No AA for the wealthy ?

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HotRod
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No AA for the wealthy ?

Post by HotRod »

Good Morning Bogelheads,

I’ve been doing a lot of lurking, reading, and thinking, which can be a dangerous combination :D

Specifically I’ve been thinking about asset allocation. Of course the common wisdom is to allocate between stocks and bonds to level things out and provide protection during down times, but I wonder if there is a better strategy for those who can afford it.

Here is what I see when I compare the S&P 500 to Vanguards LifeStrategy conservative Growth Fund (60% bonds / 40% stocks). Of course the lows are not as low, and the highs are not as high, but the lows are still significant, including a loss of 17% from November thru January of 2009.

Image

I really question if the reduction of low returns is worth the loss of the potential gains.

Again, for those who have saved enough to afford it, I wonder if a better strategy would be to put 3 or 4 years of living expenses in an FDIC insured savings account and let the rest of it ride in equities.

I see 2 scenarios during market down turns:

1) For the investor who doesn’t need the money, just wait out the down turn.
2) For the investory who is retired and needs the money to live, withdraw from the savings account during market down turns. Then when the market is back up, replenish the savings account as needed.

It seems like this plan allows for much higher gains, and offers more security during a market crash.

What am I missing ?
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timboktoo
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Re: No AA for the wealthy ?

Post by timboktoo »

The Great Depression
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TomatoTomahto
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Re: No AA for the wealthy ?

Post by TomatoTomahto »

SteveB1 wrote:What am I missing ?
I think you're missing the possibility of a downturn much longer than 3-4 years (think Japan).

A lot depends on your definition of wealthy, which I don't think we are in my definition, but we do have above average assets. The value to me of higher returns is not as obvious as the pain of losing our comfortable position. On BH, it is often expressed as betting what you need in order to get what you want. I apologize for a sports metaphor, but my personal ice hockey reminder is: you're up 2 goals, there are 5 minutes left, why would you pull the goalie to try to win by 3 goals?
I get the FI part but not the RE part of FIRE.
livesoft
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Re: No AA for the wealthy ?

Post by livesoft »

You are missing human psychology.
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Topic Author
HotRod
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Re: No AA for the wealthy ?

Post by HotRod »

livesoft wrote:You are missing human psychology.

Could you expand on that please ?
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timboktoo
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Re: No AA for the wealthy ?

Post by timboktoo »

SteveB1 wrote:
livesoft wrote:You are missing human psychology.

Could you expand on that please ?
I own bonds because I know myself. I know that if I didn't own bonds and there was a panic, I'd panic too. It takes a certain psychological makeup to watch your portfolio crash 80% in value and not make any adjustments to it. Most people can't tolerate a loss like that.

You've also got to expand the geography and timeline for your market crashes.

- Tim
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HotRod
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Re: No AA for the wealthy ?

Post by HotRod »

timboktoo wrote:
SteveB1 wrote:
livesoft wrote:You are missing human psychology.

Could you expand on that please ?
I own bonds because I know myself. I know that if I didn't own bonds and there was a panic, I'd panic too. It takes a certain psychological makeup to watch your portfolio crash 80% in value and not make any adjustments to it. Most people can't tolerate a loss like that.

You've also got to expand the geography and timeline for your market crashes.

- Tim

Makes sense, thanks !!
The Wizard
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Re: No AA for the wealthy ?

Post by The Wizard »

I suspect some of the wealthy do things like this, but I wouldn't call it "no AA". It's called Liability Matching.

Let's say it takes $3M to fund your living expenses for the next 30 years. So put that much aside in safe bond ladders.
The remaining $7M of your $10M portfolio you can invest as you like, for the next generation, etc...
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livesoft
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Re: No AA for the wealthy ?

Post by livesoft »

The Wizard wrote:I suspect some of the wealthy do things like this, but I wouldn't call it "no AA". It's called Liability Matching.

Let's say it takes $3M to fund your living expenses for the next 30 years. So put that much aside in safe bond ladders.
The remaining $7M of your $10M portfolio you can invest as you like, for the next generation, etc...
That's called a 70:30 asset allocation to start with. :)

Bond funds tie you to the mast, so that you can hear the Siren song of stocks no matter how much money they lose in a bear market and not sell out. But you will need to buy more stocks in a bear market, too. Will your crew help you do that?
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Bustoff
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Re: No AA for the wealthy ?

