"Stairway to Financial Heaven" - 30% equities??

Have a question about your personal investments? No matter how simple or complex, you can ask it here.

"Stairway to Financial Heaven" - 30% equities??

Postby Paul@ » Sat Dec 01, 2012 7:52 am

I recently came across this "Stairway to Financial Heaven" article, written back in 2005. The author tries to make a compelling case that, when one considers risk vs. reward, it makes far more sense to have an allocation of 30% equities / 70% bonds than it does to have 70% bonds / 30% equities.

http://www.fa-mag.com/news/article-1155.html

I'm a retiree and can never quite make up my mind what asset allocation I should use. I'm conservative and have been using Age in Bonds, but wonder if that's the best way to go, if I should instead pick a fixed allocation and stick with that. Anyway, this guy seems to make sense -and I wonder where the flaw in his logic is. I've lived through our modern-day stock market fiascos and know full well how long it takes a portfolio to recover from a cataclysm. Is he right that 30% equities makes more sense?
Sometimes you're the windshield, sometimes you're the bug. | - Mary Chapin Carpenter
Paul@
 
Posts: 35
Joined: 30 Sep 2008

Re: "Stairway to Financial Heaven" - 30% equities??

Postby Call_Me_Op » Sat Dec 01, 2012 8:00 am

Certainly, the risk is lower in something like a 30/70 versus a 70/30. One "caution" is that the past 50 years has included a very long and substantial period of strong bond performance - unlikely to repeat for a long time. This tends to make bond-heavy portfolios (especially holding treasuries) look pretty good. So while 30/70 may help you sleep better at night, I would not expect returns comparable to 70/30 over the next 10-20 years.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein
Call_Me_Op
 
Posts: 4266
Joined: 7 Sep 2009
Location: Milky Way

Re: "Stairway to Financial Heaven" - 30% equities??

Postby edge » Sat Dec 01, 2012 8:27 am

30% equities / 70% bonds than it does to have 70% bonds / 30% equities.



Is this some kind of mental accounting trick? Those don't usually work for me.
edge
 
Posts: 1799
Joined: 19 Feb 2007
Location: Great Falls VA

Re: "Stairway to Financial Heaven" - 30% equities??

Postby Paul@ » Sat Dec 01, 2012 8:53 am

edge wrote:
30% equities / 70% bonds than it does to have 70% bonds / 30% equities.



Is this some kind of mental accounting trick? Those don't usually work for me.


The author is not saying that a 30% stocks allocation returns more than a 70% stocks allocation. Rather, he is saying that the extra benefit of a 70% stocks allocation is only marginal, while the extra risk associated with it is not marginally worse, it is significantly worse, than a 30% stocks allocation. And that when the choice is put to people in emotional rather than statistical terms, the majority (including those who have been invested 70% or 80% in stocks), opt for the risk/reward scenario that is an allocation of 30% stocks, 70% bonds.

There's no mental accounting trick involved, unless one considers one's investing frame of mind as accounting.
Sometimes you're the windshield, sometimes you're the bug. | - Mary Chapin Carpenter
Paul@
 
Posts: 35
Joined: 30 Sep 2008

Re: "Stairway to Financial Heaven" - 30% equities??

Postby hillman » Sat Dec 01, 2012 9:00 am

Paul@ wrote:
edge wrote:
30% equities / 70% bonds than it does to have 70% bonds / 30% equities.


Is this some kind of mental accounting trick? Those don't usually work for me.


The author is not saying that a 30% stocks allocation returns more than a 70% stocks allocation. Rather, he is saying that the extra benefit of a 70% stocks allocation is only marginal, while the extra risk associated with it is not marginally worse, it is significantly worse, than a 30% stocks allocation. And that when the choice is put to people in emotional rather than statistical terms, the majority (including those who have been invested 70% or 80% in stocks), opt for the risk/reward scenario that is an allocation of 30% stocks, 70% bonds.

There's no mental accounting trick involved, unless one considers one's investing frame of mind as accounting.


