Challenge: How to invest today for a 40 year horizon?

[grayfox]

Suppose that today, in Jan-2013, you have $25,000 to invest for a 40-year period.
In Jan-2053, 40-years from now, you will liquidate the entire investment and spend all the proceeds.
There will be no additional contributions or withdrawals during the 40-year period.

The goals is to have the most money to spend in Jan-2053 with least uncertainty at the end. Let's say, at the minimum, it should grow to $200,000 by 2053. That is 8-fold over 40-years. But the more, the better.

How would you invest the money today, to achieve that goal?

For the purposes of this exercise, stick to normal assets like publicly-traded stocks and bonds, mutual funds or ETFs, commodities gold, etc. Basically you are going to deposit this somewhere like Vanguard, Schwab or Fidelity, so use whatever you can invest with them. Assume it's in a roth IRA account, so no tax considerations.

For example, the strategy could be simply to buy and hold some portfolio the entire 40 years.
Or it could be a constant mix portfolio like 80/20 or 60/40 or 50/50 or 40/60 which would require rebalancing.
It could be Harry Browne Permanent Portfolio or Harry Potter Hogwarts Portfolio.
Or it could be a glide path over the 40 years, like target retirement funds. Or some other glide path.
It could be 100% stocks or 100% TIPS or 100% gold or 100% cash.
You could lump sum in today or DCA or some other market timing scheme.

So what is your solution?

[Grt2bOutdoors]

Suppose that today, in Jan-2013, you have $25,000 to invest for a 40-year period.
In Jan-2053, 40-years from now, you will liquidate the entire investment and spend all the proceeds.
There will be no additional contributions or withdrawals during the 40-year period.

The goals is to have the most money to spend in Jan-2053 with least uncertainty. Let's say, at the minimum, it should grow to $200,000 by 2053. That is 8-fold over 40-years. But the more, the better.

How would you invest the money today, to achieve that goal?

For the purposes of this exercise, stick to normal assets like publicly-traded stocks and bonds, mutual funds or ETFs, commodities gold, etc. Basically you are going to deposit this somewhere like Vanguard, Schwab or Fidelity, so use whatever you can invest with them. Assume it's an roth IRA account, so no tax considerations.

For example, the strategy could be simply to buy and hold some portfolio the entire 40 years.
Or it could be a constant mix portfolio like 80/20 or 60/40 or 50/50 or 40/60 which would require rebalancing,
Or it could be a glide path over the 40 years, like target retirement funds. Or some other glide path.
It could be 100% stocks or 100% TIPS or 100% gold or 100% cash.
You could lump sum in today or DCA or some other market timing.

So what is your solution?

The goal is $250,000 - not the more the better. With that in mind, one would need to earn a minimum of 5.93% compounded annually per year. I would use a 60/40 portfolio, rebalanced annually - 60% large cap index, 20% small value, 20% total international ex-us and 40% Short-Term Investment Grade.

[bigred77]

Your looking for just under a 6% nominal CAGR over 40 years. You could pick most any reasonable asset allocation and hold for 40 years. I think you definately cant go wrong with any 2050 target retirement fund.

My personal choice would be a static 70/30 split rebalanced annually on my birthday:

15% - TBM (VBMFX)
15% - TIPs (VIPSX)
25% - TSM (VTSMX)
25% - TISM (VGTSX)
10% - SCV (IWN ; ishares Russel 2000 Value ETF)
10% - REITs (RWO ; Global REIT index ETF)

[MrMatt2532]

Well you need to define exactly what it is you are optimizing. You say most return with least uncertainty. If that means a sharpe ratio or a sortino ratio, then I would backtest and base a recommendation off of that. Regardless, I think you need to define what you want, and then a backtest would serve as a starting point for a recommendation. For example, the backtest will tell us one really specific portfolio that worked in the past. I would use the results to choose maybe a stock/bond ratio and maybe if I should tilt or hold reits for example.

[chicagobear]

I would put it all into the Vanguard World Stock Index Fund (VT/VTWSX) and let it ride.

[EDN]

If I read the goal correctly (about a 6% return), and the desire of the account is to be set up for DIY, I'd opt for this allocation: http://socialize.morningstar.com/NewSoc ... C1FF7784FC

If the desire is to have assistance in ongoing management, then I'd opt for something like this allocation: http://socialize.morningstar.com/NewSoc ... E699B259A5

In my mind, the biggest challenge to the $ over the next 40 years isn't so much "what its invested in" as "how it's maintained".

Eric

[rkhusky]

I would go with a 60/30/10 TSM/TISM/TBM split that linearly ramps to 10/5/85, rebalanced with 5% bands.

[tadamsmar]

Vanguard retirement 2050 (VFIFX)

[Aptenodytes]

Your question has no answer. You can't maximize for two variables that are anti-correlated. It is like asking what is the easiest way to turn lead into gold or what brand of fairy dust works best.

