Age in Stocks: Should you have a Reverse Glidepath?

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berntson
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Age in Stocks: Should you have a Reverse Glidepath?

Post by berntson »

What would happen if we turned conventional wisdom on its head and had investors hold more bonds when they are young and more stocks when they are old?

Javier Estrada answers precisely this question in a recent paper. He compares the results for traditional investors who start out with (say) 80 percent in stocks and end with 20 percent with the results for reverse investors who do precisely the opposite.

Traditional glidepaths have a conservative bias. They tell investors to be aggressive when they have are young and have a low portfolio balance and to be aggressive when they are old and have a high portfolio balance. So not surprisingly, reverse investors in the US between 1900 and 2013 ended up with more wealth at retirement on average (both the median and the mean were higher).

Here is the surprisingly thing: Reverse glidepaths are safer than traditional glidepaths. Even in the worst case scenarios, reverse investors ended up with more wealth than traditional investors. [These results can be found in exhibit one of the linked paper.]

I can already hear the complaints. "Reverse glide paths only worked in the US because we got lucky. Just try doing that in rest of the world!"

Well, let's do that. Estrada looks at traditional and reverse glidepaths between 1900 and 2013 in nineteen different countries. And the results are the same. Not only do reverse glidepaths leave investors with more wealth on average, they also leave investors with more wealth in worst case scenarios.

But there are more complains. "Holding so much in stocks right before retirement means that you could suffer huge losses at the worst possible time. That's can't make sense!" Here is what Estrada says.
The alternative strategies considered here are more likely to surprise investors with a bigger drop than lifecycle strategies by the end of an investor’s working life. But, critically important, this potential higher drop should be more than offset by earlier larger gains. In other words, the better investment results accumulated over a working lifetime are likely to more than offset potential bad luck at the end of the road. An investor following the alternative strategies discussed here may be knock down more than another following a lifecycle strategy, but will fall from a much higher place thus ultimately ending better off.
What do you think? Would you ever consider using or recommending a reverse glidepath? Is there anything we can say in defense of traditional glidepaths?
Last edited by berntson on Mon Sep 01, 2014 10:13 am, edited 1 time in total.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by Call_Me_Op »

There is a certain amount of logic to this, but I really don't like glide-paths personally. I prefer to hold an all-weather portfolio at all times.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by 555 »

This has been thoroughly debunked repeatedly. The reverse glidepath is a much higher stock allocation on average in the long run, so it's not surprising that average balance are higher. That's all there is to it.

Also a sensible allocation in retirement depends on your balance. If you have far more than you need you can just about have any allocation you like.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by berntson »

Call_Me_Op wrote:There is a certain amount of logic to this, but I really don't like glide-paths personally. I prefer to hold an all-weather portfolio at all times.
I actually agree. There are experts on both sides of the tradition vs reverse glidepath debate. One great response is to split the difference and go with simplicity: holding a constant asset allocation. This is what I do for my portfolio.

The reverse glidepath literature is interesting to me because it shows how little basis there is for conventional wisdom about glidepaths. Traditional glidepaths do not clearly make your portfolio safer. In fact, a good argument can be made that it leads to both lower average returns and lower returns in worst case scenarios.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by berntson »

555 wrote:This has been thoroughly debunked repeatedly. The reverse glidepath is a much higher stock allocation on average in the long run, so it's not surprising that average balance are higher. That's all there is to it.
The interesting point is not that reverse glidepaths lead to higher average ending balances. The interesting point is that reverse glidepath investors have more money in even the worst case scenarios. So traditional glidepaths leave investors with both lower returns and more risk.

[I'm being a bit simplistic. There are lots of ways to define risk, so I'm sure posters will come up with ways in which the reverse glidepath is more risky. All the more reason I say to split the difference and hold a fixed allocation.]
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by k66 »

There is also a cousin to this approach which, I think, also has some rational traction. In recent papers and articles, M.Kitces, W.Pfau et al have demonstrated that a rising glide path during retirement would ultimately be better for retireees. One would implement this approach by selling down bonds (allowing %EQ to increase) -- or maybe more likely, selling down bonds in higher proportions to equities to meet the intended path.

