Bogle Projects 'Nominal To Zero' Real Returns Over The Next Decade

[Kaspian]

The "adaptation alternatives" one could take include cutting expenses, seeking out alternative income sources, etc., which would probably be a good idea for someone retiring today on a 4% SWR retirement plan if the next decade witnesses 0% market returns.

Got it, thanks!  Part-time taxi driver in an off year isn't a bad plan for a Mustachian if things get shaky.  Recognizing that you might need a little padding once your plan has been implemented is definitely prudent. 

[sabertooth3]

The "adaptation alternatives" one could take include cutting expenses, seeking out alternative income sources, etc., which would probably be a good idea for someone retiring today on a 4% SWR retirement plan if the next decade witnesses 0% market returns.

Got it, thanks!  Part-time taxi driver in an off year isn't a bad plan for a Mustachian if things get shaky.  Recognizing that you might need a little padding once your plan has been implemented is definitely prudent.

Jumping in here, this is why I'm not a fan of FIRE = 25x annual expenses. As brooklynguy stated a few posts back, none of us really know what the future will hold for the market. Instead of skirting by on 25x expenses, I think it's more prudent to go for 30 or 40x expenses. Because if your adaptation alternative is going back to work, you aren't FIRE anymore.

When I worked hospitality for a couple of summers, we'd figure out how many guests were in a party, and then reserve +10% the amount of rooms, just in case they had last-minute adjustments. That's how I envision FIRE: get what you think you need, then get a little more to buffer any adjustments.

Also, finding work in an off year, aka a recession, may prove to be more challenging than you think.

[sol]

this is why I'm not a fan of FIRE = 25x annual expenses. As

Keep in mind that the 25x rule and 4% rule already account for 95 percent of scenarios, so you would only have a one in 20 chance of needing to ever reduce your expenses.

To extend your hotel analogy, the correct plan would be to take the average expectation, which in this case is a 6% withdrawal rate (has a 50/50 chance of success over 30 years) and then add a 10% safety buffer (another 0.6%) and still plan on a withdrawal rate over 5 percent.  Your plan of going with 40x expenses is like planning for every party that makes a reservation to need the entire hotel, just to be safe, even though that has never happened before in all of history.

Yes, it is safer.  No, it's not a very efficient way to make plans.

[Eric]

Jumping in here, this is why I'm not a fan of FIRE = 25x annual expenses. As brooklynguy stated a few posts back, none of us really know what the future will hold for the market. Instead of skirting by on 25x expenses, I think it's more prudent to go for 30 or 40x expenses. Because if your adaptation alternative is going back to work, you aren't FIRE anymore.

That's totally cool if that's your comfort level, but realize the trade off.  You're talking many extra years of guaranteed work, probably 5-10 years to get to 40x, versus a possible but unlikely part time work here and there if your 25x takes a big hit initially (and you choose to do that instead of implement other safety margins).  So if you go back to work "you aren't FIRE anymore", that still sounds better to a lot of us than never being FIRE to begin with until many years after 25x.

Sol touched on it above, but that 4% is already a pretty worse case scenario.  To add some numbers, the average portfolio balance at the end of 30 years using the 4% rule is over twice of what you started with (in real terms, not nominal).

[brooklynguy]

To second (third?) Sol's and Eric's point, take a look at this excellent recent post by Nords highlighting the ridiculous amount of safety built into the 4% rule (in that, besides having an excessively high historical success rate to begin with, it deliberately ignores various external levels of safety margin which, in reality, will inure to the benefit of most retirees) -- and he's one of our more conservative early retirement planners!

[arebelspy]

Those last 3 posts (counting Nords' post as part of BG's) are a blowout.

Someone clip them to post to a "Stop worrying about the 4% rule" sticky.

[tooqk4u22]

To second (third?) Sol's and Eric's point, take a look at this excellent recent post by Nords highlighting the ridiculous amount of safety built into the 4% rule (in that, besides having an excessively high historical success rate to begin with, it deliberately ignores various external levels of safety margin which, in reality, will inure to the benefit of most retirees) -- and he's one of our more conservative early retirement planners!

I too agree with the sentiment provide your willing to be flexible as noted above and in Nords post.  If not then a lower SWR may be more prudent given the current valuations, lower interest rates, slow growth prospects.   

[clifp]

To second (third?) Sol's and Eric's point, take a look at this excellent recent post by Nords highlighting the ridiculous amount of safety built into the 4% rule (in that, besides having an excessively high historical success rate to begin with, it deliberately ignores various external levels of safety margin which, in reality, will inure to the benefit of most retirees) -- and he's one of our more conservative early retirement planners!

I too agree with the sentiment provide your willing to be flexible as noted above and in Nords post.  If not then a lower SWR may be more prudent given the current valuations, lower interest rates, slow growth prospects.

