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Bogleheads
Investing Advice Inspired by Jack Bogle
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bobcat2
Joined: 20 Feb 2007
Posts: 1571
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 Posted: Mon Feb 18, 2008 8:37 am Post subject: Teaching Investors to Tell Time |
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Alexei Bayer of Research magazine has a conversation with Zvi Bodie about financial planning, setting goals, and time horizons. | Quote: | Bodie readily admits that stocks are a good investment. All he says is that you can’t structure a stock portfolio to obtain required results at a specified future time with any degree of certainty....
Bodie is not opposed to stocks as an investment instrument — far from it. What Bodie advocates, and what he says financial advisors should be telling their clients, is that they need to take care of their basic needs first and foremost. They need to make sure that they meet their future financial obligations as they themselves define it, and with minimum risk. “Then, if you have money left over, by all means, buy stocks." |
Link to article:Teaching Investors to Tell Time
Bob K
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A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it. |
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greenspam
Joined: 26 Feb 2007
Posts: 145
Location: east coast
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| Posted: Mon Feb 18, 2008 9:14 am Post subject: |
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i generally like this approach, but you definitely need to save more because your expected return is less. but, i would rather save more and invest it conservativey than save less and put it all in the stock market.
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JDeeds
Joined: 19 Feb 2007
Posts: 64
Location: Texas
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| Posted: Mon Feb 18, 2008 9:23 am Post subject: |
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Common sense advice from Bodie, as usual.
It would seem to follow, then, that a retiree should convert a sufficient portion of his portfolio to an inflation-adjusted annuity to cover his "floor" expenses and then invest anything left over in stocks or other higher return investments.
The reluctance of many investors to commit a lion's share of their savings to an annuity have been discussed here before. It's a good strategy, though, if your intention is to replace a DB pension.
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Jim |
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ajbibi
Joined: 07 May 2007
Posts: 195
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| Posted: Mon Feb 18, 2008 9:37 am Post subject: |
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This speaks to the mistaken notion that younger people with few assets "need" to take risk. It is sometimes said that if you're 20 years from retirement and have little saved, that you need to take risk, but if you have a couple of million dollars that you don't "need" to take risk. In my view this is inconsistent with the academic ideas that recommend indexing in the first place.
As a rule of thumb, the less you have, the more risk-averse you are more likely to be. The standard, "you have more so you don't need to take risk" inverts this by treating the richer individual as taking less risk. There are no reasonable models in which risk-aversion increases with increasing wealth/income.
The more correct argument is that the younger investor with a 30 year horizon has only a small fraction (say $10K) of total assets and lifetime income invested and is therefore risking little by investing all or most of it in equities. In contrast, a person with (let us say) $500K invested just two years prior to retirement who "needs" $1M should generally NOT take more risk than someone who already has 900K. You might say that the 500K individual "needs" to take more risk to achieve his goals. But, all else equal, the 500K individual should be more conservative with his portfolio than the 900K guy because he will suffer more if his portfolio goes down because he is nearer the baseline of his subsistence level.
Hence if you "need" to take more risk, you actually need to save more. Taking more risk may get you to where you're going but it may also bring you closer to ruin. If you weren't predisposed to take risks before, you shouldn't take more risk just because you "need" to.
Conversely, if you were willing to take on an 80/20 portfolio when you only had $500k you should still be 80/20 when you have $2M **assuming** that the $2M represents the same fraction of your total expected wealth. However this is not true for most. By the time the higher sum arrives, you have fewer years left in the labor force and the $2M represents a larger percentage of your likely total wealth. Hence you switch to more bonds not because you need to take less risk but because you're trying to keep your overall wealth portfolio (including non-financial assets and considering future income) at a similar risk level. |
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nisiprius
Joined: 26 Jul 2007
Posts: 7671
Location: North America; Western Hemisphere; the Earth; the Solar System; the Universe; the Mind of God
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| Posted: Mon Feb 18, 2008 9:43 am Post subject: |
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Note: ajbibi posted his note while I was composing this one... obviously I agree with him...
| Quote: | | "Sure, stock prices always come back after a dip," admits Bodie . "But if the dip happens when baby boomers are retiring, you’re going to hear from them. They have been led to believe that stocks are an inherently safe investment." |
I think this is right on.
You can always chop logic about what language is actually used by 401(k) "education" workbooks, magazine articles, etc. and whether boomers are misunderstanding, etc. but yes, I believe that many, many investors are underestimating the risk of stocks.
Part of the issue is an individual investor's ability to invest for the long term. People think "long term" means "over five years," as in | Quote: | Who should invest? ...
