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

[crowd79]

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.


Brian

Just sell and re-purchase EE Bonds at the 20th year.

[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.

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.

So you're saying keep 40% Short-Term Investment-Grade (VFSTX) as dry powder for opportunistic buying if the market falls. 40% of 25,000 is $10,000, so keep $10,000 in VFSTX as dry powder.

Well suppose stocks return 6% pa while VFTSX returns 1% pa, and you will move from VFSTX to stocks if the market falls 20%.

I set up a spreadsheet to see what would happen. Put $10,000 in VFSTX vs $10,000 in stocks, and how much you have in stocks after a crash.

Code: Select all

        1.00%     6.00%   20.00%    50.00%
        VFSTX    STOCK    DROP      DROP

0       10,000   10,000                         
1       10,100   10,600    8,480    5,300
2       10,201   11,236    8,989    5,618
3       10,303   11,910    9,528    5,955
4       10,406   12,625   10,100    6,312
5       10,510   13,382   10,706    6,691  <- even with 20% crash, stocks have more than VFSTX
6       10,615   14,185   11,348    7,093
7       10,721   15,036   12,029    7,518
8       10,829   15,938   12,751    7,969
9       10,937   16,895   13,516    8,447
10      11,046   17,908   14,327    8,954
11      11,157   18,983   15,186    9,491
12      11,268   20,122   16,098   10,061
13      11,381   21,329   17,063   10,665
14      11,495   22,609   18,087   11,305
15      11,610   23,966   19,172   11,983 <- after 50% crash, stocks still have more than VFSTX
16      11,726   25,404   20,323   12,702
17      11,843   26,928   21,542   13,464
18      11,961   28,543   22,835   14,272
19      12,081   30,256   24,205   15,128
20      12,202   32,071   25,657   16,036
21      12,324   33,996   27,197   16,998
22      12,447   36,035   28,828   18,018
23      12,572   38,197   30,558   19,099
24      12,697   40,489   32,391   20,245
25      12,824   42,919   34,335   21,459
26      12,953   45,494   36,395   22,747
27      13,082   48,223   38,579   24,112
28      13,213   51,117   40,893   25,558
29      13,345   54,184   43,347   27,092
30      13,478   57,435   45,948   28,717
31      13,613   60,881   48,705   30,441
32      13,749   64,534   51,627   32,267             
33      13,887   68,406   54,725   34,203
34      14,026   72,510   58,008   36,255
35      14,166   76,861   61,489   38,430
36      14,308   81,473   65,178   40,736               
37      14,451   86,361   69,089   43,180
38      14,595   91,543   73,234   45,771
39      14,741   97,035   77,628   48,518
40      14,889  102,857   82,286   51,429

1. After 5 years, stocks will have more than VFSTX, even after a 20% crash. For this to payoff, a 20% crash has to happen within a 5-year window.

2. If you instead wait for a 50% crash, after 15 years, stocks will have more than VFSTX even after a 50% crash. So the 50% crash would have to come within a 15-year window for the strategy to pay off.

3. If the crash never comes, after 40 years, you have 102,857 in stocks and only 14,889 in VFTSX. You gave up $87,969

Basically keeping 40% in dry powder is a bet that a crash will come within some time window. I'm not opposed to keeping dry powder. if VFSTX were yielding 3 or 5% it might be worth holding some cash back because that would push the payoff window out a lot farther. But when the dry powder is only returning 1.1% nominal, and losing to inflation, this doesn't seem like a good market timing bet.

[grap0013]

^

I think this concept is often overlooked. For instance, a 50% crash isn't so bad if you previously had quadrupled your money. If your equities have done decent, it may take a lot of losses to get down to where bond returns are. Over long holding periods, bonds have always dragged against returns of equities. With current yields, they are going to drag more than they historically have for the forseeable future.

Without a doubt, if your goal is to get the highest returns you should omit bonds. If you are striving for more efficiency (higher Sharpe Ratio) then you should include them.

[grayfox]

You can see that in this chart here going back to 1982. Vanguard S&P500 VFINX vs Vanguard ST Investment Grade VFSTX

VFINX vs VFSTX

Despite the huge stock market crashes of 2000-2003 and 2008-2009, stocks were still way way way above VFSTX.

Now if you can predict that a crash is imminent, then being out of the market makes sense. But that hasn't been demonstrated to be an ability anyone has.

[grayfox]

In an Ibbotson Associates report on Lifetime Asset Allocations: Methodologies for Target Maturity Funds, they present a chart of the "equity glide paths of the largest target maturity fund families."

I'm reposting this chart and link to an Ibbotson report from another thread because it seems apropos.

In the Executive summary of the report is a chart titled "Generalized Ibbotson Target Maturity Glide Path". It shows at about age 20 or 25, which would be about 40 years before retirement, investor would have 100% stock, with high international, high EM and high small cap.

[grap0013]

Does that mean I win?

[grayfox]

Yep, it looks like you get a gold star.

[airahcaz]

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

I like this question. Is the answer no?

[Hexdump]

Well, the 40 years caught my eye and I misread the thread title so I was looking for a different solution until I read the meat of the topic.
My problem to solve is:
I have a portfolio of 1.25m that has to last 40 years with taking a 30,000 withdrawal each year. The withdrawal can be taken once or in pieces.
I have a solution and was looking here for alternatives or verification.
Hmmm, it sounds suspiciously like articles that I have read dealing with Retirement Income Strategies.

Sorry for the attempted hijack.

[grayfox]

That sounds like the old Safe Withdrawal Rate topic that has been discussed in about 1 million different threads on Bogelheads. Here is the wiki article :

http://www.bogleheads.org/wiki/Safe_Withdrawal_Rates

I don't think there is much new to say on that subject. If any dead horse has been beaten beyond recognition, it is Safe Withdrawal Rate topic.

Search for wade pfau who has written numerous papers on the subject.

[grayfox]

I found this online calculator for S&P 500 that shows percentages of times the S&P outperformed some return over various time period.

S&P 500 Return History

I put in 5.34%, not adjust for inflation, which should give 8x in nominal terms
40-Years: 76.47% not so good

I put in 3.53%, adjust for inflation, which should give 4x in real terms
40-Years: 99.67% this would work

Note: I changed the goal part-way through the discussion from 8x before-inflation to 4x after-inflation in 40 years.
So the idea of 100% stocks for 40 years, with opportunistic switching to Treasury bonds, sounds plausible.