Asset allocation strategies at very large sums

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johnanglemen
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Asset allocation strategies at very large sums

Post by johnanglemen »

Say you had $100 million and lived according to the following principles:

(a) You need $5 million for yourself to live a happy and fulfilling life.
(b) You want to grow your money as much as possible to leave to your heirs and charity.
(c) You are willing and able to tolerate extreme volatility to secure this growth, and will not touch the funds throughout all market crashes.

Let's not argue about the principles themselves. It is completely reasonable that some people with $100 million would stick it all in a CD and live peacefully forever, but I also think the above framework is reasonable.

So, given these principles, it seems like this might be a fitting allocation strategy: Hold an amount in equities such that even if stocks fell 95%, you'd still have $5 million left over.

This would imply that on day 1, you'd put 100% of your money ($100 million) in equities.

Now what happens if equities keep going up? If your money subsequently grew to $110 million, you would hold 100.5% of your money ($110,555,555) in equities. The additional $555,555 would be borrowed on margin (at super-low Interactive Brokers rates). Again, the net result would be that you'd have $5 million if stocks fell by 95%, even with a full margin call.

But what happens when equities fall? For instance, say equities fall 20%, and now you've got $80 million in equities. If stocks lost 95% from this new position, you'd have $4 million, violating principle (a). So do you rebalance a portion of your funds into something safer, like bonds? This would seem to violate principle (c) -- don't touch the funds during a market crash, don't buy high and sell low.

What is the "right" way to think about this?
Last edited by johnanglemen on Sun Apr 19, 2015 11:00 am, edited 1 time in total.
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johnanglemen
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Re: Asset allocation strategies at very large sums

Post by johnanglemen »

I suppose there's a more general question here that doesn't require large sums. People who talk about 100% stock portfolios talk about being mentally prepared to lose 70-90% of their money. But what is the reference point for this? Is it 70-90% of the portfolio's peak value? Why isn't it 70-90% of the portfolio's value at any given moment?
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Peter Foley
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Re: Asset allocation strategies at very large sums

Post by Peter Foley »

Regardless of the amount of money, if you had 20 times more than you needed, a valid approach would be to set aside the amount that you need in "safe" investments and put the rest in equities. One might characterize this as a two bucket approach.

Imagine you had a pension that was inflation adjusted and social security benefits. You need only $10,000 in additional income per year to fund you needs and desires. You plan for 30 years of retirement. You need $300,000. You have $6,000,000. The situation is no different than the one you described. $300,000 in TIPS (or a CD ladder or ?) and the balance in stocks for heirs.
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johnanglemen
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Re: Asset allocation strategies at very large sums

Post by johnanglemen »

Peter Foley wrote:Regardless of the amount of money, if you had 20 times more than you needed, a valid approach would be to set aside the amount that you need in "safe" investments and put the rest in equities. One might characterize this as a two bucket approach.

Imagine you had a pension that was inflation adjusted and social security benefits. You need only $10,000 in additional income per year to fund you needs and desires. You plan for 30 years of retirement. You need $300,000. You have $6,000,000. The situation is no different than the one you described. $300,000 in TIPS (or a CD ladder or ?) and the balance in stocks for heirs.
I thought about this, but it actually seems too "conservative" for the facts here. The overall stock market (i.e. the world economy) will never go completely to zero, so if you're able to get to your "need" amount even at a 95% decline, then it seems unnecessary to me to maintain a separate bucket.

However, I'm trying to understand what to measure that 95% "decline" against.
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Maynard F. Speer
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Re: Asset allocation strategies at very large sums

Post by Maynard F. Speer »

Well this is how the big university endowment portfolios are run - they manage $billions; they have to take a regular amount out; and they have to be able to stand up to market melt-downs (which - although we've been lucky recently - can last 20-30 years, or indefinitely, if the global economy stops working .. Japan's meltdown from the 80s could be an example)

So they stay very diversified - avoiding too much concentration in any one asset class ... And despite this, they (the top ones) tend to comfortably beat the stock market ... They might also keep 5% in bonds/cash which is essentially your $5m spending money

A recent Yale portfolio breakdown - built on Efficient Frontiers models, so mixes high risk (such as private equity) with low risk (such as absolute return) in a very congruent and stable way

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Clive
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Re: Asset allocation strategies at very large sums

Post by Clive »

Maynard F. Speer wrote:Japan's meltdown from the 80s could be an example)
1990's 'crash' ???

