, and Equity Ed. Assume both keep 3 months in an emergency fund in money market and CDs. Lets also assume they have 50K in stock index funds. They also have 100K in 401K Ed has all his money in Total Stock Market. Balanced Bob has 2/3 total stock market and 1/3 total bond which he rebalances every year. Over the next 10 years stock return an average 9% and Bonds 4.5% (we are at historically low bond yields).. For simplicities sake we'll forget about additional savings.
At the end of the ten years they both have $118K in taxable brokerage account. Ed has 237K in his 401k. Bob only has 206K ,69K in bond fund 137K in stocks. A recession and bear market hit, Ed and Bob lose their and job and the market drops 30%, while bonds remain flat.
In addition to their 3 month emergency fund they both have roughly 83K in the stock market. Add in unemployment benefits they probably have two years to find a job before they have tap into their 401K, suffer the 10% penalty etc. But lets say they do need to tap into their 401K. After the 30% bear market hair cut Ed has only $165,715, but Bob is in even worse shape with $164,882.
So Bob actually came out worse despite his more conservative AA.
I actually think this shows that Bob comes out ahead because, although he has $800.00 less than Ed, he has more options. At or near the bottom of the market he could have sold 1/2 or 2/3 of his bonds to buy stock and he would still have a buffer of bonds in case the market continued to fall and/or he needed to tap into the 401K (selling bonds before stocks). Bond allocations aren't just for stability, they also make sure you have money available when it is time to buy low.
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I was thinking about my earlier statement, "you might shave a few months off your FI date, but you're risking adding years if things don't go your way." and thought I'd run a fun experiment. What would happen to a 100% US Stock portfolio, vs a 3 fund portfolio (essentially the Vanguard Life Strategy fund without international bonds), if stocks dropped by 50%, stayed flat for 10 years, then doubled? US stocks have fallen 50% in the past, and stocks have had negative growth for 10 years, but it's never happened together. Not yet.
In both scenarios, you started with $100,000 and saved $30,000 a year. The year you are set to retire, after accumulating $1,000,000, disaster strikes! The US stock market drops 50%, and you lose your job! During this scenario, bonds continue to appreciate at 4% a year, and international stocks are unfazed, if not a little depressed, growing at 6% a year. To keep the math simple, I'm using the following to calculate returns:
(http://i.imgur.com/sP2UAIS.png)
https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations
(http://i.imgur.com/yEckfjz.png)
(http://i.imgur.com/MxpeRlS.png)
http://www.investor.gov/tools/calculators/compound-interest-calculator
This is our starting point, just after the 50% drop:
3 fund portfolio (total $752,897)
(http://i.imgur.com/5fpFSOY.png)
100% stock portfolio
(http://i.imgur.com/IjvuNge.png)
After 10 years of joblessness, and withdrawing $400,000 from our portfolio, here's how our 3 fund portfolio looks (total $556,282):
(http://i.imgur.com/KUsJvG8.png)
During this entire time, we didn't have to sell any US stocks! Let's check in on the 100% stock portfolio:
(http://i.imgur.com/26X8dMt.png)
And now, after 10 years of pain, the 11th year sees the US stock market double! We also find a job, and didn't have to withdraw anything this year :)
(http://i.imgur.com/5tpnFu1.png)
3 fund portfolio total: $862,513
(http://i.imgur.com/LpO10dN.png)
100% stock portfolio total: $298,996
You either believe equities can lose 50% and not recover significantly from those "new normal" levels during your effective investing lifespan, or you don't. It doesn't matter if it's never happened in (recent, US, etc.) history; it only has to happen once for it to affect you.
Adding 60/40 US Stocks/US Bonds to the experiment:
(http://i.imgur.com/y6FHLdM.png)
(http://i.imgur.com/QGjHS63.png)
Starting year, right after the 50% drop:
(http://i.imgur.com/Vq4mNkT.png)
In the 7th year, we finally start having to sell some stocks:
(http://i.imgur.com/vVM7bGP.png)
After having withdrawn $400,000 (40k a year) this is where we end up after 10 years:
(http://i.imgur.com/xNksvtC.png)
Total: $402,772
And now on the 11th year, our stocks double!
Leaving us with a total of $646,759
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Lets put in some numbers for two young savers; Balanced Bob, and Equity Ed. Assume both keep 3 months in an emergency fund in money market and CDs. Lets also assume they have 50K in stock index funds. They also have 100K in 401K Ed has all his money in Total Stock Market. Balanced Bob has 2/3 total stock market and 1/3 total bond which he rebalances every year. Over the next 10 years stock return an average 9% and Bonds 4.5% (we are at historically low bond yields).. For simplicities sake we'll forget about additional savings.
At the end of the ten years they both have $118K in taxable brokerage account. Ed has 237K in his 401k. Bob only has 206K ,69K in bond fund 137K in stocks. A recession and bear market hit, Ed and Bob lose their and job and the market drops 30%, while bonds remain flat.