*Investors with a long-term investment horizon (at least five years). |
(Vanguard's statement about Vanguard Total Stock Market Index Fund). Or if not five years, then ten. Or certainly twenty. And even new retirees are going to live another twenty years, right?
But in fact I, for one, did not start socking away substantial savings until I was in my forties, and I'm going to start drawing it down soon. If you were to draw a curve of assets versus time, it probably looks like a pyramid with a base of forty years. When it's all over, the length of time my average dollar will have been in the market is probably only twenty years or less.
I think what people need to do is layer their assets, not by time (as in buckets of money) but earmarked by different degrees of risk. Define essential expenses as those such that not meeting them would require life-wrenching changes in plans... a change for the worse. Food, clothing, shelter, maybe a car, and probably Medicare supplemental.
It seems prudent to me to meet these with a combination of low-risk sources of income: Social Security, income annuities, TIPS, bonds, that kind of stuff. Equities should be reserved for amenities and luxuries... the part of your plan where you say "I'm willing to play craps and take a risk of living less well than I planned in order to have a pretty good darn good chance of living better than I planned."
I don't think this is how boomers are planning. I think they honestly believe... have been led to believe... that you can count on the stock market delivering when you need it, as long as that's a couple of decades in the future.
And that they work backwards from their desired retirement income to the amount they need to save, based on "historical returns" of the stock market.
I get concerned that that if the numbers don't work out, the conventional wisdom is "take on more risk." All your dreams can still come true, just load up your portfolio with more and more equities.
It seems to me that step one in planning should be to make a real, honest assessment of one's risk tolerance. Followed by a serious, long hard look at the inflation-adjusted dividend-reinvested growth of equities--one that does not involve glancing away from the Great Depression and the 1960s and 1970s and pretending that they never happened.
The evidence of this board seems to be that many people get seriously upset by a 10% or 15% decline in their portfolio's value over a period of a year. (BTW I happen to be one of those people, but I know it and I've never kidded myself about it).
Whatever one's risk tolerance is, that should be the starting point. Only then should you work forward. If you can't "meet your financial goals" with the amount of risk that's tolerable for you, then either save more or admit that those goals aren't realistic.
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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.
Last edited by nisiprius on Mon Feb 18, 2008 2:23 pm; edited 1 time in total |
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retired at 48
Joined: 15 Jan 2008
Posts: 1726
Location: Saratoga NY; Port Saint Lucie, FL
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| Posted: Mon Feb 18, 2008 10:03 am Post subject: |
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bobcat...thanks for link
Theme seems to be one should convert to bonds to better lock in or securely fix retirement needs.
The dilemma is that as baby boomers plan to retire, they are finding bond yields so low that it takes a much larger amount to retire. I was thankful in 1993 to have about 8%, AAA , 30 year noncallable bonds available upon which to base an early retirement.
And as more and more boomers convert to bonds (like China buying treasuries), it further drives the rates down. Some studies suggest this boomer conversion to bonds will not adversely affect stock market, but who knows. I recently increased my bond allocation, now about 55/45, smallest equity position ever. I have fared well trying to stay one step ahead of the boomers.
Retired at 48 |
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bob u.
Joined: 23 Feb 2007
Posts: 2049
Location: east lansing, mi
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| Posted: Mon Feb 18, 2008 11:06 am Post subject: |
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Help!
As a retiree, I walk much of the walk Bodie recommends, but there's one sentence in this piece (not Bodie's, but the author's) that totally mystifies me.
Under the heading Conventional Wisdom (2nd page of link), the author writes:
Of course this flies in the face of investors' gospel, especially in the world of index fund investment which we now inhabit, namely that equities over the long run are better investments.
How did the author manage to implicate index funds with equities for the long run. Is the author unaware that index funds are not limited to equity, that index funds hardly dominate what he calls the "investors' gospel," that index funds can combine nicely with other financial instruments to match long-term liabilities (you can match the duration of a bond fund with a liability)?
I know Bodie has repeatedly taken Jeremy Siegel to task, and I know Siegel thinks he's built a better mousetrap (e.g., Wisdom Tree ETFs), but I don't get the "shot" taken at index funds and I doubt it reflects Bodie's view.
