Are there other reasons besides volatility to avoid 100% equities?

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roflwaffle
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Are there other reasons besides volatility to avoid 100% equities?

Post by roflwaffle » Fri Aug 19, 2016 12:41 pm

I have a few general questions about asset allocation I'm hoping to get some feedback on. I've searched the forums on why someone shouldn't go all in on equities, and the most prominent and well supported argument is to avoid higher volatility. If someone is OK with that volatility, and can hold a broadly diversified set of equities for a long enough period of time, are there some other well supported reasons to hold bonds?

It also seems like holding equities for some sufficiently long time period (~5-15 years?) can make the higher volatility of stocks a moot point, because their low can still be higher than the low of a mixed portfolio when enough earnings have accrued to offset the higher volatility.

https://www.vanguard.com/pdf/icrpr.pdf

Something else I've thought about is how volatility is not the same as risk. Risk is reflected in volatility, but it's possible that even with a broad index fund, equities may be riskier than bonds, treasuries, and/or cash, but I've haven't found anything quantifying that. Anyhow, whatever thoughts, advice, and other breadcrumbs anyone has are appreciated.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by RyeWhiskey » Fri Aug 19, 2016 12:50 pm

roflwaffle wrote:I have a few general questions about asset allocation I'm hoping to get some feedback on. I've searched the forums on why someone shouldn't go all in on equities, and the most prominent and well supported argument is to avoid higher volatility. If someone is OK with that volatility, and can hold a broadly diversified set of equities for a long enough period of time, are there some other well supported reasons to hold bonds?
People hold bonds for all sorts of reasons. Income, reduced volatility, reduced risk, rebalancing bands, and just general reserves. By this I mean that it's nice to know that you have cash outside of the roller coaster in case you need it. No harm in that. The way I've been looking at this is to think of the asset's purpose: equities are for growth, bonds/cash are for reserves. You decide how much of each you need.
roflwaffle wrote:It also seems like holding equities for some sufficiently long time period (~5-15 years?) can make the higher volatility of stocks a moot point, because their low can still be higher than the low of a mixed portfolio when enough earnings have accrued to offset the higher volatility.
Volatility does not ever become a "moot point." What happens is that the average volatility drops over time, but this does not in any way mean that you won't experience a drop of 50% in one year just because you've held equities for 30 years. This is a very important distinction, because when you're starting out losing 50% of 20k isn't a super big deal; when you're 65 and have much more, losing 50% can be heart-attack inducing. Thus conventional wisdom starts out with higher equity allocations, and increases fixed-income as time goes by (look at any Target Retirement fund).
roflwaffle wrote:Something else I've thought about is how volatility is not the same as risk. Risk is reflected in volatility, but it's possible that even with a broad index fund, equities may be riskier than bonds, treasuries, and/or cash, but I've haven't found anything quantifying that. Anyhow, whatever thoughts, advice, and other breadcrumbs anyone has are appreciated.
Equities are riskier than bonds, treasuries, or cash, that's why the expected return is so much higher. Risk/return are two sides of the same coin. But, yes, volatility is not identical to risk (see the Permanent Portfolio for example). It is vitally important to think about the risks you can take as well as those you cannot. :beer
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by nisiprius » Fri Aug 19, 2016 1:10 pm

"Volatility is not the same as risk" is a slogan used by people who are trying to convince you, for whatever reason, to invest in volatile assets. There are many aspects of risk, but volatility certainly creates two kinds of risk: 1) the risk that you will discover that you need money at a time when, due to volatility, you don't have it; 2) the risk that you will fail to stay the course when the stock market is so low that that you stop seeing volatility as a percentage number, and start seeing it as "we're in uncharted waters and the past can't guide us."
It also seems like holding equities for some sufficiently long time period (~5-15 years?) can make the higher volatility of stocks a moot point...
This is very dangerous thinking, and you really need to spend some quality time looking at real data for yourself, rather than listening to a verbal summary of it, or looking at a place someone is pointing you to.

It is particularly troublesome when you spell out a time period of 5-15 years. How did you get that idea? Did you read something saying "you should not invest in stocks if you will need the money in five years or less" and conclude that you could turn it around, and that it would be safe to invest in stocks as long as you could wait five years before you needed the money?

If we include reinvested dividends, which often makes things look better, and correct for inflation, which often makes things look worse, then:

if you invested $10,000 into the stock market at the start of 1966, and measure in terms of 1966 dollars,
  • Five years later, at the end of 1970, you'd have the buying power of $9,441.58.
  • Ten years later, at the end of 1975, you'd have had $7,917.95.
  • Fifteen years later, at the end of 1980, you'd have had $9,788.80.
(I think) it is (probably) true that the standard deviation of the annualized return decreases over longer holding periods, but the problem is that you're concerned about the whole holding period, start to finish, and the a difference in annualized return has to be compounded out over that whole period. A very influential book, Stocks for the Long Run, by Jeremy Siegel, presents some of his research, but I think the right interpretation of his results is not that risk decreases with longer holding periods. It increases. What his research says is that it doesn't increase as fast as you'd expect if stock prices really followed a random walk, and that there seems to be a meaningful amount of mean reversion--there's a tendency for periods of high returns to be partly balanced out by periods of low returns.

The elephant in the room is a paper which doesn't seem to get mentioned much by people selling stock mutual funds to the public. This is a serious academic paper. I'll let their words speak for themselves. Uh, but I'll add boldfacing.
Are Stocks Really Less Volatile in the Long Run?
According to conventional wisdom, annualized volatility of stock returns is lower over long horizons than over short horizons, due to mean reversion induced by return predictability. In contrast, we find that stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. Mean reversion contributes strongly to reducing long-horizon variance, but it is more than offset by various uncertainties faced by the investor, especially uncertainty about the expected return. The same uncertainties reduce desired stock allocations of long-horizon investors contemplating target-date funds.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by lack_ey » Fri Aug 19, 2016 1:18 pm

I think the mental model many have is a kind of conception that stocks return a decent amount in the long term but have some bumps along the way. The underlying return is kind of a given, but there is also a significant element of volatility manifested as "noise" causing deviations from the long-term trend, which may in fact push your actual return below what you expected, perhaps even as bad as to make it negative.

In this case, if you hold for the long term you're likely to ride out the bumps and end up in a stronger position. Who cares what the bumps were if you make it to the destination?

The reasons to diversify include
  • Maybe the model is wrong in the first place.
  • Maybe we get unlucky with returns.
  • Maybe your investments never get to sit through the long term because something unexpected comes up and it's needed in the short or medium term.
It might help to consider carefully your actual goal. Is it to end up with the most money on average? Maximize the probability of having enough (what's enough mean)? What really?

Also, what does "all in" mean? 100% stocks? It's easy to use leverage and go further than 100%.