Post by Bustoff »

SteveB1 wrote: I really question if the reduction of low returns is worth the loss of the potential gains.
...
What am I missing ?
Yes, the probability of stocks outperforming bonds rises over time.
But so does the probability of stocks losing all their value.
acanthurus
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Re: No AA for the wealthy ?

Post by acanthurus »

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dbr
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Re: No AA for the wealthy ?

Post by dbr »

You might find it helpful to read some of the discussion in one or another of Larry Swedroe's books about need, ability, and willingness to take risk.

Also over the past couple of years there have been dozens of threads here on the forum about 100% stocks and variations thereof. Reading some of them may provide helpful discussion. Be aware that 100% stocks will come out of the woodwork whenever there is a recent history of good gains in the stock market. You can also read the threads that were being put up here back in 2008/2009 about how to get out of stocks altogether and what to do.

A place to start for some simple background is here:

http://www.norstad.org/finance/index.html#risktime

This is not an area for naive thinking; the world is complicated.
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midareff
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Re: No AA for the wealthy ?

Post by midareff »

SteveB1 wrote:Good Morning Bogelheads,

I’ve been doing a lot of lurking, reading, and thinking, which can be a dangerous combination :D

Specifically I’ve been thinking about asset allocation. Of course the common wisdom is to allocate between stocks and bonds to level things out and provide protection during down times, but I wonder if there is a better strategy for those who can afford it.

Here is what I see when I compare the S&P 500 to Vanguards LifeStrategy conservative Growth Fund (60% bonds / 40% stocks). Of course the lows are not as low, and the highs are not as high, but the lows are still significant, including a loss of 17% from November thru January of 2009.

Image

I really question if the reduction of low returns is worth the loss of the potential gains.

Again, for those who have saved enough to afford it, I wonder if a better strategy would be to put 3 or 4 years of living expenses in an FDIC insured savings account and let the rest of it ride in equities.

I see 2 scenarios during market down turns:

1) For the investor who doesn’t need the money, just wait out the down turn.
2) For the investory who is retired and needs the money to live, withdraw from the savings account during market down turns. Then when the market is back up, replenish the savings account as needed.

It seems like this plan allows for much higher gains, and offers more security during a market crash.

What am I missing ?
Bill Bernstein seems to feel that after you have secured your retirement with safe money your AA matters little after that. If it takes $1M to secure your retirement and you have $5M you can be as aggressive as you want with the other $4M.
Spirit Rider
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Re: No AA for the wealthy ?

Post by Spirit Rider »

midareff wrote:Bill Bernstein seems to feel that after you have secured your retirement with safe money your AA matters little after that. If it takes $1M to secure your retirement and you have $5M you can be as aggressive as you want with the other $4M.
Or you have no need for risk and can be as conservative as you want with the other $4M.
dbr
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Re: No AA for the wealthy ?

Post by dbr »

midareff wrote:
Bill Bernstein seems to feel that after you have secured your retirement with safe money your AA matters little after that. If it takes $1M to secure your retirement and you have $5M you can be as aggressive as you want with the other $4M.
That is from the point of view that a person's only objective is funding a modest retirement. Wealth provides the opportunity to do much more than that and from there would come the appropriate strategy for the placement of one's resources.

Also note the previous comment that the desired decision when AA does not matter is to be more conservative rather than more aggressive. But again, the investor needs to actually think about what they want to do. For some people the answer is to not be wealthy, as in to donate the excess to causes of interest during their own lifetime. Starting perhaps with Mr. Carnegie, it is an honored tradition.
staythecourse
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Re: No AA for the wealthy ?

Post by staythecourse »

I tend to agree. I am starting to think this whole "asset allocation" is not as important as we like to preach. If the market tanks and one loses 25% vs. 35% are they going to be like, "Oh it is not bad at least I didn't lose 35%, but only lost 25%" I don't think so.

I think one should analyze the highest expected returning asset class, i.e. stocks and see what their negative are, such as: volatility especially if shows up when you need the money the most (to pay for current bills). Then figure out a way to protect against such volatility. I am FAR LESS likely to be worried if I know I have x amount in principle stable investments then if I lost 25 vs 35%.

I have advocated the two bucket approach A LOT. I would have a bucket full of 5-10 yrs. of expenses covered by principle stable "stuff", such as: CD's, MM, bank account, I bonds, treasury bills, TIPS, etc... Then the rest put in geographically diverse equities.