Here is a recent article in AAII on this topic by Kitces and Pfau:

http://www.aaii.com/journal/article/red ... ncrease-it

Their calculated optimal path start at 30% Equities at retirement (which would roughly match "age in bonds" if one retired in their mid- to late-sixies) to 70% equities 30 years hence. However, as their output also shows, there is little sensitivity in many of the initial-final equity pairings. For example, going from 70% down to 30% over the same time frame results in over 92% success rate (compared to 95% success for the 30:70 path). In fact, maybe a constant path is just as good; going on a 50:50 path apparently yields a 94% success rate.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by 555 »

berntson wrote:The reverse glidepath literature is interesting to me because it shows how little basis there is for conventional wisdom about glidepaths.
Nonsense. If you include human capital in your allocation, then a constant allocation including human capital corresponds to a traditional glidepath for your assets other than human capital. There is a simple logical basis for a traditional glidepath. The reverse glidepath is just a gimmick.

Also you didn't addess my 2nd point.
555 wrote:Also a sensible allocation in retirement depends on your balance. If you have far more than you need you can just about have any allocation you like.
The more successful you are, the more risk you can afford to take.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by berntson »

555 wrote:Also a sensible allocation in retirement depends on your balance. If you have far more than you need you can just about have any allocation you like. The more successful you are, the more risk you can afford to take.
Ah, you're making a point about post retirement asset allocation. The paper I discuss only looks at preretirement glidepaths. This is where k66's nice contribution comes in. The linked paper presents evidence that given an equal starting balance, increasing stock allocations in retirement lowers the failure rate. Here's a nice chart of the failure rate of starting and ending equity allocations in retirement.

Image

Age in bonds corresponds to the 60-30 glidepath. Age in stocks to the 60-90 glidepath. As you can see, there's a slightly lower failure rate for 60-30 than 60-90. The problem is that this chart assumes a 4% withdrawal rate for both strategies. But an investor who uses age in stock during accumulation will have a 15% larger portfolio (both on average and in the worse case scenarios...see figure one from my link). So the 60-90 glidepath can use a 3.5% withdrawal rate instead of a 4% withdrawal rate. If we account for the larger balance at retirement, I suspect that the age in stocks strategy has an overall lower failure rate, though someone should actually test this.

It looks like the very safest strategy is something like going from 20/80 to 80/20 before retirement, dropping the stock allocation to 20/80 at retirement, then increasing it back to 80/20 through retirement. Taxable investors of course need to take into account the tax implications. This is where the constant asset allocation really shines. There's no need to sell stocks (and realize gains) to change your asset allocation.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by nisiprius »

Before advocating high stock allocations for older retirees, one should also take into account a factor: negative "wealth shocks" may be hazardous to the health of the elderly.

How wealth shocks affect the health of the elderly
Wealth Shocks and Health Outcomes: Evidence from Stock Market Fluctuations

This reinforces some traditional wisdom, such as:
In 'Of Human Bondage,' Somerset Maugham wrote:...people don't commit suicide for love, as you'd expect, that's just a fancy of novelists; they commit suicide because they haven't got any money.
In 'The Way of All Flesh,' Samuel Butler wrote:It is only on having actually lost money that one realises what an awful thing the loss of it is, and finds out how easily it is lost by those who venture out of the middle of the most beaten path.... Suicide is a common consequence of money losses; it is rarely sought as a means of escape from bodily suffering.
The loss of money can be a serious business and putting elderly retirees into a stock allocation higher than their own expressed preferences--verges on irresponsibility.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by ourbrooks »

555 wrote:
berntson wrote:The reverse glidepath literature is interesting to me because it shows how little basis there is for conventional wisdom about glidepaths.
Nonsense. If you include human capital in your allocation, then a constant allocation including human capital corresponds to a traditional glidepath for your assets other than human capital. There is a simple logical basis for a traditional glidepath. The reverse glidepath is just a gimmick.
Actually, if you take human capital into account, the traditional glidepath has you moving to investments with lower returns when your human capital is depleted. Huh? To make up for the loss of your human capital and its returns, you ought to be moving the other way, to investments with higher returns.