Which - like the Wall Street Crash (1930's), was precursored by massive booms ("Roaring 20's") - where stock prices doubled, doubled again and doubled yet again during the 1980's decade or so.
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stemikger
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Re: Asset allocation strategies at very large sums

Post by stemikger »

Warren Buffett was talking about LeBron James asking him for advice and he seriously said that he would give him the same advice he gave in his 2013 Berkshire Hathaway Annual Letter to Shareholders. Hold enough in cash to feel secure and put the rest in a low cost equity index fund that buys America. He did add that in Lebron's case he would advise him to hold more cash than most people because of his lifestyle.

In the same letter, he said he is putting his money where his mouth is and is leaving 10% in treasuries and 90% in the Vanguard 500 Index for his wife if he predeceases her. I'm not sure where I heard this, but I heard he is leaving his wife $10 million, but I'm not sure how accurate this is. He can't leave her Berkshire stock because he is giving it all away to charity. I also heard he is leaving $10 million for each of his children, but again that may not be accurate.
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Maynard F. Speer
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Re: Asset allocation strategies at very large sums

Post by Maynard F. Speer »

Clive wrote:
Maynard F. Speer wrote:Japan's meltdown from the 80s could be an example)
1990's 'crash' ???

Which - like the Wall Street Crash (1930's), was precursored by massive booms ("Roaring 20's") - where stock prices doubled, doubled again and doubled yet again during the 1980's decade or so.
Meltdown from the highs of the 80s - and the peak was right on the cusp ..

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That was a CAPE ratio 100, but we've had drawn out meltdowns from (I think) valuations comparable to the US's today .. And the debt problem today is obviously much worse than it was in 2007 .. There's also a $700 trillion derivatives bubble that could bring the whole economy down .. And bond funds could cause problems - with capital flight, a lot of industries (such as insurance) could be brought down, triggering a domino effect ... So I think there's a lot poised to go wrong thanks to post-crisis monetary policy
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dbr
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Re: Asset allocation strategies at very large sums

Post by dbr »

johnanglemen wrote:Say you had $100 million and lived according to the following principles:

(a) You need $5 million for yourself to live a happy and fulfilling life.
(b) You want to grow your money as much as possible to leave to your heirs and charity.
(c) You are willing and able to tolerate extreme volatility to secure this growth, and will not touch the funds throughout all market crashes.
I think if the conditions you state are to be taken seriously you should start by setting aside the $5mil into an inflation indexed annuity or annuities (nearly perfect guarantee, and actually you could get the same income from half the money that you could reliably withdraw from CDs and bonds). Then you should investigate ways to earn serious wealth at high risk rather than playing the penny-ante game of investing in index stock funds. Leading possibility would be buying in as a partner at an innovative tech company and leverage your wealth into a successful business and cash out in an IPO. None of the really wealthy people in the world grow wealth with true ambition by settling for stock market averages.
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johnanglemen
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Re: Asset allocation strategies at very large sums

Post by johnanglemen »

There are a lot of tangential conversations happening here, but I was asking a very specific question, so going to try to steer it back to that. If you did follow the strategy outlined in the post -- hold enough stock such that you'd have $5M left over in a 95% crash -- what would you do *during* the crash, on the way down? Would you keep rebalancing such that you'd continue to have $5M left over during a fresh 95% crash at any point (which would imply moving from a riskier allocation to a conservative allocation during the crash, which feels wrong) or would you maintain your allocation and say that you just need to survive a 95% crash from the portfolio high point (which also feels wrong somehow, since it references an arbitrary watermark rather than minding your actual exposure at any given moment)?
Last edited by johnanglemen on Sun Apr 19, 2015 10:22 am, edited 1 time in total.
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johnanglemen
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Re: Asset allocation strategies at very large sums

Post by johnanglemen »

stemikger wrote:Warren Buffett was talking about LeBron James asking him for advice and he seriously said that he would give him the same advice he gave in his 2013 Berkshire Hathaway Annual Letter to Shareholders. Hold enough in cash to feel secure and put the rest in a low cost equity index fund that buys America. He did add that in Lebron's case he would advise him to hold more cash than most people because of his lifestyle.

