Author Topic: Asset Allocation - 100% Stocks for How Long?  (Read 47706 times)

EscapeVelocity2020

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #100 on: October 08, 2014, 10:24:29 AM »
And If you have twice your target retirement funds (i.e. 2% SWR at retirement), 100% equities has historically been the best allocation if you don't mind losing half at some point and staying the course (no longer me). 
I would argue the reverse; if your stash is large enough to support a very low withdrawal rate, that's when you can afford to use a more conservative allocation.  You don't need the higher returns of a 100% equity portfolio to fund your needs.  In other words, you've already won the game, so you can stop playing.  But if you want to stop working before you are able to amass a portfolio that can support such a low withdrawal rate, that's when you need a more aggressive allocation.
OK, this exchange is what threw me off.  I guess we'll have to agree to disagree, I'm not shooting for 1-2%SWR and 3-4%SWR means you need bonds and rebalancing to counter-act sequence of return risk, especially if you are an Early Retiree, at least in every academic article I've seen.  Pfau has one out that you can get more aggressive (from 60/40 to 100/0) as you get older since your time horizon shrinks, but people pretty much shrugged it off as an interesting academic exercise, but not what they would want to do in their 80's and 90's.

I think what you are missing is that, even if success % is high with 100% equity, when you fail, you fail spectacularly (especially if you aren't eligible for SS or Medicare, and have been in retirement for 5-10 years..).  The drawdown period strategy is different from accumulation, unless you can freely hop back and forth (which seems to be the ER assumption).

brooklynguy

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #101 on: October 08, 2014, 11:23:53 AM »
And if you look at the historical data, this strategy has both a better success rate and a higher ending portfolio value than any other allocation.

I posted cfiresim results showing 100% equities having a lower success rate than other allocations.  It depends on the variables.

Fair enough.  It depends on the variables.  Using cfiresim's default settings, my statement stands.

OK, this exchange is what threw me off.  I guess we'll have to agree to disagree, I'm not shooting for 1-2%SWR and 3-4%SWR means you need bonds and rebalancing to counter-act sequence of return risk, especially if you are an Early Retiree, at least in every academic article I've seen.  Pfau has one out that you can get more aggressive (from 60/40 to 100/0) as you get older since your time horizon shrinks, but people pretty much shrugged it off as an interesting academic exercise, but not what they would want to do in their 80's and 90's.

I think what you are missing is that, even if success % is high with 100% equity, when you fail, you fail spectacularly (especially if you aren't eligible for SS or Medicare, and have been in retirement for 5-10 years..).  The drawdown period strategy is different from accumulation, unless you can freely hop back and forth (which seems to be the ER assumption).

This sounds backwards to me.  If you plan to use an extremely low withdrawal rate (like 1%), then you can get away with a 100% bond allocation -- you don't need the higher performance of stocks to fund your expenses.  But if you plan to use a 4% withdrawal rate, you need a higher stock allocation.  Run the numbers in cfiresim (using the default settings) and you will see that in the past, a 100% stock allocation had an equal or higher success rate, and higher returns, than any sub-100% allocation.

On a $1 million portfolio with $40k annual expenses over a 30 year retirement, the success rates and median ending portfolio values are as follows:

- 60% stocks / 40% bonds:  success rate of 90.43% (11 failures out of 115 cycles); ending value of $890,120.54

- 75% stocks / 25% bonds:  success rate of 93.04% (8 failures out of 115 cycles); ending value of $1,290,170

- 100% stocks / 0% bonds:  success rate of 93.04% (8 failures out of 115 cycles); ending value of $2,152,993

So, historically, with a 4% WR, shifting to a heavier bond allocation increased the risk of portfolio failure, not decreased it (which already accounts for sequence of return risk, since it is based on every historical cycle that ever occurred, including the ones where the market tanked immediately after retirement).  And it left you with a much smaller median portfolio value.  In these simulations, failure is defined as completely running out of money, so each failure is equally spectacular, but the few failures that did happen happened more often with a higher bond allocation.