Is the "simple logical basis" for a traditional glidepath that it reduces risk? Well, if it's risk of running out of money before you die, then it doesn't do what it's supposed to do. Yup, it does give you a less volatile account balance but it does that at the cost of lower returns, which increase the odds of running out of money.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by sport »

These conclusions are based on historical data. We don't know that future markets will give the same result. In addition, many retirees (perhaps most), feel that when they have achieved sufficient resources to fund a comfortable retirement, their primary objective is capital preservation, aka, don't mess up a good thing. While having higher stock allocations may provide more portfolio growth, this growth is much less important than maintaining a good situation. Sometimes "enough" is better than "more".
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by 555 »

berntson wrote:But an investor who uses age in stock during accumulation will have a 15% larger portfolio (both on average and in the worse case scenarios...see figure one from my link).
This is just the usual "more risk, more (expected) reward" situation. The ones with 15% larger portfolio have generally taken more risk to get there. It's not an apples to apples comparison.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by nisiprius »

berntson wrote:...The linked paper presents evidence that given an equal starting balance, increasing stock allocations in retirement lowers the failure rate...
The problem with many such studies is that they go at it backwards. They start from some arbitrarily chosen withdrawal rate first. They should start with risk tolerance first. One should begin by exploring carefully what "failure rate" is really acceptable to retirees, without anchoring the choice by offering preselected alternatives. Is 5% low enough? It is higher than the chances of rolling snake-eyes. Are most retirees willing to take that chance of watching their portfolio shrink sharply and having to make a wrenching change in plan? If they are, then, sure, they are.

The characteristics of conservative assets is both low return and predictability. Predictable is another way of saying they have a steep, sharp, well-defined relationship between withdrawal rate and failure rate. Stay slightly under that they can deliver and the failure rate is very low. Exceed it slightly and the failure rate is very high. The extreme is physical cash under the mattress. $1,000,000 in cash over a 30-year time period it will sustain withdrawals of $33,333 per year with 0% failure rate, while $33,334 per year gives a 100% failure rate.

Stocks and other high-risk, high-return assets have a fuzzy edge. They have almost no upper limit to the amount they can deliver, given good luck. As withdrawal rate increases, failure rate tapers off slowly, with no "cliff edge."

The result is that the effect of adding stocks depends on how aggressive the withdrawal rate chosen is.

Simplistically, if the withdrawal rate is reasonably within what bonds can deliver, then stocks are not needed, do not reduce failure rate, and failure rate is low. If the withdrawal rate outside the range that bonds can deliver, then stocks are needed, do reduce failure rate--and failure rate is high even with the best possible allocation.

The extreme case is a withdrawal rate of, let's say, 50% per year. For any portfolio of stocks and bonds, the historical failure rate will be 100%. However, if you add lottery tickets to the portfolio, the portfolio will succeed if the retiree wins the lottery. Therefore, with lottery tickets, the failure rate will be less than 100% and it will be accurate to say that "higher allocations of lottery tickets reduce the failure rate."

The reason why nobody seriously suggests this is that nobody thinks that a 99.999% failure rate is acceptable, even if it is lower than 100%.

However, statements that "stocks reduced the failure rate" has to be evaluated with regard to what the reduced failure rate was. Kitces and Pfau choose to use the "5th percentile," i.e. 5% failure rate. For example, using 20->80 cut the failure rate from 8.9% to 5%. This is great if 5% is acceptable. But where do they explain why they chose 5%? Did they interview retirees?

Would the study have shown the same benefits for a reverse glidepath if the acceptable failure rate had been set at "snake-eyes," 2.78%, and the withdrawal level reduced accordingly?

Whenever I have looked at studies that offered a wide choice of withdrawal rates and portfolios, the results I've seen have always been the same. At low withdrawal rates, the failure rate is practically independent of stock allocation. The effect that "stocks reduce failure rate" is not seen. At high withdrawal rates, the failure rates are lowER with a high stock allocation, yet still "high" relative to some investors' risk tolerance.

So, as always, it boils down to an issue of risk versus return, and the retiree's risk tolerance. A retiree who is willing to accept higher risk for higher return selects a higher stock allocation, uses a higher withdrawal rate, and experiences a higher failure rate. A retiree who is risk-averse and is willing to accept a lower withdrawal rate--and it is not that much lower--does not benefit from a high stock allocation (although their heirs may).

