Article: 60/40 produces "same" return with ~half the risk

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Louis Winthorpe III
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Article: 60/40 produces "same" return with ~half the risk

Post by Louis Winthorpe III »

http://www.marketwatch.com/story/get-th ... 2014-06-06

Premise: 60-40 earns the same returns as an all stock portfolio with about half the risk. The article acknowledges lower absolute returns but mentions behavioral reasons why many investors won't realize the higher returns of an all stock portfolio.
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stemikger
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by stemikger »

That's a great article and a good time to remind everyone that stocks don't go up forever and if you are 100% in stocks like I was recently, now might be a good time to get back into a balanced portfolio.

I'm 50 years old and am at 65/35 and I'm sleeping like a baby. When I was 100% stocks (during my investment mid-life crisis) I was watching what the market did on a daily basis. That's no way to live.

Thanks for posting this.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by andyandyandy »

Great Article!
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by steve_14 »

Thanks for the link. This is the kind of article you'd only see at the very end of a 30 year bond bull market. When it comes to stocks, trees can grow to the sky. When it comes to bonds, however, the party can't go on forever, since interest rates can't fundamentally go negative (beyond certain corner cases). By definition, bonds have two places to go from here - they can continue on at low rates of return, or crash and get back to high rates. More risk = more expected return, in a linear fashion.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by berntson »

I read this article yesterday. It's hilarious!

Here is why the idea that 8.7% and 10% annualized returns are the "same" is silly. Suppose Alice saves $10,000 a year from age 22 to age 62. We'll assume 2% inflation and the returns quoted in the article. Then, the 60/40 portfolio will give Alice about $2 million (in inflation adjusted dollars) when she turns sixty. The 100/0 portfolio, on the other hand, will give her about $3 million. Whatever else you think about asset allocation, losing 1/3 of your total returns is not "a modest price to pay" for a reduction in volatility.

Or put another way, assume that Alice's goal is to retire with $2 million. If she holds a 100/0 portfolio, she can expect to retire at 57 instead of retiring at 62. Five years of full-time work is also not "a modest price to pay" for reduced portfolio volatility. Over an investing career, losing 130 basis points a year adds up fast.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by stemikger »

berntson wrote:I read this article yesterday. It's hilarious!

Here is why the idea that 8.7% and 10% annualized returns are the "same" is silly. Suppose Alice saves $10,000 a year from age 22 to age 62. We'll assume 2% inflation and the returns quoted in the article. Then, the 60/40 portfolio will give Alice about $2 million (in inflation adjusted dollars) when she turns sixty. The 100/0 portfolio, on the other hand, will give her about $3 million. Whatever else you think about asset allocation, losing 1/3 of your total returns is not "a modest price to pay" for a reduction in volatility.

Or put another way, assume that Alice's goal is to retire with $2 million. If she holds a 100/0 portfolio, she can expect to retire at 57 instead of retiring at 62. Five years of full-time work is also not "a modest price to pay" for reduced portfolio volatility. Over an investing career, losing 130 basis points a year adds up fast.
I guess that is why Warren Buffett has been telling the average person to have enough cash to feel secure and put the rest in an index fund that buys America. However, the reality is and I think the bigger point of this article is how many mere mortals can watch their retirement balance go down 20, 30 or 50% in a bad market and wonder if and when it will come back. The book the Coffeehouse Investor has a good story on this happening to someone close to retirement. It's not true, but it does drive the point home. I don't want to go through that when I'm a year into retirement, so I'll set my expectations lower with a 65/35 AA and learn to live on what that produces.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by dharrythomas »

Of course returns are not constant and neither are investors. The sequence of returns makes a big difference in the final balance. The other thing that kills investors with 100% stocks is not being able to handle the turbulence particularly as balances increase.

It's not the annual return that is the most important but how much you actually walk away with at the end. Behavioral issues are the primary justification for balanced funds. That 50% drop when you're almost there can lead to a panic response.

Good luck.

Harry
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by packer16 »

This article also assumes volatility = risk which is also not true. Risk is permanent loss of capital and you only lose by selling stocks after they crash. Another statement that nobody can withstand the volatility of a 100% stock portfolio is also not true. It appears that these statements are not even caveated so major portions of the article are bunk. If they simply stated that most cannot stomach a 100% stock portfolio and the biggest danger of a 100% stock portfolio is selling at the bottom and if you think this applies to you then a 60/40 portfolio makes more sense for you then fine but the broad generalizations are just not true and stating them as fact is highly misleading. This also means myself and berntson are catatonic or dead.

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stemikger
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by stemikger »

dharrythomas wrote:The other thing that kills investors with 100% stocks is not being able to handle the turbulence particularly as balances increase.
This is a great point. With an portfolio approaching 500,000 or a million, it will take a special person to see that lose half it's value and although the new investor is starting with nothing (which IMHO would be wise to be 100% in stocks), in many cases, his inexperience makes him get out at the wrong time. That was what I did when I was first learning even though my balance was not that big.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by cfs »

Nothing new, but concur.