And with respect to 5-15 years, if you look beyond the US market—which historically has been relatively and remarkably consistent, all things considered—you'll find many cases where this doesn't look very satisfactory. On the other hand, if there are likely many years of contributions remaining you are getting a diversification benefit putting new money in at different times, mitigating some risk.
Last edited by lack_ey on Fri Aug 19, 2016 1:22 pm, edited 1 time in total.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by staythecourse » Fri Aug 19, 2016 1:21 pm

I would agree volatilit MAY not be the same as risk. That association is dependent on each person's situation.

For example:

Person A: 100% equities who works as a stock broker in a single income family. He has his second kid going to college at the same time this fall and is planning to go ahead and retire in the next year as well.

Person B: 100% equities who is in a 2 income family who is going to retire next year. His wife and himself have pensions that equal 120% of their living expenses over the last 5 yrs. All planned liabilities are done (kids education and house paid off).

I would be Person A would equate volatility as risk and Person B as maybe, maybe not.

So that statement you mentioned means different things to different people. That is why you see vast differences on this site when it comes to the importance of volatility.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by azanon » Fri Aug 19, 2016 1:33 pm

nisiprius wrote:(I think) it is (probably) true that the standard deviation of the annualized return decreases over longer holding periods, but the problem is that you're concerned about the whole holding period, start to finish, and the a difference in annualized return has to be compounded out over that whole period. A very influential book, Stocks for the Long Run, by Jeremy Siegel, presents some of his research, but I think the right interpretation of his results is not that risk decreases with longer holding periods. It increases. What his research says is that it doesn't increase as fast as you'd expect if stock prices really followed a random walk, and that there seems to be a meaningful amount of mean reversion--there's a tendency for periods of high returns to be partly balanced out by periods of low returns.
Nuisiprius, an excellent post as usual, but this is a strong statement to make (for anyone). You're basically saying Siegel is interpreting the results wrong.

I'll be completely candid, i read this book once, understood maybe half of of it at best, but can never forget those charts showing range of returns for stocks for varying year periods (e.g. 1, 5, 10, 20). From what i recall, once you got to 20 yrs, the worst case scenario was not only positive, but it was more positive than the worst case scenario for bonds. And for 1 and 2 yr periods, the range was for stocks was drastic. So in my simple mind (certainly much more basic than Siegel's), that's getting less risky with time, and at least from one perspective (the aforementioned chart), less risky than bonds if your holding period is long enough.

The relevant figure should be range of expected returns in terms of percent for a given holding period. A greater range implies more risk.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by azanon » Fri Aug 19, 2016 1:39 pm

roflwaffle wrote:If someone is OK with that volatility, and can hold a broadly diversified set of equities for a long enough period of time, are there some other well supported reasons to hold bonds?
It's not so much volatility, as it is just the fact that the expected risk-adjusted return of an all-stock portfolio is one of the lowest of all portfolios, save perhaps ones that only includes 10% stocks or less. So, for example, you can drop to 90% stocks, add 10% bonds, and have a dramatic effect on lowing the expected volatility relative to a very slight reduction in expected return.

To use a somewhat crude analogy, it's like buying the very best item in the store, but paying double for it, relative to one that's 90% as good. Most people will opt for the best value.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Ari » Fri Aug 19, 2016 2:00 pm

So the risk of volatility seems to have three major factors:

1: The risk you'll need the money when the market is down.
2: The risk that the returns are bad over your entire holding period.
3: The risk that you'll panic and sell.

All of these factors can be considered. If you have a sizable emergency fund and few liabilities, number one can be taken care of. Number two decreases with increasing holding periods. Number three is trickier, and entails that you have to know yourself. People react differently when they're stressed and knowing that you shouldn't sell isn't necessarily going to help you, according to some research. You'll know more about your psychological risk tolerance as you age, but then you're decreasing your holding period and thus increasing the second factor.

These are things to be considered and decided for each and every one. Personally, I believe I'm very insensitive to all three of these risks, which is why I hold 100% stocks today and have a hard time seeing myself dipping below 80% even in retirement, but this is due to factors unique to me, such as the (social democratic) country I live in, the family I (don't) plan to have, my (lack of) car and home ownership and my experience of my (extremely stable) mood and personality. Others have other factors to consider.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Engineer250 » Fri Aug 19, 2016 2:18 pm

roflwaffle wrote:If someone is OK with that volatility, and can hold a broadly diversified set of equities for a long enough period of time, are there some other well supported reasons to hold bonds?
As a former 100% equity holder (I have 5% in non-equity now! whoo!), I agree with a long time frame and not a lot money saved, it's hard to see the point in holding bonds (especially in today's bond climate). The things that interested me:

1) Dry powder
-if the stock market drops you have nothing to rebalance, having bonds as a % let's you potentially buy more stock at low prices if the price drops enough, depending on what your rebalance bands are. If you cash set aside for this purpose, I would argue you are not 100% equities either. The money effects of dry powder are probably minimal, but the psychological effects are powerful.
2) Diversification
-in 2013 there were 40 trillion dollars being traded in the US bond market (including government, corporate, treasuries, municipals).
US stock market is something like 50 trillion dollars. So the total bond market is almost the size of the stock market (for the US). If you are invested in stocks only, you're missing a huge chunk of "the market". So much business gets done with debt, bonds and treasuries. I hold US and International stock because diversification is important to me even if it means potentially lower returns than a US-only portfolio would mean. Seems like the same argument could be made for having something in bonds, though you could obviously tilt to equity depending on needs the same way you might tilt to US versus international.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Day9 » Fri Aug 19, 2016 2:25 pm

"Why not 100% stock?" posts are very common on this board when the market is at all time highs.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by NMJack » Fri Aug 19, 2016 3:14 pm

Engineer250 wrote: 1) Dry powder
-if the stock market drops you have nothing to rebalance, having bonds as a % let's you potentially buy more stock at low prices if the price drops enough, depending on what your rebalance bands are. If you cash set aside for this purpose, I would argue you are not 100% equities either. The money effects of dry powder are probably minimal, but the psychological effects are powerful.
For many who are younger, their "dry powder" is the money that goes into their 401k out of every paycheck (and also the money they put into their IRA every January).

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by pkcrafter » Fri Aug 19, 2016 3:22 pm

It is said that stocks are risky in the short term--5 years, but they aren't really risky after 20 years. What I don't get is 20 years is simply four successive 5 year periods. Aren't they risky in those periods? Years 16-20 is a 5 year period, so stocks must be just as risky in that period as in the first 5 year period.

What does risky mean? It means the money you need to purchase something important may not be there when you need it. Nothing more, nothing less. If volatility is a risk, the lack of volatility is even more of a risk. If your assets fall and don't rebound, you have no volatility and no assets. And what about Bernstein's deep risks?

It seems pretty simple -- "stocks are risky" is not really contained or defined, and it cannot be defined. It simply says your money may not be there for some reason you have yet to think of or an event that is yet to happen. Black Swan anybody? Can anyone really quantify investment risk? There's no one behind the scenes saying don't worry, we've got you covered.

If some strange set of circumstances shrinks your portfolio to 1/10 of what it was, your asset holders will simply say, gee, that's too bad, but we told you there was risk. And don't make the mistake of using history as a proof that nothing as happened.

