Author Topic: Asset Allocation - 100% Stocks for How Long?  (Read 42098 times)

justplucky

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Asset Allocation - 100% Stocks for How Long?
« on: September 29, 2014, 08:00:19 PM »
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?

Eric

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #1 on: September 29, 2014, 09:47:40 PM »
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.

RichMoose

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #2 on: September 29, 2014, 10:17:28 PM »
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.

Beric01

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #3 on: September 29, 2014, 10:45:58 PM »
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.
« Last Edit: September 30, 2014, 01:27:23 AM by Beric01 »

AnonymousCoward

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #4 on: September 30, 2014, 12:10:23 AM »
This is from The Intelligent Asset Allocator*. Standard deviation is a measure of risk.

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.
« Last Edit: September 30, 2014, 12:18:16 AM by pmallory »

wtjbatman

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #5 on: September 30, 2014, 05:36:00 AM »
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.

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #6 on: September 30, 2014, 09:05:23 AM »
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/

GGNoob

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #7 on: September 30, 2014, 10:43:19 AM »
My wife and I plan on 100% stocks forever. So I don't think you are crazy at all.

rugorak

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #8 on: September 30, 2014, 11:53:02 AM »
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.

Beric01

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #9 on: September 30, 2014, 12:11:22 PM »
This is from The Intelligent Asset Allocator*. Standard deviation is a measure of risk.

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.

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #10 on: September 30, 2014, 12:25:18 PM »
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.

Beric01

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #11 on: September 30, 2014, 03:47:10 PM »
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.

Joel

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #12 on: September 30, 2014, 10:36:42 PM »
I keep half my age in bonds and plan to do that for a long time. (25 currently)

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #13 on: October 01, 2014, 02:39:33 AM »
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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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #14 on: October 01, 2014, 05:46:06 AM »
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). 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.

Philociraptor

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #15 on: October 01, 2014, 05:46:56 AM »
I'd suggest 20% in bonds, that way you can enjoy some buy high, sell low rebalancing.

wtjbatman

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #16 on: October 01, 2014, 06:38:33 AM »
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.

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #17 on: October 01, 2014, 07:07:18 AM »

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.

Eric

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #18 on: October 01, 2014, 08:29:28 AM »
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?

ImCheap

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #19 on: October 01, 2014, 09:07:04 AM »
This is from The Intelligent Asset Allocator*. Standard deviation is a measure of risk.

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. 
« Last Edit: October 01, 2014, 09:12:37 AM by ImCheap »

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #20 on: October 01, 2014, 09:12:08 AM »
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.

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #21 on: October 01, 2014, 09:14:58 AM »
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).

ImCheap

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #22 on: October 01, 2014, 09:23:17 AM »
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.

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #23 on: October 01, 2014, 09:26:57 AM »
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.

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #24 on: October 01, 2014, 09:32:12 AM »
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.

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #25 on: October 01, 2014, 09:38:18 AM »
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.
« Last Edit: October 01, 2014, 09:40:10 AM by brooklynguy »

LordSquidworth

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #26 on: October 01, 2014, 09:53:22 AM »
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?

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #27 on: October 01, 2014, 10:18:37 AM »

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...).

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #28 on: October 01, 2014, 10:35:21 AM »
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).

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #29 on: October 01, 2014, 10:52:54 AM »
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.

Eric

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #30 on: October 01, 2014, 11:30:25 AM »
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.

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #31 on: October 01, 2014, 11:32:44 AM »
If you are going to have 100% stocks, acklowledge the long term risk. Stocks do not become risk free investments over time.

Eric

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #32 on: October 01, 2014, 11:37:46 AM »
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.

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #33 on: October 01, 2014, 12:01:09 PM »
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.

Beric01

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #34 on: October 01, 2014, 12:29:54 PM »
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.

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #35 on: October 01, 2014, 12:33:50 PM »
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).

Beric01

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #36 on: October 01, 2014, 12:48:21 PM »
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.

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #37 on: October 01, 2014, 12:53:34 PM »
Obligatory Japan 1989-2013 (25 years) chart:



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:

------------------------------------------------------------

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.

------------------------------------------------------------

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:



Using Monte Carlo (randomized) data, between 70-80% is the peak success rate:



Every time you rerun the Monte Carlo, the results are different. Some Cfiresim.com Monte Carlo results are REALLY BAD for 100% equities:



Vanguard's Monte Carlo retirement nest egg calculator 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%



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.
« Last Edit: October 01, 2014, 01:06:03 PM by Dodge »

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #38 on: October 01, 2014, 01:51:08 PM »
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.

ImCheap

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #39 on: October 01, 2014, 02:21:45 PM »
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.

geek101

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #40 on: October 01, 2014, 02:29:03 PM »

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?

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #41 on: October 01, 2014, 02:37:09 PM »
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:



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:



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:


Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #42 on: October 01, 2014, 02:56:00 PM »

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:



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?



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?



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%



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.

geek101

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #43 on: October 01, 2014, 03:22:07 PM »

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!

clifp

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #44 on: October 01, 2014, 04:23:45 PM »
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.

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #45 on: October 01, 2014, 07:05:01 PM »
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? :)

Grateful Stache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #46 on: October 01, 2014, 08:02:35 PM »
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

clifp

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #47 on: October 01, 2014, 10:29:43 PM »


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.

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #48 on: October 01, 2014, 10:56:53 PM »


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.

clifp

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #49 on: October 02, 2014, 02:42:58 AM »


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.