In the same letter, he said he is putting his money where his mouth is and is leaving 10% in treasuries and 90% in the Vanguard 500 Index for his wife if he predeceases her. I'm not sure where I heard this, but I heard he is leaving his wife $10 million, but I'm not sure how accurate this is. He can't leave her Berkshire stock because he is giving it all away to charity. I also heard he is leaving $10 million for each of his children, but again that may not be accurate.
As mentioned earlier, I think there is a point at which this is actually too conservative. If you had $1 billion, there seems to me to be no reason at all to hold a "safe" allocation (cash, bonds, etc) because even if the stock market dropped 99% and you were all in on stocks, you'd have $10 million left over.
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stemikger
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Re: Asset allocation strategies at very large sums

Post by stemikger »

johnanglemen wrote:
stemikger wrote:Warren Buffett was talking about LeBron James asking him for advice and he seriously said that he would give him the same advice he gave in his 2013 Berkshire Hathaway Annual Letter to Shareholders. Hold enough in cash to feel secure and put the rest in a low cost equity index fund that buys America. He did add that in Lebron's case he would advise him to hold more cash than most people because of his lifestyle.

In the same letter, he said he is putting his money where his mouth is and is leaving 10% in treasuries and 90% in the Vanguard 500 Index for his wife if he predeceases her. I'm not sure where I heard this, but I heard he is leaving his wife $10 million, but I'm not sure how accurate this is. He can't leave her Berkshire stock because he is giving it all away to charity. I also heard he is leaving $10 million for each of his children, but again that may not be accurate.
As mentioned earlier, I think there is a point at which this is actually too conservative. If you had $1 billion, there seems to me to be no reason at all to hold a "safe" allocation (cash, bonds, etc) because even if the stock market dropped 99% and you were all in on stocks, you'd have $10 million left over.
That would probably be Buffett's choice. He does not think cash is a good or safe investment, but he knows it makes people comfortable. If he had his way, he would be all equities. At least that's the way I understand it when he gives this advice on numerous You Tube videos. The cash or treasuries part of the advice is for us mere mortals.

As a Boglehead, not that I have to worry about a large sum, I'll just stay the course with my 65/35 AA and Stay the Course.
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Maynard F. Speer
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Re: Asset allocation strategies at very large sums

Post by Maynard F. Speer »

Warren Buffett's stance comes down to a steadfast belief in the US economy ... Whatever way you slice it, it's a conviction perspective (that could have the rug pulled out from under it), and it's the perspective of someone who's spent the best part of a century investing in US companies

Personally, if I had $1bn, I'd not be willing to lose 50% of it in a crash, let alone 90-99% .. down to $10 million and you'd go from being one of the richest people in the country to being unable to afford to live in many parts of London .. The endowment approach is what some of the best minds (economists, statisticians, scientists) in the country can come up with, as far as growing capital whilst protecting it from unforeseen worst-case-scenarios ..

Re: What would you do on the way down? Well you wouldn't achieve much rebalancing 5% cash into 95% stocks - especially not knowing when you'd hit the bottom .. chances are you'd rebalance and wind up whittling that $5m down to <$2.5m in the process ... So keep a cash buffer - a bottom 5% of a portfolio cordoned off for spending ... I know there's a level of cash I wouldn't go down beyond ... Which is why it's useful to have multiple asset classes: limits how much downside your portfolio's likely to get ..
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Re: Asset allocation strategies at very large sums

Post by midareff »

Seems to me that if you invested using a standard efficient frontier of US and International Index Funds your distributed dividends would be roughly $2M annually. If you were going to use $5M for your life, assuming that was 30 years, that would be roughly $166K annually, assuming zero growth. Looks like staying 100% equities and at the end of year 1 you could have paid $650,000 in tax, reinvested $1M, had your $166K to live on and have established near $166K in a cash slush fund and have more annual distributions coming than you could possibly use.
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