Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

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Jcraz13
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Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by Jcraz13 » Wed Dec 28, 2016 5:31 pm

Great article I often refer to in terms of risk. For those of you advocating a higher percentage in stocks in retirement, what say you ?

http://www.wsj.com/articles/how-to-tell ... 1421726456

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by Call_Me_Op » Wed Dec 28, 2016 6:11 pm

There is no problem with having a lot in equities after retirement as long as you have enough in safe investments. The folks that need to be real careful are those who have "just enough."
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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by rapporteur » Wed Dec 28, 2016 9:20 pm

Dear jcraz13,

You asked:
For those of you advocating a higher percentage in stocks in retirement, what say you?

First of all, as an advocate of a high-equity allocation in retirement, I would say to you what I said to Mr Larimore: Of course, one need never take *unnecessary* risk in retirement! …by definition, I might add.

But the relevant question is: Is it really risk? And if it isn’t risk, then what relevance does ‘unnecessary’ have?

The overwhelming weight of the historical evidence, spanning more than a century across 19 developed countries, is that an equity-heavy portfolio is LESS risky, in terms of the two risk measures that actually matter in terms of life outcomes: how much money you can spend, and the chance of running out of money prematurely. (…there’s yet a third positive outcome, a bigger estate) Not only has an equity-heavy portfolio been best (by gigantic amounts) in good times (which is nice) but it has been BETTER than an FI-heavy portfolio EVEN in bad times, and EVEN in the worst of times (which is essential!).

Yes, an equity-heavy portfolio has had lots of ups and downs, but, compared to an FI-heavy portfolio, that variance has overall been to the UPSIDE. In NO CASE was an equity allocation of less than 50% best, and most of the time higher equity allocations of 70-100% were much better, not falling noticeably short even in bad or very bad times.

Counterintuitive, even paradoxical? Perhaps. But’s that’s what the evidence says.

Now some might say, “‘I can’t handle an equity-heavy portfolio – I won’t sleep at night.” Or even worse, “I would sabotage myself and sell out in a strong downturn.” Fair enough, don’t use one. As Dirty Harry said, “A man’s gotta know his limitations.” So, if one is psychologically crippled, of course one must pander to that limitation. But that does not weaken the *rational basis* for an equity-heavy portfolio one whit!

Hand-wringing nervous-Nellie-ism isn’t counter-evidence against using an equity-heavy portfolio. Nor are contrived imaginings to justify one’s psychological shortcomings for not adopting the rational course.

‘What ifs’ and even ‘black swans’ are fine in terms of ‘scenario testing’ and ‘stress-testing’ a retirement strategy, but not if taken to extremes – that is simple financial cowardice masquerading as prudence. As Confucius said to a disciple given to needless worrying, “To think once is rash, to think twice is prudent, but to think thrice is dithering.”

[I am not always so unctuously ingratiating; sometimes my posts veer, ever so slightly, towards the inflammatory. :happy ]

***

Moreover, there’s an often-overlooked corollary to the proposition, ‘High equity retirement portfolios have better outcomes.” And that is: planning use of such a strategy lets one “hit one’s number” sooner! You can retire with a lesser number, or not postpone retirement so long. There’s less need to deny yourself and your family during your prime years – your 30s, 40s, and 50s – in order to ensure that your portfolio won’t run out at age 105. (If you ask me, it’s not a great tradeoff to diminish your core family years on the off chance that terrible stock markets and an extremely long life will somehow miraculously coincide– but, hey, it’s your call).

Bernstein rightly asks, “If you’ve already won the game, why keep playing?” IOW, if you have not just enough, but more than enough, why stick your neck out on equities in retirement? Why indeed?

Bill’s right, of course. But the counter-question is, “Why the h*ll did you oversave so very greatly prior to retirement, rather than saving ‘enough’?” (‘enough’ with a prudent margin, of course) So, if you saved - not 20, or 30, or even 40 times annual need, but much more, so much more that there’s no need for equity investment, the question becomes: ‘Why did you do that?’

If your answer is “I won the lottery” or “I loved my job and was reluctant to stop, and the money just kept rolling in almost as an afterthought" then fair enough. But, if not, I suggest you threw away a good chunk of your prime for a distant possibility in your doddering old age – and on a weak contingent basis to boot!

***

As for Pascal’s wager, where to begin, where to begin?

I spoke in a related thread about casuistry and the jesuitical, and I could, I suppose, talk now about Kolmogorov complexity vs a sparse prior – but luckily for the readership here, I have chosen not to go in that direction.