This is what I was getting at in my earlier post that threw you off:  once your stash is so large that you can live off of it with a super-low withdrawal rate (like 1%), then you can shift to a more conservative allocation without hurting your chances of success (you do give up some returns, but who cares, because you've already won the game).  This is discussed at length in the following thread:

http://forum.mrmoneymustache.com/investor-alley/william-bernstein-the-worst-retirement-investing-mistake/msg273161/#msg273161

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #102 on: October 08, 2014, 03:03:39 PM »
And if you look at the historical data, this strategy has both a better success rate and a higher ending portfolio value than any other allocation.

I posted cfiresim results showing 100% equities having a lower success rate than other allocations.  It depends on the variables.

Fair enough.  It depends on the variables.  Using cfiresim's default settings, my statement stands.

The default has a 0.18 ER, who is paying that much?  We should model based on ERs we are actually paying, not the defaults of a website :-P

In any case, I loaded up cfiresim.com in a brand new browser, on a brand new machine, changed absolutely none of the variables, selected, "Success rates with various allocations" and got identical success rates with 75%, 80%, 85%, 90%, and 100% equity allocations:











I can post a video if you'd like :)

EscapeVelocity2020

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #103 on: October 08, 2014, 03:04:28 PM »
(@ brooklynguy) Interestingly, when I run the same things (60/40, million dollar portfolio, 40k inflation adjusted spending) through FIREcalc, I get less failures (5/114, or 95.6% success).  For 75/25 I get 94.7% and 100/0, I get 93% success.  Could be the spending / rebalancing strategy is different, and I would argue that cFireSim makes a poor assumption that 60/40 allocation means you will also spend from your portfolio in that ratio.  For example, when stocks outperform, you might take all spending needs from stocks and still sell stocks to buy bonds to rebalance.

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #104 on: October 08, 2014, 03:22:34 PM »
(@ brooklynguy) Interestingly, when I run the same things (60/40, million dollar portfolio, 40k inflation adjusted spending) through FIREcalc, I get less failures (5/114, or 95.6% success).  For 75/25 I get 94.7% and 100/0, I get 93% success.  Could be the spending / rebalancing strategy is different, and I would argue that cFireSim makes a poor assumption that 60/40 allocation means you will also spend from your portfolio in that ratio.  For example, when stocks outperform, you might take all spending needs from stocks and still sell stocks to buy bonds to rebalance.

I'm also researching this, as Vanguard's historical data only shows a 0.6% annual return difference between 100/0 and 80/20, and that difference doesn't mesh with the end results I'm seeing in cfiresim.

foobar

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #105 on: October 08, 2014, 03:24:56 PM »
(@ brooklynguy) Interestingly, when I run the same things (60/40, million dollar portfolio, 40k inflation adjusted spending) through FIREcalc, I get less failures (5/114, or 95.6% success).  For 75/25 I get 94.7% and 100/0, I get 93% success.  Could be the spending / rebalancing strategy is different, and I would argue that cFireSim makes a poor assumption that 60/40 allocation means you will also spend from your portfolio in that ratio.  For example, when stocks outperform, you might take all spending needs from stocks and still sell stocks to buy bonds to rebalance.

 The exact results are very sensitive to minor changes (ER, corporate versus treasury, S&P 500 vs TSM,starting dates,...) and exact methodology.  Most studies suggest 75/25 giving the best results but the difference between 40/60 and 100/0 and everything in between is very small. as far as survival rate.

AA doesn't matter since all these studies are testing is performance in the  late 60s/70s (and after you do that the great depression). The take away is that you go 75% stock/15% gold/10% bonds and have a 99% success rate.  I am not sure if I would be willing to project that into the future though:).

For kicks run a 70/30 (Small value and lt bond) and see how you can have a 98% success with a 4.5% SWR.

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #106 on: October 08, 2014, 03:43:03 PM »

(@ brooklynguy) Interestingly, when I run the same things (60/40, million dollar portfolio, 40k inflation adjusted spending) through FIREcalc, I get less failures (5/114, or 95.6% success).  For 75/25 I get 94.7% and 100/0, I get 93% success.  Could be the spending / rebalancing strategy is different, and I would argue that cFireSim makes a poor assumption that 60/40 allocation means you will also spend from your portfolio in that ratio.  For example, when stocks outperform, you might take all spending needs from stocks and still sell stocks to buy bonds to rebalance.