Could there be a time a geographically diverse equity portfolio crash for 10+ years. Sure, but is it likely no. The POSSIBILITY is there, but the PROBABILITY is low (VERY LOW).

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
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TomatoTomahto
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Re: No AA for the wealthy ?

Post by TomatoTomahto »

Spirit Rider wrote:
midareff wrote:Bill Bernstein seems to feel that after you have secured your retirement with safe money your AA matters little after that. If it takes $1M to secure your retirement and you have $5M you can be as aggressive as you want with the other $4M.
Or you have no need for risk and can be as conservative as you want with the other $4M.
OR, you can split the difference and go 50/50 :sharebeer
I get the FI part but not the RE part of FIRE.
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HotRod
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Re: No AA for the wealthy ?

Post by HotRod »

staythecourse wrote:.... If the market tanks and one loses 25% vs. 35% are they going to be like, "Oh it is not bad at least I didn't lose 35%, but only lost 25%"...
I think this frames up the point I was trying to get at quite nicely.

And this..
staythecourse wrote: I am FAR LESS likely to be worried if I know I have x amount in principle stable investments then if I lost 25 vs 35%
Thanks for the feedback, I continue to read and ponder...
ncole1
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Re: No AA for the wealthy ?

Post by ncole1 »

SteveB1 wrote:Good Morning Bogelheads,

I’ve been doing a lot of lurking, reading, and thinking, which can be a dangerous combination :D

Specifically I’ve been thinking about asset allocation. Of course the common wisdom is to allocate between stocks and bonds to level things out and provide protection during down times, but I wonder if there is a better strategy for those who can afford it.

Here is what I see when I compare the S&P 500 to Vanguards LifeStrategy conservative Growth Fund (60% bonds / 40% stocks). Of course the lows are not as low, and the highs are not as high, but the lows are still significant, including a loss of 17% from November thru January of 2009.

Image

I really question if the reduction of low returns is worth the loss of the potential gains.

Again, for those who have saved enough to afford it, I wonder if a better strategy would be to put 3 or 4 years of living expenses in an FDIC insured savings account and let the rest of it ride in equities.

I see 2 scenarios during market down turns:

1) For the investor who doesn’t need the money, just wait out the down turn.
2) For the investory who is retired and needs the money to live, withdraw from the savings account during market down turns. Then when the market is back up, replenish the savings account as needed.

It seems like this plan allows for much higher gains, and offers more security during a market crash.

What am I missing ?
This is basically a bucket strategy - over which a lot has been written.
Alex Frakt
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Re: No AA for the wealthy ?

Post by Alex Frakt »

SteveB1 wrote:Specifically I’ve been thinking about asset allocation. Of course the common wisdom is to allocate between stocks and bonds to level things out and provide protection during down times, but I wonder if there is a better strategy for those who can afford it....

What am I missing ?
You are missing two things.

1) What you propose actually is "allocating between bonds* and stocks to level things out and provide protection during down times." You are simply doing a dollar and time based allocation rather than a percentage based one.

2) That the "common wisdom" is meant to apply to your particular situation. There really is no such thing as universal advice, every portfolio should be considered in its full context. That's why we recommend that people give us a whole bunch of info along with their allocation questions. And why I wrote the disclaimer that appears at the bottom of each page "No guarantees are made as to ... the appropriateness of any advice to your particular situation.

*OK, your scenario uses cash instead of bonds, but most bucket and HNW investors prefer to use very high quality bonds for the income portion of their portfolio for the extra yield that (normally) comes with what is really minimal risk given their overall situation.
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Electron
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Re: No AA for the wealthy ?

Post by Electron »

Morningstar has presented quite a bit of information on the Bucket Strategy. Here is one recent article.

http://news.morningstar.com/articlenet/ ... ?id=640557
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john94549
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Re: No AA for the wealthy ?

Post by john94549 »

Bucket strategies seldom go out over what I would consider a long period of time. If you have enough at age 70 to go out 15 years with your IRA CDs, that's a bucket. Tap your other investments at age 85, another bucket.
tigermilk
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Re: No AA for the wealthy ?

Post by tigermilk »

timboktoo wrote:
SteveB1 wrote:
livesoft wrote:You are missing human psychology.