Instead I will do the conventional counterargument: What weight should we apply to an infinitesimal risk multiplied by a huge consequence. Figuratively, what is epsilon times infinity? [Figuratively because the question is not well-posed mathematically.] And, of course, restricting Pascal's Wager to a dyadic choice is an unjustifiable restriction. But my arm tires from beating dead horses.

So. I'll simply give the usual answer regarding Pascal’s wager, which is, that intriguing and provoking as it may seem, it is ultimately bovine excrement.

If you *seriously* wish to advance some form of Pascal’s Wager argument, I will be happy to demolish it.

Regards,

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by AlohaJoe » Wed Dec 28, 2016 10:32 pm

Jcraz13 wrote:Great article I often refer to in terms of risk. For those of you advocating a higher percentage in stocks in retirement, what say you ?

http://www.wsj.com/articles/how-to-tell ... 1421726456


I guess my devil's advocate reply would be:

I'd say that Bernstein himself implicitly realises that his definition is basically impossible for most people and shifts the goal posts.

He says, "you've won when you've acquired enough assets to provide your basic living expenses for the rest of your life".

Then he provides an example who needs $40,000 from their portfolio a year. For a 65-year old he says that "the rest of your life" is 20 years.

Do you really, truly believe that 20 years is a fair definition of "the rest of your life"?

I sure don't. I think it is obviously not remotely true. The average couple has a 50% chance of living 31-years. But then you're still taking a 50% chance of running out of money, which doesn't sound very safe. Let's say you only want a 10% chance of running out of your "safe" money. Then you have 39 years to plan for.

So you need to have $40,000 x 39 years = $1,600,000 in RLE (Residual Living Expenses); which is double what Bernstein says is needed.

If someone is 65 and has $1,600,000 you might say they have "won the game". Though they actually still have a 10% chance of "losing the game" by outliving their safe assets.

And remember, this $1.6 million only covers your "basic living expenses". I'm not sure anyone would call "basic living expenses" having "won the game". You probably want to have more than that. (Otherwise why retire? Just work for another few years to ensure a comfortable retirement of more than just "basic living expenses".) It also results in leaving nothing to any heirs, unless you die sooner than expected.

The number of people who have actually accumulated enough to truly say they have "won the game" is so small that I'm not sure we can draw useful lessons from thinking about them.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by qwertyjazz » Wed Dec 28, 2016 10:48 pm

rapporteur wrote:Dear jcraz13,

You asked:
For those of you advocating a higher percentage in stocks in retirement, what say you?

First of all, as an advocate of a high-equity allocation in retirement, I would say to you what I said to Mr Larimore: Of course, one need never take *unnecessary* risk in retirement! …by definition, I might add.

But the relevant question is: Is it really risk? And if it isn’t risk, then what relevance does ‘unnecessary’ have?

The overwhelming weight of the historical evidence, spanning more than a century across 19 developed countries, is that an equity-heavy portfolio is LESS risky, in terms of the two risk measures that actually matter in terms of life outcomes: how much money you can spend, and the chance of running out of money prematurely. (…there’s yet a third positive outcome, a bigger estate) Not only has an equity-heavy portfolio been best (by gigantic amounts) in good times (which is nice) but it has been BETTER than an FI-heavy portfolio EVEN in bad times, and EVEN in the worst of times (which is essential!).

Yes, an equity-heavy portfolio has had lots of ups and downs, but, compared to an FI-heavy portfolio, that variance has overall been to the UPSIDE. In NO CASE was an equity allocation of less than 50% best, and most of the time higher equity allocations of 70-100% were much better, not falling noticeably short even in bad or very bad times.

Counterintuitive, even paradoxical? Perhaps. But’s that’s what the evidence says.

Now some might say, “‘I can’t handle an equity-heavy portfolio – I won’t sleep at night.” Or even worse, “I would sabotage myself and sell out in a strong downturn.” Fair enough, don’t use one. As Dirty Harry said, “A man’s gotta know his limitations.” So, if one is psychologically crippled, of course one must pander to that limitation. But that does not weaken the *rational basis* for an equity-heavy portfolio one whit!

Hand-wringing nervous-Nellie-ism isn’t counter-evidence against using an equity-heavy portfolio. Nor are contrived imaginings to justify one’s psychological shortcomings for not adopting the rational course.

‘What ifs’ and even ‘black swans’ are fine in terms of ‘scenario testing’ and ‘stress-testing’ a retirement strategy, but not if taken to extremes – that is simple financial cowardice masquerading as prudence. As Confucius said to a disciple given to needless worrying, “To think once is rash, to think twice is prudent, but to think thrice is dithering.”