Pehaps someone can 'splain the leap from "gospel" (whatever that means) to index funds to stocks in the long run. Thanks. Bob U. |
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bob90245
Joined: 19 Feb 2007
Posts: 3616
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| Posted: Mon Feb 18, 2008 11:50 am Post subject: |
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| I agree. Seems very confusing. |
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bobcat2
Joined: 20 Feb 2007
Posts: 1571
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| Posted: Mon Feb 18, 2008 5:43 pm Post subject: Seems very confusing |
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Hi to both Bobs,
This recent post by AzRunner is typical of the 'good' advice Bayer and Bodie are criticizing. | Quote: | Great interview of Jonathan Clements by IndexUniverse.com. Here in the first paragraph he summarizes his investment philosophy and defines himself as a sole brother with all Diehard indexers.
Index Universe (IU): What is your investment philosophy?
Clements: In essence, I think all investors should start by sitting down and asking themselves what mix of stocks and more-conservative investments they want to own, because that's going to be the principal driver of their portfolio's performance. And once they settle on that basic mix of stocks and more-conservative investments, they should devote all their energies to diversifying as best they can, reducing costs as much as they can and being as tax efficient as possible. If they do that, not only are they going to build a global portfolio, but also they'll inevitably end up investing in index funds. |
What Bodie is advocating is subtly, but significantly, different from the above ‘good’ advice. Notice that in Clements' advice there is no mention of goals or the timing of goals.
Bodie is recommending when investing to first pick financial goals and to plan for the timing of meeting those goals. You do this by making sure that your minimum acceptable target for those goals is met by investing in TIPS that mature in the target year. In taxable accounts you can substitute I-bonds. For college expenses you could invest in College Sure CD's or prepaid tuition plans. In retirement you could do this by investing in real annuities. All these methods allow you to match your assets to your liabilities with near certainty. Note that this matching cannot be done with bond mutual funds.
With the rest of your portfolio you can invest in some combination of risky and low risk assets, including up to 100% equity, depending on how risk adverse an investor you are. Bodie would agree that index equity funds and index REIT funds are an excellent way to invest the risky portion of your portfolio.
Best,
Bob K
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A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it. |
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LH2004
Joined: 27 Mar 2007
Posts: 1745
Location: New York, NY
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| Posted: Mon Feb 18, 2008 6:19 pm Post subject: |
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| bob u. wrote: | Under the heading Conventional Wisdom (2nd page of link), the author writes:
Of course this flies in the face of investors' gospel, especially in the world of index fund investment which we now inhabit, namely that equities over the long run are better investments.
How did the author manage to implicate index funds with equities for the long run. Is the author unaware that index funds are not limited to equity, that index funds hardly dominate what he calls the "investors' gospel," that index funds can combine nicely with other financial instruments to match long-term liabilities (you can match the duration of a bond fund with a liability)? |
Of course he knows those things. But he's right to criticize the attitude, expressed all too often around here, that stocks are safe in the long run. They're not.
I don't think that his emphasis on safety is necessarily logical: people should be willing to take some risk -- not just day-to-day volatility, but real risk of not reaching their goals -- in return for higher returns; how much depends on all of the factors that go into risk tolerance. But they shouldn't delude themselves into thinking that stocks are guaranteed to outperform bonds, no matter how long they hold. I don't know if this forum is very representative of the "index community," but around here at least, that bad advice is ever-present.
If stocks are too risky for you to hold for the short term, they're DEFINITELY too risky for you to hold over the long term as those risks multiply. |
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AzRunner
Joined: 19 Feb 2007
Posts: 722
Location: Phoenix
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| Posted: Mon Feb 18, 2008 7:19 pm Post subject: |
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I've begun reading Bodie and Clowes, Worry-Free Investing and it is a very conservative approach. The approach may work for some, especially those who can tolerate very little risk.
For the typical Diehard investor, especially those early in the accumulation phase, I think the advice is extremely conservative. Of course there are no guarantees. But no risk also guarantees very low returns, saving considerably more and having reduced retirement expectations wrt one's portfolio.
I agree that the risks in the stock market tend to be understated for an investor with a long time horizon. But even with the risk that exists, it still seems to be worth taking for the typical investor, assuming they can stay the course.
History is not guaranteed to repeat itself. True. OTOH, many Diehard retirees are in excellent financial position now because they did take equity risks during their accumulation phase of their investment time line.
Larry Swedroe's mantra of "need, willingness and ability to take risk" all need to be factored into one's thinking. One size does not fit all.
Norm |
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bobcat2
Joined: 20 Feb 2007
Posts: 1571
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| Posted: Mon Feb 18, 2008 10:13 pm Post subject: Bodie's Investment Approach |
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Zvi Bodie’s six step investment approach (from chapter 1 of Worry-Free Investing) | Quote: |
1. Set goals.
Make a list of the specific goals you want to achieve through your saving and investment plan. For example, “I want to continue to live at my customary standard of living after I retire,” or “I want to pay for my children’s college tuition at Harvard.”