Most people who gave you an answer did so by amputating one of your objectives (maximum end point). But you clearly say you want "the most money" and that $200K is only a minimum.

This is a trick question.

[Vanguard2010]

It might be a trick question - but it is essentially my thought process on my 1 year old's trust that I don't plan on her touching until she is 40. I just put it in Vanguard LifeStrategy Growth Fund for simplicity.

[Aptenodytes]

It might be a trick question - but it is essentially my thought process on my 1 year old's trust that I don't plan on her touching until she is 40. I just put it in Vanguard LifeStrategy Growth Fund for simplicity.

If you ended up with that fund your thought process was different.

As asked, you end up in an infinite loop:
a) Here's a very high risk fund that brings very high returns
b) can I lower the uncertainty of reaching my goal?
c) Yes,
d) Now I'm choosing a lower risk fund that brings lower returns
e) can I raise the expected return?
f) Yes
g) goto (a)

If you ended up with that fund, you went through a different thought process:
a) what is the relationship between risk and return on a 40-year time horizon?
b) Here's a fund that manages that tradeoff in a way I like.
c) end

[chicagobear]

Has there ever been a 40 year period when an all equity portfolio (especially if diversified internationally) hasn't beaten a balanced portfolio?

[MN Finance]

I asked myself a similar question when I put $10k into my 6 month old's Roth IRA. I split it 50/50 between the US market and EM figuring it didn't matter which equity market I was in for 60 years but I might get a rebalancing bonus if I picked two funds with a correlation below 1.

[investor]

I asked myself a similar question when I put $10k into my 6 month old's Roth IRA. I split it 50/50 between the US market and EM figuring it didn't matter which equity market I was in for 60 years but I might get a rebalancing bonus if I picked two funds with a correlation below 1.

doesn't a ROTH IRA require earned income ? Perhaps your 6mo old is a movie star and has earned income.

investor

[22twain]

Perhaps your 6mo old is a movie star and has earned income.

Nah, one baby food commercial would do it.

[Rodc]

FYI, just to be clear, an 8 fold increase in 40 years is 5.34 percent, which is lower than the numbers above.

If you really need to hit that you might find an insurance company willing to issue an annuity that gives a lump sum of $200K in 40 years based on paying $25K now.

Not sure I'd want to bet the insurance company would be around to complete the deal in 40 years, but everyone else has the standard portfolios covered.

Otherwise I would choose 35/35/30 US TSM,ITSM,TBM and put it on auto pilot and peek at the end.

[Default User BR]

Nah, one baby food commercial would do it.

Do they have baby food commercials anymore?


Brian

[grayfox]

Well you need to define exactly what it is you are optimizing. You say most return with least uncertainty. If that means a sharpe ratio or a sortino ratio, then I would backtest and base a recommendation off of that. Regardless, I think you need to define what you want, and then a backtest would serve as a starting point for a recommendation. For example, the backtest will tell us one really specific portfolio that worked in the past. I would use the results to choose maybe a stock/bond ratio and maybe if I should tilt or hold reits for example.

I tried putting the goal in laymen's terms, without using too much financial jargon.

Basically I want as much as possible with the minimum acceptable being $200,000 in Jan-2053. Let say 99.9% probability that the Balance >= $200,000. Any less would be considered a failure. But $300,000 would be better and $1,000,000 would be better still.

If you can translate this into something like maximizing the Sharpe Ratio or something to solve the problem that's fine.

[Toons]

Ditto,Lifestrategy Growth :VASGX

https://personal.vanguard.com/us/funds/ ... IntExt=INT

[G-Money]

Vanguard retirement 2050 (VFIFX)

My thoughts as well. I like simple solutions to hypothetical questions.

[grayfox]

Your question has no answer. You can't maximize for two variables that are anti-correlated. It is like asking what is the easiest way to turn lead into gold or what brand of fairy dust works best.

Most people who gave you an answer did so by amputating one of your objectives (maximum end point). But you clearly say you want "the most money" and that $200K is only a minimum.

This is a trick question.

No trick question intended. As I wrote above, basically I want as big a balance as possible when the portfolio is liquidated with the minimum acceptable amount being $200,000 in Jan-2053.

Let's say Prob(Balance >= $200,000) = 99.9% . That should constrain how much risk there can be. For instance, buying lottery tickets with a tiny chance for $300 million dollars jackpot, but large chance of 0 would not meet the minimum requirement.

So maximize the balance on Jan-2013 with the requirement that the minimum must be $200,000.

[grayfox]

The goal is $250,000 - not the more the better. With that in mind, one would need to earn a minimum of 5.93% compounded annually per year. I would use a 60/40 portfolio, rebalanced annually - 60% large cap index, 20% small value, 20% total international ex-us and 40% Short-Term Investment Grade.