[I am not always so unctuously ingratiating; sometimes my posts veer, ever so slightly, towards the inflammatory. :happy ]

***

Moreover, there’s an often-overlooked corollary to the proposition, ‘High equity retirement portfolios have better outcomes.” And that is: planning use of such a strategy lets one “hit one’s number” sooner! You can retire with a lesser number, or not postpone retirement so long. There’s less need to deny yourself and your family during your prime years – your 30s, 40s, and 50s – in order to ensure that your portfolio won’t run out at age 105. (If you ask me, it’s not a great tradeoff to diminish your core family years on the off chance that terrible stock markets and an extremely long life will somehow miraculously coincide– but, hey, it’s your call).

Bernstein rightly asks, “If you’ve already won the game, why keep playing?” IOW, if you have not just enough, but more than enough, why stick your neck out on equities in retirement? Why indeed?

Bill’s right, of course. But the counter-question is, “Why the h*ll did you oversave so very greatly prior to retirement, rather than saving ‘enough’?” (‘enough’ with a prudent margin, of course) So, if you saved - not 20, or 30, or even 40 times annual need, but much more, so much more that there’s no need for equity investment, the question becomes: ‘Why did you do that?’

If your answer is “I won the lottery” or “I loved my job and was reluctant to stop, and the money just kept rolling in almost as an afterthought" then fair enough. But, if not, I suggest you threw away a good chunk of your prime for a distant possibility in your doddering old age – and on a weak contingent basis to boot!

***

As for Pascal’s wager, where to begin, where to begin?

I spoke in a related thread about casuistry and the jesuitical, and I could, I suppose, talk now about Kolmogorov complexity vs a sparse prior – but luckily for the readership here, I have chosen not to go in that direction.

Instead I will do the conventional counterargument: What weight should we apply to an infinitesimal risk multiplied by a huge consequence. Figuratively, what is epsilon times infinity? [Figuratively because the question is not well-posed mathematically.] And, of course, restricting Pascal's Wager to a dyadic choice is an unjustifiable restriction. But my arm tires from beating dead horses.

So. I'll simply give the usual answer regarding Pascal’s wager, which is, that intriguing and provoking as it may seem, it is ultimately bovine excrement.

If you *seriously* wish to advance some form of Pascal’s Wager argument, I will be happy to demolish it.

Regards,


Curious - please go there as you wrote
Are you claiming you can simply describe future stock returns with a sparse prior? The future stocks returns would seem to be something irreducible with even the statement stocks will do better than bonds for the next 30 years not answerable using the context of a few hundred years and potential outcomes. Moreover I am not sure what those terms meant a hundred years ago prior to regulated markets and more recently index funds. I am really curious about your simplification model if understand where you were going with Kolmogorov complexity - although I could completely have misunderstood given my limited knowledge of information theory and theoretical computer science.

Thank you
QJ
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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by FIREchief » Wed Dec 28, 2016 11:04 pm

rapporteur wrote:First of all, as an advocate of a high-equity allocation in retirement.............



Fantastic post!! :sharebeer

Pascal's wager is dealing with eternity. Even if we screw up our investing, it's all the same in a matter of decades (or less). :annoyed
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: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by abuss368 » Wed Dec 28, 2016 11:12 pm

Nice post. Thank you for sharing.
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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by rapporteur » Wed Dec 28, 2016 11:28 pm

Dear qwertyjazz,

Thank you for inviting me to dance, but amusing (and instructive) as it might be for you, I will reiterate the decision I stated upthread,
…I have chosen not to go in that direction.

However, lest in your eagerness to draw me astray you confuse yourself instead, let me remind you that I spoke only of how such an argument might be applied specifically to Pascal’s Wager itself, not to the workings of the stock market.

So to your question,
Are you claiming you can simply describe future stock returns with a sparse prior?
my answer is, “I made no claim whatsoever. You, and only you, are the source of your speculative inference.” Feel free of course to pursue that divagation, but don’t count on me joining you.

Regards,

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by protagonist » Wed Dec 28, 2016 11:51 pm

AlohaJoe wrote:
If someone is 65 and has $1,600,000 you might say they have "won the game". Though they actually still have a 10% chance of "losing the game" by outliving their safe assets.



Are you assuming that person has no other source of income, such as social security? If you have that much money you are rich by any reasonable standard.

$15-35K or so/year in SS goes a long way to meeting your $40K/yr. demand.