2. Specify targets.
Determine the amount of money you will need to achieve each goal. These amounts become the targets of your plan. The very definition of risky or safe investing will depend on the target. TIPS and I Bonds have substantially lowered risk if the goal is retirement, but for college saving, special tuition-linked accounts are safer.
3. Compute your required no-risk saving rate.
Figure out how much you need to save as a fraction of your earnings on the assumption that you take no investment risk. For many people, it is appropriate to count your house as a retirement asset.
4. Determine your tolerance for risk.
Using as your benchmark the lowered-risk plan you have created in Steps 1–3, evaluate how much risk you are willing to take. Your capacity to tolerate investment risk should be related to the riskiness of your projected future earnings and your ability and willingness to postpone retirement if necessary. The safer your job and your future earnings, the greater your tolerance for risk in your investments. The more willing you are to postpone retirement if your risky investments perform badly, the greater your tolerance for risk.
5. Choose your risky asset portfolio.
After deciding how much of your wealth you are willing to put at risk, choose a form for taking the risk that gives you the greatest expected gain in welfare.
6. Minimize taxes and transaction costs.
Make sure that you are not paying any more in taxes, fees, or other investment costs than is necessary. |
To me this investment approach makes better sense than Clements' approach.
Here is a link to chapter 1 of Worry-Free Investing
Link:http://www.pearsonhighered.com....499277.pdf
Bob K
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A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it. |
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AThiker
Joined: 22 Jan 2008
Posts: 95
Location: Japan
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| Posted: Tue Feb 19, 2008 2:12 am Post subject: |
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| Quote: | Hence if you "need" to take more risk, you actually need to save more. Taking more risk may get you to where you're going but it may also bring you closer to ruin. If you weren't predisposed to take risks before, you shouldn't take more risk just because you "need" to.
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A powerful truth. Well put. |
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peter71
Joined: 24 Jul 2007
Posts: 2919
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| Posted: Tue Feb 19, 2008 2:56 am Post subject: Re: Bodie's Investment Approach |
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[quote="bobcat2"]Zvi Bodie’s six step investment approach (from chapter 1 of Worry-Free Investing) | Quote: |
1. Set goals.
Make a list of the specific goals you want to achieve through your saving and investment plan. For example, “I want to continue to live at my customary standard of living after I retire,” or “I want to pay for my children’s college tuition at Harvard.”
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This is a somewhat unfortunate example because families with incomes of $60,000 or less now receive 100% free tuition at Harvard, and even families much richer than that receive considerable concessions.
http://www.piqe.org/Assets/Home/Harvard.htm
More generally, while I agree that not eating Alpo and having health care are genuine "needs' I'm less sure saving for a child's hypothetical admission to an expensive private university is in that same category. The same goes for driving a nicer car than the average college professor -- mine's a '99 corolla 
All best,
Pete |
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bob u.
Joined: 23 Feb 2007
Posts: 2049
Location: east lansing, mi
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| Posted: Tue Feb 19, 2008 7:07 am Post subject: |
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On the other hand, Pete, it never ceases to amaze how often the cost of health care is overlooked by the "private savings" mentality. Here's a link to one study the by the Center for Retirement Research--http://escholarship.bc.edu/retirement_papers/131/
I believe a new study is to be released this morning by CRR. If so, it will show up in my e-mail. Bob U. |
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ajbibi
Joined: 07 May 2007
Posts: 195
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| Posted: Tue Feb 19, 2008 8:21 am Post subject: |
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| AzRunner wrote: |
History is not guaranteed to repeat itself. True. OTOH, many Diehard retirees are in excellent financial position now because they did take equity risks during their accumulation phase of their investment time line.
Norm |
But we're trying to understand what a rational course of action should be based on. The mere fact that we have "lucked out" at the end of a long period of rising equities should not be a strong basis for doing the same.
For example, my guess is that more people became wealthy by following the mantra of "Buy more house than you can afford" from the 1970s to the mid 1990s than from the stock market. So long as they bought in California, New York, Boston, Seattle, and other high growth areas, got long term mortgages and held on for several decades without using their homes as ATMS, they did well. The mere fact of their success is not a good basis for trying to repeat.
I think that there is a lot of usefulness in the general Boglehead wisdom. But even "conservative" advice -- such as AA of Bonds =age-10 -- is misleading for a number of subtle and not-so-subtle reasons.