OK, 60% stocks and 40% ST Investment-Grade (VFSTX).

The YTM on VFTSX is only 1.1%. It seems like 40% of the portfolio would be dead money.

I suppose 40% in cash or ST would make the portfolio less volatile, but it would greatly reduce the expected return of the portfolio. I don't think it would maximize the return. It may make it hard to even reach the minimum $200,000.

[dbr]

Well you need to define exactly what it is you are optimizing. You say most return with least uncertainty. If that means a sharpe ratio or a sortino ratio, then I would backtest and base a recommendation off of that. Regardless, I think you need to define what you want, and then a backtest would serve as a starting point for a recommendation. For example, the backtest will tell us one really specific portfolio that worked in the past. I would use the results to choose maybe a stock/bond ratio and maybe if I should tilt or hold reits for example.

I tried putting the goal in laymen's terms, without using too much financial jargon.

Basically I want as much as possible with the minimum acceptable being $200,000 in Jan-2053. Let say 99.9% probability that the Balance >= $200,000. Any less would be considered a failure. But $300,000 would be better and $1,000,000 would be better still.

If you can translate this into something like maximizing the Sharpe Ratio or something to solve the problem that's fine.

The general answer is that one can attempt to forecast a distribution of possible outcomes of final wealth. Distribution means that one knows at each value of possible wealth the probability of getting that result. The distribution can be described in other ways, such as trying to estimate such statistics as the probability that 99.9% of the outcomes exceed $200,000, so we have progress toward a specification there.

Maybe some useful insight would come from looking at this article:

http://www.norstad.org/finance/risk-and-time.html

One thing that would need to be added to the charts there would be to mentally superimpose a chart for a risky but high returning investment over a less risky but lower returning asset. If one does that one finds such things as the following:

Obvious results:
1. The average of the distribution for the high return is much higher than the average expectation of the low return.
2. The spread in the high distribution is much larger than the spread in the low distribution.

Less obvious results:
1. The higher returning distribution could have a higher probability of really bad results than the lower distribution.
2. Most of the results of the higher distribution, even the bad ones, may exceed most of the results of the lower distribution, even the good ones, and that fraction may increase over time.
3. The chances either distribution will end up above a fixed target depends on the mean expected return compared to the target. There is no a-priori selection between the two.

Conditions:
1. The illustration is for a random-walk model. The relative departures of the various distributions from normal models can change the odds of some things significantly.
2. The randomness means no serial correlation is assumed. Real markets may be rather different from this.
3. The model is stationary. The distribution itself may change significantly over time.
4. The properties of the distribution(s) are not known but need to be estimated from samples. This introduces more uncertainty. For example returns and volatility of returns are not actually known. That means that if one were to estimate a 99.9% probability for reaching $200,000 we would still have uncertainty in that estimate. This estimation uncertainty is increased by 2. and 3. on top of 4. 1. also means that we may be using distribution models that are not appropriate and introduce more error.

[DiscoBunny1979]

Basically I want as much as possible with the minimum acceptable being $200,000 in Jan-2053. Let say 99.9% probability that the Balance >= $200,000. Any less would be considered a failure. But $300,000 would be better and $1,000,000 would be better still.

There are no guarantees of any type of return investing in stock funds or bond funds. Prospectus reading tells us that anyone can loose money investing in any Fund from any investment firm. Therefore, any answer has to take a 99.9% chance that the Balance >= $200,000 off the table. Anything within the next 40 years can derail the likelihood of reaching that goal. Some concerns would be Global War, World Starvation, Global Warming, Lack of Drinking Water creating war for water resources, Inability to move products/services due to Peak Oil occurring years earlier/no energy, the depletion of silver/gold/metal resources and therefore the inability to make electronics, the U.S. declaring bankruptcy and sending the stock market into a panic decline . . . and other scenarios that may or may not pan out but one might have to statistically calculate the likelihood of any known and unknown events from happening versus absolutely nothing happening that would either prevent or allow such $200,000 value at the end of 40 years.

Over the past 30 years or so, the STAR Fund has returned an annualized return of about 9.x% and therefore the STAR Fund is my choice that over a period of 30 years, one most likely would reach the $200,000 target if money doubles every 10 years (a 7% annualized return, which is lower than STAR). $25,000 becomes $50,000, then $50,000 becomes $100,000, then $100,000 becomes $200,000. In 40 years at 7%, total should be about $400,000.

[grayfox]

I would put it all into the Vanguard World Stock Index Fund (VT/VTWSX) and let it ride.

That's what I was thinking. Why not 100% diversified stock portfolio? You could hold it for 40 years and see what it is at the end.

