Larry Swedroe's latest market returns forecast

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smpatel
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Re: Larry Swedroe's latest market returns forecast

Post by smpatel »

larryswedroe wrote:And because of the much higher than expected returns and given the new valuations and bond yields they determine they now only have a need to take risk that can be met by holding only 30% stocks.
Wouldn't this trigger a re-balancing band? So, re-balancing/AA allocation change due to valuations change/market timing, are they all just different color hats?

I guess so far you stick to your methodology of market timing and make it emotionless it could be beneficial, oh I know I am supposed to hate market timing on this forum for sure!

cheers!
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Kevin M
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Re: Larry Swedroe's latest market returns forecast

Post by Kevin M »

HomerJ wrote:<snip> and planned on getting around 4% real long-term on the stock side to figure out how much I need to save.
Why? How did you come up with 4% real for your plan?
HomerJ wrote:Planning for a low number leaves a lot of upside, which I've been lucky to experience.
Why do you think 4% real is a low number?

Kevin
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HomerJ
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Re: Larry Swedroe's latest market returns forecast

Post by HomerJ »

larryswedroe wrote:Homer
Here's an example of why you clearly must be incorrect
It's okay. You can just say "You're an idiot" :)
Then the market returns 15.2 percent in real terms. And because of the much higher than expected returns and given the new valuations and bond yields they determine they now only have a need to take risk that can be met by holding only 30% stocks. Moving to this has nothing to do with market timing, nor a belief that bonds will now outperform stocks, but solely to do with whether one needs to take risk and their marginal utility of wealth. There is no judgment whatsoever about whether stocks are overvalued or not which is what market timing is all about.
I agree with you... But expected returns, going forward, have nothing to do with it. Actual returns were good, so now they can cut back.
Last edited by HomerJ on Tue Nov 01, 2016 10:45 pm, edited 2 times in total.
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Re: Larry Swedroe's latest market returns forecast

Post by HomerJ »

Kevin M wrote:
HomerJ wrote:<snip> and planned on getting around 4% real long-term on the stock side to figure out how much I need to save.
Why? How did you come up with 4% real for your plan?
HomerJ wrote:Planning for a low number leaves a lot of upside, which I've been lucky to experience.
Why do you think 4% real is a low number?

Kevin
http://awealthofcommonsense.com/2016/05 ... t-returns/
The worst 30 year return — using rolling monthly performance — occurred at the height of the market just before the Great Depression and stocks still returned almost 8% per year over the ensuing three decades.
I picked a number that is lower than the worst return on record so far.

4% seems pretty conservative to me... I could be wrong... If so, I'll work a little longer, or lower my lifestyle in retirement. I'm good now. I could retire to my lake condo today, but my wife likes to travel, so I have to work a little longer and build up a bigger cushion :)
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Re: Larry Swedroe's latest market returns forecast

Post by FIREchief »

HomerJ wrote: http://awealthofcommonsense.com/2016/05 ... t-returns/
The worst 30 year return — using rolling monthly performance — occurred at the height of the market just before the Great Depression and stocks still returned almost 8% per year over the ensuing three decades.
"There you go again," bringing real historical facts into a discussion centered around who has the best analytical theory for predicting the future. :twisted:
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: Larry Swedroe's latest market returns forecast

Post by randomguy »

Random Walker wrote:Jamrock,
If you are 60% equities, would you sleep differently at night with P/E 30 v. P/E 10? Seems to me the downside risk is greater in one case than the other.

Dave
Most people would sleep worse with PE of 10 than say 25 or 30. Think about it. Did you worry more about finances in March of 2009 or in say Sept of 1999? There were a lot more people worried about stocks going to zero in 2009 than during any bull market. Those low PE10s might be a good buying sign but they are a result of markets that have dropped a ton. Most people struggle to buy in those cases. The difference between a market bottom and a failing knife is hard to see.
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Re: Larry Swedroe's latest market returns forecast

Post by ks289 »

HomerJ wrote:
Kevin M wrote:
HomerJ wrote:<snip> and planned on getting around 4% real long-term on the stock side to figure out how much I need to save.
Why? How did you come up with 4% real for your plan?
HomerJ wrote:Planning for a low number leaves a lot of upside, which I've been lucky to experience.
Why do you think 4% real is a low number?

Kevin
http://awealthofcommonsense.com/2016/05 ... t-returns/
The worst 30 year return — using rolling monthly performance — occurred at the height of the market just before the Great Depression and stocks still returned almost 8% per year over the ensuing three decades.
I picked a number that is lower than the worst return on record so far.

4% seems pretty conservative to me... I could be wrong... If so, I'll work a little longer, or lower my lifestyle in retirement. I'm good now. I could retire to my lake condo today, but my wife likes to travel, so I have to work a little longer and build up a bigger cushion :)
I think the original point of this thread which Larry's etf.com article also mentions, is that valuations and future expected returns can be a useful tool for allowing investors to feel comfortable staying the course with their AA (presumably including some international) in the setting of poor recent performance. To me, this is a useful tool AGAINST changing AA and market timing as well.