I agree with the idea that a high equity allocation is only risky if you don't have enough in fixed income (taking into account SS or other income you can rely on) to meet your needs. If you are on the edge, then yes, a high equity allocation is risky....if you have just enough to meet your needs, you are in 100% stocks, and the market falls 30%, or 50% , or more, and does not recover soon enough, you are in financial jeopardy and potentially miserable. On the other hand, if the market triples in value in the next 10 years, you are a lot richer, but not necessarily a lot happier. Your primary concern should be to preserve that which you need....any additional growth is just what cajuns call "lagniappe".

Plus, quertyjazz hit the nail on the head with "Are you claiming you can simply describe future stock returns with a sparse prior?"

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by AlohaJoe » Thu Dec 29, 2016 12:14 am

protagonist wrote:
AlohaJoe wrote:
If someone is 65 and has $1,600,000 you might say they have "won the game". Though they actually still have a 10% chance of "losing the game" by outliving their safe assets.



Are you assuming that person has no other source of income, such as social security? If you have that much money you are rich by any reasonable standard.

$15-35K or so/year in SS goes a long way to meeting your $40K/yr. demand.


I suggest you read the linked Bernstein article, since that's where the example comes from. As I said above, they need $40,000 from their portfolio. Bernstein assumes they are getting $30,000 elsewhere (Social Security and a pension) and have total "basic needs" of $70,000 a year. (Yes, that sounds high to me too but that's what's in the article so we'll run with it.)

I agree that if you have $1.6 million you are rich by any reasonable standard. But Bernstein's definition of "having won the game" was "having enough money to pay your residual living expenses for the rest of your life". Having $1.6 million doesn't do that. It only guarantees 39 years of expenses. People can and do live longer than 39 years in retirement.

If you want to say "well, you'll probably die before then", I agree that's true. Just like stocks will probably be fine if you go 100% stocks.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by protagonist » Thu Dec 29, 2016 12:21 am

AlohaJoe wrote:
protagonist wrote:
AlohaJoe wrote:
If someone is 65 and has $1,600,000 you might say they have "won the game". Though they actually still have a 10% chance of "losing the game" by outliving their safe assets.



Are you assuming that person has no other source of income, such as social security? If you have that much money you are rich by any reasonable standard.

$15-35K or so/year in SS goes a long way to meeting your $40K/yr. demand.


I suggest you read the linked Bernstein article, since that's where the example comes from. As I said above, they need $40,000 from their portfolio. Bernstein assumes they are getting $30,000 elsewhere (Social Security and a pension) and have total "basic needs" of $70,000 a year. (Yes, that sounds high to me too but that's what's in the article so we'll run with it.)

I agree that if you have $1.6 million you are rich by any reasonable standard. But Bernstein's definition of "having won the game" was "having enough money to pay your residual living expenses for the rest of your life". Having $1.6 million doesn't do that. It only guarantees 39 years of expenses. People can and do live longer than 39 years in retirement.

If you want to say "well, you'll probably die before then", I agree that's true. Just like stocks will probably be fine if you go 100% stocks.


My bad. But I agree that you don't need $70K/yr to meet "basic needs". That is a bit ridiculous, when the median family income in the US is less than $52K/yr (and that is FAMILY income....assuming children to feed, house, clothe, educate, etc). Certainly way more than 50% of American families have their "basic needs met", and you probably need a lot less money in retirement than when you are working.

A large percentage of Americans do just fine on social security , with maybe a little saved up on the side. It irks me when I see these models that assume nobody but multimillionaires can have a secure retirement. It is marketing fear.

And there is no GUARANTEE that anybody will be 100% safe. Everything in life is a risk. If you penny-pinch and scrimp and save and work your fingers to the bone so that you will have a secure retirement with $1.6M plus, and then you have a heart attack at 55, I would say you "lost the game" big time . He who dies with the most toys does NOT win. On the other hand, maybe you will run out of money when you are 96 and "lose the game". Life is a gamble no matter how you play it. All the world is a stage.

100% stocks is obviously risky in retirement. Whoever thinks that 1929 is the worst thing that could possibly happen financially over the next 30 or 40 years is deluding themselves. There is no statistically valid way to come to that conclusion.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by rapporteur » Thu Dec 29, 2016 2:45 am

protagonist said,
Life is a gamble no matter how you play it. …. 100% stocks is obviously risky in retirement.


Having made one side of the case, it’s time for me to present the other.

Yes, ANY retirement strategy is a gamble. The question, then, as protagonist so accurately pinpointed it, is HOW to play it.