BTW, someone who did this in 1973, let's say put $2,400 in S&P500 I calculate would have $99,200 in today, which is 41X. (CAGR=9.7%, but, a lot of that is inflation.)

However, maybe holding 100% stocks until about 10 years to go (2043) and see how it is doing. If it's way above $200K, maybe sell all and put in a 10-year Treasury for safety. Would it be worth risking losing 50% the year before you have to sell?

Vanguard retirement 2050 (VFIFX)

I think TR2050 is about 90% stock / 10% TBM. You could say that Vanguard experts already thought about this problem abd this is their solution. This also takes care of the glide path.

It might be a trick question - but it is essentially my thought process on my 1 year old's trust that I don't plan on her touching until she is 40. I just put it in Vanguard LifeStrategy Growth Fund for simplicity.

It sounds like you already found and implemented a solution to a similar problem.

[umfundi]

Not sure this really addresses the OP's question, but Rick Ferri (Portfolio Solutions) puts out an annual "30-year Market Forecast for Investment Planning".

I wonder what the 1983 forecast would have said?

Keith

[Don Christy]

Zero coupon treasury bonds (STRIPS, zeros) are probably the best way I know to fund a specific long term nominal goal with basically no uncertainty. Zeros should yield more than FDIC CDs, but still aren't yielding anywhere near the 5.3%+ needed to turn $25k into $200k. The 30 year treasury Zero is yielding about 3.285 right now. IMO once you start adding in risky assets, you don't get even close to a 99.9% probability with reasonable confidence. 99.9% is a high bar.

You need to really think through the relative utilities of meeting your minimum goal versus maximizing end balance to have a realistic plan.

In any event, you will have to take on some risk for a chance to meet your goals. I would either select an inexpensive target date fund or DIY with 3-4 fund portfolio. IMO it would be highly likely that you would end up with a portfolio that exceeds the minimum, though highly likely to me is still less than 99.9%.

The more important the $200k bogey is, the more important it will be to have a de-risking strategy to go along with whatever portfolio you choose. For example, at one extreme, if the portfolio performs such that at any point you can cover the minimum with zeros, you could completely de-risk.

[grap0013]

This is an easy one.

50% PXSV
25% PDN
25% DGS

Let that ride 25 years and add 3% bonds yearly for the final 15 years.

[Padlin]

Not sure this really addresses the OP's question, but Rick Ferri (Portfolio Solutions) puts out an annual "30-year Market Forecast for Investment Planning".

I wonder what the 1983 forecast would have said?

Keith

Chances are Rick was in the Marines in 85, probably had other things on his mind then the market. Then again, maybe not.

[grayfox]

The general answer is that one can attempt to forecast a distribution of possible outcomes of final wealth. Distribution means that one knows at each value of possible wealth the probability of getting that result. The distribution can be described in other ways, such as trying to estimate such statistics as the probability that 99.9% of the outcomes exceed $200,000, so we have progress toward a specification there.

Maybe some useful insight would come from looking at this article:

http://www.norstad.org/finance/risk-and-time.html

I looked at that article Risk and Time. He used a random walk model with parameters mu=0.09707 and sigma=0.194756 for continuously -compounded returns.

I tried simulating that RW model and, under the assumptions of that model, it was somewhere from 6% to 8% of the time the balance would be less than $200 thousand. So that would be only about 92% to 94% chance of meeting the minimum goal.

And maybe 1 out of 1000 times it would end with less than $25,000, what you started with. So that would be perhaps 99.9% chance of having a positive return.

I seem to recall from some book, maybe Stocks For The Long Run, that over the long term the variation of return was less than you would get with a RW model. Mean reversion, or something. In other words the RW model might be showing volatility increasing too quickly.

One question is, can you use Modern Portfolio Theory to reduce the volatility of stocks stocks without reducing the return?

Edit: I searched the internet and found references to Variance-Ratio Tests that compare the stock market to Random Walk. At least some of the papers rejected the random walk hypothesis for stock returns. For ecample, http://press.princeton.edu/books/lo/chapt2.pdf So the variation in results may not be as wide as with a RW model.

[freebeer]

...The goals is to have the most money to spend in Jan-2053 with least uncertainty at the end. Let's say, at the minimum, it should grow to $200,000 by 2053. That is 8-fold over 40-years. But the more, the better.

Are you talking nominal $200,000 or $200,000 in 2013 dollars? If the former, then it's highly dependent on future rate of inflation and as well rather meaningless. If the latter it's a pretty long throw to expect 8-fold growth in 40 years... you would need to get 5.5% *real* returns net of taxes, which means 7%+ at today's inflation rates. If it's really "$200K or bust" then I would say invest it 50% small-cap-value, 50% emerging markets and hope.