In addition to their 3 month emergency fund they both have roughly 83K in the stock market. Add in unemployment benefits they probably have two years to find a job before they have tap into their 401K, suffer the 10% penalty etc. But lets say they do need to tap into their 401K. After the 30% bear market hair cut Ed has only $165,715, but Bob is in even worse shape with $164,882.
So Bob actually came out worse despite his more conservative AA.
I actually think this shows that Bob comes out ahead because, although he has $800.00 less than Ed, he has more options. At or near the bottom of the market he could have sold 1/2 or 2/3 of his bonds to buy stock and he would still have a buffer of bonds in case the market continued to fall and/or he needed to tap into the 401K (selling bonds before stocks). Bond allocations aren't just for stability, they also make sure you have money available when it is time to buy low.
With this logic you should keep 20% or maybe even 30% in cash. This allocation will do better than bonds during a recession
Can't find any data to support this. Can you provide a source data-set we can look at? During the last recession (the Great Recession), bonds did significantly better than cash:
(http://i.imgur.com/NDpCl3f.png)
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If I knew how to post a pic I would but the data below proves the point just as well.
VBLTX 12/6/2005 $11.82
VBLTX 9/5/2008 $11.49
VBLTX 10/31/2008 $9.92
So if I invested $10,000 on 9/5/2008 in bonds on 10/31/2008 I would have $8,634. While if I left my money in cash I would still have $10,000. So if your plan is to buy during the dip (And we are talking about attempting to time the market not dollar cost averaging) you should keep your dry powder in cash to get the most out of buying the dip.
What you're missing, in cherry-picking this specific scenario, is the drag that cash puts on your portfolio over the years. If you're holding 20-30% cash as you posted earlier, you're missing out on huge gains during the good times that just can't be made up for "buying low" during the recessions.
Food for thought: http://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/
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If I knew how to post a pic I would but the data below proves the point just as well.
VBLTX 12/6/2005 $11.82
VBLTX 9/5/2008 $11.49
VBLTX 10/31/2008 $9.92
So if I invested $10,000 on 9/5/2008 in bonds on 10/31/2008 I would have $8,634. While if I left my money in cash I would still have $10,000. So if your plan is to buy during the dip (And we are talking about attempting to time the market not dollar cost averaging) you should keep your dry powder in cash to get the most out of buying the dip.
What you're missing, in cherry-picking this specific scenario, is the drag that cash puts on your portfolio over the years. If you're holding 20-30% cash as you posted earlier, you're missing out on huge gains during the good times that just can't be made up for "buying low" during the recessions.
Food for thought: http://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/
That was exactly Virtus's point in the first place. The historical data show that the drag effect of holding a cash or bond position (significantly) outweighs the benefits of having dry powder to convert into stocks during market downturns. Historically, over long periods, the only way you could improve your returns by holding a cash/bond position would be by successfully timing the market (and good luck to anyone who tries that). So while it may make sense to argue that it's a good idea to have bonds in your allocation to reduce volatility, the historical data do not support the notion that it makes sent to hold bonds purely for the purpose of having dry powder available to convert into stocks.
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Lets put in some numbers for two young savers; Balanced Bob, and Equity Ed. Assume both keep 3 months in an emergency fund in money market and CDs. Lets also assume they have 50K in stock index funds. They also have 100K in 401K Ed has all his money in Total Stock Market. Balanced Bob has 2/3 total stock market and 1/3 total bond which he rebalances every year. Over the next 10 years stock return an average 9% and Bonds 4.5% (we are at historically low bond yields).. For simplicities sake we'll forget about additional savings.
At the end of the ten years they both have $118K in taxable brokerage account. Ed has 237K in his 401k. Bob only has 206K ,69K in bond fund 137K in stocks. A recession and bear market hit, Ed and Bob lose their and job and the market drops 30%, while bonds remain flat.
In addition to their 3 month emergency fund they both have roughly 83K in the stock market. Add in unemployment benefits they probably have two years to find a job before they have tap into their 401K, suffer the 10% penalty etc. But lets say they do need to tap into their 401K. After the 30% bear market hair cut Ed has only $165,715, but Bob is in even worse shape with $164,882.
So Bob actually came out worse despite his more conservative AA.
I actually think this shows that Bob comes out ahead because, although he has $800.00 less than Ed, he has more options. At or near the bottom of the market he could have sold 1/2 or 2/3 of his bonds to buy stock and he would still have a buffer of bonds in case the market continued to fall and/or he needed to tap into the 401K (selling bonds before stocks). Bond allocations aren't just for stability, they also make sure you have money available when it is time to buy low.
With this logic you should keep 20% or maybe even 30% in cash. This allocation will do better than bonds during a recession
Can't find any data to support this. Can you provide a source data-set we can look at? During the last recession (the Great Recession), bonds did significantly better than cash:
(http://i.imgur.com/NDpCl3f.png)
If I knew how to post a pic I would but the data below proves the point just as well.
VBLTX 12/6/2005 $11.82
VBLTX 9/5/2008 $11.49
VBLTX 10/31/2008 $9.92
So if I invested $10,000 on 9/5/2008 in bonds on 10/31/2008 I would have $8,634. While if I left my money in cash I would still have $10,000. So if your plan is to buy during the dip (And we are talking about attempting to time the market not dollar cost averaging) you should keep your dry powder in cash to get the most out of buying the dip.