On the other side of this argument is faith in the capitalistic system, and that drives the idea of investing your money in the future of creative endeavor and success of the system. I conclude investing is good, but investing everything is a blind leap of faith.

Paul

Here's some information from FINRA on risk

http://www.finra.org/investors/reality-investment-risk
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by backpacker » Fri Aug 19, 2016 4:17 pm

pkcrafter wrote:It is said that stocks are risky in the short term--5 years, but they aren't really risky after 20 years. What I don't get is 20 years is simply four successive 5 year periods. Aren't they risky in those periods? Years 16-20 is a 5 year period, so stocks must be just as risky in that period as in the first 5 year period.
Suppose I have a coin and offer you a bet. Heads I pay you $2, tails you pay me $1. We can flip the coin as many times as you want.

If we flip it once, you have a 50% chance of losing money. If we flip it three times, you have a 12.5% chance of losing money. And so on and so forth. This despite the fact that each time the coin is flipped, you have the same 50% chance of losing money on that flip.

The stock market is basically just a complicated version of the coin game. :beer

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Engineer250 » Fri Aug 19, 2016 4:23 pm

NMJack wrote:
Engineer250 wrote: 1) Dry powder
-if the stock market drops you have nothing to rebalance, having bonds as a % let's you potentially buy more stock at low prices if the price drops enough, depending on what your rebalance bands are. If you cash set aside for this purpose, I would argue you are not 100% equities either. The money effects of dry powder are probably minimal, but the psychological effects are powerful.
For many who are younger, their "dry powder" is the money that goes into their 401k out of every paycheck (and also the money they put into their IRA every January).
In 2008 I was young. I was putting in 8% of my salary into my 401k which was $2400 a year. I was not and maybe could not have afforded to put money into an IRA in addition, forget being able to max it out in January like you imply. At the time I increased my contribution to 12% so I could put in an extra $1200 a year at the new low prices. Young people typically aren't putting in enough for it to make much of a dent during a downturn that happens early in their careers.

And mostly my point was to bring up reasons other than volatility that people might want to hang on to bonds, not to suggest they are the best reasons or that people shouldn't have whatever allocation they want :D
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by retiredjg » Fri Aug 19, 2016 4:24 pm

Haven't linked these in awhile. Many good thoughts contained here.

viewtopic.php?p=538014

viewtopic.php?f=1&t=101277&newpost=1468140

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by nisiprius » Fri Aug 19, 2016 4:27 pm

azanon wrote:...Nisiprius, an excellent post as usual, but this is a strong statement to make (for anyone). You're basically saying Siegel is interpreting the results wrong...
I don't think so. I think I'm interpreting it the same way Jeremy Siegel interprets them. It's other people (for example, the authors of "Dow 36000") that oversimplify it into what they want to hear. These are Siegel's words; my boldfacing:
The Great Debate: Bodie vs. Siegel (2008)
Let me show you the graph that is in my book, Stocks for the Long Run, that I think is so critical to that. We have it on my right, on your left. It is the standard deviation of stocks, bonds, and treasury bills after inflation, measured over the longest period we have ever done research on. 200 years. That’s the one year standard deviations, those are the two year average standard deviations, five, ten, 20, and 30. Now, many of you who have gone to my presentations have probably seen that slide before.

Now, one thing I should make very clear, I never said that that means stocks are safer in the long run. This is the standard deviation of average annual returns. We know the standard deviation of the average goes down when you have more periods. Even if it’s random walk, it goes down. What I pointed out here is that the standard deviation for stocks goes down twice as much— twice as fast as random walk theory would predict. In other words, they are relatively safer in the long run than random walk theory would predict.

Doesn’t mean they’re safe. The whole point is that they are relatively safer.
Siegel is saying that because of mean reversion, a long period of time will be riskier than a short period of time, just not as much riskier as if stocks followed a random walk.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by dodecahedron » Fri Aug 19, 2016 4:36 pm

nisiprius wrote: If we include reinvested dividends, which often makes things look better, and correct for inflation, which often makes things look worse, then:

if you invested $10,000 into the stock market at the start of 1966, and measure in terms of 1966 dollars,
  • Five years later, at the end of 1970, you'd have the buying power of $9,441.58.
  • Ten years later, at the end of 1975, you'd have had $7,917.95.
  • Fifteen years later, at the end of 1980, you'd have had $9,788.80.
If you correct for taxes on dividends (which were quite high at the time), this would look even worse. And 401k plans did not come on the scenes until 1980, so most folks had no easy way to avoid the tax drag. Not to mention that if you actually wanted to cash in your equity holdings to spend the proceeds on consumption, there would have been substantial long term capital gains tax due, because taxes are based on nominal rather than real gains.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by heyyou » Fri Aug 19, 2016 4:45 pm

Are there other reasons besides volatility to avoid 100% equities?
If you are trying to maximize growth, the highest performing allocation was 93/7 or 87/13 due to this reason:
1) Dry powder
-if the stock market drops you have nothing to rebalance, having bonds as a % let's you potentially buy more stock at low prices if the price drops enough, depending on what your rebalance bands are. If you cash set aside for this purpose, I would argue you are not 100% equities either. The money effects of dry powder are probably minimal, but the psychological effects are powerful.
Risk is subjective. If you were given 10 multiples of your current spending, then lost half of it in a market crash, is your glass half full or half empty? That happened with the 2000 Crash following the late 1980s then 1990s stock gains. I still had more retirement savings than my spendthrift coworkers, then the recovery happened.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by lemonPepper » Fri Aug 19, 2016 4:51 pm

volatility causes sequence of returns risk and bonds are a way to reduce that risk

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by nisiprius » Fri Aug 19, 2016 4:51 pm

Two questionable things about most "why not 100% stocks" posts, including this one:

a) The unexplained magnetism of the round number. If you believe your risk tolerance is high enough, is no possible justification for not considering some leverage. You can get into a further discussion about how much. One point of view (pure MPT) is that no amount is too much, it's completely determined by your risk tolerance. Those Ivy League professors who market timer (at least thought he was following), literally into ruin, suggested 200% for young people. Another set of arguments involve the Kelly criterion, which I maybe a quarter understand. This methodology seems to say that even if you have infinite risk tolerance, you should not be using more than 140% stocks. If you throw in a safety factor, you still conclude that an all-in risk-ignoring return-maximizing investor should be using more than 100% stocks.

b) The lack of any explanation of how the poster knows his risk tolerance. (A notable exception is Vision, who gave the results of two "risk tolerance" questionnaires.) Mostly as in this one, they take it as a given that they have high risk tolerance (often "because I'm young") and don't actually want to discuss it. In effect, "just accept that I have high risk tolerance and take that as the starting point."

I don't think risk tolerance questionnaires are worth much. It is absurd that the way you would measure someone's risk tolerance is simply to ask them how they think they would behave in various hypothetical super-stressful situations. And they always pull their punches on the hypothetical situations. Vanguard, for example, doesn''t say "what if your portfolio fell 52%," which is exactly what a 100% stocks portfolio actually did in 2008-2009. They are much more likely to talk about "dropping 37%, as it did in 2008" (i.e. calendar year), and I think the reason is that they want to avoid saying "losing more than half."