History says high equity has been the way to go! But that doesn’t mean it’s *guaranteed* to win in future, only that the odds strongly favour us. That is, if history is any guide.

And I’ve argued that history (better known as the available evidence) SHOULD be given considerable weight as our guide, especially when the pattern is pervasive and persistent.

But should history be our ONLY guide? No way! But what other guide, on what grounds, with what confidence, and with what weight given to it? Thorny questions.

But I have a candidate in mind…

protagonist also said,
Whoever thinks that 1929 is the worst thing that could possibly happen financially over the next 30 or 40 years is deluding themselves.

Quite so. I can invent some pretty fearsome black swans when I’ve a mind to; I even conjure up some pretty frightening ‘white swans’ such as a medical breakthrough that lets everyone live to 125. But how likely are these swans and how hard should I work to fend them off? As old Will S. puts it:
“I can call spirits from the vasty deep.”
“Why, so can I, or so can any man; But will they come when you do call for them?”

So no need to go looking for new monsters; the old ones are fearsome enough. For instance, 1929 is a very big clue as to what can go wrong with a 100% equity retirement portfolio. And while the full retirement planning period of 30+ years is only halfway or less along, anyone who retired with a 100% S&P500 equity portfolio in March 2000 better have kept his drawings at 3% or less if anything reasonable was to survive for the second half of retirement.

What do 1929 and 2000 have in common that militates against a 100% equity retirement portfolio starting then? Yep, insanely high valuations. And that’s where my candidate alternate guide comes in: common sense. Don’t do anything quite so stupid!

Extreme positions (1) require extreme evidence to support them. The evidence for 100% equity in retirement is very strong but that evidence doesn’t amount to ‘extreme’ confirmation. In fact, there is one case in the past – 1929 - where 100% equity, while far from resulting in penury, did do noticeably worse than even slightly less equity heavy portfolios.

In that respect I am reminded of the hypothetical case of the fellow looking for evidence supporting the proposition “No crow is white.” Time and again, day after day, he sees black crows, and his confidence in the proposition grows. Then one day he sees a red crow. Technically it’s yet another confirming instance, so why is it so unnerving?

So where does that leave us? Dump high-equity retirement portfolios?

No, no, and no! Baby with the bathwater…

No, the case I made earlier is still rock-solid: high equity retirement portfolios are the way to go (a fortiori these days when prospective real returns to FI over the next decade+ are abysmal). But, supplementing the historical guide with the common sense guide, draw back from 100% equity when valuations are high. Draw back, yes, but not to anything remotely like ‘age in bonds’. I suggest 50% equity should be the absolute floor for even the most conservative (60% for less than utter cowards :happy ) while up to 75 or 80% looks very sound. If valuations moderate, then even the 75-100% range could be considered.

Regards,

(1) logical or financial

PS All this, of course, is predicated on ‘vanilla’ portfolios of conventional FI/equity. More exotic portfolios with high tilts, components such as gold, commodities, etc, may require deviations from the above (e.g., for a Larry Portfolio).

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by Levett » Thu Dec 29, 2016 7:03 am

AlohaJoe commented: "I'm not sure anyone would call "basic living expenses" having "won the game"."

Speaking as a longtime retiree, I sure wouldn't identify "basic" with having "won the game."

"Basic" certainly keeps you in the game (it's a useful planning tool), but the retirees I know aim to live their lives in a manner greater than "basic" (to be defined by the individual's desired standard of living).

Just one man's view from the bleachers. :wink:

Lev
Last edited by Levett on Thu Dec 29, 2016 10:34 am, edited 1 time in total.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by plannerman » Thu Dec 29, 2016 8:44 am

rapporteur wrote:Dear jcraz13,

You asked:
For those of you advocating a higher percentage in stocks in retirement, what say you?

First of all, as an advocate of a high-equity allocation in retirement, I would say to you what I said to Mr Larimore: Of course, one need never take *unnecessary* risk in retirement! …by definition, I might add.

But the relevant question is: Is it really risk? And if it isn’t risk, then what relevance does ‘unnecessary’ have?...Regards,


Wow! Boy do I wish I could write like that. You have quite a gift.

plannerman

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by Dandy » Thu Dec 29, 2016 10:17 am

Alas, for some reason the article posts then fades to unreadable. The post shows the biases of both positions very well. We have had many decades of very good performance overall from stocks and bonds. That could color opinions. Don't think if we lived that last 2 decades in Japan or this post was made just after the Great Depression the 100% stock position would be as solid. Also, residual expenses covered for 20-25 years is nice but doesn't account for longer life, emergencies (new roof, new car, long term care, high inflation, etc.).