I am especially pleased that Bodie emphasized how life prospects -- including job security and willingness to delay retirement -- should be big factors in determining how much risk you should be able to take and not just how far away you are from retirement. |
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nisiprius
Joined: 26 Jul 2007
Posts: 7671
Location: North America; Western Hemisphere; the Earth; the Solar System; the Universe; the Mind of God
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| Posted: Tue Feb 19, 2008 8:27 am Post subject: |
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| bob u. wrote: | On the other hand, Pete, it never ceases to amaze how often the cost of health care is overlooked by the "private savings" mentality. Here's a link to one study the by the Center for Retirement Research--http://escholarship.bc.edu/retirement_papers/131/
I believe a new study is to be released this morning by CRR. If so, it will show up in my e-mail. Bob U. |
I've got to hand it to Fidelity. In my spreadsheet planning for retirement I just plugged in one number for inflation. When I went for my "retirement checkup" with their handy-dandy "retirement income planner," I'd already used the tool and plugged in rough numbers and everything looked fine.
The Fidelity rep insisted on opening the "detailed budget" part of the tool. My estimated health costs were in the same ballpark as his, but he put them in the "health cost" section of the tool, where it cranked in an inflation rate of 7%, versus about 3% for everything else.
Not only did this make every projection look lousy, but it had another effect as well. With a fixed inflation rate, tiny changes in income and expenses had huge cumulative effects. If the tool showed that under bad market conditions your money might only last to age 85, reducing expenses just a little bit made them last to age 94 with a lot left over.
Assuming a 7% inflation rate for health costs, suddenly small changes in expenses made only a small change in portfolio survival time. Those rising health costs create a steep wall which, in the simulations, is not easy to climb.
Of course, neither I nor the Fidelity rep (a CFP) believe that health costs can really continue to inflate at 4% more per year than the CPI. Something is going to happen at some point. When it does, it probably isn't going to be pretty.
This is an interesting case where you can pretty well see that something unpredictable and disruptive is coming, but the exact form that it takes unknown and hard to prepare for
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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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Ron
Joined: 23 Feb 2007
Posts: 3072
Location: Lehigh Valley, PA
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| Posted: Tue Feb 19, 2008 8:52 am Post subject: |
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| nisiprius wrote: | Assuming a 7% inflation rate for health costs, suddenly small changes in expenses made only a small change in portfolio survival time. Those rising health costs create a steep wall which, in the simulations, is not easy to climb.
Of course, neither I nor the Fidelity rep (a CFP) believe that health costs can really continue to inflate at 4% more per year than the CPI. Something is going to happen at some point. When it does, it probably isn't going to be pretty.
This is an interesting case where you can pretty well see that something unpredictable and disruptive is coming, but the exact form that it takes unknown and hard to prepare for |
N***,
I (like you) use the Fidelity RIP as part of my "planning process" (along with Vanguard's Financial Engines and FIRECalc).
What's interesting is that I know that RIP uses the 7% inflation rate for medical expenses but (for instance) my own expenses (being my contribution to my/DW's medical insurance premium in retirement) only increased by 1% from '07 to '08.
What's most important in this discussion is that folks (maybe only a few - the ones on this forum) are looking at their "possible" future, and at least trying to forecast what they will need in retirement. Whether the future looks good/bad, it dosen't matter. What's most important is that you look at the "possibilties".
We're fortunate in the case of RIP since the return graph shows an increase in value over the years. Sure, I/DW will leave a lot to charity, but that's OK. As long as we have enough to live on in the manner in which we have been during our working years (actually, a bit "above" it  ) we're more than willing to "share" our good fortune.
- Ron |
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biasion
Joined: 13 Aug 2007
Posts: 1053
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| Posted: Tue Feb 19, 2008 8:55 am Post subject: |
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bobcat2
Joined: 20 Feb 2007
Posts: 1571
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| Posted: Tue Feb 19, 2008 9:14 am Post subject: Determining How Much Risk to Take |
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ajbibi wrote: | Quote: | | I am especially pleased that Bodie emphasized how life prospects -- including job security and willingness to delay retirement -- should be big factors in determining how much risk you should be able to take and not just how far away you are from retirement. |
Amen!
In addition I would add at least the following two factors in determining how much risk to take in your investment portfolio.
1) How much are you willing to increase your pre-retirement savings rate if your risky investments head south?
2) Are you willing to take out a reverse mortgage if your risky investments head south?
Bob K
_________________
A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it. |
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bob u.
Joined: 23 Feb 2007
Posts: 2049
Location: east lansing, mi
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| Posted: Tue Feb 19, 2008 9:57 am Post subject: |
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| Hats off to Fidelity's RIP! That's responsible planning. Bob U. |
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bob u.