They definitely do not ask "if you had a slice-and-dice multi-asset portfolio, and one of the funds in it fell 73%, what would you do?" But that's exactly what Vanguard REIT index did during 2008-2009.

The financial economics community would be doing us a favor if they spent a tenth as much time researching valid ways of measuring risk tolerance accurately, as they spend looking for new factors.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by azanon » Fri Aug 19, 2016 5:23 pm

nisiprius wrote:
azanon wrote:...Nisiprius, an excellent post as usual, but this is a strong statement to make (for anyone). You're basically saying Siegel is interpreting the results wrong...
I don't think so. I think I'm interpreting it the same way Jeremy Siegel interprets them. It's other people (for example, the authors of "Dow 36000") that oversimplify it into what they want to hear.

...................

Siegel is saying that because of mean reversion, a long period of time will be riskier than a short period of time, just not as much riskier as if stocks followed a random walk.
Ok, so I pulled up my copy of Siegel's SFTLR, 5th edition (Kindle). Chapter 6 is entitled "Why Stocks Are Less Risky Than Bonds in the Long Run", and within that chapter, there's figure 6-1 that shows even at 10 years stocks highest and lowest return is 16.8% and -4.1%, respectively (for holding periods 1802-2012), and Bonds highest and lowest return is 12.4% and -5.4%, respectively, and that scenario just gets even more drastic for 20 and 30 years.

Now I didn't re-read the chapter, but it's really hard to conclude from that chart that stocks are more risky than bonds if you define the time horizon as 10 or more years, and especially 20 years, that debate notwithstanding, and surely he wouldn't entitle the chapter that way if he didn't believe it. That's a heck of a lot of 10 year holding periods for stock to not, once, fall below bonds.

In fairness though, figure 6-2 shows ave. standard deviation of stocks vs. bonds real return, and the ave standard deviation of stock's return doesn't drop below bonds until the 20 yr. holding period. But SD is the most popular measure of volatility, and if it's lower, it implies less risk. And Siegel actually makes that equation with the language; "Although the SD of stock returns is higher than for bond returns over short-term holding periods, once the holding period increases to between 15 and 20 years, stocks become less risky than bonds."

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by backpacker » Fri Aug 19, 2016 5:46 pm

roflwaffle wrote: It also seems like holding equities for some sufficiently long time period (~5-15 years?) can make the higher volatility of stocks a moot point, because their low can still be higher than the low of a mixed portfolio when enough earnings have accrued to offset the higher volatility.
Indeed, the following efficiency frontier from chapter two of Stocks for the Long Run makes the same point. It indicates that an investor with a 30 year term who wanted to minimize risk should hold no less than about 70% of her portfolio in stock. More bonds than that not only decreases returns but needlessly increases risk. More stock increases returns without adding much risk.

Image

Siegel has a nice table with recommended stock percentages for investors of various risk tolerance. For an investor with a 30 year term, a 100% stock portfolio is somewhere between conservative and moderate.

Image

Of course, there is always the question of the extent to which past returns--and especially past returns from a market as successful as the US--can be relied on to predict future scenarios. Also, not all the money a young investor saves is long-term even if retirement is decades away. Some of it may be needed sooner in the case of job loss or what have you, so should be invested as though it had a shorter term.

On the other hand, this table may to some extend underestimates the stock percentage that is ideal for young investors because the returns are for investing a lump sum and leaving it there for 30 years. It ignores the fact that most of your portfolio is human capital and in neither stocks nor bonds.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by patrick » Fri Aug 19, 2016 5:52 pm

nisiprius wrote:It is particularly troublesome when you spell out a time period of 5-15 years. How did you get that idea? Did you read something saying "you should not invest in stocks if you will need the money in five years or less" and conclude that you could turn it around, and that it would be safe to invest in stocks as long as you could wait five years before you needed the money?

If we include reinvested dividends, which often makes things look better, and correct for inflation, which often makes things look worse, then:

if you invested $10,000 into the stock market at the start of 1966, and measure in terms of 1966 dollars,
  • Five years later, at the end of 1970, you'd have the buying power of $9,441.58.
  • Ten years later, at the end of 1975, you'd have had $7,917.95.
  • Fifteen years later, at the end of 1980, you'd have had $9,788.80.
Bonds did even worse from 1966-1980. Using 10-year Treasury returns from http://pages.stern.nyu.edu/~adamodar/Ne ... retSP.html and inflation data from table 24 of http://www.bls.gov/cpi/cpid1404.pdf we see that a $10,000 bond investment would have gone down to about $6,016 over this period. Avoiding the volatile of stocks would not have protected you from losses over these 15 years.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Elbowman » Fri Aug 19, 2016 6:58 pm

1) Either you have an ENORMOUS emergency fund, in which case your "100% stocks portfolio" is really just mental accounting, or you can't really guarantee any particular holding period.

2) When everyone whose financial opinion I respect (most of whom have much more experience than me) recommends a minimum of 10% of bonds, I think it would be a dangerous combination of hubris and greed to decide that I know better and should be 100% stocks.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by njboater74 » Fri Aug 19, 2016 7:42 pm

nisiprius wrote: a) The unexplained magnetism of the round number. If you believe your risk tolerance is high enough, is no possible justification for not considering some leverage. You can get into a further discussion about how much. One point of view (pure MPT) is that no amount is too much, it's completely determined by your risk tolerance. Those Ivy League professors who market timer (at least thought he was following), literally into ruin, suggested 200% for young people. Another set of arguments involve the Kelly criterion, which I maybe a quarter understand. This methodology seems to say that even if you have infinite risk tolerance, you should not be using more than 140% stocks. If you throw in a safety factor, you still conclude that an all-in risk-ignoring return-maximizing investor should be using more than 100% stocks.
Excellent point. I've never thought about it this way. I suppose that the volatility goes up in these circumstances, but if you're *OK* with volatility, then why not? Since you have the patience to wait out the troughs.

It's easy to look back at the W curve the S&P took between 2000 and 2010 and think that wouldn't bother you, because it will go back up, it always has. How would you feel if you were in the middle of it, except instead of bouncing right back in 2009, it sat there for a few years, and then slowly slowly started to creep back up over two decades?

I think an important measure of risk tolerance is not just whether you can handle volatility, but whether you can financially absorb the permanent loss. Early in your investing life, you might be able to make up a 50% loss of your investment through a change in spending and a change in your saving rate. Late in your investing life, you don't have the time to make up the loss with your own cash. So that means a drastically different retirement.

Why do people leer over the subway tracks to see if the train is coming? It certainly isn't going to help the train come any faster. Why would they take the risk of being so close to something so dangerous? Our anxieties about waiting for something are very strong, especially if we don't know when it will come.
When the mob and the press and the whole world tell you to move, your job is to plant yourself like a tree beside the river of truth and tell the whole world - 'No, YOU move'--Captain America, Boglehead

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by magneto » Sat Aug 20, 2016 3:15 am

Would tentatively add the 'Rebalancing Bonus' would not be available to the 100% Stocks investor.