Carefully reread what Edge quoted. Think the 'accounting trick' comment was a joke zeroing in a typo (not the right word for using the wrong word). :D

Interesting point though, haven't read the article. I wonder what the difference in return is and the difference in volatility.
hillman
 
Posts: 128
Joined: 7 Jun 2012

Re: "Stairway to Financial Heaven" - 30% equities??

Postby Call_Me_Op » Sat Dec 01, 2012 9:01 am

Paul@ wrote:
edge wrote:
30% equities / 70% bonds than it does to have 70% bonds / 30% equities.



Is this some kind of mental accounting trick? Those don't usually work for me.


The author is not saying that a 30% stocks allocation returns more than a 70% stocks allocation. Rather, he is saying that the extra benefit of a 70% stocks allocation is only marginal, while the extra risk associated with it is not marginally worse, it is significantly worse, than a 30% stocks allocation.


Clarification - he is saying this has been the case over the past 50 years. As I pointed-out above, expecting anything close to past bond returns (over the next 10-20 years) is unrealistic.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein
Call_Me_Op
 
Posts: 4266
Joined: 7 Sep 2009
Location: Milky Way

Re: "Stairway to Financial Heaven" - 30% equities??

Postby Paul@ » Sat Dec 01, 2012 9:16 am

Whoops! My thanks to both Call_Me_Op and Edge for pointing out the error in the original post.

It should indeed say "30% equities /70% bonds than it does to have 70% EQUITIES / 30% bonds".
Sometimes you're the windshield, sometimes you're the bug. | - Mary Chapin Carpenter
Paul@
 
Posts: 35
Joined: 30 Sep 2008

Re: "Stairway to Financial Heaven" - 30% equities??

Postby YDNAL » Sat Dec 01, 2012 9:47 am

Paul@ wrote:I recently came across this "Stairway to Financial Heaven" article, written back in 2005. The author tries to make a compelling case that, when one considers risk vs. reward, it makes far more sense to have an allocation of 30% equities / 70% bonds than it does to have 70% bonds equities / 30% equities bonds.

Here is my take.
Financial Advisor article, Mitch Anthony wrote:If there was a stairway to financial heaven and I offered you the following two climbing scenarios, which would you prefer? In scenario one, you would climb ten stairs in an average year. In a bad year, you would tumble down 18 stairs. In a really good year, you would climb 38 stairs. In scenario two, you would climb eight stairs instead of ten in your average year, but you would only fall down six stairs in a bad year. In a really good year, you would climb 35 stairs. Which scenario most appeals to you?
Now, what is your choice? If you are like the majority of those who I have presented this scenario to, you will choose the scenario with an average of eight stairs in the average year, losing six stairs in a bad year, and gaining 35 stairs in a really good year.

We tend to think that we can easily accept "the good/bad years." Truth be told, when $#!^ hits the fan, the natural human reaction is to run away from the fan*.
  • If to meet our savings goal we allocate 30/70 Equity/Fixed and have a highly aggressive savings plan, then great, and a sound plan.
  • If to meet our goal we rely on 70/30 E/F in hopes to compensate for a different savings plan, then you must live (maybe :) ) with risks you take.
* I know, I know... Bogleheads are special people.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
YDNAL
 
Posts: 13290
Joined: 10 Apr 2007
Location: Biscayne Bay

Re: "Stairway to Financial Heaven" - 30% equities??

Postby Dandy » Sat Dec 01, 2012 11:10 am

no one can tell where the stairway will eventually lead. If you are a conservative investor you should pick an equity allocation that fits your risk tolerance. The lower your equity allocation usually means the lower your volitility and lower growth of your portfolio. Will you be missing out on some gains when the market surges - you bet. Will you lose less when the market plunges - most likely.

So, you need to figure will modest returns on a 30% equity allocation enabled you to fund your retirement for 30 years or so. If your withdrawal rate is 4% or more that might be hard to do - especially with such historically low interest rates on fixed income choices. If you are comfortable with an allocation of 30% to equities it might work not to glide much lower as you age. You could do that with a conservative life strategy fund and use a CD ladder or short term bond fund to get the overall equity allocation to 30%.
Dandy
 
Posts: 1842
Joined: 25 Apr 2010

Re: "Stairway to Financial Heaven" - 30% equities??