So, if you have enough pick your bias: 100% stocks will still reward you enough for 30 years or more or safe assets will cover your residual needs and any extra will support any long life, unusual expenses.

Let's face it unless you have mega millions there is no set it and forget it retirement investment/savings/withdrawal strategy that works 100% under all personal and world conditions. I also think that you need to have a decent amount more than "enough".

Being a conservative investor and having more than "enough" I chose to go with basically Dr. Bernstein's approach. I feel after securing the basic funding until age 90 (my variation) with "safe" products makes sense -- as long as I have sufficient extra assets to have a healthy allocation to equities and intermediate bonds (including TIPS). Despite having "safe" assets to fund until age 90 -- my RMDs may take some or all from equites if they do well and none from them if they don't. I believe this approach also reduces the risk. I also think that each year I need to assess any changes in residual expenses and adjust my "safe" assets accordingly.

Finally, each year or so I need to examine my health and portfolio to assure that this approach still makes sense.

Good luck to all as we navigate our retirement funding path down the future road.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by SGM » Thu Dec 29, 2016 10:39 am

This is a well written article that I read in 2015 when it first came out. Bill makes well thought out arguments and I enjoy listening to his fireside chats with Jack at the Phillie meetings.

It seems prudent to cut back somewhat on stock allocation early in retirement. I find the run up in the stock market to be a temptation to go back to the 100% stock allocation I had during most of my accumulation period. But fortunately I can resist that temptation, just as I resisted the temptation to sell stock during market lows. Like Alfalfa said in Our Gang Comedies, "Satan get the behind me, and doooon't push." :wink:

Thanks for posting.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by freebeer » Thu Dec 29, 2016 10:52 am

AlohaJoe wrote:... For a 65-year old he says that "the rest of your life" is 20 years.

Do you really, truly believe that 20 years is a fair definition of "the rest of your life"?.


He didn't say that. The article suggests that a "rule of thumb" is that a 65 year old should have at least 20 years of residual living expenses (RLE) saved (vs. a 60-year-old who should have at least 25 years). Obviously your investments will be earning returns and while a 5% portfolio withdrawal (the effective rate if you've saved 20x your RLE) is far from safe for of a 65-year-old, neither is it crazy especially if your baseline (SS, pension) means that there is some flexibility to your residual spending.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by larryswedroe » Thu Dec 29, 2016 11:03 am

FWIW, the answer can depend of course on for whom you are actually investing. If you have enough in safe assets and are in effect investing for the next generation and are willing to take the risks then that is appropriate to have a higher equity allocation, as you are not viewing it as your assets any longer. With that said

a) the arguments for higher equity in retirement as you move into it were presented in a paper by Kitces and another author. We examined their claims and found that the ENTIRE benefit they found was due to starting with a low equity allocation, not from the rising equity allocation.

b) the arguments should always consider the marginal utility of wealth which for most people, the vast majority, tends to decline very rapidly once they have "enough"--whatever that means to them, generally supporting a lifestyle that they are comfortable with. That means they become more and more risk averse and the benefits of likely ending up with more money from a high equity allocation are FAR outweighed by the risk of the ending up with far less, and running out of money, which increase as you raise the equity allocation. In other words both tails increase as you raise equity allocations but investors care much more generally about the risk of the left tail then the opportunity for the right tail

c) I think all who have worked with investors as advisors would agree that the vast majority of investors risk tolerance, their ability to sleep well and enjoy life through bear markets, declines as we age and no longer have earned income to rely on to replenish or maintain the portfolio. Being able to enjoy life is far more important than dying with more assets!

d) Taleb said it best that only fools judge a strategy by its outcome without considering what alternative universe might have shown up. So those who rely on US only data for example and fail to consider say the 1930s or that we might have lost WWII and the world might have looked very different for US investors are IMO making the mistake which has been called the Triumph of the Optimists. Rising equity allocations in retirement for Japanese investors would likely have turned out extremely poorly for the past 30 years. That can happen here as well.

Bottom line is that IMO unless truly investing for the next generation and are willing to "lose those assets" a rising equity allocation in retirement is just plain wrong. Remember the consequences of your actions should dominate the probabilities, whatever you think they may be. You must be willing to live with the negative outcomes or don't take the action.