That Bonus is maximised at 50/50 (volatile/stable).

However most investors will logicallly head towards the 60/40, 70/30 region,since the volatile asset (Stocks) tends to outperform long-term (esp US).
But horizontal Stock Markets do exist, as for example the UK market since 1999.
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by wearahat » Sat Aug 20, 2016 8:01 am

Good question.

For a long-term holder there is no reason to not go 100% equities, in fact you should probably go 100% equities for the best long-term return.
Volatility is irrelevant for a long-term holder. Therefore there is zero risk to 100% equities in the long-term.
The biggest risk is not having high enough returns, which means cash and bonds is more risky than equities in the long-term.
Volatility is good in the long-term because it allows fast accumulation of equities.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by bobcat2 » Sat Aug 20, 2016 9:40 am

Volatility is a measure of investing risk (uncertainty) – nothing more, nothing less. It shows that the riskiness of stocks stays about the same over time, unless there is significant mean reversion over time.

But recent research, alluded to by Nisiprius earlier in this thread, shows that the riskiness of holding equities increases the longer the holding period. The reasons are somewhat technical, but basically revolve around the fact that when dealing with historical returns we know the sample historical mean return. However, when dealing with future returns we must use an estimate of the mean return and the uncertainty or risk associated with that estimate increases with the length of the future holding period. Until recent research on this aspect of equity risk no one had taken this extra risk of equity investing in the long-run (LR) into account. This, and other LR risks of equity investing, more than offsets any mean reversion lessening of the LR risk of holding stocks.

Holding stocks for six months is less risky than holding them for a year, which is less risky than holding stocks for ten years, which in turn is less risky than holding stocks for forty years. This is very easy to see in the real world. A Japanese investor holding stocks for the last 28 years has been subject to much more equity risk than a US investor holding stocks during the market crash from October 2007 until March 2009.
Link to paper – http://papers.ssrn.com/sol3/papers.cfm? ... id=1136847

From the abstract of the paper.
Mean reversion contributes strongly to reducing long-horizon variance, but it is more than offset by various uncertainties faced by the investor, especially uncertainty about the expected return. The same uncertainties reduce desired stock allocations of long-horizon investors contemplating target-date funds.
Fama and French discussed this additional LR risk of equities at some length in their blog.

Ken French -
The Pastor-Stambaugh result is driven by uncertainty about the true expected return. The volatility or standard deviation of returns is usually defined as the expected variation relative to the true mean of the process generating returns - as if we knew the true expected return. But, as Pastor and Stambaugh emphasize, we never actually know the true mean. When they include uncertainty about the true mean (as well as uncertainty about other true parameters) in the analysis, they find that long-run returns are indeed more volatile than short-run returns. ...

if we knew the true expected return, our uncertainty about long-run returns would grow with the return horizon. But we do not know the true expected return. Because we make the same error when we forecast the one-year return one year out, two years out, and N years out, our uncertainty about long-run returns grows more quickly than the return horizon.
Link - https://www.dimensional.com/famafrench/ ... g-run.aspx


There is also the question of whether LR mean reversion in equity returns is truly reliable. At best the answer appears to be, maybe.
Here is a link to a research paper by Philippe Jorion on LR mean reversion in many stock markets around the globe. Jorion found that long-horizon standard deviations were consistent with what we would expect from pure random walks without any RTM. Here is his conclusion.
This research investigates the persistence of investment risk across time horizon, a crucial issue in asset allocation decisions. Previous empirical results have focused mainly on US data and suffer from limited sample size in the analysis of long-horizon returns. Investigation of a long-term sample of thirty countries provides additional empirical evidence. The results are not reassuring. There is no evidence of long-term mean reversion in the expanded data sample. Downside risk is not reduced as the horizon lengthens.
Link - http://merage.uci.edu/~jorion/papers%5Crisk.pdf

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Ari » Sat Aug 20, 2016 9:43 am

nisiprius wrote:The unexplained magnetism of the round number. If you believe your risk tolerance is high enough, is no possible justification for not considering some leverage.
Considering leverage is fine, but since it comes with extra costs and extra risks, many find investing with leverage to be much less appealing than investing without it. It's not a smooth transition from 100% to 101%, there's a kink in the curve.
Elbowman wrote:1) Either you have an ENORMOUS emergency fund, in which case your "100% stocks portfolio" is really just mental accounting, or you can't really guarantee any particular holding period.
Depends on your lifestyle. I have a hard time imagining a scenario where I would need an enormous emergency fund. If I lost my job and all my belongings were consumed in a fire, I still don't think I'd need more than, say, six months of expenses to get by. That's enough to live in a cheap hostel while finding a new place to live and registering for unemployment benefits. And that's just because I don't like to pay for income insurance. If I had that, I don't think I'd need even this much of an EF.
njboater74 wrote:I think an important measure of risk tolerance is not just whether you can handle volatility, but whether you can financially absorb the permanent loss. Early in your investing life, you might be able to make up a 50% loss of your investment through a change in spending and a change in your saving rate. Late in your investing life, you don't have the time to make up the loss with your own cash. So that means a drastically different retirement.
Then again, in the vast majority of the last 100 years, a retiree with a 100% stock allocation could sustain a higher withdrawal rate without portfolio failure, than could a retiree who owned bonds: https://retirementresearcher.com/asset- ... wal-rates/. The only periods where bonds would mean you had a higher potential SWD was around the stock crash of '29 and in the mid-60's (where the difference was very small). It seems like even in retirement, most of the stock risk is on the upside, not the downside.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by FIREchief » Sat Aug 20, 2016 9:46 am

azanon wrote: Ok, so I pulled up my copy of Siegel's SFTLR, 5th edition (Kindle). Chapter 6 is entitled "Why Stocks Are Less Risky Than Bonds in the Long Run", and within that chapter, there's figure 6-1 that shows even at 10 years stocks highest and lowest return is 16.8% and -4.1%, respectively (for holding periods 1802-2012), and Bonds highest and lowest return is 12.4% and -5.4%, respectively, and that scenario just gets even more drastic for 20 and 30 years.
Very interesting. Does your book elaborate on the composition of "bonds" in the scenario described? Obviously, if an investor focused on short durations, the chance of a -5.4% return would be little or none.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by FIREchief » Sat Aug 20, 2016 9:52 am

njboater74 wrote: I think an important measure of risk tolerance is not just whether you can handle volatility, but whether you can financially absorb the permanent loss. Early in your investing life, you might be able to make up a 50% loss of your investment through a change in spending and a change in your saving rate. Late in your investing life, you don't have the time to make up the loss with your own cash. So that means a drastically different retirement.
I think we need to also look at the permanent loss on the flip side. Every year that equities return more than bonds/FI, an investor with anything less than 100% stocks has also sustained a permanent loss. Over time, these losses can far exceed any permanent loss that the 100% investor might incur when forced to sell some small portion of their stocks in a down market to pay the rent.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by nisiprius » Sat Aug 20, 2016 9:53 am

The real-world question is how do you behave, and how do you budget, given some anticipated distribution of returns.