Don't think anyone here is talking about market timing. My interpretation of smilla's post was regarding rebalancing, which happens once a year, not market timing.
When determining returns, you can't simply look at price, you need a growth chart to take into account the dividend. Here's a growth chart from 9/5/2008 to 10/31/2008:
(http://i.imgur.com/nP9iGUF.png)
During this time, you would end up with $9,560. So you're right, if someone did a lump sum of $10,000 into the Vanguard Total Bond Market Index (VBTLX), then tried to time the market a month later, they would have been better off in cash. Of course, in choosing these dates, you skipped over the vast majority of time during the recent recession, when bonds would have easily beaten out cash :) This data does not show "This allocation will do better than bonds during a recession", on the contrary, when looking at the recession from peak to bottom of the S&P500, a bond allocation would have increased 12.5%
(http://i.imgur.com/Rh3xGXR.png)
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I've been Googling with no success to try and find this data, can anyone here help?
The last time US 10 yr Treasury notes were this low was in the period of ~ 1930 to 1955. Can you find a chart or something else to indicate how a bond fund performed from 1955 to 1980 (or so) when yields were increasing?
I'm hoping this might give a better picture to a long term investor of how bond funds will perform in a period of rising yields.
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That was exactly Virtus's point in the first place. The historical data show that the drag effect of holding a cash or bond position (significantly) outweighs the benefits of having dry powder to convert into stocks during market downturns. Historically, over long periods, the only way you could improve your returns by holding a cash/bond position would be by successfully timing the market (and good luck to anyone who tries that). So while it may make sense to argue that it's a good idea to have bonds in your allocation to reduce volatility, the historical data do not support the notion that it makes sent to hold bonds purely for the purpose of having dry powder available to convert into stocks.
I totally missed that from his/her last 2 posts. I thought they were advocating for that allocation.
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I've been Googling with no success to try and find this data, can anyone here help?
The last time US 10 yr Treasury notes were this low was in the period of ~ 1930 to 1955. Can you find a chart or something else to indicate how a bond fund performed from 1955 to 1980 (or so) when yields were increasing?
I'm hoping this might give a better picture to a long term investor of how bond funds will perform in a period of rising yields.
I was doing some research myself on this lately, and found this:
(http://i45.tinypic.com/2hre8hs.jpg)
Taken from the following post on Bogleheads:
http://www.bogleheads.org/forum/viewtopic.php?t=56811&mrr=1277152736#p764608
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Don't think anyone here is talking about market timing. My interpretation of smilla's post was regarding rebalancing, which happens once a year, not market timing.
I interpreted Smilia's post in the same way as Virtus (i.e., advocating market timing), since he/she talked about using bonds as dry powder during market bottoms. And the fact is that historically, successful market timing would be the only way to improve returns over long periods by having bonds (or cash) in your allocation. The effect of rebalancing is to reduce volatility, arguably without giving up much in the way of gains, but you do give up something.
Over extended time horizons, 100% stocks historically outperformed any sub-100% allocation, with an equal or better portfolio success rate. People seem to be missing that aspect of the argument. Having bonds in your allocation may reduce volatility, may guard against the risk that you need to access your funds sooner than expected, and may improve your portfolio's performance if history does not repeat itself, but if you are using history as a guide, over sufficiently long time horizons, a 100% stock allocation not only increased total returns but also improved your chances of portfolio success. So any talk of holding bonds for the "dry powder" effect does not pan out in the historical data. (In other words, as long as you stick to your planned withdrawal rate or lower, the increased volatility doesn't matter.)
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Don't think anyone here is talking about market timing. My interpretation of smilla's post was regarding rebalancing, which happens once a year, not market timing.
Thanks Dodge. I wasn't talking about market timing, I was just saying in clifp's example Balanced Bob found himself in a position where the market was down 30% and at that time, compared to Equity Ed, he had options. Whether it was the bottom of the market or not, he could have rebalanced then and taken advantage.
Also I wasn't advocating keeping a bond allocation ONLY to have dry powder but stating that having a bond allocation gives you both the benefit of lower volatility AND dry powder. If you don't care to reduce volatility than you needn't have any money in bonds.
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Thanks Dodge. I wasn't talking about market timing, I was just saying in clifp's example Balanced Bob found himself in a position where the market was down 30% and at that time, compared to Equity Ed, he had options. Whether it was the bottom of the market or not, he could have rebalanced then and taken advantage.
Also I wasn't advocating keeping a bond allocation ONLY to have dry powder but stating that having a bond allocation gives you both the benefit of lower volatility AND dry powder. If you don't care to reduce volatility than you needn't have any money in bonds.
Rebalancing at a specific time in light of your perception of then-current market conditions (instead of at a predetermined set interval that you don't deviate from) IS market timing.
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Thanks Dodge! That chart is exactly what I was looking for.