[grayfox]

Are you talking nominal $200,000 or $200,000 in 2013 dollars? If the former, then it's highly dependent on future rate of inflation and as well rather meaningless. If the latter it's a pretty long throw to expect 8-fold growth in 40 years... you would need to get 5.5% *real* returns net of taxes, which means 7%+ at today's inflation rates. If it's really "$200K or bust" then I would say invest it 50% small-cap-value, 50% emerging markets and hope.

I was thinking $200,000 nominal terms. Let's say $100,000 in real terms. That's more what I had in mind. So 4x in 40 years. I believe that would work out to about 3.53% real CAGR.

It does not sound like it should be that hard to get minimum 3.53% annualized real return over 40 years. You can't get it with bonds now, But S&P 500 has about 2% dividend yield and foreign sticks have even higher dividend yield.

[Snowjob]

Basically I want as much as possible with the minimum acceptable being $200,000 in Jan-2053. Let say 99.9% probability that the Balance >= $200,000. Any less would be considered a failure. But $300,000 would be better and $1,000,000 would be better still.

There are no guarantees of any type of return investing in stock funds or bond funds. Prospectus reading tells us that anyone can loose money investing in any Fund from any investment firm. Therefore, any answer has to take a 99.9% chance that the Balance >= $200,000 off the table. Anything within the next 40 years can derail the likelihood of reaching that goal. Some concerns would be Global War, World Starvation, Global Warming, Lack of Drinking Water creating war for water resources, Inability to move products/services due to Peak Oil occurring years earlier/no energy, the depletion of silver/gold/metal resources and therefore the inability to make electronics, the U.S. declaring bankruptcy and sending the stock market into a panic decline . . . and other scenarios that may or may not pan out but one might have to statistically calculate the likelihood of any known and unknown events from happening versus absolutely nothing happening that would either prevent or allow such $200,000 value at the end of 40 years.
....

Agreed, and while one could debate the speed at which certain events would happen (metals risk is certainly much much much farther away from today than food risk which is more immediate and hydrocarbon risk which with a global shale revolution would be farther out towards the metal risk than food) the idea that all the factors of a vibrant worldwide economy that we have today continue to allow for compounding growth at this level for the next 40 years is a leap of faith. That said, I think dbr's suggestion of 1/3 domestic 1/3 international 1/3 bond with regular rebalancing is probably the best way to approach this if we ignore the pitfalls of the future. We dont know what can happen over that extended amount of time, so in the context of the question (take financial assets at T0 and end up with atleast x financial assets in T1) diversify and let what happens happen.

[Aptenodytes]

Your question has no answer. You can't maximize for two variables that are anti-correlated. It is like asking what is the easiest way to turn lead into gold or what brand of fairy dust works best.

Most people who gave you an answer did so by amputating one of your objectives (maximum end point). But you clearly say you want "the most money" and that $200K is only a minimum.

This is a trick question.

No trick question intended. As I wrote above, basically I want as big a balance as possible when the portfolio is liquidated with the minimum acceptable amount being $200,000 in Jan-2053.

Let's say Prob(Balance >= $200,000) = 99.9% . That should constrain how much risk there can be. For instance, buying lottery tickets with a tiny chance for $300 million dollars jackpot, but large chance of 0 would not meet the minimum requirement.

So maximize the balance on Jan-2013 with the requirement that the minimum must be $200,000.

Well that's a solvable problem. Loosely similar to many investment decisions except for the need to goose the return as high as possible -- I think most people settle for "high enough" because attempting to chase the stratospheric returns while preserving some safety can be dicey. It brings to mind the America's Cup yachts -- the people who design those yachts also need the very fastest possible ships (because unlike in investing, coming in second is failing), but they also desire some minimum amount of safety that the ship won't break apart. The result is a far different design dynamic than most sailors would find appropriate, and some absolutely spectacular failures. I hope you don't actually do what you literally say you want to do.

I don't have access to the data or the expertise to run the right simulations, but my guess is that you'd probably want to go very heavily into small value. And although I don't do this myself (I stick with Vanguard), if I were doing what you say you want to do and I was totally serious about it, I'd definitely be trying to work with DFA or someone who can slice the Fama-French dices as effectively as possible. Otherwise the odds are that someone who does that will beat you (even if the someone is fictional, you still lose under your specs). You might need to move your personal account there to achieve minimum balance requirements.

Some people have said once you get to $200K you can cash out, but that clearly won't work because you still desire the maximum possible return within the constraint of a $200K minimum. You do clearly need some kind of dynamic risk strategy, but I'm not sure the literature will be of much use since your use case is so quirky (nobody cares what the balance is on a single day so far in the future -- they invest for a multi-decade time horizon). You probably will need to do a lot of work with options in the last decade and go bonkers in the last few months.

Why this obsession with maximum possible return? In 40 years will you really care if the total is $250,000 or $252,000?