When you cite pure historical performance as a guide for planning, this is another tool, but one which has even less data behind it to speak to your earlier criticism of Larry's approach. It is not wrong, but simply demonstrates that all of our decisions are based on limited information which will never reliably predict the future.
Leesbro63
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Re: Larry Swedroe's latest market returns forecast

Post by Leesbro63 »

Any chance that one or some of the Bogleheads, directly connected to Mr. Bogle, can get him to issue a response?
Random Walker
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Re: Larry Swedroe's latest market returns forecast

Post by Random Walker »

Random guy,
I agree it would be scary seeing the portfolio drop, and the marginal utility of wealth increases as the portfolio plunges! That being said, thinking as rationally as we can about probabilities. Wouldn't one worry more about losing what they currently have at P/E 30 than P/E 10? Moreover, wouldn't they have more faith in new money invested at P/E 10? The higher the P/E, the greater the downside risk.

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Kevin M
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Re: Larry Swedroe's latest market returns forecast

Post by Kevin M »

HomerJ wrote:
Kevin M wrote:Why? How did you come up with 4% real for your plan?
<snip>
Why do you think 4% real is a low number?
I picked a number that is lower than the worst return on record so far.
OK, so you used historical returns to create your forecast of future returns for planning purposes, right?

Specifically, you selected a value slightly less than the worst case historical 30-year real return for US stocks since 1926, and used that as your worst-case 30-year forecast of future returns for your balanced portfolio of stocks and bonds (using age in bonds to determine your asset allocation) to calculate your required savings rate. Correct?

Kevin
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longinvest
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Re: Larry Swedroe's latest market returns forecast

Post by longinvest »

Random Walker wrote: I agree it would be scary seeing the portfolio drop, and the marginal utility of wealth increases as the portfolio plunges! That being said, thinking as rationally as we can about probabilities. Wouldn't one worry more about losing what they currently have at P/E 30 than P/E 10? Moreover, wouldn't they have more faith in new money invested at P/E 10? The higher the P/E, the greater the downside risk.
In his booklet The Ages of the Investor William Bernstein wrote:
About 40 years ago Paul Samuelson and Robert Merton formulated a theory of life-cycle investing that mathematically integrated human capital and investment capital. They concluded that a rational investor maintains a constant risk tolerance, and thus a constant percentage of exposure to stocks, throughout his or her lifetime.[2]
...
[2] Robert C. Merton, “Lifetime Portfolio Selection under Uncertainty: The Continuous-time Case,” The Review of Economics and Statistics 51, no. 3 (August 1969): 247–57, and Paul A. Samuelson, “Lifetime Portfolio Selection by Dynamic Stochastic Programming,” The Review of Economics and Statistics 51, no. 3: (August 1969): 237–46.
So, it would seem perfectly rational, based on mathematics, for an investor to stick to a constant asset allocation all life long, regardless of age, wealth, or valuations.

In other words, one's AA could rationally be set based on one's risk tolerance as suggested by our investment philosophy. I see no reference, in our investment philosophy, to currently expected returns and valuations.
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Re: Larry Swedroe's latest market returns forecast

Post by HomerJ »

Kevin M wrote:
HomerJ wrote:
Kevin M wrote:Why? How did you come up with 4% real for your plan?
<snip>
Why do you think 4% real is a low number?
I picked a number that is lower than the worst return on record so far.
OK, so you used historical returns to create your forecast of future returns for planning purposes, right?

Specifically, you selected a value slightly less than the worst case historical 30-year real return for US stocks since 1926, and used that as your worst-case 30-year forecast of future returns for your balanced portfolio of stocks and bonds (using age in bonds to determine your asset allocation) to calculate your required savings rate. Correct?

Kevin
Nowhere near that exact.

I have never looked at valuations or expected returns or tried to calculate a "required savings rate". We just saved a lot.

I basically just use 4% now to see how we're doing when playing around with financial calculators. As in, "If we get 4% from now on, here's how much we'll have at 55. Sweet!" I did choose a conservative number so that's there a lot of upside potential. If we get less, I'll work longer or cut back on our retirement lifestyle. So it's not a worst-case scenario. If we get less, I'll adjust.

But I'm going to adjust on ACTUAL returns, not on what you guys guess is going to happen.

Does it bother any of you that many of the "expected return" predictions in the past (recent past even) have turned out to be wrong? Anyone who used them to carefully plan out an investment strategy or required savings rate has not seen the numbers that were predicted.

Look, my opinion is you pick a conservative number for planning and adjust to actual returns. Surely, you wouldn't suggest to someone to cut back on their savings rate if valuations were low, and expected return was high? (The proper answer to that is "Don't call me Shirley")

Because what if the forecast was wrong, just like it's been wrong many times before? You can't really plan out a "required savings rate" on a forecast that has a plus or minus 8% range.

I picked a number that is lower than any 30-year period in the past, AND I remain flexible to go even lower if necessary.

I guess I don't care about valuations, because I plan around a number that is low enough to be nearly off the bottom of the chart of the range of expected returns anyway.
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Re: Larry Swedroe's latest market returns forecast

Post by Kevin M »

Leesbro63 wrote:Any chance that one or some of the Bogleheads, directly connected to Mr. Bogle, can get him to issue a response?
Mr. Bogle's thoughts on these topics are well known.

First, it is well known that he uses a version of the Gordon equation to set expectations for US stock returns:

Expected Return = dividend yield + earnings growth + speculative return

Where speculative return is due to the change in P/E. He has written about this in various books and articles; I happen to have a copy of The Little Book on Common Sense Investing, published in 2007, handy. Following are some excerpts.