 The exact results are very sensitive to minor changes (ER, corporate versus treasury, S&P 500 vs TSM,starting dates,...) and exact methodology.  Most studies suggest 75/25 giving the best results but the difference between 40/60 and 100/0 and everything in between is very small. as far as survival rate.

AA doesn't matter since all these studies are testing is performance in the  late 60s/70s (and after you do that the great depression). The take away is that you go 75% stock/15% gold/10% bonds and have a 99% success rate.  I am not sure if I would be willing to project that into the future though:).

For kicks run a 70/30 (Small value and lt bond) and see how you can have a 98% success with a 4.5% SWR.

Indeed. AA isn't the most important factor. It isn't even the second most important. Savings Rate rules all.

foobar

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #107 on: October 08, 2014, 04:11:53 PM »


Indeed. AA isn't the most important factor. It isn't even the second most important. Savings Rate rules all.

Yeah you can have an 8% SWR if you save half of it......

Saving rates matter when your have a low net worth early on. Towards the end they don't matter much. Adding 20k to a 200k account makes a nice difference difference. Adding 20k to a 2 million dollar one get lost in the noise of investment returns.

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #108 on: October 08, 2014, 04:19:12 PM »


Indeed. AA isn't the most important factor. It isn't even the second most important. Savings Rate rules all.

Yeah you can have an 8% SWR if you save half of it......

Saving rates matter when your have a low net worth early on. Towards the end they don't matter much. Adding 20k to a 200k account makes a nice difference difference. Adding 20k to a 2 million dollar one get lost in the noise of investment returns.

That's not how I look at it.  $20,000 ($1667 a month) adds to your portfolio the same way, no matter how much money you have.  It doesn't matter if you start with 0, or you start with $10 million, adding $1667 a month will add about $3 million over 30 years. :)

skyrefuge

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Re: .
« Reply #109 on: October 08, 2014, 04:24:18 PM »
Is someone able to explain with simple words and short sentences why a person should not have 100% shares?

Because investors have human emotions, and are subject to panic and making self-defeating moves to their portfolio.

Someone who owns 100% stocks is more likely to panic and sell the next time the market drops 50%, because their portfolio will also drop 50% and they'll think the world is coming to an end. Someone who owns 80% stocks and 20% bonds won't see their portfolio drop as steeply, and thus, will be less likely to defeat themselves.

You might think you wouldn't be stupid enough to panic like that. But until you've lived through it, you can't say for sure.

Some reports show that the average investor's return over the long term is only a small fraction of what the market returned. That's due to their poor choices. Maybe you'll make better choices than the average investor. But the odds are against it.

I get the feeling that people asking "why not 100% stocks?" are relatively new to investing, and thus, have never experienced anything but a continually rising stock market. Or, even if they were around for the crash in 2008, saw their portfolio cut from only $10,000 to $5,000, rather than $1m to $500k.

If you held multiple decades worth of living expenses invested in 100% stocks in 2007, and still held 100% stocks in 2009, then congratulations, you are more robotic than most, and staying 100% in stocks going forward will probably produce the best results for you.

But for many other people, being 100% in stocks today will not produce the most money in 30 years.

(about dividends: they aren't very relevant. They can be cut/eliminated, inducing probably even more panic than the share price drop alone. And in the US market these days, earnings tend to be retained more than they're paid out, so selling shares is going to be part of most withdrawal methods.)

foobar

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #110 on: October 08, 2014, 05:41:39 PM »


That's not how I look at it.  $20,000 ($1667 a month) adds to your portfolio the same way, no matter how much money you have.  It doesn't matter if you start with 0, or you start with $10 million, adding $1667 a month will add about $3 million over 30 years. :)

If you had 10 million dollars, you would have about 170 million in 30 years. The difference between having  170 million and 173 million probably doesn't matter. The difference for the 2 million guy (35 million versus 38) is also in the category of things that probably don't matter:)

brooklynguy

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Re: .
« Reply #111 on: October 09, 2014, 07:27:23 AM »
I get the feeling that people asking "why not 100% stocks?" are relatively new to investing, and thus, have never experienced anything but a continually rising stock market. Or, even if they were around for the crash in 2008, saw their portfolio cut from only $10,000 to $5,000, rather than $1m to $500k.