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Thanks Dodge. I wasn't talking about market timing, I was just saying in clifp's example Balanced Bob found himself in a position where the market was down 30% and at that time, compared to Equity Ed, he had options. Whether it was the bottom of the market or not, he could have rebalanced then and taken advantage.
Also I wasn't advocating keeping a bond allocation ONLY to have dry powder but stating that having a bond allocation gives you both the benefit of lower volatility AND dry powder. If you don't care to reduce volatility than you needn't have any money in bonds.
Rebalancing at a specific time in light of your perception of then-current market conditions (instead of at a predetermined set interval that you don't deviate from) IS market timing.
Sorry, I looked back and I also see that Bob was already rebalanced in the example, but I still say he has more options. Although I suppose it is unlikely that he would use those options to his advantage so I guess his bond holdings wouldn't be helpful to him and he IS worse off than Equity Ed. But why couldn't someone have a floating bond ratio? 20% most of the time and 0% when markets are extremely low? I realize that you aren't going to get it perfect any of the time, but if you want the reduced volatility that bonds get you generally but are willing to take a bit more risk when it seems extra worthwhile, why wouldn't this work.
I am new to investing and I am not suggesting I am smarter than Buffett or anyone else and I see that many posters keep saying it doesn't work but I just don't understand why. I mean I understand why, if you're trying to wring out every last cent every day or week, but if you are only doing it in one or two chunks AROUND extremes and you're not holding investment money waiting for exactly the right moment (aside from the bond allocation that you choose to have for your own comfort anyway) why not?
(Regarding rebalancing, I thought you could do it by calendar, eg annually, and/or by threshold, say when an allocation is off by 5% or more.)
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The answer is: The Efficient Market Hypothesis (In its semi-strong form)
Eugene Fama created the Efficient Market Hypothesis(EMH) which basically says that you cannot beat the market, so just try to meet the market return. Any one that suggests the best way to invest is using index or mutual funds believes this theory.
Suggested reading: A Random Walk Down Wall Street.
Thank you. It's not in my library catalogue but they do have The Elements of Investing by the same author so I will start there.
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I am new to investing and I am not suggesting I am smarter than Buffett or anyone else and I see that many posters keep saying it doesn't work but I just don't understand why. I mean I understand why, if you're trying to wring out every last cent every day or week, but if you are only doing it in one or two chunks AROUND extremes and you're not holding investment money waiting for exactly the right moment (aside from the bond allocation that you choose to have for your own comfort anyway) why not?
The problem is that with perfect hindsight it is easy to look at a chart of past performance and point to the obvious peaks and valleys (or thereabouts) when you should have rebalanced in one direction or the other, but it wasn't so obvious while you were living through it. Today the market is down over 4% from its high a few weeks ago. Is now the right time to reallocate into stocks? Maybe this is a temporary dip in a continuing upward trend, or maybe it is only the beginning of a long retreat downwards. It's impossible to know for sure.
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I still don't really get why a person should not have 100% shares. It is obvious that the expected return is higher for shares.
There is a lot of talk about variance: changing asset values. But isn't it more important to have consistent income (dividends) ?.
The asset price seems irrelevant. e.g. Buffett's parable of the mouthy and mentally unstable farm neighbour. http://cuffelinks.com.au/beware-curse-liquidity-share-market/
Is someone able to explain with simple words and short sentences why a person should not have 100% shares?
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I still don't really get why a person should not have 100% shares. It is obvious that the expected return is higher for shares.
There is a lot of talk about variance: changing asset values. But isn't it more important to have consistent income (dividends) ?.
The asset price seems irrelevant. e.g. Buffett's parable of the mouthy and mentally unstable farm neighbour. http://cuffelinks.com.au/beware-curse-liquidity-share-market/
Is someone able to explain with simple words and short sentences why a person should not have 100% shares?
The argument people are making for having some bonds in your allocation boils down to this: you reduce volatility without giving up that much in returns. And the reduction of volatility DOES matter if you end up needing to access your funds earlier than expected because of job loss, unforeseen emergency expenses, etc. (in Buffet's analogy, you end up needing to sell the farm to your neighbor on one of those days when he's calling out his buy price).
However, my view is that holding 100% stocks is a perfectly legitimate approach for someone whose goal is to retire ASAP (and whose disposition will allow that person to stay the course even during the inevitable periods when the market tanks). Historically, over extended periods, a 100% stock portfolio has the lowest failure rate and the highest ending value (by what I consider to be a huge amount, so I would argue that you are giving up much in the way of returns in exchange for the reduction in volatility provided by bond exposure). As far as dealing with unforeseen circumstances, that's why safety margins should be built into your retirement plan.
In my view, the arguments being put forth in this thread on both sides of the issue are valid, so everyone needs to pick an allocation that they are comfortable with. But some of the blanket statements being made above that "100% stock allocation is stupid" for all people at all times are simply wrong.
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I don't think anyone has argued, if you are in the accumulation phase indefinitely, that 100% stock would be bad. I get the impression that people here want to retire and are wondering if, when you get 10 or 5 years out, if you should shift asset allocation. At least that's what my comment was trying to address, and I still stand by the idea that, when you transition from having a 20 year time horizon to a 5-10 year horizon, that it is worth having bonds. It also sounded like no one argued (even in Brooklynguy's response to me), that you should be 100% in stock in retirement (because of sequence of return risk).