Suppose that investor A really believes that thirty years from how, considering "could-really-happen-to-me" 10%-probability bounds, not the absolute extremes, that they could have anywhere from $1 million to $1.5 million.

Suppose that investor B really believes they could have anywhere from $1 million to $5 million.

If they both plan and budget for $1 million, then B does not benefit from the upside potential.

If A budgets for $1 million and B budgets on an anticipation of $3 million, then B will quite likely end up in financial and psychological trouble.

Now if you add to this the likely behavior of the two investors if A sees a balance of $750,000 along the way, and B sees a balance of $250,000 somewhere along the way, then you have a second problem.

So, B incurs the "risk of too-optimistic budgeting and not taking into account the full range of variability in outcome," and B also incurs the risk of "panic selling during a downturn."

I personally know that I am subject to both of these risks, and I invest accordingly. That doesn't speak to anyone else's situation. However, one shouldn't just brush them aside as outside the range of things to be considered.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by nisiprius » Sat Aug 20, 2016 9:54 am

P.S. Just to clarify one more time. Siegel does say that stocks are less risky then bonds in the undefined long run. He does not say how long "the long run" is.

What he does not say is that the risk of stocks declines over longer holding periods, and in the transcript I quote he not only says it doesn't, he says, verbatim quote, "I never said that that means stocks are safer in the long run. "
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by bobcat2 » Sat Aug 20, 2016 10:16 am

Here is Jeremy Siegel discussing risk when investing for retirement.
(The previous discussions) reinforce the need for goal- or liability-driven investing. Forget
about strategies. What is the risk-free rate for investors? You cannot know what risk is until you know
the time frame of the investors.


t is important to decide whether the pot is a savings account or a retirement account. It is hard to have
two different goals because they conflict. One calls for having principal stability, which is a Treasury
bill. The other calls for standard-of-living and income stability, which is a long-term bond. You cannot have both.
If you get clients to focus on rates of return and asset mixes, it is likely to be the wrong approach.
You should get people to determine their goals instead of asking them how much they want to
put in real estate.


Everyone in this room knows what people want for retirement. It is an income. Social security
gives an income. DB plans give an income. In DC plans, for some reason, we do not show people
the funded ratio. We are showing them the wrong thing, and then we are saying they are making the
wrong decisions. We are telling people that risk is the value of their fund, when risk is really how
much income they can sustain for retirement.


In other words Siegel strongly recommends that for retirement saving and investing people should follow liability driven investment (LDI) strategies. Such LDI strategies are far removed from 100% stock investing strategies!

Link to full panel discussion provided by the CFA Institute.
http://robertcmerton.com/wp-content/upl ... Future.pdf

BobK
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Waba » Sat Aug 20, 2016 10:23 am

Also note that the risk tolerance of "you" can be very different from the risk tolerance of "you and your partner"

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Rodc » Sat Aug 20, 2016 1:34 pm

nisiprius wrote:Two questionable things about most "why not 100% stocks" posts, including this one:

a) The unexplained magnetism of the round number. If you believe your risk tolerance is high enough, is no possible justification for not considering some leverage. You can get into a further discussion about how much. One point of view (pure MPT) is that no amount is too much, it's completely determined by your risk tolerance. Those Ivy League professors who market timer (at least thought he was following), literally into ruin, suggested 200% for young people. Another set of arguments involve the Kelly criterion, which I maybe a quarter understand. This methodology seems to say that even if you have infinite risk tolerance, you should not be using more than 140% stocks. If you throw in a safety factor, you still conclude that an all-in risk-ignoring return-maximizing investor should be using more than 100% stocks.
I don't think this is an entirely fair criticism. Few people have access to free leverage and moreover to leverage that does not entail some level of additional risk (like margin calls) that they can use to directly lever up. Fewer know how to find good leverage even if in theory they could. Anyone can easily go 100% stocks, but not so easy to go 120% stocks. Can it be done? Sure, someone will likely come along and tell me how to use LEAPS or something. And I suppose if I wanted I could learn what a LEAP is and how to use one. Reality is right now I do not know how to use them and since I do all my long term investing in my 401K it might not work very well (though yes if determined I could open a taxable account).

The one way this is not true, is in some sense anyone with a mortgage is "leveraged" in the sense that borrowing for a house frees up a lot of cash that would otherwise be locked up either in a savings account or something while they save to pay cash, or if they have the money using a mortgage frees money up for investing. This is the old "Mortgage is a negative bond" idea. I do not quite buy the duality, I don't think the equivalence is exact, but nonetheless often young new homeowners have large mortgages they chose to not pay off as aggressively as they could and instead put the money into stocks. Since mortgage rates tend to be favorable compared to other borrowing and there is no margin call if the house value goes down, and moreover most people know how to get a mortgage, and for many people home ownership has many favorable attributes this often makes sense.

At any rate, I get the sense that nearly always when someone asked about an X% of stocks portfolio they are talking strictly about a general stock/bond portfolio (and maybe REIT or other type of commonly available to the public investment). It is not easy to go beyond 100% so for most this is a very reasonable non-arbitrary upper bound. IMHO.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by duffer » Sat Aug 20, 2016 2:35 pm

nisiprius wrote:
azanon wrote:...Nisiprius, an excellent post as usual, but this is a strong statement to make (for anyone). You're basically saying Siegel is interpreting the results wrong...
I don't think so. I think I'm interpreting it the same way Jeremy Siegel interprets them. It's other people (for example, the authors of "Dow 36000") that oversimplify it into what they want to hear. These are Siegel's words; my boldfacing:
The Great Debate: Bodie vs. Siegel (2008)
Let me show you the graph that is in my book, Stocks for the Long Run, that I think is so critical to that. We have it on my right, on your left. It is the standard deviation of stocks, bonds, and treasury bills after inflation, measured over the longest period we have ever done research on. 200 years. That’s the one year standard deviations, those are the two year average standard deviations, five, ten, 20, and 30. Now, many of you who have gone to my presentations have probably seen that slide before.

Now, one thing I should make very clear, I never said that that means stocks are safer in the long run. This is the standard deviation of average annual returns. We know the standard deviation of the average goes down when you have more periods. Even if it’s random walk, it goes down. What I pointed out here is that the standard deviation for stocks goes down twice as much— twice as fast as random walk theory would predict. In other words, they are relatively safer in the long run than random walk theory would predict.

Doesn’t mean they’re safe. The whole point is that they are relatively safer.
Siegel is saying that because of mean reversion, a long period of time will be riskier than a short period of time, just not as much riskier as if stocks followed a random walk.

Nisi--

I think you are clearly misrepresenting Siegel's views. Where is that quote from? I believe you have used it before, but it seems to come from an unpublished account by someone of spoken remarks by Siegel. Please correct me if I am wrong on this.