If you held multiple decades worth of living expenses invested in 100% stocks in 2007, and still held 100% stocks in 2009, then congratulations, you are more robotic than most, and staying 100% in stocks going forward will probably produce the best results for you.

For investors who did not live through 2008, I think reading the summary of what it felt like to do so in the introduction to Dr. Doom's drawdown series is a good mental exercise to begin to judge your true risk tolerance:

http://www.livingafi.com/2014/05/drawdown-part-1-the-basics/


RichMoose

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Re: .
« Reply #112 on: October 09, 2014, 09:48:21 AM »
(about dividends: they aren't very relevant. They can be cut/eliminated, inducing probably even more panic than the share price drop alone. And in the US market these days, earnings tend to be retained more than they're paid out, so selling shares is going to be part of most withdrawal methods.)

Its unfortunate that dividends are not getting the respect they deserve these days. They've actually been dropping slowly but surely since the 1920's when a ~6% yield was common. I really hope that this changes because I don't see any advantages for investors when companies repurchase their own shares while they are at high valuations instead of giving the money back to shareholders as dividends.

MrMonkeyMustache

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #113 on: October 09, 2014, 10:46:23 AM »
I gave my money to the company because I thought they could make smarter decisions with it than me. I don't want them to be like "We
 have no idea how to productively use this money, please just take it back LOL!".

Dodge

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Re: Asset Allocation - 100% Stocks for How Long?
« Reply #114 on: October 09, 2014, 10:55:17 AM »

I get the feeling that people asking "why not 100% stocks?" are relatively new to investing, and thus, have never experienced anything but a continually rising stock market. Or, even if they were around for the crash in 2008, saw their portfolio cut from only $10,000 to $5,000, rather than $1m to $500k.

If you held multiple decades worth of living expenses invested in 100% stocks in 2007, and still held 100% stocks in 2009, then congratulations, you are more robotic than most, and staying 100% in stocks going forward will probably produce the best results for you.

For investors who did not live through 2008, I think reading the summary of what it felt like to do so in the introduction to Dr. Doom's drawdown series is a good mental exercise to begin to judge your true risk tolerance:

http://www.livingafi.com/2014/05/drawdown-part-1-the-basics/

What a great read. Thanks for the link!

GardenFun

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Re: .
« Reply #115 on: October 09, 2014, 10:57:17 AM »
(about dividends: they aren't very relevant. They can be cut/eliminated, inducing probably even more panic than the share price drop alone. And in the US market these days, earnings tend to be retained more than they're paid out, so selling shares is going to be part of most withdrawal methods.)

Its unfortunate that dividends are not getting the respect they deserve these days. They've actually been dropping slowly but surely since the 1920's when a ~6% yield was common. I really hope that this changes because I don't see any advantages for investors when companies repurchase their own shares while they are at high valuations instead of giving the money back to shareholders as dividends.

There are tax advantages. Dividends are taxed, if I remember correctly, at regular tax rate. Long Term Capital Gains (Stocks going up in value) are taxed at a maximum of 15%.

Agree to a point.  Don't like paying more in taxes.  However, Senior Executives don't strike me as very Mustachian, so what prevents them from spending my earnings on non-productive projects?  Yes, they have to deliver certain ROI, but these are the same people who think they are awesome by saving 10% of their income, when they should be around 70%.  Do I want them handling my money?  (No, I'm not saying stocks are bad.  Just more of a discussion thought.)

foobar

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Re: .
« Reply #116 on: October 09, 2014, 12:06:43 PM »

Agree to a point.  Don't like paying more in taxes.  However, Senior Executives don't strike me as very Mustachian, so what prevents them from spending my earnings on non-productive projects?  Yes, they have to deliver certain ROI, but these are the same people who think they are awesome by saving 10% of their income, when they should be around 70%.  Do I want them handling my money?  (No, I'm not saying stocks are bad.  Just more of a discussion thought.)