After discussing the large contribution of speculative return to US stock returns from 1980-2005 due to a doubling of the P/E ratio from about 9 to about 18, he says (page 70):
John Bogle wrote:Since it is unrealistic to expect the P/E ratio to double in the coming decade, a similar 12.5 percent return is unlikely to recur. Common sense tells us that we're facing an era of subdued returns in the stock market.
And later, on pages 72-73:
John Bogle wrote:In summary, the future outlook for stock returns is far below the long-term real return on U.S stocks of about 6.5 percent annually. My projection of a future real return of 4.7 percent (before costs and taxes) is conservative largely because today's dividend yield of 2 percent is below the long-term norm of 4.5 percent, partilly offset by my optimistic projection of real earnings growth of 2.5 percent per year versus the 1.5 percent long-term norm. The long-term rate of per share earnings growth of U.S. corporations has been no more than that humble figure.
Second, he's not a fan of international stocks, and I'm 99% certain that low valuations relative to US stocks would not change his mind on this.

Finally, we also know that he is a proponent of using age-in-bonds as a starting point for determining one's asset allocation.

So I think we can summarize by saying that he does use a model to set expectations for future US stock returns, but he does not advocate using that to determine ones asset allocation, and he certainly doesn't advocate using an expected-returns model to adjust one's allocation to international stocks (he has mentioned 20% of stocks as an upper limit for international stocks, but personally does not invest in them at all).

Of course many of us do not follow his advice with respect to our international stock allocations, nor does Vanguard.

So John Bogle seems to be on a similar page as Larry, Bill Bernstein, and many others in terms of using dividend or earnings yield, dividend or earnings growth, and a speculative return component in estimating future stock returns, but not necessarily on the same page in terms of how to use this model in making investment decisions.

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Re: Larry Swedroe's latest market returns forecast

Post by Random Walker »

Longinvest,
I'm a huge Bernstein fan, and obviously I'm a mental midget compared to Samuelson and Merton, but I think it is very silly to assume a person's risk tolerance is constant throughout lifetime! Are you sure Bernstein agrees with that statement? First of all, how do you define risk tolerance: absolute dollar loss, percent dollar loss, volatility?
As a person progresses through life, he converts human capital into investment capital. As his potential to earn future income decreases and he accumulates more, circumstances change, and it makes virtually no sense that risk tolerance would be constant throughout life.
Bernstein's Liability Matching Portfolio / Risk Portfolio concept really doesn't fit at all with a fixed AA throughout one's lifetime. I got to go back and find my copy of Ages of Investor!

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Re: Larry Swedroe's latest market returns forecast

Post by betablocker »

HomerJ, you are confusing the tool with the decision. The lowest return was 4%. That's a tool called historical data just like the CAPE is a tool. It happens to be statistically less significant but you can pick the tools you like. Your decision to be conservative is what you did with the tool. Additionally why would you rebalance at all if you have no expectations of the future? Wouldn't you just wait to see what the actual returns are and then adjust your lifestyle accordingly under your philosophy? If you rebalance to reduce risk, you are making some prediction about the future based on past results. There is no way to calculate risk without past returns so you are market timing under your definition.
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Re: Larry Swedroe's latest market returns forecast

Post by Kevin M »

HomerJ wrote: Nowhere near that exact.

I have never looked at valuations or expected returns or tried to calculate a "required savings rate". We just saved a lot.
I see. So this statement wasn't really accurate then:
HomerJ wrote:<snip> and planned on getting around 4% real long-term on the stock side to figure out how much I need to save.
Nevertheless, your approach of "saving a lot" probably is a good idea for most people, since most people don't save nearly enough for a comfortable retirement (there are lots of statistics on this, and I see it in interacting with young people I come in contact with through my blog, friend's children and their friends, etc.).

Coincidentally, I've been writing a blog series on calculating required savings rates, and have been using 4% real for stock expected returns in most of the examples. Of course I came up with this figure using the types of models we've been discussing here rather than using worst-case historical returns, and I've emphasized that this is not a point estimate, but the mean of a wide dispersion of probably outcomes.
HomerJ wrote:I basically just use 4% now to see how we're doing when playing around with financial calculators. As in, "If we get 4% from now on, here's how much we'll have at 55. Sweet!" I did choose a conservative number so that's there a lot of upside potential. If we get less, I'll work longer or cut back on our retirement lifestyle. So it's not a worst-case scenario. If we get less, I'll adjust.
Gotcha. I'd just comment that I wouldn't consider 4% real a conservative number for "how much we'll have at 55", assuming you are age 35 or older, since we've seen historical real US stock returns as low as about 1% for 20-year time periods (1962-1981).
HomerJ wrote:But I'm going to adjust on ACTUAL returns, not on what you guys guess is going to happen.
Larry also talks a lot about adjusting to actual returns, since he acknowledges that actual return could be at the low end of the dispersion around expected return, so I think there's no disagreement about that.