Joined: 23 Feb 2007
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Rodc
Joined: 26 Jun 2007
Posts: 4825
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| Posted: Tue Feb 19, 2008 11:27 am Post subject: |
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| nisiprius wrote: | | bob u. wrote: | On the other hand, Pete, it never ceases to amaze how often the cost of health care is overlooked by the "private savings" mentality. Here's a link to one study the by the Center for Retirement Research--http://escholarship.bc.edu/retirement_papers/131/
I believe a new study is to be released this morning by CRR. If so, it will show up in my e-mail. Bob U. |
I've got to hand it to Fidelity. In my spreadsheet planning for retirement I just plugged in one number for inflation. When I went for my "retirement checkup" with their handy-dandy "retirement income planner," I'd already used the tool and plugged in rough numbers and everything looked fine.
The Fidelity rep insisted on opening the "detailed budget" part of the tool. My estimated health costs were in the same ballpark as his, but he put them in the "health cost" section of the tool, where it cranked in an inflation rate of 7%, versus about 3% for everything else.
Not only did this make every projection look lousy, but it had another effect as well. With a fixed inflation rate, tiny changes in income and expenses had huge cumulative effects. If the tool showed that under bad market conditions your money might only last to age 85, reducing expenses just a little bit made them last to age 94 with a lot left over.
Assuming a 7% inflation rate for health costs, suddenly small changes in expenses made only a small change in portfolio survival time. Those rising health costs create a steep wall which, in the simulations, is not easy to climb.
Of course, neither I nor the Fidelity rep (a CFP) believe that health costs can really continue to inflate at 4% more per year than the CPI. Something is going to happen at some point. When it does, it probably isn't going to be pretty.
This is an interesting case where you can pretty well see that something unpredictable and disruptive is coming, but the exact form that it takes unknown and hard to prepare for |
A few years ago I started thinking about retirement planning in a concerted way. I used the Fidelity planners and noted similar strange results. My wife was in her mid forties and her grandfather, a grand old guy, lived to be 98, so I was planning out 50 years.
I talked to three different Fidelity reps who all told me the quirky results were due to a problem in the software such that the detailed planner did not accumulate assets correctly and I should use the simpler planner.
After poking around I discovered the 7% medical inflation which is hard wired. I wrote several versions of monte carlo simulations which I could tailor to look like Fidelity's, or could match my own assumptions (such as 75% cpi adjustments to my pension). I learned none of the Fidelity reps had a clue, the hardwired medical inflation was the problem.
But I learned a great deal more, although it should have been obvious. If any one thing grows exponentially faster than the general inflation rate for decades it swamps everything. Moreover if it will bankrupt me with two good pensions and likely substantial savings, and no debt heading in to retirement, it will bankrupt just about everyone and so somewhere down the line things will simply change. When? Who knows. How? Who knows.
Hence modeling out that far is an exercise in the absurd!
No one at age 20 can project out say 30 years to see just what is coming. And we all, once being 20, mostly did fine. You just set yourself on a course that makes sense at the time, you stay flexible, you adjust. Now admittedly that is easier in your 20's or 30's than in your 70's and 80's, but the lesson is there anyway.
Make prudent investment choices, save a decent amount, pray a little if you are religious, and just don't get too hung up with detailed projections in the hope of bypassing the fact that life is full of uncertainty.
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Warner
Joined: 19 Apr 2007
Posts: 185
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| Posted: Tue Feb 19, 2008 12:08 pm Post subject: |
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Rodc says: | Quote: | | If any one thing grows exponentially faster than the general inflation rate for decades it swamps everything. Moreover if it will bankrupt me with two good pensions and likely substantial savings, and no debt heading in to retirement, it will bankrupt just about everyone and so somewhere down the line things will simply change. When? Who knows. How? Who knows. |
Sam Nunn says in 20 years four items (medicare, medicaid, social security & interest on the debt) will consume the entire budget.
A Conversation with Sam Nunn & William Cohen (that discussion is at about time 19:40 on the video) |
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AzRunner
Joined: 19 Feb 2007
Posts: 722
Location: Phoenix
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| Posted: Tue Feb 19, 2008 1:23 pm Post subject: |
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| ajbibi wrote: | | AzRunner wrote: |
History is not guaranteed to repeat itself. True. OTOH, many Diehard retirees are in excellent financial position now because they did take equity risks during their accumulation phase of their investment time line.
Norm |
But we're trying to understand what a rational course of action should be based on. The mere fact that we have "lucked out" at the end of a long period of rising equities should not be a strong basis for doing the same.