I complete agree about not worrying about the 4% rule if we were talking about people retiring in their 60s.  But according to this calculator http://gosset.wharton.upenn.edu/mortality/perl/CalcForm.html, I as a 55 year old, have a 25% change of living another 34 years (same age as my mom) and if I was a woman a 50% chance.  So anybody planning on retiring before 50 should be looking at 40 year retirement (especially a couple) .  At 40 years a 4% WR only gives 81% success rate according to CFiresim.   Plus life expectancy is increasing at >1.2 year/decade in the US so a 25 year old today is likely to have a life expectancy at age 50 that is 3 years longer than a 50 year old today.   In order to get to a 95% success rate you need to dial the withdrawal rate down to 3.5%.

For somebody looking to retire in their early 40s or before, who has already slashed their lifestyle expenditures  to Mustachian levels, I don't think you are being too conservative to move the SWR rate to 3.0%.  Social security for a 40 year old is 22 years away and conceivably that age maybe raised by a couple of year.

[waltworks]

I just posted this elsewhere, but Clif - I think your financial conservatism is a little extreme. Here's why:

I'd just like to point out that the 4% SWR assumes:
-That you live for 30+ years. You might not.
-That no cataclysmic natural disaster befalls the earth in that time. One might.
-That no social upheaval/revolution/political change makes your earnings and savings valueless.
-Etc - the world is unpredictable.

So, when you say you want a 2% withdrawal rate because it's safer, you're ignoring the fact that it's arguably impossible to be "safer" than, say, 85-90% with any long term plan, because the world may have other plans for you and running out of money in a future that looks just like the present isn't the biggest concern anymore.

-W

[clifp]

I just posted this elsewhere, but Clif - I think your financial conservatism is a little extreme. Here's why:

I'd just like to point out that the 4% SWR assumes:
-That you live for 30+ years. You might not.
-That no cataclysmic natural disaster befalls the earth in that time. One might.
-That no social upheaval/revolution/political change makes your earnings and savings valueless.
-Etc - the world is unpredictable.

So, when you say you want a 2% withdrawal rate because it's safer, you're ignoring the fact that it's arguably impossible to be "safer" than, say, 85-90% with any long term plan, because the world may have other plans for you and running out of money in a future that looks just like the present isn't the biggest concern anymore.

-W

First of all I didn't say 2%, I said 3%. That's the difference between a 33x vs 25x stash not a 50x vs 25x stash.

A 40 year old female has about 90% chance of living another 30 year to age 70, and that is assuming no big medical breakthroughs. Folks on this forum can be expected to have a longer than average life time.
In 3.5 billion years life has been on earth how many cataclysmic disaster have we experienced a dozen a 100? what are the odds one will occur in the next 50 years lets say (100 x50)/3,500,000,000 =.000146% close enough to zero to ignore IMO.
In the last 250 year among the dozens or so countries settled primarily by English speaking people with tradition of law, how many times has the political system change such that elite lost the majority of their wealth?  I can think of 3 or 4 to be pessimistic lets call it 10% that in the next 50 years the poor will revolt and they'll take all of us "rich folks" money.  For example taking 50% of all assets over $1,000,000.

ignoring the fact that it's arguably impossible to be "safer" than, say, 85-90%"

Let's be clear that isn't a fact, it's someone opinion (probably William Bernstein, a man who I respect).  Yes you can argue there is 10% or so chance you die before you hit 30 years,and 10% chance the economy changes and that works out to be 80 odd percent. But minimizing your chances of running out of money for that 80% of the time things go as expected isn't being overly conservative.


I'll also say that I'm one of the least conservative investors on the forum: individual securities, microcap stocks, peer to peer lending, hard money loans, real estate, angel investment, VC funds, margin loans, shorting stocks, leverage closed end funds, structured investments, junk bonds, virtually every type of option.  Other than day trading, and buying options on VIX futures,  there is pretty much nothing that I haven't bought or sold over the decades. I am also much closer to a perma bull than perma bear.

I retired at a pretty awful time, 2000.  I  have seen more than few folks who also retired young because they believe that their paper wealth they accumulated during the internet bubble was real and after terrific bull market in the 1990 they thought 5-8% returns were pretty much their birthright.  Many of them went back to work by 2005, most of the rest stop  posting on forums.
IMO (like Bogle's) the market is no where near as overvalued as it was back then. Although many tech stocks are getting close.  But an important difference back then was you could put money in bonds at get 3.5+ inflation protected return or a 5% on Muni bonds.   A reasonable 25%+ bond allocation made a big difference in retirees portfolio.

There is no place to hide (other than some of the alternative investment I listed) this time around.  In addition to the 25-30% correction that Jack Bogle talks about, a 3% rise in interest rates over the next say 3 years would result in roughly a -10% loss to a bond portfolio (~-18% price drop + ~8% interest payments). That is a huge change from the decade long bull market we had in bonds during the 2000s.

Now just to be clear I have zero problem with 60 year old saying I'm going to plan on spending 4% of my stash to supplement my social security. 
A 40 year old planning the same thing (today) I think is risky. Back in 2010 it was slightly risky. 