The thing is that if someone determines their savings rate (or amount of risk in their portfolio, or whatever) based on artificially high estimates of future returns, or simply doesn't save enough because they just don't think about it, then the closer they get to the terminal point (say retirement, if that's the goal), the less ability they have to adjust their savings rate (or amount of risk, or whatever) to compensate. Clearly this hasn't been a problem for you, but it is a problem for many other people. So it seems to me that most people should give some thought to expected return estimates in their planning, and then we can just debate which approaches to determine these estimates make the most sense.
HomerJ wrote:Does it bother any of you that many of the "expected return" predictions in the past (recent past even) have turned out to be wrong? Anyone who used them to carefully plan out an investment strategy or required savings rate has not seen the numbers that were predicted.
Continuing to say it this way misrepresents the meaning of "expected return", which is the mean of a dispersion of probable returns. It is not a prediction. Since it is not a prediction, it can't really be wrong, and if we look at it correctly with approriate error bands, the 20-year expected return forecasts for US stocks using E10/P have been remarkably accurate. All you have to do is look at some of the charts that I've shared to see that essentially all 20-year returns for US stocks since 1926 have been within +/- 4% (percentage points) of the initial E10/P value, and have been dispersed quite symetrically around this value.

I think Larry is very honest and fair about this in his article:
Larry Swedroe wrote:Thus, we must be very humble about how we think about such forecasts. By that I mean we shouldn't treat them as single-point estimates. With U.S. stocks, based on the historical evidence, to include all actual subsequent outcomes, you would have to both add and subtract about 8% from the expected real return.

In other words, while the mean expected real return for the S&P 500 Index going forward is 4.1%, potential outcomes range from a real loss of about 4% to a real gain of about 12%. That's a very wide dispersion of potential outcomes. It also shows how difficult it is to forecast returns.
I'd say that Larry is even much more conservative in terms of the +/-8% error band than the historical evidence suggests, at least for 20-year time periods for US stocks since 1926, which we have seen is about +/-4%.

Of course we can't really know that the future will resemble the past, but to the extent it does, it's highly unlikely that you'll earn more than 8% or less than 0% real over the next 20 years with a current E10/P of about 4%. It's certainly less unlikely than that you will earn no less than 4% real over the next 20 years.
HomerJ wrote:Look, my opinion is you pick a conservative number for planning and adjust to actual returns.
Picking a conservative number for planning seems prudent, in which case we're back to discussing different methods for determining what a conservative number is. As already mentioned, I think we're all in agreement about adjusting to actual returns (after all, what other choice do we have?).
HomerJ wrote:Surely, you wouldn't suggest to someone to cut back on their savings rate if valuations were low, and expected return was high? (The proper answer to that is "Don't call me Shirley")
OK, I won't call your Shirley. :wink:

I tend to agree with you that one should simply save as much as possible. Unfortunately most people don't save enough, so probably the best advice for most people is to save as much as possible--actually, probably to save more than they think is possible by cutting back on what they perceive to be necessary expenses that are in reality discretionay expenses (the amount my kids spend on cell phones and entertainment comes to mind).

But economists do discuss the concept of consumption smoothing, the idea being not to deprive yourself excessively during your accumulation years, but also not to consume so much and save so little that your consumption must be severely reduced in your retirement years. To the extent you think this makes sense, it can indeed make sense to adjust your savings rate (and/or the amount of risk you take in your portfolio) based on your esimate of future returns.
HomerJ wrote:Because what if the forecast was wrong, just like it's been wrong many times before?.
Again, when viewed properly, with approrpriate error bands as Larry is advocating, expected return forecasts using either earnings yield or some form of the Gordon model have been remarkably accurate.
HomerJ wrote:You can't really plan out a "required savings rate" on a forecast that has a plus or minus 8% range.
This isn't really so different than planning on what you consider to be a conservative estimate of future returns, which although you say you haven't actually done, you have said more than once that you think this makes sense. If you want to be conservative, pick something toward the bottom of the range, if you want to place more emphasis on consumption smoothing, perhaps pick something closer to the middle of the range.

Interestingly, both Larry's expected-return estimate of about 4% real and your worst-case estimate of about 4% real are the same value! Larry's approach is even more conservative, since he puts the worst-case real return at -4%, while I'd say it's probably closer to 0% to the extent the earnings yield model has predictive power (out to about 20 years), and closer to -1% if you rely just on historical 20-year returns.

Of course the lower bound is higher, at about 4%, if you look at 30-year US stock returns since 1926, but we only have three independent 30-year periods since 1926, which isn't nearly enough to make any statistically valid forecasts. Using a lower bound of 4% real is placing even more confidence that the future will resemble the past than using a model that has been more accurate historically.

Also, it doesn't really make sense to use worst-case historical stock returns as a worst-case estimate for a balanced portfolio of stocks and bonds, which would only be about 60% stocks at age 40 with an age-in-bonds portfolio construction model.
HomerJ wrote:I guess I don't care about valuations, because I plan around a number that is low enough to be nearly off the bottom of the chart of the range of expected returns anyway.
Again, it's not at all off the bottom of the chart if you look at different time periods (e.g., 20 years instead of 30 years), and use slightly more sophisticated models that have been historically much more accurate than simply looking at the lowest 30-year rolling return. But now we're just back to discussing what forecasting model makes the most sense.

I've focused a lot on savings rate because we seem to have more common ground here than with respect to using an expected return forecast to adjust your asset allocation, even though we disagree on which forecasting model makes the most sense (it seems clear to me that planning around a worst-case real return of 4% is based on a simplistic forecasting model, whether it's acknowledged or not). Larry just extends the use of an expected return forecast to portfolio construction, so let's bring the conversation back to that.