Nothing new on the article, but actually, I like the photo of the life boat and the note below "A life boat during stock-market volatility is bonds, which ought to be a part of any portfolio."

Thanks for reading.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by Leesbro63 »

berntson wrote:I read this article yesterday. It's hilarious!

Here is why the idea that 8.7% and 10% annualized returns are the "same" is silly. Suppose Alice saves $10,000 a year from age 22 to age 62. We'll assume 2% inflation and the returns quoted in the article. Then, the 60/40 portfolio will give Alice about $2 million (in inflation adjusted dollars) when she turns sixty. The 100/0 portfolio, on the other hand, will give her about $3 million. Whatever else you think about asset allocation, losing 1/3 of your total returns is not "a modest price to pay" for a reduction in volatility.

Or put another way, assume that Alice's goal is to retire with $2 million. If she holds a 100/0 portfolio, she can expect to retire at 57 instead of retiring at 62. Five years of full-time work is also not "a modest price to pay" for reduced portfolio volatility. Over an investing career, losing 130 basis points a year adds up fast.
What if Alice was scheduled to retired in March, 2009?
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by in_reality »

berntson wrote: Or put another way, assume that Alice's goal is to retire with $2 million. If she holds a 100/0 portfolio, she can expect to retire at 57 instead of retiring at 62. Five years of full-time work is also not "a modest price to pay" for reduced portfolio volatility. Over an investing career, losing 130 basis points a year adds up fast.
Your assumptions and the authors are different. You assume Alice won't sell in a downturn and the author assumes Alice would if 100% stocks.

That's the point of the article. Retiring at 57 is possible in theory on paper but if you panic and sell, it may end up being 67.

So yes an astute reader can see a 100/0 portfolio returns a meaningfully different amount provided they can weather all storms to achieve it.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by Stonebr »

More on this topic from a classic article by Peter Bernstein:

http://web.archive.org/web/200612140619 ... in6040.pdf
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by nedsaid »

I admire Packer16 and Berntson for their courage. They are right, a 100% stock portfolio over long periods of time should do better than a 60/40 portfolio. And yes, the real risk is loss of purchasing power over time is a bigger risk than market volatility. And I am a stock guy. At age 54 and soon to be 55, I feel like I am hanging way out there with a 69% stock and 31% bonds and cash portfolio. But as I get older and older, market volatility gets to be a bigger and bigger issue because I am getting closer and closer to the time where I will need to draw from my retirement kitty.

So as much as I like Packer16 and Berntson and have agreed with many of their posts, I am doing something different than what they are. I admit to being a bit of a scaredy-cat.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by freddie »

She would have been fine. Seriously plot out a 60/40 versus 100% TSM for the the time period and you will see that TSM pretty much never trails. Heck she probably retired in 1998 given the outsized returns during the preceding years and coasted through 2000-2008 since she was retired and switched to a 30/70 portfolio after winning the game. But lets say she didn't and is now unhappy with her balances and decides to work 2 more years until her balance recovers. She is still retiring 3 years earlier.

Obviously in the real world, the 100% stock investor should be dialing down the risk when they get close to their retirement. The question is when and how much.
Leesbro63 wrote:
berntson wrote:I read this article yesterday. It's hilarious!

Here is why the idea that 8.7% and 10% annualized returns are the "same" is silly. Suppose Alice saves $10,000 a year from age 22 to age 62. We'll assume 2% inflation and the returns quoted in the article. Then, the 60/40 portfolio will give Alice about $2 million (in inflation adjusted dollars) when she turns sixty. The 100/0 portfolio, on the other hand, will give her about $3 million. Whatever else you think about asset allocation, losing 1/3 of your total returns is not "a modest price to pay" for a reduction in volatility.

Or put another way, assume that Alice's goal is to retire with $2 million. If she holds a 100/0 portfolio, she can expect to retire at 57 instead of retiring at 62. Five years of full-time work is also not "a modest price to pay" for reduced portfolio volatility. Over an investing career, losing 130 basis points a year adds up fast.
What if Alice was scheduled to retired in March, 2009?
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by sambb »

The key is staying the course - if you look at this board in 2007-9, you will see that many did cut back at market lows. I think that is less likely in a 60/40 mix. Asset allocation is not always fixed, and people can guess wrong at the wrong time.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by Stonebr »

sambb wrote:The key is staying the course - if you look at this board in 2007-9, you will see that many did cut back at market lows. I think that is less likely in a 60/40 mix. Asset allocation is not always fixed, and people can guess wrong at the wrong time.
Yeah. There was talk about "Plan B" on bogleheads -- right around the market lows in March, 2009.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by Leesbro63 »

freddie wrote:She would have been fine. Seriously plot out a 60/40 versus 100% TSM for the the time period and you will see that TSM pretty much never trails. Heck she probably retired in 1998 given the outsized returns during the preceding years and coasted through 2000-2008 since she was retired and switched to a 30/70 portfolio after winning the game. But lets say she didn't and is now unhappy with her balances and decides to work 2 more years until her balance recovers. She is still retiring 3 years earlier.