The big problem is that so many published studies start out by sneaking in an assumption that they already know the retiree's risk tolerance, and that it is relatively high.

This flies in the face of the common observation that many retirees choose to hold their entire retirement savings "portfolio" in a bank account. A common interpretation is that they are fools who do not know what is best for them, but perhaps they are better in touch with their own risk tolerance than some retirement advisors are.
Last edited by nisiprius on Mon Sep 01, 2014 2:03 pm, edited 4 times in total.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by Garco »

Upward, downward; downward, upward. Kitces and Pfau's approach, which I think of as a "bowtie" shape, makes sense to me. As I'm just on the cusp of retiring, I'm at the lowest equities percentage of my investing career. But I haven't moved to K & P's 20 or 30% stock allocation. Rather it's about 40%, across multiple tax qualified and taxable accounts some of which are 50-50 (tax qualified), some 80-20 (tax qualified), and some 20-80 (taxable). I expect to hold here for the next few years.

I wholeheartedly agree with this statement by 555: "... a sensible allocation in retirement depends on your balance. If you have far more than you need you can just about have any allocation you like." I'm not wealthy, but I've got a pretty substantial accumulation. So I'm using a strategy of risk moderation -- but not risk minimization.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by 555 »

Another point. You don't start adulthood choosing a glidepath(=age-based asset allocation) that you're going to stick with through thick and thin. Even assuming you are educated about all the issues, you may continually update your plans as circumstances change and new information arrives.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by trueblueky »

ourbrooks wrote: Actually, if you take human capital into account, the traditional glidepath has you moving to investments with lower returns when your human capital is depleted. Huh? To make up for the loss of your human capital and its returns, you ought to be moving the other way, to investments with higher returns.
When you have a lot of human capital (are young), you can afford to take risks with investments because you have time to make up any reverses. When you've depleted your human capital, you can't afford to take as much risk. You use your human capital to move consumption to a later period, that frequently means save for retirement.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by Dandy »

Of course a lot depends on the sequence of future equity returns, your financial position at the start of retirement, your retirement drawdown needs, your medical expense/insurance coverage etc. Over the long run equities should return more than a balanced portfolio. That fact tends to creep into "newer" ideas of how to invest for or in retirement. I take some comfort in back testing but not great comfort.

Once the earning power in close to the minimum wage and the retirement pot has to last 30 years of so - I'm not so taken with higher risk ideas even when "proven" by some respected people. Most people have a poor idea of their true risk tolerance - some of us learned a good lesson a few years back. Being in retirement and having zero earning power could be another test for knowing your true risk tolerance. How will you or your spouse handle a 50%+ drop in your retirement equity portfolio when your are increasing your withdrawals to meet higher medical costs etc. and the media is doing its hyping. It might be a lot harder to stay the course and sleep will with an increasing equity allocation.

Hard to tell. I might bump my equity position a bit later in retirement but I doubt I'll have a reverse glide path. I like Wm Bernstein's idea of securing your retirement with "safe" investment/savings and then deciding how to allocate the rest.
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Taylor Larimore
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by Taylor Larimore »

Bogleheads:

I think it is significant that target fund experts at ALL mutual fund companies (including Mr. Bogle) recommend decreasing our stock allocation as we get older.

In 1929 the Dow plunged 89%. I would feel very vulnerable if all my portfolio was in stocks.

Best wishes.
Taylor
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by Jebediah »

Estrada wrote:The alternative strategies considered here are more likely to surprise investors with a bigger drop than lifecycle strategies by the end of an investor’s working life. But, critically important, this potential higher drop should be more than offset by earlier larger gains. In other words, the better investment results accumulated over a working lifetime are likely to more than offset potential bad luck at the end of the road. An investor following the alternative strategies discussed here may be knock down more than another following a lifecycle strategy, but will fall from a much higher place thus ultimately ending better off.
Oh my lord, this is so absurd. Yeah he "discovered" that holding more equity in a century of good equity returns netted higher returns. Maybe for his next paper he'll "discover" that if you held 100% equities constant you would've beat all glidepaths because, once again, you would've made billions before you lost millions. Good job, professor! :beer
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by grabiner »