According to Siegel's writing and research, over longer periods (about 10-15 years by his data), you are more likely to lose significantly by holding bonds than you are by holding stocks.

For example, on pp. 94-95 of the fifth edition of Stocks for the Long Run, he reports about the relative real returns of holdings in stocks, bonds, and bills:

"Stocks are unquestionably riskier than bonds or Treasury bills over one- or two-year periods. However, in every five-year period since 1802, the worst performance in stocks, at -11.9 percent per year, has been only slightly worse than the worst performance in bonds or bills [-11.9 vs -10.1 vs -8.3 respectively]. and for 10-year holding periods, the worst stock performance has actually been better than for bonds or bills [-4.1 vs -5.4 vs -5.1]. For 20-year holding periods, stock returns have never fallen below inflation, while returns for bonds and bills once fell as much as 3 percent per year below the inflation rate. During that inflationary episode, the real value of a portfolio of Treasury bonds, including all reinvested coupons, fell by nearly 50 percent. The worst 30-year return for stocks remained comfortably ahead of inflation by 2.6 percent per year, a return that is not far below the average performance of fixed-income assets. It is very significant that stocks, in contrast to bonds or bills, have never delivered to investors a negative real return over periods lasting 17 years or more. Although it might appear to be riskier to accumulate wealth in stocks rather than in bonds over long periods of time, for the preservation of purchasing power, precisely the opposite is true: the safest long-term investment has clearly been a diversified portfolio of equities."

I think this is very different from what you claim he is saying.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by duffer » Sat Aug 20, 2016 3:02 pm

bobcat2 wrote:Here is Jeremy Siegel discussing risk when investing for retirement.
(The previous discussions) reinforce the need for goal- or liability-driven investing. Forget
about strategies. What is the risk-free rate for investors? You cannot know what risk is until you know
the time frame of the investors.


t is important to decide whether the pot is a savings account or a retirement account. It is hard to have
two different goals because they conflict. One calls for having principal stability, which is a Treasury
bill. The other calls for standard-of-living and income stability, which is a long-term bond. You cannot have both.
If you get clients to focus on rates of return and asset mixes, it is likely to be the wrong approach.
You should get people to determine their goals instead of asking them how much they want to
put in real estate.


Everyone in this room knows what people want for retirement. It is an income. Social security
gives an income. DB plans give an income. In DC plans, for some reason, we do not show people
the funded ratio. We are showing them the wrong thing, and then we are saying they are making the
wrong decisions. We are telling people that risk is the value of their fund, when risk is really how
much income they can sustain for retirement.


In other words Siegel strongly recommends that for retirement saving and investing people should follow liability driven investment (LDI) strategies. Such LDI strategies are far removed from 100% stock investing strategies!

Link to full panel discussion provided by the CFA Institute.
http://robertcmerton.com/wp-content/upl ... Future.pdf

BobK


Au contraire. Siegel has repeatedly written and said that bonds are more likely to lose income to inflation and that a diversified stock portfolio is the safest over longer terms of investment.

According to Siegel, over longer periods (about 10-15 years by this data), you are more likely to lose significantly by holding bonds than you are by holding stocks.

For example, on pp. 94-95 of the fifth edition of Stocks for the Long Run, he reports about the relative real returns of holdings in stocks, bonds, and bills:

"Stocks are unquestionably riskier than bonds or Treasury bills over one- or two-year periods. However, in every five-year period since 1802, the worst performance in stocks, at -11.9 percent per year, has been only slightly worse than the worst performance in bonds or bills [-11.9 vs -10.1 vs -8.3 respectively]. and for 10-year holding periods, the worst stock performance has actually been better than for bonds or bills [-4.1 vs -5.4 vs -5.1]. For 20-year holding periods, stock returns have never fallen below inflation, while returns for bonds and bills once fell as much as 3 percent per year below the inflation rate. During that inflationary episode, the real value of a portfolio of Treasury bonds, including all reinvested coupons, fell by nearly 50 percent. The worst 30-year return for stocks remained comfortably ahead of inflation by 2.6 percent per year, a return that is not far below the average performance of fixed-income assets. It is very significant that stocks, in contrast to bonds or bills, have never delivered to investors a negative real return over periods lasting 17 years or more. Although it might appear to be riskier to accumulate wealth in stocks rather than in bonds over long periods of time, for the preservation of purchasing power, precisely the opposite is true: the safest long-term investment has clearly been a diversified portfolio of equities."

Siegel also reports that he holds trivial amounts of bonds in his own portfolio.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by bobcat2 » Sat Aug 20, 2016 3:23 pm

Duffer here is what Siegal said earlier this year about investing for retirement.
(The previous discussions) reinforce the need for goal- or liability-driven investing. ...

t is important to decide whether the pot is a savings account or a retirement account. It is hard to have
two different goals because they conflict. One calls for having principal stability, which is a Treasury
bill. The other calls for standard-of-living and income stability, which is a long-term bond. You cannot have both.
If you get clients to focus on rates of return and asset mixes, it is likely to be the wrong approach.
You should get people to determine their goals instead of asking them how much they want to
put in real estate.


Everyone in this room knows what people want for retirement. It is an income. Social security
gives an income. DB plans give an income. In DC plans, for some reason, we do not show people
the funded ratio. We are showing them the wrong thing, and then we are saying they are making the
wrong decisions. We are telling people that risk is the value of their fund, when risk is really how
much income they can sustain for retirement.


Link - http://robertcmerton.com/wp-content/upl ... Future.pdf

LDI investing involves matching the duration of bonds to the duration of the investor's liabilities, which in the case of retirement is annual spending. This is impossible if the investor is holding primarily equity, because fixed income must be used for the matching required in an LDI strategy. To implement an LDI strategy for retirement you must be primarily invested in bonds from at least 10 years before retirement and then stay that way until death. Siegel knows this and I assume was fully aware of it when he made the above points about retirement planning earlier this year. When Siegel said "... the risk is really how much income they can sustain for retirement, " he was talking about using an LDI matching strategy using bonds. He was not talking about investing in equities.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by bobcat2 » Sat Aug 20, 2016 3:31 pm

Here is more from Jeremy Siegel on investing for retirement from the same panel discussion earlier this year.
If a target date fund is a fund that is designed to hit a particular objective, or to get as close as you can to a particular objective, it would save investors the trouble of trying to figure how to do it. I am a big fan of that, but the current incarnations of target date funds do not do that at all. They are based on a variety of different myths about how much you should have in equity and fixed income as you get closer to some projected horizon for the individual.

One other point is that target date funds are completely divorced from life expectancy risk. How can you possibly run funds that supposedly benefit the individual without providing a complete solution that covers both insurance risk and inflation issues? What
kind of annuity are you going to have at the end?

Link - http://robertcmerton.com/wp-content/upl ... Future.pdf

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by bobcat2 » Sat Aug 20, 2016 3:41 pm

Duffer -

Looking at stock returns of 15 years or more in only the US stock & bond markets tells us little reliably about the relative LR returns of equities vs.bonds. US stock market data is at best dubious before 1890. That leaves us with 8 independent samples of 15 year returns, which is not nearly enough data to draw robust inferences about relative returns.