So, if we seem to agree on these two things, when do you shift AA?
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No, I have been arguing that it can make sense to NEVER shift from 100% equity allocation (but from the perspective of an early retiree by MMM standards--i.e., someone with a 30 or 40+ year retirement period). That is, it can make sense for someone to throw all their savings into 100% equities during their working years, retire when they hit their FIRE number, and live off their 100% equity stash for the rest of their life without ever shifting their allocation below 100% equities. And if you look at the historical data, this strategy has both a better success rate and a higher ending portfolio value than any other allocation. So, if you assume that the future will be no worse than the past, and you have the stomach to stay the course during market downturns (and you stick to your planned withdrawal rate, but that assumption underlies every scenario we ever talk about), then this approach is the best one to take.
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And if you look at the historical data, this strategy has both a better success rate and a higher ending portfolio value than any other allocation.
I posted cfiresim results showing 100% equities having a lower success rate than other allocations. It depends on the variables.
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And If you have twice your target retirement funds (i.e. 2% SWR at retirement), 100% equities has historically been the best allocation if you don't mind losing half at some point and staying the course (no longer me).
I would argue the reverse; if your stash is large enough to support a very low withdrawal rate, that's when you can afford to use a more conservative allocation. You don't need the higher returns of a 100% equity portfolio to fund your needs. In other words, you've already won the game, so you can stop playing. But if you want to stop working before you are able to amass a portfolio that can support such a low withdrawal rate, that's when you need a more aggressive allocation.
OK, this exchange is what threw me off. I guess we'll have to agree to disagree, I'm not shooting for 1-2%SWR and 3-4%SWR means you need bonds and rebalancing to counter-act sequence of return risk, especially if you are an Early Retiree, at least in every academic article I've seen. Pfau has one out that you can get more aggressive (from 60/40 to 100/0) as you get older since your time horizon shrinks, but people pretty much shrugged it off as an interesting academic exercise, but not what they would want to do in their 80's and 90's.
I think what you are missing is that, even if success % is high with 100% equity, when you fail, you fail spectacularly (especially if you aren't eligible for SS or Medicare, and have been in retirement for 5-10 years..). The drawdown period strategy is different from accumulation, unless you can freely hop back and forth (which seems to be the ER assumption).
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And if you look at the historical data, this strategy has both a better success rate and a higher ending portfolio value than any other allocation.
I posted cfiresim results showing 100% equities having a lower success rate than other allocations. It depends on the variables.
Fair enough. It depends on the variables. Using cfiresim's default settings, my statement stands.
OK, this exchange is what threw me off. I guess we'll have to agree to disagree, I'm not shooting for 1-2%SWR and 3-4%SWR means you need bonds and rebalancing to counter-act sequence of return risk, especially if you are an Early Retiree, at least in every academic article I've seen. Pfau has one out that you can get more aggressive (from 60/40 to 100/0) as you get older since your time horizon shrinks, but people pretty much shrugged it off as an interesting academic exercise, but not what they would want to do in their 80's and 90's.
I think what you are missing is that, even if success % is high with 100% equity, when you fail, you fail spectacularly (especially if you aren't eligible for SS or Medicare, and have been in retirement for 5-10 years..). The drawdown period strategy is different from accumulation, unless you can freely hop back and forth (which seems to be the ER assumption).
This sounds backwards to me. If you plan to use an extremely low withdrawal rate (like 1%), then you can get away with a 100% bond allocation -- you don't need the higher performance of stocks to fund your expenses. But if you plan to use a 4% withdrawal rate, you need a higher stock allocation. Run the numbers in cfiresim (using the default settings) and you will see that in the past, a 100% stock allocation had an equal or higher success rate, and higher returns, than any sub-100% allocation.
On a $1 million portfolio with $40k annual expenses over a 30 year retirement, the success rates and median ending portfolio values are as follows:
- 60% stocks / 40% bonds: success rate of 90.43% (11 failures out of 115 cycles); ending value of $890,120.54
- 75% stocks / 25% bonds: success rate of 93.04% (8 failures out of 115 cycles); ending value of $1,290,170
- 100% stocks / 0% bonds: success rate of 93.04% (8 failures out of 115 cycles); ending value of $2,152,993
So, historically, with a 4% WR, shifting to a heavier bond allocation increased the risk of portfolio failure, not decreased it (which already accounts for sequence of return risk, since it is based on every historical cycle that ever occurred, including the ones where the market tanked immediately after retirement). And it left you with a much smaller median portfolio value. In these simulations, failure is defined as completely running out of money, so each failure is equally spectacular, but the few failures that did happen happened more often with a higher bond allocation.
This is what I was getting at in my earlier post that threw you off: once your stash is so large that you can live off of it with a super-low withdrawal rate (like 1%), then you can shift to a more conservative allocation without hurting your chances of success (you do give up some returns, but who cares, because you've already won the game). This is discussed at length in the following thread:
http://forum.mrmoneymustache.com/investor-alley/william-bernstein-the-worst-retirement-investing-mistake/msg273161/#msg273161
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And if you look at the historical data, this strategy has both a better success rate and a higher ending portfolio value than any other allocation.