Obviously in the real world, the 100% stock investor should be dialing down the risk when they get close to their retirement. The question is when and how much.
Leesbro63 wrote:
berntson wrote:I read this article yesterday. It's hilarious!

Here is why the idea that 8.7% and 10% annualized returns are the "same" is silly. Suppose Alice saves $10,000 a year from age 22 to age 62. We'll assume 2% inflation and the returns quoted in the article. Then, the 60/40 portfolio will give Alice about $2 million (in inflation adjusted dollars) when she turns sixty. The 100/0 portfolio, on the other hand, will give her about $3 million. Whatever else you think about asset allocation, losing 1/3 of your total returns is not "a modest price to pay" for a reduction in volatility.

Or put another way, assume that Alice's goal is to retire with $2 million. If she holds a 100/0 portfolio, she can expect to retire at 57 instead of retiring at 62. Five years of full-time work is also not "a modest price to pay" for reduced portfolio volatility. Over an investing career, losing 130 basis points a year adds up fast.
What if Alice was scheduled to retired in March, 2009?
You only know she would have been fine in hindsight. Not true in 1929 or Japan 1989.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by rca1824 »

I'd like to bring up another valuable point: Even if you retire with 100% equity the day the market crashes 50%, so long as you are drawing down a conservative % each year, your portfolio can still recover throughout retirement. And even if you undershoot your goal a little in some black swan event, you can either continue working for another year, or just live more frugally in the early years of retirement while your assets grow back.
QUESTION: Is there not a diversification benefit to holding stocks with long-term treasury bonds? Long-term treasuries have pretty high rate of returns too--not as high as stocks--but higher than total bond market. They also tend to be negatively correlated, or at least independent of, stocks. Hence something like 75/25 stocks/long-treasuries can give almost the same returns at much much less risk.
The more I think about it, if you're drawing down a very small % each year and plan to build true inter-generational wealth, an aggressive 75-100% equity portfolio throughout retirement should be optimal.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by freddie »

We didn't ask about all cases. We asked about the blip that was 2007-2009. If you have the numbers to compare a 60/40 portfolio to a 100% stock starting 35 years or so before those markets, I would love to see them. I am guessing that since the Nikki (yeah I know that isn't remotely a total market) was at 667 at the close of 1958 and the person would have been liquidating in the 20ks, they would have done ok. Remember the person didn't wake invest 100% versus 60/40 at the peaks. They benefited by riding the waves the preceded these peaks. It sucks to lose 50% rather than 25% but when your starting out with 50% more money, things work out about the same.

Again if your retiring in 5 years, being 100% stocks would not be the way I would go. Change that to 10 years out and you can make a decent argument for it.

Leesbro63 wrote:
freddie wrote:She would have been fine. Seriously plot out a 60/40 versus 100% TSM for the the time period and you will see that TSM pretty much never trails. Heck she probably retired in 1998 given the outsized returns during the preceding years and coasted through 2000-2008 since she was retired and switched to a 30/70 portfolio after winning the game. But lets say she didn't and is now unhappy with her balances and decides to work 2 more years until her balance recovers. She is still retiring 3 years earlier.

Obviously in the real world, the 100% stock investor should be dialing down the risk when they get close to their retirement. The question is when and how much.
Leesbro63 wrote:
berntson wrote:I read this article yesterday. It's hilarious!

Here is why the idea that 8.7% and 10% annualized returns are the "same" is silly. Suppose Alice saves $10,000 a year from age 22 to age 62. We'll assume 2% inflation and the returns quoted in the article. Then, the 60/40 portfolio will give Alice about $2 million (in inflation adjusted dollars) when she turns sixty. The 100/0 portfolio, on the other hand, will give her about $3 million. Whatever else you think about asset allocation, losing 1/3 of your total returns is not "a modest price to pay" for a reduction in volatility.

Or put another way, assume that Alice's goal is to retire with $2 million. If she holds a 100/0 portfolio, she can expect to retire at 57 instead of retiring at 62. Five years of full-time work is also not "a modest price to pay" for reduced portfolio volatility. Over an investing career, losing 130 basis points a year adds up fast.
What if Alice was scheduled to retired in March, 2009?
You only know she would have been fine in hindsight. Not true in 1929 or Japan 1989.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by rca1824 »

The idea behind having 100% stocks in retirement is that if you plan to live for another 30 years after retiring, and plan to create significant inter-generational wealth, then the riskiness of stocks is not a bad idea. If you have a large enough sum that you can be flexible in your drawn-down amount, or just draw down a very small fraction, there virtually no risk.
To drill home the intuition, suppose you have $100 million in assets but only need to drawdown $100,000 a year to live comfortably. In the worst case scenario, if your assets lose 50% of your value, you still have $50 million which is more than enough. Your withdrawals are so small to the size of your portfolio that they make virtually no affect. At this point, the goal of having enough money to survive retirement is satiated. The next goal: creating real intergenerational wealth and establishing a powerful dynasty within your family. The best way to achieve this is to maximize the expected amount you leave behind for your children upon death. That means going 100% equity. When your children inherit the sum, they will then be so wealthy too that they can also afford to leave it at 100% equity. And forever and ever, the wealth remains at 100% equity and maximizes returns.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by staythecourse »

The more I read folks on this site the more I am starting to think it is NOT the 100% equity folks who are out of touch with the basics of investing. Folks who think they should expect to get the same return as someone who takes the risk of a 100% equity position for HALF of the risk is breaking the ONE dogma of all of investing: THERE IS NO FREE LUNCH!!