It seems like a case of selective hearing that when St. Jack talks about index funds, everybody treats as the word of God. When he advise caution on future returns, he is some old guy who is often wrong.

[SnackDog]

Worst case, the market drags while inflation ramps up and we get stagflation for a decade and all the recent retirees are stuck with "only" 4%.   

Remember, if the market does well the first decade of your retirement, you can easily crank that up to 5% or more.  Those who retired in 2003 or so have seen great returns (9%) and are all set to crank up spending if they so desire.

I guess in 5-10 years we'll all be using fully automated, customized investing and withdrawals so we won't have to argue about any of this - the computer will figure it all out and just make a deposit in our bank account every month.

[forummm]

Worst case, the market drags while inflation ramps up and we get stagflation for a decade and all the recent retirees are stuck with "only" 4%.   

Remember, if the market does well the first decade of your retirement, you can easily crank that up to 5% or more.  Those who retired in 2003 or so have seen great returns (9%) and are all set to crank up spending if they so desire.

I guess in 5-10 years we'll all be using fully automated, customized investing and withdrawals so we won't have to argue about any of this - the computer will figure it all out and just make a deposit in our bank account every month.

If it gets this easy, it will be seen as less risky, so everyone will be doing it, and so our returns will drop.

[brooklynguy]

ignoring the fact that it's arguably impossible to be "safer" than, say, 85-90%"

Let's be clear that isn't a fact, it's someone opinion (probably William Bernstein, a man who I respect).  Yes you can argue there is 10% or so chance you die before you hit 30 years,and 10% chance the economy changes and that works out to be 80 odd percent. But minimizing your chances of running out of money for that 80% of the time things go as expected isn't being overly conservative.

I agree with this and have noted before the irony in how Bernstein's 80% concept of false precision has itself become an example of false precision.

If this thread's purpose is to serve as a compilation of arguments about the 4% Rule and SWRs, we might as well add a link to the full thread where I made that observation, which had some good discussion on these matters in general:

http://forum.mrmoneymustache.com/welcome-to-the-forum/cfiresim-success-rate/

EDIT: Oops, just realized this is not the "Stop worrying about the 4% Rule thread."  But, for posterity's sake, clifp, maybe you want to respond to walt's identical post in that thread with the same response, and I'll do likewise to yours? :)

[nobodyspecial]

If it gets this easy, it will be seen as less risky, so everyone will be doing it, and so our returns will drop.

So the reason people buy expensive cars with expensive loans rather than saving is the complexity of buying Vanguard ETFs? ;-)

[PeteD01]

Worst case, the market drags while inflation ramps up and we get stagflation for a decade and all the recent retirees are stuck with "only" 4%.   

Remember, if the market does well the first decade of your retirement, you can easily crank that up to 5% or more.  Those who retired in 2003 or so have seen great returns (9%) and are all set to crank up spending if they so desire.

I guess in 5-10 years we'll all be using fully automated, customized investing and withdrawals so we won't have to argue about any of this - the computer will figure it all out and just make a deposit in our bank account every month.

It's already available. My personal allocation:

TIAA Traditional 35% (fixed/participating)
TIAA Real Estate Account 25% (variable)
TIAA-CREF 67/33 (domestic/international) 40% (variable)

All annuitized with a twenty year guaranteed period and 2/3 to the survivor.
Payout is 5.25% with starting age of 53.
No worries with SS starting towards the end of the twenty year guaranteed period.

[forummm]

If it gets this easy, it will be seen as less risky, so everyone will be doing it, and so our returns will drop.

So the reason people buy expensive cars with expensive loans rather than saving is the complexity of buying Vanguard ETFs? ;-)

I see the winking, but this is probably true to a very small extent. The much bigger change would be when investing in the stock market is widely seen as being "what you do" and "not risky" and is super easy and you don't even know it's happening. Research shows that when something is the default, people go with it. When your employer sets you up with a default contribution to the 401k, participation rates shoot up. People go with autopilot and what everyone else is doing.

[milesdividendmd]

Worst case, the market drags while inflation ramps up and we get stagflation for a decade and all the recent retirees are stuck with "only" 4%.   

Remember, if the market does well the first decade of your retirement, you can easily crank that up to 5% or more.  Those who retired in 2003 or so have seen great returns (9%) and are all set to crank up spending if they so desire.

I guess in 5-10 years we'll all be using fully automated, customized investing and withdrawals so we won't have to argue about any of this - the computer will figure it all out and just make a deposit in our bank account every month.

That's not the worst case scenario. Not even close.

Stock markets can go to zero. Assets can be seized by the government or foreign invaders.

Hyerinflation, deflation, depression, famine, the possibilities are endless!

The smart money still invests at least partially in equites, for the most probable outcome is that that will continue to offer the best long term outcome.