You have a model for portfolio construction, which you have said is "age in bonds". Aside from John Bogle's recommendation for using this as a starting point, Bill Bernstein and others have taught us that a rational economic justification for doing something along these lines involves the concept of human capital and financial capital. But this is really just a subset of Larry's broader paradigm of basing portfolio construction on ones ability, willingness and need to take risk. You generally have more ability to take risk when young, since then your human/labor capital is enormously larger than your financial/investment capital, so a risky portfolio is not really very risky when viewed in the context of your total capital (human + financial). Or to put it another way, using a concept that you and Larry both use, you have more time to adjust your plan when young.

Larry adds the concept of need to take risk to the model, and uses expected return as one component of determining need to take risk.

So you have a model, and Larry has a model, so it seems that what we're really discussing is which portfolio construction model makes more sense, and what factors you should incorporate into the model. Does age in bonds make more sense than rationally evaluating your ability, willingness and need to take risk, using whatever factors you think make sense based on your assessment of the evidence? Is an expected return estimate based on earnings yield a reasonable factor to include in your assessment of need to take risk?

I personally agree with John Bogle that age in bonds is a good starting point (and probably better than nothing for someone who will never take the time to study the topic), but I also agree with Larry that evaluating one's ability, need, and willingess to take risk is a more rational approach than simply following age-in-bonds without further evaulation. I'm also becoming quite convinced that smoothed earnings yield is a decent way to forecast expected 20-year returns for stocks (again, keeping in mind that this is only the mean of a wide dispersion of probable outcomes), and I do think that it's rational to include expected returns estimates in determining one's need to take risk.

I also respect that others may come to completely different conclusions based on their own research and study. My perception is that Larry has studied these topics more deeply and rationally than most of us, so I pay a lot of attention to what he says, but I don't always follow his advice (I reserve the right to be somewhat irrational in my investing decisions).

Kevin
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Re: Larry Swedroe's latest market returns forecast

Post by longinvest »

Random Walker wrote: I'm a huge Bernstein fan, and obviously I'm a mental midget compared to Samuelson and Merton, but I think it is very silly to assume a person's risk tolerance is constant throughout lifetime! Are you sure Bernstein agrees with that statement? First of all, how do you define risk tolerance: absolute dollar loss, percent dollar loss, volatility?
As a person progresses through life, he converts human capital into investment capital. As his potential to earn future income decreases and he accumulates more, circumstances change, and it makes virtually no sense that risk tolerance would be constant throughout life.
Bernstein's Liability Matching Portfolio / Risk Portfolio concept really doesn't fit at all with a fixed AA throughout one's lifetime. I got to go back and find my copy of Ages of Investor!
Dave,

The Ages of the Investor is a booklet for what William Bernstein call investment adults; its main objective is to help us think about things by telling us about different views.

I don't want to misrepresent his views. Bernstein's opinion is in favor of liability matching, by converting enough wealth into a TIPS ladder once one reaches retirement.

Also, note that I did not say that this was the only rational approach to setting one's AA. I only said that it was one rational approach to do it.

Without going through the entire Samuelson paper, you could read its introduction which is fairly readable (it's only later that the paper gets into complex mathematical formulas). In the intro, Samuelson tells us about what people of his time called "businessman risk", which he defines as follows:
In the literature of finance, one often reads; "Security A should be avoided by widows as too risky, but is highly suitable as a businessman's risk." What is involved in this distinction? Many things.

First, the "businessman" is more affluent than the widow; and being further removed from the threat of falling below some subsistence level, he has a high propensity to embrace variance for the sake of better yield.

Second, he can look forward to a high salary in the future; and with so high a present discounted value of wealth, it is only prudent for him to put more into common stocks compared to his present tangible wealth, borrowing if necessary for the purpose, or accomplishing the same thing by selecting volatile stocks that widows shun.

Third, being still in the prime of life, the businessman can "recoup" any present losses in the future. The widow or retired man nearing life's end has no such "second or nth chance."

Fourth (and apparently related to the last point), since the businessman will be investing for so many periods, "the law of averages will even out for him," and he can afford to act almost as if he were not subject to diminishing marginal utility.
Like many opinions we read on this forum, people of Samuelson's time thought that a person meeting four "businessman" criteria could take more risk by investing more of his wealth into stocks. The criteria defining a businessman are his wealth (first point), his future high salary (second point), he has more time to wait for the market to recover (third point), and that dollar-cost averaging should make things fine for him (fourth point).

In the paper, Samuelson answers the following question:
Is it [...] true that lifetime considerations justify the concept of a businessman's risk in his prime of life?
The answer of his paper, based on complex mathematics, is:
The present lifetime model reveals that investing for many periods does not itself introduce extra tolerance for riskiness at early, or any, stages of life.
Of course, there could be other considerations.

In 1969, Treasury Inflation-Protected Securities (TIPS) and inflation-indexed single premium immediate annuities (inflation-indexed SPIAs) did not exist. They do exist, today.

Yet, based on this framework, one could rationally choose a static balanced AA that suits one's volatility tolerance and stick to it throughout his investing life. This does not prevent the investor from transforming part of his wealth into a liability matched portfolio when sufficient wealth is reached (the moment of which is usually defined by Mr. Market).

In other words, a Boglehead can rationally do all of his investing and reach his financial goals, securing a robust retirement, without every worrying about expected returns and valuations.