If OTOH we look at the Triumph of the Optimists market data back to 1900 on stock and bond data for 25 or so countries, we see numerous examples of bonds out performing stocks for periods of 30 years or more.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by njboater74 » Sat Aug 20, 2016 4:00 pm

Ari wrote:
njboater74 wrote:I think an important measure of risk tolerance is not just whether you can handle volatility, but whether you can financially absorb the permanent loss. Early in your investing life, you might be able to make up a 50% loss of your investment through a change in spending and a change in your saving rate. Late in your investing life, you don't have the time to make up the loss with your own cash. So that means a drastically different retirement.
Then again, in the vast majority of the last 100 years, a retiree with a 100% stock allocation could sustain a higher withdrawal rate without portfolio failure, than could a retiree who owned bonds: https://retirementresearcher.com/asset- ... wal-rates/. The only periods where bonds would mean you had a higher potential SWD was around the stock crash of '29 and in the mid-60's (where the difference was very small). It seems like even in retirement, most of the stock risk is on the upside, not the downside.
I noticed that the article says "Using SBBI Data, 1926-2015, S&P 500 and Intermediate-Term Government Bonds", but then shows a chart that only goes up to 1990.

Which actually illustrates my point. If you had been reading this in 1999, you might think it was perfectly safe to hold a high stock portfolio because stocks always go up. As long as you don't plan on retiring in the 30's, 60's or 00's, you should be fine.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by FIREchief » Sat Aug 20, 2016 4:00 pm

bobcat2 wrote: If OTOH we look at the Triumph of the Optimists market data back to 1900 on stock and bond data for 25 or so countries, we see numerous examples of bonds out performing stocks for periods of 30 years or more.
Do you have any idea if any of those periods began with global interest rates at or near zero (i.e. like now)? This is simply a math issue, as I'm assuming that for bonds to outperform stocks over a long period, it would require that bond returns get juiced from falling interest rates.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by itstoomuch » Sat Aug 20, 2016 4:22 pm

I very rarely hold 100% equity in Discretionary trading accounts because I never know when a new opportunity comes in being.
Being fully invested means you have sell something in order to buy. That's one more decision that I don't want to make... I only a single buy decision or a single sell decision. I hold no bonds because that is a 2 decision process.
YMMV
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by njboater74 » Sat Aug 20, 2016 4:28 pm

FIREchief wrote:
njboater74 wrote: I think an important measure of risk tolerance is not just whether you can handle volatility, but whether you can financially absorb the permanent loss. Early in your investing life, you might be able to make up a 50% loss of your investment through a change in spending and a change in your saving rate. Late in your investing life, you don't have the time to make up the loss with your own cash. So that means a drastically different retirement.
I think we need to also look at the permanent loss on the flip side. Every year that equities return more than bonds/FI, an investor with anything less than 100% stocks has also sustained a permanent loss. Over time, these losses can far exceed any permanent loss that the 100% investor might incur when forced to sell some small portion of their stocks in a down market to pay the rent.
Very good point. This is why it's important to understand what you will need to be drawing during your retirement. You certainly don't want too conservative an allocation if it means that you won't generate enough earnings to actually retire.

On the other hand, if you're shooting for a safe, comfortable retirement, having a too aggressive allocation can make it more likely that you'll have a luxurious retirement, but will also make it more likely you'll have a difficult retirement, or a delayed retirement.

And this also speaks to the OP's original question - since the risks are not just in pure dollars and cents, but how this will impact your life. An extra $1M might allow you to buy cadillacs and cruises, but $1M less might mean you won't even be able to afford chevys and camping. You need to decide what kind of lifestyle you want, and what you're willing to risk to get it.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by Rodc » Sat Aug 20, 2016 4:47 pm

itstoomuch wrote:I very rarely hold 100% equity in Discretionary trading accounts because I never know when a new opportunity comes in being.
Being fully invested means you have sell something in order to buy. That's one more decision that I don't want to make... I only a single buy decision or a single sell decision. I hold no bonds because that is a 2 decision process.
YMMV
Problem is you have to factor in opportunity cost - while you wait for the new op to turn up you lose ground in about 2 out of 3 years. The new op has to be so good that it overcomes the earlier loses that mounted while you were waiting.

I don't think this is a very good reason to not be 100% stocks. There are other more compelling reasons for most investors.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by FIREchief » Sat Aug 20, 2016 5:09 pm

itstoomuch wrote:I very rarely hold 100% equity in Discretionary trading accounts because I never know when a new opportunity comes in being.
I think we know that new opportunities come along every day. Problem is, we have no way of knowing what they are until the future when we're looking in the rear view mirror.
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by itstoomuch » Sat Aug 20, 2016 7:32 pm

I make buy/sell decisions fairly quickly. Since the Discretionary is purely discretionary, I normally like to keep 20% cash, which vary considerably . I know that I lose opportunity cost for being Not fully invested but I like that reserve fund cushion. Currently near 50% cash in preparation to buy a retirement home.
We are retired with enough dedicated assets for retirement needs.
YMMV
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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by goingup » Sat Aug 20, 2016 7:47 pm

Ari wrote:So the risk of volatility seems to have three major factors:

1: The risk you'll need the money when the market is down.
2: The risk that the returns are bad over your entire holding period.
3: The risk that you'll panic and sell.

All of these factors can be considered. If you have a sizable emergency fund and few liabilities, number one can be taken care of. Number two decreases with increasing holding periods. Number three is trickier, and entails that you have to know yourself. People react differently when they're stressed and knowing that you shouldn't sell isn't necessarily going to help you, according to some research. You'll know more about your psychological risk tolerance as you age, but then you're decreasing your holding period and thus increasing the second factor.
OP-
I like the way Ari has laid this out for you. There's an old saying: "The Market can stay irrational longer than you can stay solvent."

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Re: Are there other reasons besides volatility to avoid 100% equities?

Post by azanon » Sat Aug 20, 2016 9:28 pm

nisiprius wrote:P.S. Just to clarify one more time. Siegel does say that stocks are less risky then bonds in the undefined long run. He does not say how long "the long run" is.

What he does not say is that the risk of stocks declines over longer holding periods, and in the transcript I quote he not only says it doesn't, he says, verbatim quote, "I never said that that means stocks are safer in the long run. "
So I admit I put more weight in a well researched (and presumably edited/vetted) book, than a transcript of a debate. It just seems the more conservative approach.

Debates are fun and interesting, but the participants are being put on-the-spot and usually someone gets the better of the other person, and not necessarily because their information is more correct.

And one quick observation about Zvi Bodie, I confess I like the guy. His viewpoints are interesting, even if nothing else. He also seems quite charming, and would probably be fun to hang around. That being said, it would be an understatement to say his views towards investing and portfolio management are an outlier compared to conventional wisdom that continues to this very day. And even Bodie admits that, but still doubles-down.
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