I would argue that smart money also would disregard saint jacks advice not to internationally diversify.

[a1smith]

I would argue that smart money also would disregard saint jacks advice not to internationally diversify.

It's interesting that he says not to diversify internationally but Vanguard recommends a 60/40 US/Intl AA for stocks and 70/30 US/Intl AA for bonds.  Vanguard announced raising the international allocation on both stocks and bonds by 10% in February of this year and said they would be complete by the end of the year.

Vanguard enhances diversification for target date funds and other all-in-one funds

[forummm]

I would argue that smart money also would disregard saint jacks advice not to internationally diversify.

It's interesting that he says not to diversify internationally but Vanguard recommends a 60/40 US/Intl AA for stocks and 70/30 US/Intl AA for bonds.  Vanguard announced raising the international allocation on both stocks and bonds by 10% in February of this year and said they would be complete by the end of the year.

Vanguard enhances diversification for target date funds and other all-in-one funds

Since he left, Vanguard has done a lot of things that Bogle doesn't like. Like ETFs. I think Bogle is wrong on this one.

[a1smith]

It sounds like Bill Gross is in general agreement with Bogle in A Sense of an Ending, his May monthly investment outlook to Janus investors.  Here are some snippets.

He mentions others of the same opinion (my emphasis):

Stanley Druckenmiller, George Soros, Ray Dalio, Jeremy Grantham, among others warn investors that our 35 year investment supercycle may be exhausted. They don’t necessarily counsel heading for the hills, or liquidating assets for cash, but they do speak to low future returns and the increasingly fat tail possibilities of a “bang” at some future date.

Here is a wonderful comment on fees:

Active asset managers as well, conveniently forget that their (my) industry has failed to reduce fees as a percentage of assets which have multiplied by at least a factor of 20 since 1981. They believe therefore, that they and their industry deserve to be 20 times richer because of their skill or better yet, their introduction of confusing and sometimes destructive quantitative technologies and derivatives that led to Lehman and the Great Recession.

And here is his final paragraph looking forward:

Hogwash. This is all ending. The successful portfolio manager for the next 35 years will be one that refocuses on the possibility of periodic negative annual returns and miniscule Sharpe ratios and who employs defensive choices that can be mildly levered to exceed cash returns, if only by 300 to 400 basis points. My recent view of a German Bund short is one such example. At 0%, the cost of carry is just that, and the inevitable return to 1 or 2% yields becomes a high probability, which will lead to a 15% “capital gain” over an uncertain period of time. I wish to still be active in say 2020 to see how this ends. As it is, in 2015, I merely have a sense of an ending, a secular bull market ending with a whimper, not a bang. But if so, like death, only the timing is in doubt. Because of this sense, however, I have unrest, increasingly a great unrest. You should as well.

[milesdividendmd]

Just to remake a point that I have been hammering away on.

If current high U.S. equity valuations predict lower future returns in the U.S. Stock market. (And I agree with Bogle, they probably do. )

And if current US bond yields are vanishingly small, guaranteeing low future performance (and they are.)

...Then isn't the smart play to make sure your portfolio does not overweight high priced US stocks?

The take home for me is obvious. Buy and holders should not invest more than 50% of their equities in U.S. Stocks. (50% being the cap weighting of the U.S. Relative to the world economy.) and if you go by global GDP, even less should be allocated to US equites.

In other words instead of whining about low expected future returns, why not save more and allocate more intelligently (ie diversify more.)

Worry about that which you have the power to effect, and forget the rest.

[clifp]

Just to remake a point that I have been hammering away on.

If current high U.S. equity valuations predict lower future returns in the U.S. Stock market. (And I agree with Bogle, they probably do. )

And if current US bond yields are vanishingly small, guaranteeing low future performance (and they are.)

...Then isn't the smart play to make sure your portfolio does not overweight high priced US stocks?

The take home for me is obvious. Buy and holders should not invest more than 50% of their equities in U.S. Stocks. (50% being the cap weighting of the U.S. Relative to the world economy.) and if you go by global GDP, even less should be allocated to US equites.

In other words instead of whining about low expected future returns, why not save more and allocate more intelligently (ie diversify more.)

Worry about that which you have the power to effect, and forget the rest.

Yes this make sense but there aren't a lot "approved" alternatives. International equity is reasonable alternative but correlation between international stocks and the US market has been so high over the last 7 years that diversification doesn't buy you much.   Bonds I think are an even worse investment.  A 5% increase in interest rates over the next 3 years will result in -20% loss for total bond market and heck of a lot worse for long bonds.  As expensive and potentially risky as US equities are there is still a reasonable chance of 25-40% return in the next 3 year, the upside for bonds is probably no more than 10-12% period.

[milesdividendmd]

I disagree with the whole premise that there is limited diversification benefit between international and domestic equities.

While when there is a global crisis, there is near perfect correlation between all risky assets, during bull markets this is simply not so.