Investing is simple and not sure why folks always have trouble with it: Return and risk on two sides of the same coin like heads and tails. If ex post it turns out different that doesn't change the ex ante approach. One can/ should not expect a higher return WITHOUT taking on more risk. The heavy bond holder on this site seem to be forgetting this after a huge bull market in bonds AND a terrible performance in 2000's for stocks with two bear markets in their as well.

Good luck.
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Louis Winthorpe III
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by Louis Winthorpe III »

staythecourse wrote:The more I read folks on this site the more I am starting to think it is NOT the 100% equity folks who are out of touch with the basics of investing. Folks who think they should expect to get the same return as someone who takes the risk of a 100% equity position for HALF of the risk is breaking the ONE dogma of all of investing: THERE IS NO FREE LUNCH!!
Maybe it's a reading comprehension issue. You've refuted a point that was never made by the author or anyone else in this thread.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by berntson »

Just to clarify, I don't necessarily think that Alice should hold a 100/0 portfolio rather than some other portfolio. I just wanted to point out that the difference between 8.7% and 10% annualized returns is big deal over an investors lifetime. Holding a large bond position as a young investor can be a reasonable choice, but it is also an expensive choice (in terms of expected returns).

For many investors, the best plan may be a very steep glide path. So maybe Alice holds a 100/0 portfolio until she is 57, then quickly moves to a 50/50 portfolio for retirement at 62. Because she can expect to have a larger next-egg at retirement, Alice can expect to be able to live on a lower withdrawal rate. If she has $3 million instead of $2 million, she can get the same result with a 2.6% withdrawal rate that she could have gotten with a 4% withdrawal rate if she had been more conservative in her youth.

Young accumulators who have 100/0 portfolios are not necessarily less risk averse than other investors. They may just be more worried about certain long-term risks, like needing a high withdrawal rate in retirement.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by taegirain3 »

For a young investor, a relatively high bond allocation may make sense -- being 'wiped out' early may convince you to stop participating in the markets entirely. A high bond allocation lets you 'lock in' (modulo inflation if you use nominal bonds) your early savings and get comfortable with the processes before you start piling on stocks.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by Garco »

Choosing an optimal asset allocation really needs to be related to one's age, one's expected working life (age of retirement), and one's tolerance for volatility. (I am not conflating volatility with risk.) But you really do have to have a plan about what you will do when the market takes a deep dive. Here's my story about how I dealt with two hairy crashes: the 2000-2001 dot-com crash, and the 2008-2009 housing bust crash. This is just one story. And it's not a pretty one. But I learned from it.

For the early years of my investing career -- from age ~30 to 55 (years ~1975-2000) -- I kept to a 75-25 contribution of new funds from salary every year -- 15% including my and my employer's contributions. Set it and forget it. Black Monday, October 1987? Who cares!? I was busy -- in the most demanding time of my working career, I was doing a lot of international travel, I had young kids to raise, etc. By the end of 1999, my cumulative AA had reached >85% equities because the stock market was soaring in the late 1990's and I was financially illiterate. Rebalancing? What is that? I wasn't thinking much about AA or my investments. Then all hell broke loose: the dot-com crash in March 2000. I was overexposed to equities, high-tech in particular. I saw my life savings disappearing before my eyes. I immediately made up my own "Plan B": I ramped down, and -- alas -- did just what the author cited above said I would be prone to do: I reduced my stock exposure, selling near the bottom. I don't recall the exact amount but I took my accumulation down from 85% to about 60% equities. It took 4.5 years for me to get back to par -- i.e., where I was at the end of 1999. Thus, the first half of the so-called "lost decade" to investors had been really bad for me. My net growth in invested assets from the end of 1999 til the end of 2004 was zero, even after including my continuing salary contributions.

Nonetheless, things started going swimmingly good again, 2005-2007 were very good years. Irrationally exuberant ones. By late 2007, my accumulation peaked at about 133% of what its value had been at the end of 1999, with my staying away from high tech stocks and keeping my equities share at roughly 65%. Then boom went to bust again in 2008-2009. I watched my accumulation fall into a deep pit by March 2009, losing about 35% from its end-of-2008 value. But this time I didn't do a "Plan B." The problem wasn't my AA, which wasn't far out of line. The problem was the economy, and the market. And I had time to recover again. But this would likely be the last chance in my working career to make such a recovery, because by 2009 I was reaching my mid-60's. I still had my good job. I was still DCA'ing salary each month, and even adding optional contributions to 457b. But I was now financially semi-literate, and focused on making sure this "last chance" wasn't mishandled.