Postby baw703916 » Sat Dec 01, 2012 11:22 am

I'll just comment on two aspects:

Paul@ wrote:I recently came across this "Stairway to Financial Heaven" article, written back in 2005.


In 2005, things were a lot different. I bought a 5 year CD during that time frame with a 6.6% interest rate. OK, it was a special promotion, but still... Back then you could get a reasonable return on fixed income investments. Now, you are pretty much guaranteed to lose to inflation.

I'm a retiree and can never quite make up my mind what asset allocation I should use.


If one is retired and has enough of a nest egg to meet one's needs, then a 30% allocation to equities may indeed be appropriate, in spite of the low yields on fixed income. I think it would be a big mistake, however, for a 20- or 30-something to have this AA.

Brad
Most of my posts assume no behavioral errors.
User avatar
baw703916
 
Posts: 5335
Joined: 1 Apr 2007
Location: Northern Virginia

Re: "Stairway to Financial Heaven" - 30% equities??

Postby stratton » Sat Dec 01, 2012 12:03 pm

I will point out the following two portfolios have roughly the same expected return because of high fees.

A: 70/30 stocks/bonds with a 2.25% ER.

B: 30/70 stock/bonds with 0.25% ER.

Which one would be better to hold during 2008/9?

Which one is less likely to have an investor bail out in 2008/9?

High fees are really bad for you. 30/70 stocks/bonds is available in one fund via the retirement income fund and is great for the sleep better effect. Save more money to increase your certainty level.

If the 70/30 stock/bond portfolio is low fee and an investor bails out in 2008/9 at the low point they might as well have held 30/70. The sleep better effect is important to staying the course.

Paul
...and then Buffy staked Edward. The end.
User avatar
stratton
 
Posts: 10745
Joined: 4 Mar 2007
Location: Puget Sound

Re: "Stairway to Financial Heaven" - 30% equities??

Postby Joe S. » Sun Dec 02, 2012 11:43 am

A major problem with this author's data is that he doesn't explain where he gets his data from. Is he using the Ibbotson data from 1926-2005? Is he using some other data set? If he won't tell me what data he is using, I don't trust him. Also, an average 10% return for a 70% stock/30% bond portfolio sounds to high. I suspect he is using a cherry-picked data set. However if he won't say where his data is from, his analysis is worthless.
User avatar
Joe S.
 
Posts: 477
Joined: 5 May 2007

Re: "Stairway to Financial Heaven" - 30% equities??

Postby Paul@ » Tue Dec 04, 2012 7:44 am

Joe S. wrote:A major problem with this author's data is that he doesn't explain where he gets his data from. Is he using the Ibbotson data from 1926-2005? Is he using some other data set? If he won't tell me what data he is using, I don't trust him. Also, an average 10% return for a 70% stock/30% bond portfolio sounds to high. I suspect he is using a cherry-picked data set. However if he won't say where his data is from, his analysis is worthless.


Vanguard's Portfolio Allocation Models give a 9% average annual return for a portfolio of 70% stocks/30% bonds, and a 7.3% average annual return for a portfolio of 30% stocks/70% bonds.
Sometimes you're the windshield, sometimes you're the bug. | - Mary Chapin Carpenter
Paul@
 
Posts: 35
Joined: 30 Sep 2008

Re: "Stairway to Financial Heaven" - 30% equities??

Postby Browser » Tue Dec 04, 2012 9:37 am

Look at Swedroe's "fat tails" portfolio, or the Permanent Portfolio. Same thing. The idea is to reduce volatility, particularly downside volatility, and produce smoother annual growth.
If we have data, let’s look at data. If all we have are opinions, let’s go with mine. – Jim Barksdale
Browser
 
Posts: 2234
Joined: 5 Sep 2012


Return to Investing - Help with Personal Investments

Who is online

Users browsing this forum: adptnt, Baidu [Spider], InvestorNewb, jayhawk20, Yahoo [Bot], zed and 53 guests