I posted cfiresim results showing 100% equities having a lower success rate than other allocations. It depends on the variables.
Fair enough. It depends on the variables. Using cfiresim's default settings, my statement stands.
The default has a 0.18 ER, who is paying that much? We should model based on ERs we are actually paying, not the defaults of a website :-P
In any case, I loaded up cfiresim.com in a brand new browser, on a brand new machine, changed absolutely none of the variables, selected, "Success rates with various allocations" and got identical success rates with 75%, 80%, 85%, 90%, and 100% equity allocations:
(http://i.imgur.com/e38huPG.png)
(http://i.imgur.com/9RpRBYM.png)
(http://i.imgur.com/ukxLAM4.png)
(http://i.imgur.com/5rQ2N8o.png)
(http://i.imgur.com/fsfToLS.png)
I can post a video if you'd like :)
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(@ brooklynguy) Interestingly, when I run the same things (60/40, million dollar portfolio, 40k inflation adjusted spending) through FIREcalc, I get less failures (5/114, or 95.6% success). For 75/25 I get 94.7% and 100/0, I get 93% success. Could be the spending / rebalancing strategy is different, and I would argue that cFireSim makes a poor assumption that 60/40 allocation means you will also spend from your portfolio in that ratio. For example, when stocks outperform, you might take all spending needs from stocks and still sell stocks to buy bonds to rebalance.
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(@ brooklynguy) Interestingly, when I run the same things (60/40, million dollar portfolio, 40k inflation adjusted spending) through FIREcalc, I get less failures (5/114, or 95.6% success). For 75/25 I get 94.7% and 100/0, I get 93% success. Could be the spending / rebalancing strategy is different, and I would argue that cFireSim makes a poor assumption that 60/40 allocation means you will also spend from your portfolio in that ratio. For example, when stocks outperform, you might take all spending needs from stocks and still sell stocks to buy bonds to rebalance.
I'm also researching this, as Vanguard's historical data only shows a 0.6% annual return difference between 100/0 and 80/20, and that difference doesn't mesh with the end results I'm seeing in cfiresim.
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(@ brooklynguy) Interestingly, when I run the same things (60/40, million dollar portfolio, 40k inflation adjusted spending) through FIREcalc, I get less failures (5/114, or 95.6% success). For 75/25 I get 94.7% and 100/0, I get 93% success. Could be the spending / rebalancing strategy is different, and I would argue that cFireSim makes a poor assumption that 60/40 allocation means you will also spend from your portfolio in that ratio. For example, when stocks outperform, you might take all spending needs from stocks and still sell stocks to buy bonds to rebalance.
The exact results are very sensitive to minor changes (ER, corporate versus treasury, S&P 500 vs TSM,starting dates,...) and exact methodology. Most studies suggest 75/25 giving the best results but the difference between 40/60 and 100/0 and everything in between is very small. as far as survival rate.
AA doesn't matter since all these studies are testing is performance in the late 60s/70s (and after you do that the great depression). The take away is that you go 75% stock/15% gold/10% bonds and have a 99% success rate. I am not sure if I would be willing to project that into the future though:).
For kicks run a 70/30 (Small value and lt bond) and see how you can have a 98% success with a 4.5% SWR.
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(@ brooklynguy) Interestingly, when I run the same things (60/40, million dollar portfolio, 40k inflation adjusted spending) through FIREcalc, I get less failures (5/114, or 95.6% success). For 75/25 I get 94.7% and 100/0, I get 93% success. Could be the spending / rebalancing strategy is different, and I would argue that cFireSim makes a poor assumption that 60/40 allocation means you will also spend from your portfolio in that ratio. For example, when stocks outperform, you might take all spending needs from stocks and still sell stocks to buy bonds to rebalance.
The exact results are very sensitive to minor changes (ER, corporate versus treasury, S&P 500 vs TSM,starting dates,...) and exact methodology. Most studies suggest 75/25 giving the best results but the difference between 40/60 and 100/0 and everything in between is very small. as far as survival rate.
AA doesn't matter since all these studies are testing is performance in the late 60s/70s (and after you do that the great depression). The take away is that you go 75% stock/15% gold/10% bonds and have a 99% success rate. I am not sure if I would be willing to project that into the future though:).
For kicks run a 70/30 (Small value and lt bond) and see how you can have a 98% success with a 4.5% SWR.
Indeed. AA isn't the most important factor. It isn't even the second most important. Savings Rate rules all.
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Indeed. AA isn't the most important factor. It isn't even the second most important. Savings Rate rules all.
Yeah you can have an 8% SWR if you save half of it......
Saving rates matter when your have a low net worth early on. Towards the end they don't matter much. Adding 20k to a 200k account makes a nice difference difference. Adding 20k to a 2 million dollar one get lost in the noise of investment returns.