It's not the only approach to investing, but it is one that works and that is perfectly rational.
Last edited by longinvest on Wed Nov 02, 2016 4:13 pm, edited 4 times in total.
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Re: Larry Swedroe's latest market returns forecast

Post by larryswedroe »

smpatel
Wouldn't this trigger a re-balancing band? So, re-balancing/AA allocation change due to valuations change/market timing, are they all just different color hats?
Of course along the way there would have been rebalancing, which also of course has NOTHING to do with market timing, but restoring your asset allocation to the level that is appropriate for your ability, willingness and need to take risk.

That's the problem Homer has, he cannot seem able to distinguish the two. Rebalancing has no more to do with market timing than using the CAPE 10 to forecast returns does. Both are done to ensure your portfolio isn't taking more risk than the ability, willingness or need requires.
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Re: Larry Swedroe's latest market returns forecast

Post by larryswedroe »

Homer
Let's consider your statement, which of obviously is incorrect
I agree with you... But expected returns, going forward, have nothing to do with it. Actual returns were good, so now they can cut back.



First, to set one's original AA one can only do so rationally by estimating returns.

For example, if you determine you need X dollars at a certain date and you will save Y then you can calculate the return you need. Now to determine your AA you can only do so by estimating the return to stocks and bonds. There is no other way, at least not logically. The foolishness of blindly using age in bonds minus 100 ignores totally the need to take risk as well as one's ability and willingness.

And you state it's okay and one should cut back. But that tells you nothing. The question is by how much? You cannot know unless you estimate returns for both stocks and bonds. Otherwise you are just pulling a number, with no logic, out of thin air. And we clearly know that higher valuations lead to lower future returns (lower lows, lower means and lower best cases) then when we have higher valuations and the same is true for bonds. Ignoring facts doesn't make them go away.

It makes a big difference if you estimate stock returns going forward at 7% real (historical for example) or more like 4% (maybe 5) as almost all financial economists do today. The lower the rate the more equity risk one has to take.
But your other problem is failing to understand, despite my pointing it out many times, that doesn't mean one should have higher equity allocation, it only means one NEEDS to unless they take other actions, which they may or may not be willing or able to take. For example, instead of raising equity allocation one could
a) save more (if possible)
b) lower goal (if possible)
c) tilt more to higher expected returning asset classes instead of raising equity allocation)
d) plan on working longer
and other life issues could be adjusted. But none of this has a single thing to do with market timing (which is based on belief that market prices are wrong).
Last edited by larryswedroe on Wed Nov 02, 2016 6:58 pm, edited 1 time in total.
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HomerJ
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Re: Larry Swedroe's latest market returns forecast

Post by HomerJ »

larryswedroe wrote:smpatel
Wouldn't this trigger a re-balancing band? So, re-balancing/AA allocation change due to valuations change/market timing, are they all just different color hats?
Of course along the way there would have been rebalancing, which also of course has NOTHING to do with market timing, but restoring your asset allocation to the level that is appropriate for your ability, willingness and need to take risk.

That's the problem Homer has, he cannot seem able to distinguish the two. Rebalancing has no more to do with market timing than using the CAPE 10 to forecast returns does. Both are done to ensure your portfolio isn't taking more risk than the ability, willingness or need requires.
Larry
This is incorrect, Larry... I understand rebalancing perfectly. "Restoring your asset allocation to the level that is appropriate for your ability, willingness and need to take risk." is a definition I agree with completely.

Many people in this thread have used "rebalance" incorrectly to mean CHANGING their AA to tilt one sector (like International) over another because of your posts on valuations and "expected" returns. This is the definition of market timing. Picking a time to invest (Today, not yesterday) in a market because you predict it will do well going forward.

So you and I agree on the correct definition of rebalance where one RESTORES the AA back to it's ORIGINAL allocation based on the past actual returns, not predicted returns going forward.
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Re: Larry Swedroe's latest market returns forecast

Post by saltycaper »

Larry,

Sorry if I missed it here or elsewhere, but in your models, do you use valuations also to assess expected returns for asset classes incorporating factors such as US small, US value, foreign small, etc., with the same mean/dispersion "predictions"? Anything you can share outside of overall US/Developed/Emerging?
Quod vitae sectabor iter?
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Re: Larry Swedroe's latest market returns forecast

Post by Kevin M »

longinvest wrote: In other words, one's AA could rationally be set based on one's risk tolerance as suggested by our investment philosophy. I see no reference, in our investment philosophy, to currently expected returns and valuations.
This statement is misleading at best, and flat out wrong at worst, as is the statment that's been made several times about our Wiki not considering expected returns or valuations in determing one's AA.

From the investment philosophy item "Never bear too much or too little risk":
Owning stocks is necessary to get the expected return needed to accumulate funds for retirement.
There's the reference to expected return, so the statement that it's not mentioned is flat out wrong.

Then we see this:
How much in bonds? That's the basic question of asset allocation. Before you decide, you first need to balance your ability, willingness, and need to take risk.
This is exactly the risk framework that Larry mentions over and over again. As he has explained many times, an estimate of expected returns is fundamental to determining need to take risk.