For example, my guess is that more people became wealthy by following the mantra of "Buy more house than you can afford" from the 1970s to the mid 1990s than from the stock market. So long as they bought in California, New York, Boston, Seattle, and other high growth areas, got long term mortgages and held on for several decades without using their homes as ATMS, they did well. The mere fact of their success is not a good basis for trying to repeat.
I think that there is a lot of usefulness in the general Boglehead wisdom. But even "conservative" advice -- such as AA of Bonds =age-10 -- is misleading for a number of subtle and not-so-subtle reasons.
I am especially pleased that Bodie emphasized how life prospects -- including job security and willingness to delay retirement -- should be big factors in determining how much risk you should be able to take and not just how far away you are from retirement. |
Certainly some homeowners have done very well in certain parts of the country. That said, a key benefit of home ownership is living in the house rent free. This is true even if the home just keeps up with inflation.
I have no problem with having investors fully understand the risks of equity investing. That said, for many risk tolerant investors, the stock market offers an opportunity to benefit due to the real growth that companies generate. A widely diversified portfolio based on indexing still seems like the way to go assuming that one stays the course.
Norm |
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pkcrafter
Joined: 04 Mar 2007
Posts: 2526
Location: CA
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| Posted: Tue Feb 19, 2008 9:33 pm Post subject: Risk - a four letter word |
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Thanks to all who have participated in this thread. Great discussion; I've really enjoyed it.
Paul
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bobcat2
Joined: 20 Feb 2007
Posts: 1571
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| Posted: Thu Feb 21, 2008 6:58 am Post subject: Plan B |
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AzRunner wrote. | Quote: | I have no problem with having investors fully understand the risks of equity investing. That said, for many risk tolerant investors, the stock market offers an opportunity to benefit due to the real growth that companies generate. A widely diversified portfolio based on indexing still seems like the way to go assuming that one stays the course.
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I don't think anyone on this thread disagrees with that. I certainly don't. The question Bodie is raising is if your portfolio does not have enough relatively safe investments to meet your minimum retirement goals and equity risk manifests itself, even though you stayed the course, what is Plan B for dealing with that eventuality going forward?
Will you be willing to delay retirement? Will you be willing to save at a higher rate? Will you be willing to work part-time in retirement? Will you be willing to take out a reverse mortgage? If the answer to these and similar questions is no, then isn't it prudent to have a portfolio strategy that prioritizes including enough safe investments to virtually lock in your minimum retirement goals.
Bob K
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A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it. |
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nisiprius
Joined: 26 Jul 2007
Posts: 7671
Location: North America; Western Hemisphere; the Earth; the Solar System; the Universe; the Mind of God
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| Posted: Thu Feb 21, 2008 8:56 am Post subject: Re: Plan B |
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| bobcat2 wrote: | AzRunner wrote. | Quote: | I have no problem with having investors fully understand the risks of equity investing. That said, for many risk tolerant investors, the stock market offers an opportunity to benefit due to the real growth that companies generate. A widely diversified portfolio based on indexing still seems like the way to go assuming that one stays the course.
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I don't think anyone on this thread disagrees with that. I don't. The question Bodie is raising is if your portfolio does not have enough relatively safe investments to meet your minimum retirement goals and equity risk manifests itself, even though you stayed the course, what is Plan B for dealing with that eventuality going forward?
Will you be willing to delay retirement? Will you be willing to save at a higher rate? Will you be willing to work part-time in retirement? Will you be willing to take out a reverse mortgage? If the answer to these and similar questions is no, then isn't it prudent to have a portfolio strategy that prioritizes including enough safe investments to virtually lock in your minimum retirement goals.
Bob K |
Exactly. Seems like common sense.
I'm flabbergasted when people say that increasing equities "improves the survivability" of a portfolio and when I check out the paper they're citing, it turns out that they're referring to (say) a situation where 100% bonds have an 88% failure rate... but 100% stocks have a 32% failure rate.
When you say "what if you encounter the 32% chance? what's plan B?" the answers seem to be either fatalistic, or suggest a hidden assumption of reserve resources.
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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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bobcat2
Joined: 20 Feb 2007
Posts: 1571
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| Posted: Fri Feb 22, 2008 8:13 am Post subject: Associating Time Horizons with Financial Goals |
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More from the article:
| Quote: | “Every personal finance book says you have to start with a goal,” Bodie says.
The SEC, too, has a list of five or six different potential goals on its website, all of which are good examples. However, after listing a few of them, Bodie asks the obvious question: “If you have a goal, shouldn’t there be a time horizon associated with this goal?”