Best wishes
larry

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by freebeer » Thu Dec 29, 2016 11:43 am

larryswedroe wrote:...a) the arguments for higher equity in retirement as you move into it were presented in a paper by Kitces and another author. We examined their claims and found that the ENTIRE benefit they found was due to starting with a low equity allocation, not from the rising equity allocation. ...


thanks for taking the time for a detailed response. re: the above finding, is there a link or reference to your analysis of the Kitces paper?

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by dkturner » Thu Dec 29, 2016 11:50 am

protagonist wrote: But I agree that you don't need $70K/yr to meet "basic needs". That is a bit ridiculous, when the median family income in the US is less than $52K/yr (and that is FAMILY income....assuming children to feed, house, clothe, educate, etc). Certainly way more than 50% of American families have their "basic needs met", and you probably need a lot less money in retirement than when you are working.


"Basic needs" is a relative concept. [OT comment removed by moderator --triceratop]

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by BlueEars » Thu Dec 29, 2016 11:57 am

I wonder how Bernstein (and Larry Swedroe above) would critique the VPW tool. That allows one to run with bad start year's of 1930 or 1968. That is how I set our AA. But what about the start year 2017?

The article discussed the different outcomes for a bond heavy versus stock heavy one starting in the year 2000. But bond real yields (TIPS for example) were very high back then. Now real yields are historically low. Yes, it was a bad stretch for stocks until Feb 2009 and I lived through it with a 55/45 going into the 2008 crash. Not fun at all as a retiree back then. So I can relate to the thought but would personally not sell stocks for bonds until real yields get more towards historical average levels. Using the start year 2000 as a primary example is not a good example for current markets.

My guess is Bernstein was warning against high stock AA's, like 80/20 for a couple in their 60's.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by HomerJ » Thu Dec 29, 2016 12:05 pm

rapporteur wrote:Yes, an equity-heavy portfolio has had lots of ups and downs, but, compared to an FI-heavy portfolio, that variance has overall been to the UPSIDE. In NO CASE was an equity allocation of less than 50% best, and most of the time higher equity allocations of 70-100% were much better, not falling noticeably short even in bad or very bad times.

Counterintuitive, even paradoxical? Perhaps. But’s that’s what the evidence says.

Now some might say, “‘I can’t handle an equity-heavy portfolio – I won’t sleep at night.” Or even worse, “I would sabotage myself and sell out in a strong downturn.” Fair enough, don’t use one. As Dirty Harry said, “A man’s gotta know his limitations.” So, if one is psychologically crippled, of course one must pander to that limitation. But that does not weaken the *rational basis* for an equity-heavy portfolio one whit!


Let me ask you two questions...

(1) Do you really believe you've proven it's impossible for stocks to go down a significant amount and stay down for an extended period of time? Are you actually saying that it's IMPOSSIBLE for that to happen? Just because it hasn't happened yet? (in this country)

(2) Are you going to personally make up my losses if the above (1) actually does happen?


If your answer to #1 or #2 is No, then I suggest you stop calling others psychologically crippled and irrational.

As for Pascal’s wager, where to begin, where to begin?

I spoke in a related thread about casuistry and the jesuitical, and I could, I suppose, talk now about Kolmogorov complexity vs a sparse prior – but luckily for the readership here, I have chosen not to go in that direction.

Instead I will do the conventional counterargument: What weight should we apply to an infinitesimal risk multiplied by a huge consequence.

Figuratively, what is epsilon times infinity? [Figuratively because the question is not well-posed mathematically.] And, of course, restricting Pascal's Wager to a dyadic choice is an unjustifiable restriction. But my arm tires from beating dead horses.

So. I'll simply give the usual answer regarding Pascal’s wager, which is, that intriguing and provoking as it may seem, it is ultimately bovine excrement.

If you *seriously* wish to advance some form of Pascal’s Wager argument, I will be happy to demolish it.


Ugh, my first impression is that there's not going to be any kind of discussion here. You are presenting yourself as one of those lovely people who think you must WIN when talking to others.

I will take one second to suggest that you don't know if the risk of stocks doing something different in the future than they have in the past is "infinitesimal".