By the end of 2010 I came within a few thousand dollars of recovering my end-of-2007 accumulation. It wasn't a lost decade after all. For me, the recovery from the 2008-2009 crash was much faster than the recovery from the dot-com debacle of 2000. I kept a fairly aggressive AA with ~65% equities through the end of 2012, when I dialed back to ~50% equities, which is where I am now, and on a glide path to retirement. At this time the value of my holdings is ~48% above where it was at end of 2007, and ~94% ahead of where it was at the end of 1999 -- before the dot.com crash. (These percentages are not inflation adjusted.) Now I'm doing a bit more tailoring of my portfolio as I approach retirement. I may be fooling myself, but I feel that with my current ~50-50 AA I am much less likely to panic if the market crashes again. Because of the size and increased diversity of my overall portfolio, and some cash set-asides that I have now and am building further, I think I'm less financially vulnerable than i was before.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by packer16 »

I personally think AA allocation should be based upon expense requirements for the individual not age. Lets say you are going to retire today. If you have 3 years of living expenses in something safe (t-bills), then you can allocate the rest of your assets to something more risky like equities. The years the equities increase take the money out of the equity returns. In down/flat years take the money out of the safe pool. Refill the safe pool when your risk pool reaches its previous high. I have ran this approach with various value mutual funds, value indexes and REITs and they all have performed very well (providing for 5 to 7% withdraw rates plus portfolio appreciation) from 2000 to 2014 (a very challenging time).

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Re: Article: 60/40 produces "same" return with ~half the ri

Post by Dandy »

The lure of 100% stock allocation has many attractions:
1. Stocks outperform over time -- so the more the better.
2. It is hard to know your real risk tolerance and how that changes as your age and/or your portfolio grows
3. There is a bit of macho in being 100% stocks
4. Like all things we commit to -- it is hard to change - especially if the approach has been golden for years
5. It is simple and people like simple things, little need to rebalance, or change allocation as one ages.

It seems every time there is a severe market drop like 2008 there are many, not all, 100%ers that get a wake up call. And it seems like every time there is an amazing bull run there are more 100%ers.

Yet from what I have read, except for early accumulators, about 80% is the most most "experts" recommend. Do you think many people can live with a potential 90% drop in their portfolio and not lose sleep, panic or at least change their allocation? The Great Depression changed peoples behavior and their children's behavior when it came to investing, saving and debt.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by linenfort »

Hulbert, in the article wrote:A portfolio that allocated just 60% to this S&P index fund and the remainder to intermediate-term U.S. Treasurys (which are considered risk-free) would have gained 8.7% annualized
What constitutes intermediate-term treasurys? I've never been certain. Is that 7- and 10-year notes? Or, 5- and 7-year notes?

Edit: Investopedia includes 3-year notes. I've always thought of that as short term. :?: :?:
Last edited by linenfort on Mon Jun 09, 2014 9:19 am, edited 1 time in total.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by staythecourse »

Louis Winthorpe III wrote:
staythecourse wrote:The more I read folks on this site the more I am starting to think it is NOT the 100% equity folks who are out of touch with the basics of investing. Folks who think they should expect to get the same return as someone who takes the risk of a 100% equity position for HALF of the risk is breaking the ONE dogma of all of investing: THERE IS NO FREE LUNCH!!
Maybe it's a reading comprehension issue. You've refuted a point that was never made by the author or anyone else in this thread.
Hope reading is not an issue. I trained at Harvard am a physician so I'm pretty sure that is not it.

The reason you posted the article as many here have commented is hoping that by taking on less risk one can still be rewarded as a person taking max. risk. I'm sorry that is against the fundamentals of investing.

How about the behavioral risk of 60/40 folks? Have you ever thought of the folks who are 60/40 and during a bull market they go 80 or 100% stocks in the same hysteria only to be hurt as well when the bear shows?? Folks reading this (maybe you as well) will assume 100% stocks equal behavioral mistakes and 60/40 means you stick to the plan and thus 60/40 is the better plan. That is not how life works. There are folks who are 60/40 who stick to the plan and there are folks 100/0 who stick to the plan. To assume one can only stick to the plan if they are magically at 60/40 makes no sense. Does that mean a 40/60 person has a better shot at realizing returns same as 60/40 as they are even more likely to decrease behavioral mistakes??