Since 2008 US equities have vastly outperformed the rest of the world. And the proof is in the pudding, U.S. CAPE IS 27, the rest of the worlds is what, 17??

So if you are like Bogle, and you argue that valuations matter (the basis of his "nominal to zero" argument) and that assets will mean revert over the long term, then there is truly no credible argument for overweighting US equities.

[Patrick A]

Those last 3 posts (counting Nords' post as part of BG's) are a blowout.

Someone clip them to post to a "Stop worrying about the 4% rule" sticky.

Yup. 

[Kaspian]

Since 2008 US equities have vastly outperformed the rest of the world. And the proof is in the pudding, U.S. CAPE IS 27, the rest of the worlds is what, 17??

I think this very much depends where you're coming from?  And what pudding you're eating?  You sure you're looking at the whole picture?  (See attached.)

[Kaspian]

That's totally cool if that's your comfort level, but realize the trade off.  You're talking many extra years of guaranteed work, probably 5-10 years to get to 40x, versus a possible but unlikely part time work here and there if your 25x takes a big hit initially (and you choose to do that instead of implement other safety margins).  So if you go back to work "you aren't FIRE anymore", that still sounds better to a lot of us than never being FIRE to begin with until many years after 25x.

Right on!  I think the chances of any of us doing FIRE dicking around doing *nothing* involving money for the rest of our lives is very slim.  Hell, it allows you to do what you want.  Fun, low-paying job?  Once FIRE I won't care, I'll take it.  ...'Until it gets boring or stupid, then I'm off.  I certainly plan on lazing around a year or two travelling, but the rest of my life doing nothing ever for cash?  That's probably not going to happen.  I'll easily take the 25x over the extra full years to get 40x.

[milesdividendmd]

Since 2008 US equities have vastly outperformed the rest of the world. And the proof is in the pudding, U.S. CAPE IS 27, the rest of the worlds is what, 17??

I think this very much depends where you're coming from?  And what pudding you're eating?  You sure you're looking at the whole picture?  (See attached.)

Your chart is a clever retort to the statement "US Equities have been the number 1 asset class in the world every year since 2008."

Unfortunately no one made any such statement.

What I did say was...

"Since 2008 US equities have vastly outperformed the rest of the world" so let's examine that statement specifically.  Lets compare US equities to all world ex-us equities since 2008, shall we?

(see attachment)

For those keeping score at home thats a CAGR of 8.1 for the US vs 0.8 for the rest of the world, with a higher sharpe ratio and lesser volatility, so it's not really close...

I guess the pudding is simply pudding after all.  It turns out that PE expansion for equities in one region relative to another does cause an increase in relative CAPE value.  Who knew?

[nobodyspecial]

Since 2008 US equities have vastly outperformed the rest of the world. And the proof is in the pudding, U.S. CAPE IS 27, the rest of the worlds is what, 17??

Depends on the company.
Apple, Nokia and Blackberry are all in the same international markets - which would you rather own?
Of course the same also applies to Toyota, Volkswagon and GM ;-)

[clifp]

I disagree with the whole premise that there is limited diversification benefit between international and domestic equities.

While when there is a global crisis, there is near perfect correlation between all risky assets, during bull markets this is simply not so.

Since 2008 US equities have vastly outperformed the rest of the world. And the proof is in the pudding, U.S. CAPE IS 27, the rest of the worlds is what, 17??

So if you are like Bogle, and you argue that valuations matter (the basis of his "nominal to zero" argument) and that assets will mean revert over the long term, then there is truly no credible argument for overweighting US equities.

I'd suggest that you read William Bernstein's E-book "Skating where the puck was: The correlation Game in a flat world".
He provides compelling data that while formerly buying international equities was a a good diversification strategy it is no longer true the first chart. (I can't seem to figure out how to cut and paste from the Kindle app on the PC), is interesting. Back in 1992 the 3 year rolling correlation for international REITS was .1 by 2012 it was over .8.  The correlation between the MCSI EAFE (the  European equivalent of the S&P 500) and the S&P 500 from 1975-2000 varied between .4 and .6.  It spiked up dramatically during the 2000s and by 2012 reached .9.  It fact is is now higher than the correlation between small cap and large cap stocks.

If you want to do a bit of market speculation and think that buying international stocks are good deal right now be my guest, but don't kid yourself that you are helping created a diversified portfolio.  That's 20th century investing. 

[a1smith]

I'm happy I have my international and emerging ETF's.  Here's today's results:

VTI - +0.61%
VWO - +1.30%
VXUS - +1.72%

So, today emerging markets is 2.1X better, intl is 2.8X better.

Ok, ok, I can already hear the complaining about looking at one day of results.  So, here are the YTD results:

VTI - +3.61%
VWO - +5.98%  1.7X better
VXUS - +8.51%  2.4X better

The multipliers are similar.

[arebelspy]

Do you base all your investing decisions on the last 6 months of returns?  If not, I'm not sure why those numbers are relevant.