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Indeed. AA isn't the most important factor. It isn't even the second most important. Savings Rate rules all.
Yeah you can have an 8% SWR if you save half of it......
Saving rates matter when your have a low net worth early on. Towards the end they don't matter much. Adding 20k to a 200k account makes a nice difference difference. Adding 20k to a 2 million dollar one get lost in the noise of investment returns.
That's not how I look at it. $20,000 ($1667 a month) adds to your portfolio the same way, no matter how much money you have. It doesn't matter if you start with 0, or you start with $10 million, adding $1667 a month will add about $3 million over 30 years. :)
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Is someone able to explain with simple words and short sentences why a person should not have 100% shares?
Because investors have human emotions, and are subject to panic and making self-defeating moves to their portfolio.
Someone who owns 100% stocks is more likely to panic and sell the next time the market drops 50%, because their portfolio will also drop 50% and they'll think the world is coming to an end. Someone who owns 80% stocks and 20% bonds won't see their portfolio drop as steeply, and thus, will be less likely to defeat themselves.
You might think you wouldn't be stupid enough to panic like that. But until you've lived through it, you can't say for sure.
Some reports (http://www.forbes.com/sites/advisor/2014/04/24/why-the-average-investors-investment-return-is-so-low/) show that the average investor's return over the long term is only a small fraction of what the market returned. That's due to their poor choices. Maybe you'll make better choices than the average investor. But the odds are against it.
I get the feeling that people asking "why not 100% stocks?" are relatively new to investing, and thus, have never experienced anything but a continually rising stock market. Or, even if they were around for the crash in 2008, saw their portfolio cut from only $10,000 to $5,000, rather than $1m to $500k.
If you held multiple decades worth of living expenses invested in 100% stocks in 2007, and still held 100% stocks in 2009, then congratulations, you are more robotic than most, and staying 100% in stocks going forward will probably produce the best results for you.
But for many other people, being 100% in stocks today will not produce the most money in 30 years.
(about dividends: they aren't very relevant. They can be cut/eliminated, inducing probably even more panic than the share price drop alone. And in the US market these days, earnings tend to be retained more than they're paid out, so selling shares is going to be part of most withdrawal methods.)
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That's not how I look at it. $20,000 ($1667 a month) adds to your portfolio the same way, no matter how much money you have. It doesn't matter if you start with 0, or you start with $10 million, adding $1667 a month will add about $3 million over 30 years. :)
If you had 10 million dollars, you would have about 170 million in 30 years. The difference between having 170 million and 173 million probably doesn't matter. The difference for the 2 million guy (35 million versus 38) is also in the category of things that probably don't matter:)
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I get the feeling that people asking "why not 100% stocks?" are relatively new to investing, and thus, have never experienced anything but a continually rising stock market. Or, even if they were around for the crash in 2008, saw their portfolio cut from only $10,000 to $5,000, rather than $1m to $500k.
If you held multiple decades worth of living expenses invested in 100% stocks in 2007, and still held 100% stocks in 2009, then congratulations, you are more robotic than most, and staying 100% in stocks going forward will probably produce the best results for you.
For investors who did not live through 2008, I think reading the summary of what it felt like to do so in the introduction to Dr. Doom's drawdown series is a good mental exercise to begin to judge your true risk tolerance:
http://www.livingafi.com/2014/05/drawdown-part-1-the-basics/
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(about dividends: they aren't very relevant. They can be cut/eliminated, inducing probably even more panic than the share price drop alone. And in the US market these days, earnings tend to be retained more than they're paid out, so selling shares is going to be part of most withdrawal methods.)
Its unfortunate that dividends are not getting the respect they deserve these days. They've actually been dropping slowly but surely since the 1920's when a ~6% yield was common. I really hope that this changes because I don't see any advantages for investors when companies repurchase their own shares while they are at high valuations instead of giving the money back to shareholders as dividends.
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I gave my money to the company because I thought they could make smarter decisions with it than me. I don't want them to be like "We
have no idea how to productively use this money, please just take it back LOL!".
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I get the feeling that people asking "why not 100% stocks?" are relatively new to investing, and thus, have never experienced anything but a continually rising stock market. Or, even if they were around for the crash in 2008, saw their portfolio cut from only $10,000 to $5,000, rather than $1m to $500k.
If you held multiple decades worth of living expenses invested in 100% stocks in 2007, and still held 100% stocks in 2009, then congratulations, you are more robotic than most, and staying 100% in stocks going forward will probably produce the best results for you.
For investors who did not live through 2008, I think reading the summary of what it felt like to do so in the introduction to Dr. Doom's drawdown series is a good mental exercise to begin to judge your true risk tolerance:
http://www.livingafi.com/2014/05/drawdown-part-1-the-basics/
What a great read. Thanks for the link!
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(about dividends: they aren't very relevant. They can be cut/eliminated, inducing probably even more panic than the share price drop alone. And in the US market these days, earnings tend to be retained more than they're paid out, so selling shares is going to be part of most withdrawal methods.)