If you’re saving to make a down-payment on a house, you have a pretty good idea when you’re planning to buy your own place. If your investment is supposed to provide tuition for your children or grandchildren’s education, this too has a set time frame. And even if your goal is a prosperous or self-sufficient retirement, you can’t avoid thinking of its approximate beginning and, alas, eventual end.
Defining Risk
Economists think of risk as volatility over time. The wider the price fluctuation, the riskier the asset. But in personal finance this definition of risk is not especially relevant, insists Bodie. Applied to a specific goal, he sees risk in far more commonsensical terms — as the probability that you’re going to fall short of attaining your goal.
Volatility can be reduced by diversification — which is what financial advisors typically tell their clients. If you agree with Bodie , however, and assign a specific time period to your goal, diversification may not always work for you. There is no inherent reason in theory or in practice why most assets in your portfolio can’t drop at the same time — which could be exactly the time when you have been planning to achieve your goal.
Or, if you insist on thinking of risk as volatility, Bodie proposes a more relevant measure of it. Typically, the change in the value of your portfolio is gauged against the S&P 500 index or other conventional benchmarks. However, unless your future goal is to buy units of the S&P 500, you really don’t care about this kind of volatility. You need your investments to match the cost of your goal — for instance, college tuition.
While attacking the conventional wisdom of the financial advisory industry, Bodie proposes nothing novel or extravagant. On the contrary, his solution is more conventional than conventional wisdom, as it were. The right way of thinking of your investment needs is by using a basic principle of finance — matching your assets to your liabilities. |
Bob K
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A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it. |
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VictoriaF
Joined: 27 Feb 2007
Posts: 2467
Location: Arlington, VA
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| Posted: Fri Feb 22, 2008 10:23 am Post subject: |
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| bob u. wrote: | | Hats off to Fidelity's RIP! That's responsible planning. Bob U. |
May be.
Or may be not.
This depends on what the planner said next. If she said that in order for nisiprius to meet his goals he needs to invest in the latest Fidelity star fund--that would not be very responsible.
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bobbyrx
Joined: 09 Dec 2007
Posts: 306
Location: New York
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| Posted: Fri Feb 22, 2008 11:05 am Post subject: |
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This has been a great thread- thanks to all. I would appreciate any feedback on the following idea. Similar to many of the postings, I have planned to have the bulk of my investments (around 70%) in fixed securities to generate a reasonably stable stream of income to last for a reasonable length of retirement (around 25 years). The remaining 30% of investments in equities to grow and cover the possibility of living into 90s or, alternately, to leave an estate. No rebalancing along the way!
Since the sequence of outsized portfolio losses at the beginning of retirement can doom a portfolio from lasting through an average longevity, would it not be safer to wind up with more equities near the end of life than at the beginning. |
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AzRunner
Joined: 19 Feb 2007
Posts: 722
Location: Phoenix
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| Posted: Fri Feb 22, 2008 12:57 pm Post subject: |
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| bobbyrx wrote: | | - snip - Similar to many of the postings, I have planned to have the bulk of my investments (around 70%) in fixed securities to generate a reasonably stable stream of income to last for a reasonable length of retirement (around 25 years). The remaining 30% of investments in equities to grow and cover the possibility of living into 90s or, alternately, to leave an estate. No rebalancing along the way! |
Actually every time you do a withdrawal from an account is has the effect of rebalancing. In the accumulation phase you choose what assets to buy. During retirement your decision becomes what to sell. If you live on your fixed income, by definition you are allowing your equity the opportunity to grow. This is a strategy but it is not inherently better than maintaining your 30/70 AA by drawing dividends and capital gains from your equity as well as using some of your fixed income.
| bobbyrx wrote: | | Since the sequence of out-sized portfolio losses at the beginning of retirement can doom a portfolio from lasting through an average longevity, would it not be safer to wind up with more equities near the end of life than at the beginning. |
Yes, a severe bear market coinciding with the beginning of retirement may devastate a portfolio depending on its AA and diversification. It would also be a function of the individual's withdrawal rate and ability to cut back on discretionary spending.
There is no one right answer. It's best to explore the issues and then decide on what makes the most sense for your specific situation.
Norm |
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bobbyrx
Joined: 09 Dec 2007
Posts: 306
Location: New York
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| Posted: Fri Feb 22, 2008 1:17 pm Post subject: |
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Thanks Norm for your feedback.
By the way, for all participants in this thread, I am currently reading "Retirement Income Redesigned- Master Plans for Distribution", a compilation of numerous contributions by a variety of authors on withdrawal strategy perspectives. The book is edited by Harold Evensjy and Deena Katz, who are also contributing authors. |
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