[sol]

Do you base all your investing decisions on the last 6 months of returns?

Sure, why not?  I'm pretty sure there are a handful of people here who call that a "lookback period".

And if you don't like six months, why not try a year?  They tell me it will give you a similar result.  Or maybe a totally different result, I'm not really clear on that part.

[milesdividendmd]

I disagree with the whole premise that there is limited diversification benefit between international and domestic equities.

While when there is a global crisis, there is near perfect correlation between all risky assets, during bull markets this is simply not so.

Since 2008 US equities have vastly outperformed the rest of the world. And the proof is in the pudding, U.S. CAPE IS 27, the rest of the worlds is what, 17??

So if you are like Bogle, and you argue that valuations matter (the basis of his "nominal to zero" argument) and that assets will mean revert over the long term, then there is truly no credible argument for overweighting US equities.

I'd suggest that you read William Bernstein's E-book "Skating where the puck was: The correlation Game in a flat world".
He provides compelling data that while formerly buying international equities was a a good diversification strategy it is no longer true the first chart. (I can't seem to figure out how to cut and paste from the Kindle app on the PC), is interesting. Back in 1992 the 3 year rolling correlation for international REITS was .1 by 2012 it was over .8.  The correlation between the MCSI EAFE (the  European equivalent of the S&P 500) and the S&P 500 from 1975-2000 varied between .4 and .6.  It spiked up dramatically during the 2000s and by 2012 reached .9.  It fact is is now higher than the correlation between small cap and large cap stocks.

If you want to do a bit of market speculation and think that buying international stocks are good deal right now be my guest, but don't kid yourself that you are helping created a diversified portfolio.  That's 20th century investing.

You are missing the point.  I've read "Skating where the puck was," as well as most of Bernstein's library.  Love the man.

Bernstein's observation, as I read it, was not that one should not diversify internationally (a la Bogle) because of increasing market correlations, its that today's ideal portfolio must necessarily have a different efficient frontier from yesterday's because the world is constantly changing and yesterday is not the same as tomorrow.

The point that I am making here is really one of internal consistency. 

What I am pointing out is that if you think you can estimate future returns based on current equity valuations, (which is the basis for Bogle's whole argument about future equity returns here, after all) then it makes no sense to also advocate a portfolio that overweights the expensive domestic market.

I know that I am guilty of having diverted this topic into a different one here which is whether or not international diversification is wise for buy and hold investors, but the purpose of my comment was simply to point out the logical inconsistency of Bogle's argument.

I am a firm believer of diversifying internationally as much as possible in buy and hold portfolios, (even though I am personally not a passive investor and am horribly under diversified with my own holdings) regardless of current relevant valuations, but surely that is an argument for another day.

[brooklynguy]

The point that I am making here is really one of internal consistency. 

What I am pointing out is that if you think you can estimate future returns based on current equity valuations, (which is the basis for Bogle's whole argument about future equity returns here, after all) then it makes no sense to also advocate a portfolio that overweights the expensive domestic market.

I know that I am guilty of having diverted this topic into a different one here which is whether or not international diversification is wise for buy and hold investors, but the purpose of my comment was simply to point out the logical inconsistency of Bogle's argument.

There is no logical inconsistency in Bogle's argument.  Now, I'm not saying I agree with it (because I don't - I think it's a smart idea to diversify internationally), but there are a host of reasons why one could believe (with logical consistency) that it makes sense to passively invest in the U.S. to the exclusion of foreign markets (some of which I find more compelling than others), including, but not limited to, the following:

- it costs less
- the U.S. has the world's most robust and transparent equity markets
- the U.S. has more established governmental and legal institutions
- U.S. investments will expose U.S.-resident investors to less currency risk

Bogle advocates for an active investment approach when it comes to selecting the jurisdiction in which to invest even though he advocates for a totally passive investing approach when it comes to investing within that selected jurisdiction.  As I said, I don't completely buy his argument (because in doing so you're basically betting that the reasons for preferring the U.S. will persist into the future), but there is no logical inconsistency in holding both opinions simultaneously.

[milesdividendmd]

The point that I am making here is really one of internal consistency. 

What I am pointing out is that if you think you can estimate future returns based on current equity valuations, (which is the basis for Bogle's whole argument about future equity returns here, after all) then it makes no sense to also advocate a portfolio that overweights the expensive domestic market.

I know that I am guilty of having diverted this topic into a different one here which is whether or not international diversification is wise for buy and hold investors, but the purpose of my comment was simply to point out the logical inconsistency of Bogle's argument.