It is impossible for most senior executives to save 70% of their income:) I wouldn't want a mustachian running my company. Mustachian make a lot of penny smart pound foolish decisions. Every read the threads where people spend hours to save 5 bucks? Paying people to do that is a losing strategy. Senior executives tend to have the same goals as I do (higher share price). The difference is the time frame (I want it in 10 years, they want it in 2 years when their options vest).

justplucky

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Re: .
« Reply #117 on: October 09, 2014, 06:04:14 PM »
For investors who did not live through 2008, I think reading the summary of what it felt like to do so in the introduction to Dr. Doom's drawdown series is a good mental exercise to begin to judge your true risk tolerance:

http://www.livingafi.com/2014/05/drawdown-part-1-the-basics/

Thanks for this link! I'm thinking the hard part about asset allocation is that the emotional reaction can't necessarily be predicted and therefore its effect can't be quantified.

I'm still not 100% sure what AA I'm going to use going forwards. I'm leaning towards 100% stocks until I'm 40, then re-assessing at that point in time based on the market returns I've seen up to that point and my retirement timeline and plans (which will hopefully be more firm). Can I handle the emotional side of market fluctuations for the next 10 years? The blog entry linked to above is a compelling argument for diversification into bond funds to temper an emotional reaction. However, I believe that personally I would've needed a significant percentage in bonds to temper the gut emotional reaction of the fluctuation experienced in 2008. Let's say on January 1 I started with $1M in assets, but the equities market dropped 40% during the year and bonds returned 20% over the course of the year. Here's a table of what would've happened based on different AAs:

% in Bonds on Jan 1Value of Bonds Dec 31Value of Equities Dec 31Total Portfolio Value
0%$0$600,000$600,000
10%$120,000$540,000$660,000
20%$240,000$480,000$700,000
30%$360,000$420,000$780,000
50%$600,000$300,000$900,000

Basically it sucked to be an investor from an emotional standpoint and a financial standpoint in 2008, no matter your AA.


GardenFun

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Re: .
« Reply #118 on: October 10, 2014, 07:32:43 AM »

Agree to a point.  Don't like paying more in taxes.  However, Senior Executives don't strike me as very Mustachian, so what prevents them from spending my earnings on non-productive projects?  Yes, they have to deliver certain ROI, but these are the same people who think they are awesome by saving 10% of their income, when they should be around 70%.  Do I want them handling my money?  (No, I'm not saying stocks are bad.  Just more of a discussion thought.)

It is impossible for most senior executives to save 70% of their income:) I wouldn't want a mustachian running my company. Mustachian make a lot of penny smart pound foolish decisions. Every read the threads where people spend hours to save 5 bucks? Paying people to do that is a losing strategy. Senior executives tend to have the same goals as I do (higher share price). The difference is the time frame (I want it in 10 years, they want it in 2 years when their options vest).

I can agree to the penny wise, pound foolish in some cases.  Wish there was a hybrid between the two types of people.

Kaspian

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Re: .
« Reply #119 on: October 10, 2014, 12:26:18 PM »
Someone who owns 100% stocks is more likely to panic and sell the next time the market drops 50%, because their portfolio will also drop 50% and they'll think the world is coming to an end. Someone who owns 80% stocks and 20% bonds won't see their portfolio drop as steeply, and thus, will be less likely to defeat themselves.

Exactly.  And that is exactly what happens in almost all cases.  No one is disputing historical data here.  (Even though most calculators don't take rebalancing into consideration.)  It's easy to think that you can weather three or four years of horrible returns, but in actuality it's a very long time for a buy-and-hold strategy when all human factors are considered.  I think it's something like 90% of people have an extremely difficult time imagining their future selves.  (Hence all the foolish debt we see around us.)  I imagine Mustachians are better than most at imagining our future selves because most of us are working towards FIRE, however, that person is never to be fully trusted.   Just look up Bogle's articles on why ETF index investors on average don't beat the market.  Sounds like an oxymoron, right?  But sadly, it's not.

This is one of the best articles I've ever read on investing vs. human behaviour.  I'd recommend it to anyone.
http://www.moneysense.ca/invest/train-your-investing-brain