If it were me I would go in a totally different direction and settle for a good, decent return. I'd buy the stock sailboat, not commission an America's Cup yacht. E.g. a target date fund. It definitely would lose the race you create, but it would be SO much easier and also VERY good.

[rkhusky]

The problem stated in the OP is different than retirement planning, making a Target Retirement fund, such as TR 2050, not necessarily appropriate. In the latter case, the target date is roughly your retirement date and you expect the portfolio to fund your retirement for 30 or so years. In the OP, all the funds will be removed after 40 years and spent. This is similar to saving for a house or an education, where you would want to be much more conservative as you approach the end of the time period.

On the other hand, if this is just a game and you lose if you don't reach the goal, then you should adjust the portfolio risk as a function of how close you are to $200K.

[Aptenodytes]

The problem stated in the OP is different than retirement planning, making a Target Retirement fund, such as TR 2050, not necessarily appropriate. In the latter case, the target date is roughly your retirement date and you expect the portfolio to fund your retirement for 30 or so years. In the OP, all the funds will be removed after 40 years and spent. This is similar to saving for a house or an education, where you would want to be much more conservative as you approach the end of the time period.

On the other hand, if this is just a game and you lose if you don't reach the goal, then you should adjust the portfolio risk as a function of how close you are to $200K.

I'm saying the game is a bit nuts and I'd play a different game. For my different game the Target Date 2060 is appropriate. In the new game I'm not looking to achieve the highest possible sum in 40 years, but a good enough sum in 40 years.

I agree you need to become more conservative near the end, but not in the sense most of us become more conservative as we get older. Because you have to aim for two very opposed objectives -- don't fall below $200K, and end up with as much as possible. That's why I'd change the terms before I played.

[rkhusky]

I'm saying the game is a bit nuts and I'd play a different game. For my different game the Target Date 2060 is appropriate. In the new game I'm not looking to achieve the highest possible sum in 40 years, but a good enough sum in 40 years.

I agree you need to become more conservative near the end, but not in the sense most of us become more conservative as we get older. Because you have to aim for two very opposed objectives -- don't fall below $200K, and end up with as much as possible. That's why I'd change the terms before I played.

How about this game: You borrow $25K from a loan shark, with the agreement that if you don't repay $200K in 40 years, you get a pair of cement boots. You can keep anything over $200K. How conservative would you be towards the end?

[crowd79]

Take $10,000 of that money and park it in Government EE Bonds. As a 100% safe floor for your retirement portfolio, you will quadruple your money in 40 years at 3.53%. Also, state income tax free.

[Grt2bOutdoors]

I'm saying the game is a bit nuts and I'd play a different game. For my different game the Target Date 2060 is appropriate. In the new game I'm not looking to achieve the highest possible sum in 40 years, but a good enough sum in 40 years.

I agree you need to become more conservative near the end, but not in the sense most of us become more conservative as we get older. Because you have to aim for two very opposed objectives -- don't fall below $200K, and end up with as much as possible. That's why I'd change the terms before I played.

How about this game: You borrow $25K from a loan shark, with the agreement that if you don't repay $200K in 40 years, you get a pair of cement boots. You can keep anything over $200K. How conservative would you be towards the end?

Just one problem with that - in return for lending you the money, the loan shark demands 25% interest per month. The alternative is to have bone torsion followed by a cement boot fitting and then a boat ride. How stupid would you be to play that game?

[Aptenodytes]

I'm saying the game is a bit nuts and I'd play a different game. For my different game the Target Date 2060 is appropriate. In the new game I'm not looking to achieve the highest possible sum in 40 years, but a good enough sum in 40 years.

I agree you need to become more conservative near the end, but not in the sense most of us become more conservative as we get older. Because you have to aim for two very opposed objectives -- don't fall below $200K, and end up with as much as possible. That's why I'd change the terms before I played.

How about this game: You borrow $25K from a loan shark, with the agreement that if you don't repay $200K in 40 years, you get a pair of cement boots. You can keep anything over $200K. How conservative would you be towards the end?

I would be very conservative.

[Grt2bOutdoors]

The goal is $250,000 - not the more the better. With that in mind, one would need to earn a minimum of 5.93% compounded annually per year. I would use a 60/40 portfolio, rebalanced annually - 60% large cap index, 20% small value, 20% total international ex-us and 40% Short-Term Investment Grade.

OK, 60% stocks and 40% ST Investment-Grade (VFSTX).

The YTM on VFTSX is only 1.1%. It seems like 40% of the portfolio would be dead money.

I suppose 40% in cash or ST would make the portfolio less volatile, but it would greatly reduce the expected return of the portfolio. I don't think it would maximize the return. It may make it hard to even reach the minimum $200,000.