Could you expand on that please ?
I own bonds because I know myself. I know that if I didn't own bonds and there was a panic, I'd panic too. It takes a certain psychological makeup to watch your portfolio crash 80% in value and not make any adjustments to it. Most people can't tolerate a loss like that.

You've also got to expand the geography and timeline for your market crashes.

- Tim
At what point would you not panic with a 80% drop? In any case an 80% drop would be a killer

100/0 --> 20% remains
80/20 --> 36% remains
50/50 --> 60% remains

Not accounting for increased gains lost in good years for a more equity focused AA, any way you slice it an 80% drop would rile up most anyone. Does a 40% drop scare you? If so, even that 50/50 AA is not right for you.
tj-longterm
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Re: No AA for the wealthy ?

Post by tj-longterm »

Theory (and data) would tend to suggest that you'll get higher total returns with some percent allocated to bonds. Having bonds is not *just* about reducing risk, it's also about increasing returns.
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Re: No AA for the wealthy ?

Post by DaleMaley »

Anyone contemplating a 100% allocation to stocks might want to read Benjamin Roth's Diary of the Great Depression.....

http://tinyurl.com/omfuvaa

This is the only eyewitness account of someone living through the Great Depression that I know of, with respect to the impact on business people and professionals.

Many business people who owned 100% stocks, or 100% real estate, lamented to Roth that in retro-spect, they should have had some government bonds in their portfolio.

from my book review:

My father was born in 1932. The only thing my father said about the Great Depression was about being hungry all the time when he was a boy. He and his brother were once so hungry they ate dried powder Jell-O. My dad turned out to be a hoarder of scrap wood, nuts, and bolts on his farm.

My father-in-law was born in 1920. He turned out to have a life long hatred of the stock market and refused to ever invest in stocks.

After reading this book, I better appreciate how the Depression experience changed their lives forever.

During the Roaring Twenties, the Dow Jones average grew at a compounded growth rate of 16% a year. It increased from about 100 in 1920 to 381 in 1929. This boom period is similar to the decades of the 1980s and 1990s. In each of these decades, the stock market appreciated at a compounded annual growth rate of about 18%.

It is hard for me to comprehend the stock market shrinking in value by 90%. I first started investing in stock mutual funds in 1980. I lived through the 1-day decline of 22% in 1987, and the roughly 50% declines in both the Tech Wreck of 2000 and the Sub-Prime Crash of 2008. I stayed the course and stayed fully invested through these declines. I am not sure I could stay the course through a 90% decline like in the Depression.

It was interesting to read about Roth's struggles to understand all the economic factors changing around him. It seems that 70 years later in 2008, nobody really understands economics yet. When the first rumbling of troubles in the real estate market surfaced in 2006, I remember an "expert" talking head on TV commenting on the situation. His prediction was that since real estate and construction were less than 10% of the annual GDP, even if we lost the whole sector it would not have much impact on the economy. He did not realize that like the Great Depression, highly leveraged investments implode when the market prices goes down.

I liked Roth's internal struggles to develop an investment strategy that would survive the inevitable boom and bust cycles. He trends towards buying investments at the bottom and selling at the top. He then realizes it is almost impossible to make 2 decisions at exactly the right times (the buy and sell decisions).

The Great Depression prompted other to try to develop a better investment strategy. Benjamin Graham settled in on a portfolio with both stocks and bonds. He suggested the stock portion range from 25% to 75%, with the balance in bonds. He suggested buying stocks when they were selling for less than 50% on the dollar, and selling when they reached 100% of their intrinsic value.

Roth observed that investors with a diversified portfolio did ok. This included blue chip stocks, government bonds, and real estate. None of these should be purchased using borrowed money.

It is too bad the authors did not add a graph of the Dow Jones from 1920 until 1940. This graphic would help readers to understand with an image how high the market went, and how dramatically it declined.

If you are going to attempt to grow your wealth over time, I highly recommend you read this book.
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett
dc81584
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Re: No AA for the wealthy ?

Post by dc81584 »

My thoughts are as follows:

Could one "get away" with it? Assuming that he or she has accumulated a great deal of wealth and has more than enough money to meet his or her needs and then some, probably.

However, the risk, as I see it, has less to do with the fact that stocks careen in value and more to do with the fact that holding at least a small portion (10%+) in bonds provides a modicum of diversification.
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