How you choose your asset allocation is up to you so why would I care? What I care is not portraying a free lunch when there isn't.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
dhodson
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by dhodson »

I agree, I'm not aware of any actual evidence that shows that people with more bonds are better at staying the course and those with high stock %s are more likely to make behavioral mistakes. Its commonly talked about that the bonds help protect you but frankly I find that weak logic. The way you protect yourself is by truly understanding the plan ahead of time and that its normal to have negative years in the market. If you understand the stay the course plan and understand that you can't market time then I'm not sure behaviorally that there is a lot of advantage for a specific bond percentage.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by stemikger »

Stonebr wrote:More on this topic from a classic article by Peter Bernstein:

http://web.archive.org/web/200612140619 ... in6040.pdf
This article is one of my favorites and seems to disappear from the web when I go looking for it. There is another copy, but the one showing Peter Bernstein is the original. I am definitely going to print this one out and save it because God knows if I'll be able to get this again. Thanks for posting it.
Choose Simplicity ~ Stay the Course!! ~ Press on Regardless!!!
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by staythecourse »

dhodson wrote:The way you protect yourself is by truly understanding the plan ahead of time and that its normal to have negative years in the market.
I don't have any data in front of me, but I would intuitively agree with that 100%.

Folks who understand the negatives of any plan are more likely prepared to handle them emotionally when they do finally come.

The issue of 100% equity is bad if folks think "stocks are great they will always go up so why not be 100%". That again is not in line with the fundamentals of risk and reward.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by rca1824 »

staythecourse wrote:The more I read folks on this site the more I am starting to think it is NOT the 100% equity folks who are out of touch with the basics of investing. Folks who think they should expect to get the same return as someone who takes the risk of a 100% equity position for HALF of the risk is breaking the ONE dogma of all of investing: THERE IS NO FREE LUNCH!!
I would really like to see what how different AA perform over long haul. Could it be possible that, e.g. 90/10 outperforms 100/0 due to the diversification and rebalancing bonus of holding some bonds? You would sell stocks when they're overvalued, buy stocks when they're undervalued, and come out ahead of the 100% equity group?
There are some efficient frontier graphs that actually have portions that are downward-sloping i.e. moving towards an extreme 100% asset position not only increased risk but reduced returns!
I guess the question is did it only reduce realized returns or did it also reduce expected returns? What IS the expected risk/return of varying AA?

Also this article implies that diversification is the ONLY free lunch: http://www.capitalatwork.com/index.php/ ... sophy/260/
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by staythecourse »

rca,

You ask excellent questions and one's I have asked myself. This is how I look at it when asking "can a combo. of bonds and stocks do better then a 100% stocks?" The answer from reading and deducing from books like Lussier's book was: Yes it is possible. The rebalancing bonus would have to be > then the realized equity risk premiums.

What does that mean? That means unless stocks have a realized return LESS then bonds then 100% stocks will always do better as they are "expected" to have an equity risk premium over bonds (otherwise who would invest in the more volatile asset class?).

To simply it think back to start of 2000. The theory says stocks should have a higher expected returns then bonds. Now what happened. Adding stocks to a 100% bond portfolio from 2000-2009 only DECREASED returns. Why was that? The realized returns of stocks was, in fact, LESS then that of bonds.

That is when ex ante and ex post views make a difference. Ex ante stocks should do best. Ex post may be a different story. That is the risk stock holders take is if ex ante ends up being predictive of ex post.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by linenfort »

Well, no one had a answer here unless I missed it, but I emailed Mark Hulbert.
His answer, in case anyone else is curious: "Vanguard, as well as Ibbotson, considers 5 years to be the maturity".
___
linenfort wrote:
Hulbert, in the article wrote:A portfolio that allocated just 60% to this S&P index fund and the remainder to intermediate-term U.S. Treasurys (which are considered risk-free) would have gained 8.7% annualized
What constitutes intermediate-term treasurys? I've never been certain. Is that 7- and 10-year notes? Or, 5- and 7-year notes?

Edit: Investopedia includes 3-year notes. I've always thought of that as short term. :?: :?:
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by arcticpineapplecorp. »

stemikger wrote:I guess that is why Warren Buffett has been telling the average person to have enough cash to feel secure and put the rest in an index fund that buys America. However, the reality is and I think the bigger point of this article is how many mere mortals can watch their retirement balance go down 20, 30 or 50% in a bad market and wonder if and when it will come back. The book the Coffeehouse Investor has a good story on this happening to someone close to retirement. It's not true, but it does drive the point home. I don't want to go through that when I'm a year into retirement, so I'll set my expectations lower with a 65/35 AA and learn to live on what that produces.
A portfolio containing 65% stocks would lose around 32.5% overall (depending on what bonds do) if the stock market goes down by 50% again. So setting your expectations lower (with 65% in stocks) might still result in the balance going down between 20% and 30% in the example above. Would that be a problem?
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by rca1824 »

staythecourse wrote:rca,

You ask excellent questions and one's I have asked myself. This is how I look at it when asking "can a combo. of bonds and stocks do better then a 100% stocks?" The answer from reading and deducing from books like Lussier's book was: Yes it is possible. The rebalancing bonus would have to be > then the realized equity risk premiums.

What does that mean? That means unless stocks have a realized return LESS then bonds then 100% stocks will always do better as they are "expected" to have an equity risk premium over bonds (otherwise who would invest in the more volatile asset class?).

To simply it think back to start of 2000. The theory says stocks should have a higher expected returns then bonds. Now what happened. Adding stocks to a 100% bond portfolio from 2000-2009 only DECREASED returns. Why was that? The realized returns of stocks was, in fact, LESS then that of bonds.