You're suffering from recency bias. The VFTSX fund currently yields 1.1%, the duration is 2.3 years. Historical performance since inception in 1982 is 6.74% per year. The portfolio relies on the small cap value and international equities to provide some oomph with large cap index. Those inevitable moments where there is a downdraft in the marketplace allows for opportunitic buying and that is where the Short-Term fund comes into play. Stability of your powder is important and do you really believe that corporate bond yields will be this low over the next 40 years? We should all hope not.

[freebeer]

...
You're suffering from recency bias. The VFTSX fund currently yields 1.1%, the duration is 2.3 years. Historical performance since inception in 1982 is 6.74% per year ... do you really believe that corporate bond yields will be this low over the next 40 years? We should all hope not.

You're suffering from recency bias too! "since inception in 1982" is not much of a "historical" perspective in the long view, esp. starting when US was still ramping down from unprecedented inflation. And who is to say that we should hope against low inflation? Or, even (although I hate to say it) hope against a low rate of risk-free real return? The latter would for example encourage capital to flow towards innovators which could benefit our economy and the human condition.

I'm not saying you're wrong - just that we should encompass the possibility that the US financial environment that prevailed over the last 30 years, even 60 years, is structurally changing and that there won't necessarily be a "reversion to the mean" around some of these factors.

[grayfox]

Take $10,000 of that money and park it in Government EE Bonds. As a 100% safe floor for your retirement portfolio, you will quadruple your money in 40 years at 3.53%. Also, state income tax free.

How can you get 3.53% with EE Savings bonds? It looks like its only paying 0.2%

If I buy an EE Bond now, what interest will it earn?
The interest rate for bonds bought between November 1, 2012 and April 30, 2013 is an annual rate of 0.20%.

http://www.treasurydirect.gov/indiv/res ... _bonds.htm

[grayfox]

Basically I want as much as possible with the minimum acceptable being $200,000 in Jan-2053. Let say 99.9% probability that the Balance >= $200,000. Any less would be considered a failure. But $300,000 would be better and $1,000,000 would be better still.

There are no guarantees of any type of return investing in stock funds or bond funds. Prospectus reading tells us that anyone can loose money investing in any Fund from any investment firm. Therefore, any answer has to take a 99.9% chance that the Balance >= $200,000 off the table. Anything within the next 40 years can derail the likelihood of reaching that goal. Some concerns would be Global War, World Starvation, Global Warming, Lack of Drinking Water creating war for water resources, Inability to move products/services due to Peak Oil occurring years earlier/no energy, the depletion of silver/gold/metal resources and therefore the inability to make electronics, the U.S. declaring bankruptcy and sending the stock market into a panic decline . . . and other scenarios that may or may not pan out but one might have to statistically calculate the likelihood of any known and unknown events from happening versus absolutely nothing happening that would either prevent or allow such $200,000 value at the end of 40 years.

Major calamities like World War III or an asteroid hitting the earth are out of my control. No way to see them coming and nothing I cam do about them. So consider 99.9% probability assuming normal life continues. If the future is the zombie apocalypse, then all bets are off.

[YDNAL]

Suppose that today, in Jan-2013, you have $25,000 to invest for a 40-year period.
In Jan-2053, 40-years from now, you will liquidate the entire investment and spend all the proceeds.
There will be no additional contributions or withdrawals during the 40-year period.

The goals is to have the most money to spend in Jan-2053 with least uncertainty at the end. Let's say, at the minimum, it should grow to $200,000 by 2053. That is 8-fold over 40-years. But the more, the better.

How would you invest the money today, to achieve that goal?

Your premise is faulty.
1. We invest in Equities for highest expected return and take risk for it. So, the logical response is Total World VTWSX for "least uncertainty at the end to have the most money."
2. We invest in non-Equities to rebalance when necessary, and increase the asset class when our goals are within reach (or reached).
3. We don't invest for 40 years without adjustment to investments as the timeframe shrinks.... 35, 25, 15, 5, blastoff!

[rkhusky]

Just one problem with that - in return for lending you the money, the loan shark demands 25% interest per month. The alternative is to have bone torsion followed by a cement boot fitting and then a boat ride. How stupid would you be to play that game?

Just trying to put some differential weights for hitting the target on time versus making extra money.

[dbr]

I looked at that article Risk and Time. He used a random walk model with parameters mu=0.09707 and sigma=0.194756 for continuously -compounded returns.

I tried simulating that RW model and, under the assumptions of that model, it was somewhere from 6% to 8% of the time the balance would be less than $200 thousand. So that would be only about 92% to 94% chance of meeting the minimum goal.

And maybe 1 out of 1000 times it would end with less than $25,000, what you started with. So that would be perhaps 99.9% chance of having a positive return.