ourbrooks wrote:Actually, if you take human capital into account, the traditional glidepath has you moving to investments with lower returns when your human capital is depleted. Huh? To make up for the loss of your human capital and its returns, you ought to be moving the other way, to investments with higher returns.
The logical basis for a traditional glidepath is adjusting risk based on your human capital; you should take more risk with your investment capital when you have a lot of lower-risk human capital. If you lose 25% of your portfolio when 80% of your retirement will come from your human capital, that is only a 4% loss in your retirement income. If you lose 25% of your portfolio when you are retired and have no human capital, that is a 25% loss in your retirement income.

For this to make sense, you need to have low-risk human capital: a secure job (or skill set which will make employment easy to find in a recession), and disability insurance to cover any loss of human capital. It would make sense for an investment banker to have a bond-heavy portfolio early in her career because her human capital is tied to the stock market.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by berntson »

nisiprius wrote: The problem with many such studies is that they go at it backwards. They start from some arbitrarily chosen withdrawal rate first. They should start with risk tolerance first. One should begin by exploring carefully what "failure rate" is really acceptable to retirees, without anchoring the choice by offering preselected alternatives. Is 5% low enough? It is higher than the chances of rolling snake-eyes. Are most retirees willing to take that chance of watching their portfolio shrink sharply and having to make a wrenching change in plan? If they are, then, sure, they are....
This is a really nice post. Everyone should read it. At least twice.

Maybe studies are implicitly assuming that retirees are "consumption maximizing"? They assume that a high priority for retirees is spending as much of their retirement funds as possible. This is one of the things that leads certain academics (cough...Pau...cough...) to conclude that retirees should use reverse mortgages. After all, not mortgaging your house means you're leaving possible spending on the table. :oops:

Maybe studies are assuming that retirees usually only barely have enough for retirement? You can only choose a 3% withdrawal rate if you have saved enough to live on a 3% withdrawal rate. If you only have 25 years of barely-making-it expenses saved up, then it doesn't matter if you don't like a 5% chance at failure. That's the best you're gonna do, so you better use an increasing glidepath.
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Re: Age in Stocks: Should you have a Reverse Glidepath?

Post by k66 »

berntson wrote:
nisiprius wrote: The problem with many such studies is that they go at it backwards. They start from some arbitrarily chosen withdrawal rate first. They should start with risk tolerance first. One should begin by exploring carefully what "failure rate" is really acceptable to retirees, without anchoring the choice by offering preselected alternatives. Is 5% low enough? It is higher than the chances of rolling snake-eyes. Are most retirees willing to take that chance of watching their portfolio shrink sharply and having to make a wrenching change in plan? If they are, then, sure, they are....
This is a really nice post. Everyone should read it. At least twice.
I agree. Nisiprius' posts are very thought-provoking and well-organized but I would offer that, at least for myself, retirement planning is not meant to be an entirely rigid framework. I have absolutely no idea what my own risk tolerance is now or what it will be in the future -- at least risk tolerance expressed as some quantifiable number like the Wattage of a lightbulb. In looking through these types of studies, I can't say that 95% success (5% failure) is acceptable, only that it is better than 93% and not as good as 97%. So, with that, perhaps all we can really do is generalize about which is better (or worse) rather than which is acceptable or not.

In looking at the Kitces and Pfau "Table 1", they express their results as a "heat map" -- allowing one to see the potential and apparently consistent advantage to a rising (equities) glide path during retirement.

Image

But, as was also pointed out by other posters above, this is only one slice of bread from a larger loaf that we can not otherwise see and assume that other slices would be generally the same as well. What if we do change the withdrawal rate (from 4%) and what if we do extend the terminal timeframe (from 30 years)? If we had these types of adjacent slices from the loaf, we could better see if there was some type of unsavoury "cliff" (as Nisiprius described it) in our bread.

If nothing else, a rising (or perhaps neutral) glide path is possibly the better way to control sequece of return risk at both the early and advanced stages of retirement regardless of what your own individual "tolerance of failure" quotent actually is.
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