Asset Allocation - 100% Stocks for How Long?

[EscapeVelocity2020]

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  No money is added or withdrawn.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).

 

[Kaspian]

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

[Dodge]

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:


100/0:



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.

[This_Is_My_Username]

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.

[steveo]

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.

[clifp]

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.

[EscapeVelocity2020]

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...

[Dodge]

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.

[brooklynguy]

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).

[lauren_knows]

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

[Dodge]

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



1973-2014 (41 years) - Vanguard Long-Term Investment-Grade vs S&P 500



(Sorry for the inclusion of the active fund, couldn't find any other bond funds at Vanguard that went back that far)

[lauren_knows]

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



1973-2014 (41 years) - Vanguard Long-Term Investment-Grade vs S&P 500



(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. 

[brooklynguy]

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).

[GardenFun]

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.   

[GardenFun]

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.   

[Dodge]

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 ;)

[clifp]

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.

[steveo]

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.

[clifp]

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.

[steveo]

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.

[heybro]

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?

[NorCal]

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.

[Dodge]

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:



https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations





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)


100% stock portfolio


After 10 years of joblessness, and withdrawing $400,000 from our portfolio, here's how our 3 fund portfolio looks (total $556,282):



During this entire time, we didn't have to sell any US stocks!  Let's check in on the 100% stock portfolio:



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 :)



3 fund portfolio total:  $862,513



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.

[WillPen]

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.

[Jags4186]

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?

[Joel]

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.

[Dodge]

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 :)

[Dodge]

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.

[Dodge]

The scenario you created is about as realistic as me finding a unicorn in my backyard.

Yup

[smilla]

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.

[Dodge]

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:



https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations





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)


100% stock portfolio


After 10 years of joblessness, and withdrawing $400,000 from our portfolio, here's how our 3 fund portfolio looks (total $556,282):



During this entire time, we didn't have to sell any US stocks!  Let's check in on the 100% stock portfolio:



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 :)



3 fund portfolio total:  $862,513



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:





Starting year, right after the 50% drop:



In the 7th year, we finally start having to sell some stocks:



After having withdrawn $400,000 (40k a year) this is where we end up after 10 years:



Total: $402,772

And now on the 11th year, our stocks double!

Leaving us with a total of $646,759

[Dodge]

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:

[lauren_knows]

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/

[brooklynguy]

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.

[Dodge]

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:

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:



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%

[RichMoose]

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.

[lauren_knows]

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. 

[Dodge]

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:



Taken from the following post on Bogleheads:

http://www.bogleheads.org/forum/viewtopic.php?t=56811&mrr=1277152736#p764608

[brooklynguy]

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.)

[smilla]

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.

[brooklynguy]

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.

[RichMoose]

Thanks Dodge! That chart is exactly what I was looking for.

[smilla]

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.)

[smilla]

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.

[brooklynguy]

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.

[This_Is_My_Username]

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?

[brooklynguy]

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.

[EscapeVelocity2020]

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? 

[brooklynguy]

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.

[Dodge]

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.