I seem to recall from some book, maybe Stocks For The Long Run, that over the long term the variation of return was less than you would get with a RW model. Mean reversion, or something. In other words the RW model might be showing volatility increasing too quickly.

One question is, can you use Modern Portfolio Theory to reduce the volatility of stocks stocks without reducing the return?

Edit: I searched the internet and found references to Variance-Ratio Tests that compare the stock market to Random Walk. At least some of the papers rejected the random walk hypothesis for stock returns. For ecample, http://press.princeton.edu/books/lo/chapt2.pdf So the variation in results may not be as wide as with a RW model.

Yes, I mentioned those considerations and more. I did not mean to actually use the numbers in Norstad's article to develop a plan. I meant for the article to be an illustration of the horns of the dilemma. My real point is that your request contains elements that are so contradictory that it is impossible to meet all the requirements. A more refined concept of the objective that can actually be fit by the behavior of investments will have to be devised.

The specific challenge of growing 25K to 200K cannot be met because 40 year certain obligations paying sufficient return do not exist in any market you can access today.

[crowd79]

Take $10,000 of that money and park it in Government EE Bonds. As a 100% safe floor for your retirement portfolio, you will quadruple your money in 40 years at 3.53%. Also, state income tax free.

How can you get 3.53% with EE Savings bonds? It looks like its only paying 0.2%

If I buy an EE Bond now, what interest will it earn?
The interest rate for bonds bought between November 1, 2012 and April 30, 2013 is an annual rate of 0.20%.

http://www.treasurydirect.gov/indiv/res ... _bonds.htm

That's because the US Treasury makes a 1 time adjustment to the Bonds every 20 years exactly, doubling the value on them, regardless of interest rate. I know they are not sexy investments, but believe they are good for people who want some "certainty" in their portfolio by the time they retire.

[grayfox]

Here are summary of ideas:

100% Stock
100% VTWSX or VT
50/50 TSM/EM
50/25/25 PXSV/PDN/DGS, 100/0 then -> 55/45 over last 15 years
50/50 SCV/EM
DFA SCV

70-80% Stocks
Robert T MSCI/S&P Portfolio 75/25
Robert T DFA Vector /Core 75/25
70/30 - 15% VBMFX 15% VIPSX 25% VTSMX 25% VGTSX 10% SCV 10% REIT
35/35/30 TSM/TISM/TBM
33/33/33 TSM/TISM/TBM with rebalancing

60/40 Stocks/Bonds
60/20/10 TSM/TISM/TBM
60/40 - 36% LCV 12% SCV 12% TISM 40% STIG

Target Retirement Funds
TR 2060
Vanguard retirement 2050 (VFIFX)
Lifestrategy Growth :VASGX 80/20
TR or DIY 3or4-Fund, then STRIPS
not TR2050, because cash-out at end

Fixed-Income
Seies EE Savings Bonds

Comments:
1a. Why not 100% stock? Bonds lower the volatility but also the expected return. Especially in 2013 when interest rates are so low. Someone may not sleep if their whole portfolio is 100% stock, but if just a part that is earmarked for a purpose 40 years hence, that you don't even have to look at, the volatility should not be a concern.

1b. Has anyone who recommend less than 100% stock do so because they think it will have higher return than 100% stock? Is it only to reduce the volatility? Or is it using MPT to get a better risk-adjusted return? In other words, reduce volatility without reducing return?

2. 100% stock probably needs some kind of risk reduction as the horizon approaches, like shifting to bonds over the last XX years or opportunistically switching to STRIPS when it can be shown to solve problem.

3. Stocks can be broadly diversidied TSM/TISM or concentrated in higher risk/ higher return like SCV/EM

4. Target Retirement provides a glide path. But is it a suitable glidepath for liquidating in one fell swoop?

5. WIth current interest rates, I don't think any kind of fixed income would be a solution. First of all, there is no 40-year maturity. 30-year STRIPS is priced at 380 for $1000 for a yield of 3.27% U.S. Treasury Strips. $25,000 would only buy 65.8 bonds, so in 30-years it would be worth $65,800 with ten years to get to 200,000. That won't work. Maybe it will be feasible to switch to STRIPS in after 2023 if rates are high enough.

6. I like the single-fund solutions because there is no need to re-balance or even look at it. Just plant an acorn and come back in 40 years to harvest a full grown tree.

[Default User BR]

That's because the US Treasury makes a 1 time adjustment to the Bonds every 20 years exactly, doubling the value on them, regardless of interest rate. I know they are not sexy investments, but believe they are good for people who want some "certainty" in their portfolio by the time they retire.

No. They give a one-time doubling at 20 years, not every 20 years. EE bonds stop earning interest at all (and tax is due) at 30 years. I wish they would keep earning interest. I have a bunch of them reaching final maturity each year now.


Brian