One of the Wiki articles linked directly under the "Never bear too much or too little risk" is this: Risk tolerance - Bogleheads. In this article we see this:
Author Larry Swedroe defines asset allocation as "the process of investing assets in a manner reflecting one’s unique ability, willingness and need to take risk,"
<snip>
Need to take risk is determined by the rate of return required to achieve financial objectives.
<snip>
Now this is an incomplete description, but a rational interpretation is that if a certain rate of return is required to achieve financial objectives, then one must use estimates of expected returns to determine whether or not one's portfolio is likely to meet these objectives, and to adjust one's asset allocation accordingly.

The very fact that the Wiki references Larry's writings fairly extensively in discussing the topics of asset allocation and risk seems to me to be evidence, from the Wiki, that we should not be ignoring Larry's elaboration on how one should use expected return estimates to evaulate one's need to take risk, and in turn use that to set or adjust one's AA.

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)
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Re: Larry Swedroe's latest market returns forecast

Post by betablocker »

HomerJ. you said in your last post that you set your asset allocation based on past actual results. Another phrase for that is historical data. Statistics show that current valuations have more predictive power than a historical average. So your argument boils down to, I like the data I like and I don't care what the basic math says. Perfect encapsulation of why this is terrible advice.
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Re: Larry Swedroe's latest market returns forecast

Post by HomerJ »

larryswedroe wrote:
I agree with you... But expected returns, going forward, have nothing to do with it. Actual returns were good, so now they can cut back.


First, to set one's original AA one can only do so rationally by estimating returns.

For example, if you determine you need X dollars at a certain date and you will save Y then you can calculate the return you need. Now to determine your AA you can only do so by estimating the return to stocks and bonds. There is no other way, at least not logically. The foolishness of blindly using age in bonds minus 100 ignores totally the need to take risk as well as one's ability and willingness.

And you state it's okay and one should cut back. But that tells you nothing. The question is by how much? You cannot know unless you estimate returns for both stocks and bonds. Otherwise you are just pulling a number, with no logic, out of thin in. And we clearly know that higher valuations lead to lower future returns (lower lows, lower means and lower best cases) then when we have higher valuations and the same is true for bonds. Ignoring facts doesn't make them go away.

It makes a big difference if you estimate stock returns going forward at 7% real (historical for example) or more like 4% (maybe 5) as almost all financial economists do today. The lower the rate the more equity risk one has to take.
But your other problem is failing to understand, despite my pointing it out many times, that doesn't mean one should have higher equity allocation, it only means one NEEDS to unless they take other actions, which they may or may not be willing or able to take. For example, instead of raising equity allocation one could
a) save more (if possible)
b) lower goal (if possible)
c) tilt more to higher expected returning asset classes instead of raising equity allocation) <- market timing
d) plan on working longer
and other life issues could be adjusted. But none of this has a single thing to do with market timing (which is based on belief that market prices are wrong).
This is a very good breakdown of your position... Thank you.

Here's my take on investing. Age in bonds. You get what you get. Saving more, lowering goal, working longer are how you deal with what you get.

One can easily do the math, using different return numbers, and figure out how you're doing. If I see I need 9% a year to reach my goal, I'm going to start saving more, or lower my goal, or plan on working longer.

Increasing equities, or tilting to a higher expected returning asset classes is market-timing and is rolling the dice. I'm sure you will admit that a higher expected return is no guarantee. Tilting heavily to Emerging Markets or some other sector isn't the answer to save a plan that is underfunded, or to achieve goals that are too lofty.

I see no reason to bother with valuations or expected returns. 3 fund portfolio with a conservative AA is good enough. If you have to tilt to sectors and hope the predictions come true, then you're not saving enough, or your goal is unrealistic.

Age in bonds is to protect you from the downside, from the next crash that make take 5-10 years or more to recover. If you're young, you can wait for the recovery (or make the money back if it never recovers). If you're old, you need to protect yourself from that downside. If that means your returns are too low to make your goal, then save more, work longer, or change your goal.

You should NOT increase equities to 80% 5 years from retirement to increase your returns, because now you are exposed to that crash possibility. AA for someone near retirement should be set up to, first and foremost, protect yourself from the next crash. Save more, work longer, change your goal is how you fix a problem, not calculating expected returns and tilting to the "best" market.
Last edited by HomerJ on Wed Nov 02, 2016 5:15 pm, edited 2 times in total.
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Re: Larry Swedroe's latest market returns forecast

Post by kosomoto »

Forgive me if I missed it, but has the data been merged? I assume you have data on CAPE and corresponding returns for US, international, and emerging markets. Has the correlation found between CAPE and returns in US markets been used to predict international data? Has all data been merged? Or has only US data been used for US returns and only international for international returns? How does the R squared change for each situation? This data seems overly simplistic at first glance and I would love to know more.
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Re: Larry Swedroe's latest market returns forecast

Post by betablocker »

HomerJ your age in bonds is based on expected returns. Short replies are based on exhaustion. I'm done.
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Re: Larry Swedroe's latest market returns forecast

Post by larryswedroe »

Many people in this thread have used "rebalance" incorrectly to mean CHANGING their AA to tilt one sector (like International) over another because of your posts on valuations and "expected" returns.
Homer again you keep making the mistake of blaming the tool instead of people who misuse it. Need to stop doing that.