Its unfortunate that dividends are not getting the respect they deserve these days. They've actually been dropping slowly but surely since the 1920's when a ~6% yield was common. I really hope that this changes because I don't see any advantages for investors when companies repurchase their own shares while they are at high valuations instead of giving the money back to shareholders as dividends.
There are tax advantages. Dividends are taxed, if I remember correctly, at regular tax rate. Long Term Capital Gains (Stocks going up in value) are taxed at a maximum of 15%.
Agree to a point. Don't like paying more in taxes. However, Senior Executives don't strike me as very Mustachian, so what prevents them from spending my earnings on non-productive projects? Yes, they have to deliver certain ROI, but these are the same people who think they are awesome by saving 10% of their income, when they should be around 70%. Do I want them handling my money? (No, I'm not saying stocks are bad. Just more of a discussion thought.)
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Agree to a point. Don't like paying more in taxes. However, Senior Executives don't strike me as very Mustachian, so what prevents them from spending my earnings on non-productive projects? Yes, they have to deliver certain ROI, but these are the same people who think they are awesome by saving 10% of their income, when they should be around 70%. Do I want them handling my money? (No, I'm not saying stocks are bad. Just more of a discussion thought.)
It is impossible for most senior executives to save 70% of their income:) I wouldn't want a mustachian running my company. Mustachian make a lot of penny smart pound foolish decisions. Every read the threads where people spend hours to save 5 bucks? Paying people to do that is a losing strategy. Senior executives tend to have the same goals as I do (higher share price). The difference is the time frame (I want it in 10 years, they want it in 2 years when their options vest).
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For investors who did not live through 2008, I think reading the summary of what it felt like to do so in the introduction to Dr. Doom's drawdown series is a good mental exercise to begin to judge your true risk tolerance:
http://www.livingafi.com/2014/05/drawdown-part-1-the-basics/
Thanks for this link! I'm thinking the hard part about asset allocation is that the emotional reaction can't necessarily be predicted and therefore its effect can't be quantified.
I'm still not 100% sure what AA I'm going to use going forwards. I'm leaning towards 100% stocks until I'm 40, then re-assessing at that point in time based on the market returns I've seen up to that point and my retirement timeline and plans (which will hopefully be more firm). Can I handle the emotional side of market fluctuations for the next 10 years? The blog entry linked to above is a compelling argument for diversification into bond funds to temper an emotional reaction. However, I believe that personally I would've needed a significant percentage in bonds to temper the gut emotional reaction of the fluctuation experienced in 2008. Let's say on January 1 I started with $1M in assets, but the equities market dropped 40% during the year and bonds returned 20% over the course of the year. Here's a table of what would've happened based on different AAs:
| % in Bonds on Jan 1 | Value of Bonds Dec 31 | Value of Equities Dec 31 | Total Portfolio Value |
| 0% | $0 | $600,000 | $600,000 |
| 10% | $120,000 | $540,000 | $660,000 |
| 20% | $240,000 | $480,000 | $700,000 |
| 30% | $360,000 | $420,000 | $780,000 |
| 50% | $600,000 | $300,000 | $900,000 |
Basically it sucked to be an investor from an emotional standpoint and a financial standpoint in 2008, no matter your AA.
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Agree to a point. Don't like paying more in taxes. However, Senior Executives don't strike me as very Mustachian, so what prevents them from spending my earnings on non-productive projects? Yes, they have to deliver certain ROI, but these are the same people who think they are awesome by saving 10% of their income, when they should be around 70%. Do I want them handling my money? (No, I'm not saying stocks are bad. Just more of a discussion thought.)
It is impossible for most senior executives to save 70% of their income:) I wouldn't want a mustachian running my company. Mustachian make a lot of penny smart pound foolish decisions. Every read the threads where people spend hours to save 5 bucks? Paying people to do that is a losing strategy. Senior executives tend to have the same goals as I do (higher share price). The difference is the time frame (I want it in 10 years, they want it in 2 years when their options vest).
I can agree to the penny wise, pound foolish in some cases. Wish there was a hybrid between the two types of people.
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Someone who owns 100% stocks is more likely to panic and sell the next time the market drops 50%, because their portfolio will also drop 50% and they'll think the world is coming to an end. Someone who owns 80% stocks and 20% bonds won't see their portfolio drop as steeply, and thus, will be less likely to defeat themselves.
Exactly. And that is exactly what happens in almost all cases. No one is disputing historical data here. (Even though most calculators don't take rebalancing into consideration.) It's easy to think that you can weather three or four years of horrible returns, but in actuality it's a very long time for a buy-and-hold strategy when all human factors are considered. I think it's something like 90% of people have an extremely difficult time imagining their future selves. (Hence all the foolish debt we see around us.) I imagine Mustachians are better than most at imagining our future selves because most of us are working towards FIRE, however, that person is never to be fully trusted. Just look up Bogle's articles on why ETF index investors on average don't beat the market. Sounds like an oxymoron, right? But sadly, it's not.
This is one of the best articles I've ever read on investing vs. human behaviour. I'd recommend it to anyone.
http://www.moneysense.ca/invest/train-your-investing-brain (http://www.moneysense.ca/invest/train-your-investing-brain)