That is when ex ante and ex post views make a difference. Ex ante stocks should do best. Ex post may be a different story. That is the risk stock holders take is if ex ante ends up being predictive of ex post.

Good luck.
I I had some data, I don't know where I put it, but I found that holding HYG and IJS over a recent five year period actually produced better returns than holding either asset alone. I believe the difference in CAGR was 0.25% between the two assets, and the 50/50 portfolio did 0.25% better than the best. This is possible because of the cyclical nature of the market.
So rebalancing over a cycle provides a "rebalancing bonus" which, if greater than the difference in asset returns, can be better than any single asset.
But is it consistent? I don't think so. The period I tested was dominated by the 08 recession in the middle. I believe over a longer investment horizon where the long term trend is more steeply positive, the rebalancing bonus would be dwarfed by the difference in returns.
So while there may be some special case short-to-medium-term periods where a split portfolio outperforms either extreme or even when a safe portfolio outperforms a risky portfolio, over the long run, the Law of Large Numbers and Random Walk favors the most risky asset, provided the period is long enough so that the risky asset has time to recover from losses.

My concern is only with ax ante returns, not ex post returns, which makes using past returns to predict the optimal future portfolio quite difficult.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by MathWizard »

Louis Winthorpe III wrote:http://www.marketwatch.com/story/get-th ... 2014-06-06

Premise: 60-40 earns the same returns as an all stock portfolio with about half the risk. The article acknowledges lower absolute returns but mentions behavioral reasons why many investors won't realize the higher returns of an all stock portfolio.
Two points:
1) On what planet are 10.1% and 8.7% the same? If this were an article talking about 1.4% extra in ER being insignificant, imagine
the howls there would be.

2) Why pick intermediate term treasuries for the bond portion? Why not AAA corporate bonds, or long term or short term treasuries?
Presumably because intermediate term makes the argument better. But then, a different index, or perhaps an individual stock
would make things better.

The reduction in volatility is expected to come with a cost.
Whether it is worth it is up to each investor.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by dl7848 »

Louis Winthorpe III wrote:
Premise: 60-40 earns the same returns as an all stock portfolio with about half the risk. The article acknowledges lower absolute returns but mentions behavioral reasons why many investors won't realize the higher returns of an all stock portfolio.
Besides the obvious behavioral error of selling at the bottom out of fear, here are some other non-economic reasons (some of them economic as well) for going with a balanced portfolio:

1. Health issues. Risk-takers always like to put on a macho front, but some suffer internally. How does one factor in health issues like ulcers, depression, etc. that might happen during a prolonged and/or deep stock decline?

2. Risks to marriage. What if your spouse has a different risk tolerance than you and it leads to acute confrontations during a prolonged market decline? There have been lesser reasons for divorces.

3. Planning for an early retirement may be unrealistic and combined with equity crashes can lead to undue self-pressure, and again, may lead to health issues and/or marital strife.

Bottom line for me is that 100% equity might be for a Type-A personality and Type-A personalities have risks in and of themselves.

Why not be a little more Type-B and relax and enjoy life? ...and benefit from the "buffering" effect that an equity portfolio balanced by bonds can provide?
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by linenfort »

Those are some very good points!
I think something like #2 has come up a few times in the other subforum.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by azanon »

That article is way too oversimplified. He discusses "stocks" yet never clarifies (though it is quite easy to deduce) that he's referring to (very expensive) US stock, and that future US stock returns is likely to be much lower, which would be a fair estimation (Gordon equation, P/E 10, many other valuation techniques). That would be devastating except for the fact that foreign stock has been largely estimated to be "fair" value at worst, and most likely slightly on the cheap side (google Meb Faber, gurufocus articles on foreign stock valuations). And when you're talking about equities at fair valuations in just about any part of the world (give or take less than 1%), your looking in the 6.5% real return neighborhood (Source: SFTLY, 100s of others on the net).

So provided you avoid expensive stock, I fail to see how a 100% portfolio of fairly valued, or even cheap stock is going to underperform a 60/40 where bonds, which should return roughly 0-1% real (where's that coming from? I noticed bond yields are strangely similar to the inflation rate, so there's the 0% real. But I'm willing to go as high as 1% real since over very long term, that's what you get with ST treasuries).

The only logical reason to lower stock allocation is a sub 5 year time horizon (again, source SFTLR), or because one just doesn't need the higher return to accomplish a goal (see Swedroe's "need" discussions). If there are behavioral issues, I'd suggest either a therapist, or turning over your asset management to a fee only financial adviser. Rephrased, if you're selling at the bottom, the problem isn't your allocation, the problem is YOU!