Rebalancing has a very specific meaning--to restore the plan's allocation, eliminating the style drift. That of course has nothing to do with market timing, though it tends to lead to a buy at relatively lower valuations (when expected returns are higher) and sell at relatively higher valuations (when expected returns are lower).
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Re: Larry Swedroe's latest market returns forecast

Post by larryswedroe »

Homer
Amazing how you can keep making statements that ignores so much, you seem just stuck in your view of the world that you ignore anything that doesn't agree with it
Here's an example
If I see I need 9% a year to reach my goal, I'm going to start saving more, or lower my goal, or plan on working longer.
Those are only SOME of the options, as I explained, and sometimes they aren't available. There are other alternatives that don't have anything to do with market timing but based on EXPECTED returns==meeting your need to take risk
Increasing equities, or tilting to a higher expected returning asset classes is market-timing and is rolling the dice. I'm sure you will admit that a higher expected return is no guarantee. Tilting heavily to Emerging Markets or some other sector isn't the answer to save a plan that is underfunded, or to achieve goals that are too lofty.
Here again you ignore the basic facts that there is no market timing which is based on belief the market is wrong on prices. That's what market timing is all about. Here we are accepting the market price as being right. And adding EM does raise the odds of achieving a certain return because it has higher expected returns. It might add some tail risk of course if it is used in that way. But it does raise the odds of achieving the funding goal, in same way that raising equity allocation does. No different.

And of course higher expected returns are not guarantees, any more than lower ones or any assumption you make. Clearly I made that point over and over again. But we must make decisions based on best information we have. And we know that using historical returns is illogical.

I would add that of course your own 4% rule is based on expected returns, which are historical, and clearly wrong, whatever you believe about stocks because bonds are not going to return the same as they have. And sorry to disagree but IMO a 4% withdrawal rate is FAR from conservative today for an average 65 year old. In fact unless one has options they are willing and able to exercise in the event returns are below historical, then IMO its extremely aggressive because your assumptions are too aggressive.


And by the way if you like relying on history than adding more exposure to higher returning equity asset classes and lowering overall equity allocation at same time, with objective of keeping mean expected return the same has clearly produced more efficient portfolios with far less tail risk. Those are facts, not opinions. You can see the evidence in Reducing the Risk of Black Swans.

I've now reached even the limits of my patience. I leave it to others who care to try and help you.

Best wishes
Larry
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Re: Larry Swedroe's latest market returns forecast

Post by HomerJ »

larryswedroe wrote:
HomerJ wrote:Increasing equities, or tilting to a higher expected returning asset classes is market-timing and is rolling the dice. I'm sure you will admit that a higher expected return is no guarantee. Tilting heavily to Emerging Markets or some other sector isn't the answer to save a plan that is underfunded, or to achieve goals that are too lofty.
Here again you ignore the basic facts that there is no market timing which is based on belief the market is wrong on prices. That's what market timing is all about. Here we are accepting the market price as being right. And adding EM does raise the odds of achieving a certain return because it has higher expected returns. It might add some tail risk of course if it is used in that way. But it does raise the odds of achieving the funding goal, in same way that raising equity allocation does. No different.
We disagree on terms. Market timing is not only about a belief that a market is wrong on prices. Market timing is about picking a TIME to enter (or overweight) and exit (or underweight) a particular market or sector based on a prediction of future returns.

I cannot believe that you don't think moving money from one market to another, and then back again, based on SIGNALS, is not market-timing. It's basically the definition of market-timing. "I'm going to put money in EM at THIS time, but not at THAT time, because of XXX"

I don't believe in market-timing. I say own the markets, take what they give. Don't try to predict the future. Change your AA slowly to bonds to reduce risk as you approach retirement. You guys believe you can play the odds, move money around between sectors, and make more money (or reduce risk).

We'll have to agree to disagree...

Thank you for the discussion.
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Re: Larry Swedroe's latest market returns forecast

Post by LadyGeek »

I removed an off-topic post. This thread has run its course and is locked (Topic exhausted, no added value to continue, getting contentious). See: Locked Topics
Moderators or site admins may lock a topic (set it so no more replies may be added) when a violation of posting policy has occurred. Occasionally, even if there are no overt violations of posting policy, a topic (or thread) will reach a point where the information content of the discussion has been essentially exhausted and further replies are much more likely to cause distress to the community than add anything of value.
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Re: Larry Swedroe's latest market returns forecast

Post by LadyGeek »

After receiving a PM, longinvest would like an opportunity to correct a misunderstanding by Kevin M. The thread was locked before this reply could be made.
longinvest wrote:
Kevin M wrote:
longinvest wrote:In other words, one's AA could rationally be set based on one's risk tolerance as suggested by our investment philosophy. I see no reference, in our investment philosophy, to currently expected returns and valuations.
This statement is misleading at best, and flat out wrong at worst, as is the statment that's been made several times about our Wiki not considering expected returns or valuations in determing one's AA.

From the investment philosophy item "Never bear too much or too little risk":
Owning stocks is necessary to get the expected return needed to accumulate funds for retirement.
There's the reference to expected return, so the statement that it's not mentioned is flat out wrong.
The Philosophy document is simply making a general statement related to the risk/reward nature of investments. Stocks are expected to deliver higher returns than bonds often enough as to attract investors, which is a mathematical thing. It is not discussing the use of quantitative measures to estimate future returns.

My statement was pretty clear and not misleading in any way. I explicitly wrote "currently expected returns and valuations". The use of both the "currently" and "valuations" words should make it pretty clear that I am not discussing the general expectation of stocks beating bonds often enough; that I am discussing the quantification of future returns.
(The thread will remain locked.)
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