There is no logical inconsistency in Bogle's argument.  Now, I'm not saying I agree with it (because I don't - I think it's a smart idea to diversify internationally), but there are a host of reasons why one could believe (with logical consistency) that it makes sense to passively invest in the U.S. to the exclusion of foreign markets (some of which I find more compelling than others), including, but not limited to, the following:

- it costs less
- the U.S. has the world's most robust and transparent equity markets
- the U.S. has more established governmental and legal institutions
- U.S. investments will expose U.S.-resident investors to less currency risk

Bogle advocates for an active investment approach when it comes to selecting the jurisdiction in which to invest even though he advocates for a totally passive investing approach when it comes to investing within that selected jurisdiction.  As I said, I don't completely buy his argument (because in doing so you're basically betting that the reasons for preferring the U.S. will persist into the future), but there is no logical inconsistency in holding both opinions simultaneously.

Again,  one can credibly argue that international investing is wise or not for all of the reasons that you give and more, (whether you are American or not.)

Happy to engage on that on another thread.

I will simply point out that exactly one of the arguments that you provide is quantitative; The question of cost.

And cost is easy to measure.

VTI has an expense ratio of 0.05 whereas VT has an expense ratio 0.17. So the cost to diversify is 12 basis points a year.

But what Bogle is saying when he predicts nominal to zero returns going forward, is of an entirely different order of magnitude. He is saying that current valuations will have a negative effect on the order of 700 basis points a year!

So he is saying that valuations matter A LOT. but ignore valuations when it comes to geographical asset allocation. This is the logical inconsistency.

[brooklynguy]

So he is saying that valuations matter A LOT. but ignore valuations when it comes to geographical asset allocation. This is the logical inconsistency.

No, there's still no logical inconsistency.  If he were saying "the US market is overvalued, foreign markets are undervalued, and all else is equal," then his argument to stick to the US would be logically inconsistent.  But he's not saying all else is equal -- he's saying all else is not equal, and the other things constituting "all else" should lead US investors to stick to the US.  I'm not sure whether or not he's ever stated his opinion about the relative expensiveness of foreign markets, but even if he does believe they are undervalued, his argument is still not logically inconsistent -- in that case, the argument is that those other things should lead US investors to stick to the US even though the US is more expensive than foreign markets, because those other things justify the premium.  Or, said differently, foreign markets are not cheaper relative to the US on a risk-adjusted basis.

Again, I don't agree with this - I'm just pointing out that it is not a logically inconsistent position to take.

[sol]

Get a room, you two.  I can't stand the sexual tension in this thread.

[milesdividendmd]

So he is saying that valuations matter A LOT. but ignore valuations when it comes to geographical asset allocation. This is the logical inconsistency.

No, there's still no logical inconsistency.  If he were saying "the US market is overvalued, foreign markets are undervalued, and all else is equal," then his argument to stick to the US would be logically inconsistent.  But he's not saying all else is equal -- he's saying all else is not equal, and the other things constituting "all else" should lead US investors to stick to the US.  I'm not sure whether or not he's ever stated his opinion about the relative expensiveness of foreign markets, but even if he does believe they are undervalued, his argument is still not logically inconsistent -- in that case, the argument is that those other things should lead US investors to stick to the US even though the US is more expensive than foreign markets, because those other things justify the premium.  Or, said differently, foreign markets are not cheaper relative to the US on a risk-adjusted basis.

Again, I don't agree with this - I'm just pointing out that it is not a logically inconsistent position to take.

Whether he is explicitly saying it or not, U.S. Equity Valuation is high right now relative to the rest of the world. This is not debatable. This is a simple fact.

You can't name one method for market valuation that contradicts this observation.  CAPE or otherwise. It's not really worth discussing further.

Now one can argue that valuations don't matter. But Bogle is making precisely the opposite argument. He argues That valuations do matter to the tune of 700 basis points in future returns a year!

If you find this to be internally consistent on St Jack's behalf, fair enough, but it's certainly not so on the basis of any rules of logic that I am aware of.

[milesdividendmd]

Get a room, you two.  I can't stand the sexual tension in this thread.

Sol,

You big perv.

One can have a rational disagreement without sexual arousal.
(Even when the subject is as titillating as Grandpa Jack's logical transgressions.)

[brooklynguy]

If you find this to be internally consistent on St Jack's behalf, fair enough, but it's certainly not so on the basis of any rules of logic that I am aware of.

That's because you are mischaracterizing his argument.  Again, Bogle is arguing that valid reasons exist to avoid international diversification (which, again, I happen to disagree with), and those reasons are independent of valuation.  So, with complete logical coherence, he can argue that US investors should avoid investing in foreign markets even while recognizing that those markets are undervalued relative to the US using identical valuation methodologies.

To see why this is true, consider the following extreme hypothetical situation:  Congress enacts a law imposing a universal 99% tax on all foreign investment gains by any American citizen.  In that circumstance, do you see how you would (quite logically) conclude that you should avoid investing in foreign markets, no matter what their relative valuation is, even if you generally consider valuation to be of fundamental importance?  Bogle's argument is no different, except in degree.

Get a room, you two.  I can't stand the sexual tension in this thread.

If you can't stand the heat, get out of the kitchen.  Like Miles said, this is titillating subject matter.