And for the risk/return discussion in the thread, I always get confused as to what someone means by risk. Is it volatility risk or what Dr. Bernstein calls "shallow risk", or inflation risk/risk of not meeting goals "deep risk". It's the latter that always scares me, but it seems like every time I see this brought up, most seem to be usually referring to the less relevant, former kind. From my studies, equities give high return and low risk (again, I'm referring to the latter kind of risk), so both sides of that coin are really nice.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by gisborne »

1. Selling stocks when the market dips isn't inherently bad. Say you're 100% stocks and you decrease to 60/40 when the market drops, that's still going to outperform a 60/40 allocation that never changes.
2. Why do people continuously assume that scared investors can reverse-time the market and always sell out at the bottom? What a great way to make billions: have your buddy who is timid invest $10,000 all in stocks. When he sells he'll sell at the bottom so you invest in some call options and win...
3. If you're not selling out at the bottom then you're avoiding some (sometimes significant) losses. In fact, you're almost as likely to avoid losses in the short term as lose out on gains. All you really lose in the long run is the expected return for the given time you stayed out of stocks. This can be bad but not nearly as bad as many people make it out to be.
4. Someone who's going to sell out of stocks with 100% allocation is probably going to sell out of stocks with 60/40 or 80/20 as well. As someone else pointed out, a 50% drop in the market will be a 30% drop in a 60/40 portfolio. Bonds don't help you avoid losses entirely.
5. There is no rebalancing bonus. More market timing mumbo-jumbo in disguise.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by Index Fan »

Stonebr wrote:
sambb wrote:The key is staying the course - if you look at this board in 2007-9, you will see that many did cut back at market lows. I think that is less likely in a 60/40 mix. Asset allocation is not always fixed, and people can guess wrong at the wrong time.
Yeah. There was talk about "Plan B" on bogleheads -- right around the market lows in March, 2009.

This is a very important point. Everyone coming to this board should be aware of the Boglehead 'Plan B' talk during market lows, because it was never talked about before that.

Great article.
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by RunningRad »

Stonebr wrote:More on this topic from a classic article by Peter Bernstein:

http://web.archive.org/web/200612140619 ... in6040.pdf
Thank you for reposting. An excellent read, one that should be revisited regularly.
Few decisions in life motivated by greed ever have happy outcomes--Peter Bernstein, The 60/40 Solution
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by rca1824 »

60/40 does not produce the same returns. It largely depends upon the period:

average returns for equity/bonds over different years

Code: Select all

equity       1      3      5      7     10     15     20     25     30     40     50     75
   60%   8.24%  7.69%  7.79%  7.90%  8.07%  8.38%  8.66%  8.79%  8.80%  8.63%  8.66%  8.17%
  100%  11.37%  9.91%  9.94% 10.05% 10.29% 10.73% 11.11% 11.22% 11.14% 10.77% 10.84% 10.38%
standard deviation
   60%  11.93%  6.85%  5.20%  4.13%  3.63%  2.92%  2.19%  1.54%  1.06%  0.96%  1.04%  0.33%
  100%  19.82% 11.32%  8.50%  6.57%  5.74%  4.56%  3.35%  2.26%  1.33%  1.04%  1.50%  0.60%
worst case scenario
   60% -27.33%-15.21% -5.37%  0.24%  1.80%  2.18%  3.48%  5.04%  6.58%  6.65%  6.24%  8.21%
  100% -43.84%-27.30%-12.71% -4.01% -1.67% -0.20%  2.37%  5.22%  7.97%  8.45%  7.39%  9.45%
60/40 never has as high average returns.
60/40 never has 1/2 the risk, it hovers closer to 2/3.
But why does standard deviation matter when after 25 years, 100% equity dominates 60/40 in the worst case scenario?

I think a more accurate way to assess risk/return is to look at the average returns minus one standard deviation unit. This gives about the 15th percentile returns:

Code: Select all

equity       1      3      5      7     10     15     20     25     30     40     50     75
   60%  -3.69%  0.85%  2.59%  3.78%  4.43%  5.46%  6.47%  7.25%  7.73%  7.67%  7.62%  7.84%
  100%  -8.45% -1.42%  1.44%  3.48%  4.55%  6.17%  7.76%  8.96%  9.81%  9.73%  9.34%  9.78%
Here we can see the 15th percentile returns for 100% equity dominates 60/40 after ~13.5 years.

The optimal asset allocation is highly depend on your investment horizon.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Article: 60/40 produces "same" return with ~half the ri

Post by rkhusky »

gisborne wrote:Selling stocks when the market dips isn't inherently bad. Say you're 100% stocks and you decrease to 60/40 when the market drops, that's still going to outperform a 60/40 allocation that never changes.
That is not always true. It depends on your investing horizon and individual circumstances. While it may be true on average over a long period of time, there will be people for whom it is not true even over a long period of time and there will be even more people for whom it is not true over a short period of time.

Think of bonds like insurance. On average, insurance companies make money over long periods of time. Therefore, on average, people who buy insurance are losing money. However, we buy insurance in case we are one of the few who encounters a catastrophic situation - house burns down, get in an accident, are diagnosed with cancer, etc. On average, these things probably won't happen very often, but if they do, we want to be covered.

On average, the more stocks you have, the higher your returns. But there will always be time periods when that it is not true. And if that time period coincides with other important events in your life, such as retirement, you could regret it.
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