[milesdividendmd]

If you find this to be internally consistent on St Jack's behalf, fair enough, but it's certainly not so on the basis of any rules of logic that I am aware of.

That's because you are mischaracterizing his argument.  Again, Bogle is arguing that valid reasons exist to avoid international diversification (which, again, I happen to disagree with), and those reasons are independent of valuation.  So, with complete logical coherence, he can argue that US investors should avoid investing in foreign markets even while recognizing that those markets are undervalued relative to the US using identical valuation methodologies.

To see why this is true, consider the following extreme hypothetical situation:  Congress enacts a law imposing a universal 99% tax on all foreign investment gains by any American citizen.  In that circumstance, do you see how you would (quite logically) conclude that you should avoid investing in foreign markets, no matter what their relative valuation is, even if you generally consider valuation to be of fundamental importance?  Bogle's argument is no different, except in degree.

Get a room, you two.  I can't stand the sexual tension in this thread.

If you can't stand the heat, get out of the kitchen.  Like Miles said, this is titillating subject matter.

Great point!

In such a world where foreign equities were taxed at 99% Bogle's reasoning would be sound.

In the actual reality based world, though, it is not.

[milesdividendmd]

(The point is that all of the arguments taken together for not internationally diversifying can under no reasonable assumption argue for a decrease expected returns of 700 basis points per annum, relative to a global portfolio.

And yet Bogle argues that we should expect zero to nominal returns going forward based on current domestic equity valuation.)

It's kind of an obvious example of logical inconsistency.

And if you still disagree, please detail how any combination of arguments against international diversification could be reasonably expected to decrease future returns by 700 basis points per annum relative to a global portfolio.

The math simply becomes too ridiculous.

[brooklynguy]

Great point!

In such a world where foreign equities were taxed at 99% Bogle's reasoning would be sound.

In the actual reality based world, though, it is not.

For the reasons I laid out, his reasoning issound - it's his premises that (in both your view and my own) are faulty.

I've been disagreeing only with the single, narrow aspect of your posts stating that Bogle is exercising inconsistent logic, which simply isn't true (as a matter of fact, not opinion).  We can reduce Bogle's argument to representative symbols and construct a formal proof to show there's no error in the logic.

It is not logically inconsistent to argue that external factors beyond valuation make foreign investment a bad idea even if you believe valuation matters, whether those external factors are imaginary 99% tax rates or the more realistic factors of the type I listed in my post above.  You and I both disagree with the premises of Bogle's argument, but his logic is sound.  That's all.

[forummm]

Can't you guys start throwing around more equations and variables? The 401k loan epic nerd-off thread was much more exciting.

[brooklynguy]

Can't you guys start throwing around more equations and variables? The 401k loan epic nerd-off thread was much more exciting.

That nerd-off was in a different league:  it was an actual substantive debate.  This one is more like a contest between two equally stubborn old goats who agree in substance yet insist on seeing who can split the semantic hair the finest.  Though I must say, Miles, I was quite impressed with your deflection of sol's mischievous attempt to restart the entire dual momentum debate :)

[clifp]

I see your point Miles, on a relative basis US stocks do appear to be more over valued than international, but I don't find his argument to be particularly inconsistent.

First I said in my previous post the diversification benefits of International equity are significantly smaller now than in the past.  It makes no sense for Jack to change his mind about international investing now having been a skeptic all his life.

But I think you are placing too much weight on things like the relative P/E between the US and rest of the world.

ALL E AREN"T EQUAL.

I have friend who used to be the CFO of a medium sized Turkish company, she moved to the US with husband several years ago and is working on getting her CPA license in the US. In talking with her I found that in countries like Turkey and Russia and many other countries there multiple sets of books kept one for tax reasons, one for the public, and then the true sets of books.

So it is entirely possible that even though a US and foreign company both have earnings of a $1 the US company is properly valued at $25 and the foreign company at $15 because of the higher quality of the earnings of the US company.

[forummm]

There are substantive differences between the compositions of the US and EU markets. The US market has a ton more (by percentage) tech companies and other firms that tend to have higher PEs, where the EU markets have a lot more (by percentage) firms like banks and utilities and telecomms that tend to have lower PEs. So the US PE should be > than the EU PE all else equal. I don't know exactly how much.

[nobodyspecial]

ALL E AREN"T EQUAL.
...many other countries there multiple sets of books kept one for tax reasons, one for the public, and then the true sets of books....

< cough > enron < /cough >

[arebelspy]

It's kind of an obvious example of logical inconsistency.

If you agree with the 99% tax example, you agree there's no logical inconsistency.  You don't disagree with the logic of the argument, just the premise (and therefore conclusion).

[arebelspy]

Though I must say, Miles, I was quite impressed with your deflection of sol's mischievous attempt to restart the entire dual momentum debate :)

I missed miles' deflection, I just saw him ignore it. But it did make me laugh.  And ban sol for trolling.