I will have enough when I retire to meet all my needs and wants. There will be no reason for me to try to maximize returns, because MORE will mean nothing to me. I will already have enough to meet all my needs and wants. My only interest will be protection of my assets. Since I do not know that the risk of stocks going down and staying down for an extended period is "infinitesimal", I will protect myself from that possibility.
Last edited by HomerJ on Thu Dec 29, 2016 12:22 pm, edited 1 time in total.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by HomerJ » Thu Dec 29, 2016 12:20 pm

larryswedroe wrote:FWIW, the answer can depend of course on for whom you are actually investing. If you have enough in safe assets and are in effect investing for the next generation and are willing to take the risks then that is appropriate to have a higher equity allocation, as you are not viewing it as your assets any longer. With that said

a) the arguments for higher equity in retirement as you move into it were presented in a paper by Kitces and another author. We examined their claims and found that the ENTIRE benefit they found was due to starting with a low equity allocation, not from the rising equity allocation.

b) the arguments should always consider the marginal utility of wealth which for most people, the vast majority, tends to decline very rapidly once they have "enough"--whatever that means to them, generally supporting a lifestyle that they are comfortable with. That means they become more and more risk averse and the benefits of likely ending up with more money from a high equity allocation are FAR outweighed by the risk of the ending up with far less, and running out of money, which increase as you raise the equity allocation. In other words both tails increase as you raise equity allocations but investors care much more generally about the risk of the left tail then the opportunity for the right tail

c) I think all who have worked with investors as advisors would agree that the vast majority of investors risk tolerance, their ability to sleep well and enjoy life through bear markets, declines as we age and no longer have earned income to rely on to replenish or maintain the portfolio. Being able to enjoy life is far more important than dying with more assets!

d) Taleb said it best that only fools judge a strategy by its outcome without considering what alternative universe might have shown up. So those who rely on US only data for example and fail to consider say the 1930s or that we might have lost WWII and the world might have looked very different for US investors are IMO making the mistake which has been called the Triumph of the Optimists. Rising equity allocations in retirement for Japanese investors would likely have turned out extremely poorly for the past 30 years. That can happen here as well.

Bottom line is that IMO unless truly investing for the next generation and are willing to "lose those assets" a rising equity allocation in retirement is just plain wrong. Remember the consequences of your actions should dominate the probabilities, whatever you think they may be. You must be willing to live with the negative outcomes or don't take the action.

Best wishes
larry


Great post Larry... I agree with everything you say here.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by Levett » Thu Dec 29, 2016 12:30 pm

Larry writes:

"Being able to enjoy life is far more important than dying with more assets!"

Say it again and again, brother. I believe!

Lev

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by Tycoon » Thu Dec 29, 2016 12:38 pm

larryswedroe wrote: You must be willing to live with the negative outcomes or don't take the action.

Best wishes
larry


I wish more people understood this!
...I might be just beginning | I might be near the end. Enya | | C'est la vie

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by TheTimeLord » Thu Dec 29, 2016 12:47 pm

Tycoon wrote:
larryswedroe wrote: You must be willing to live with the negative outcomes or don't take the action.

Best wishes
larry


I wish more people understood this!


One must be willing to accept the consequences of their decisions.
Run, You Clever Boy!

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by larryswedroe » Thu Dec 29, 2016 12:52 pm

Freebeer
We didn't publish anything, was just an internal analysis

Blue Ears
The way we do this is to run MCS to look at the risks in the tails and how big they are. So we look say at the bottom 5, 10 and 15% of all the outcomes and see if the portfolio can survive. So that's similar to what you are doing. The more options that the investor has that they are WILLING to exercise the more downside risk than can take, if they desire. But have to be sure willing to do that. For example some couples I have heard say if we get the left tail we'll move to a lower cost of living area, and then the spouse shouts no way am I moving away from the grandkids. So the couple has to agree on what they really are willing to do.

Best wishes
Larry

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by dognose » Thu Dec 29, 2016 1:14 pm

Larry,

I hope that someday you write a book focused solely on the marginal utility of wealth. It's a fascinating subject, and no one writes about it with as much passion and wisdom as you do.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by HomerJ » Thu Dec 29, 2016 1:39 pm

dognose wrote:Larry,

I hope that someday you write a book focused solely on the marginal utility of wealth. It's a fascinating subject, and no one writes about it with as much passion and wisdom as you do.


It's very strange to me that so many people don't understand the concept of diminishing returns.

For example, I have a boat...

Going from zero boats to one boat made me very happy.

Going from one boat to a larger boat would barely change my happiness at all.

Going from one boat to two boats would probably DIMINISH my happiness... :)

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by BlueEars » Thu Dec 29, 2016 1:47 pm

HomerJ wrote:
dognose wrote:...
For example, I have a boat...

Going from zero boats to one boat made me very happy.

Going from one boat to a larger boat would barely change my happiness at all.

Going from one boat to two boats would probably DIMINISH my happiness... :)

Zero boats makes me very happy. :wink:

Viva la difference.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by beardsworth » Thu Dec 29, 2016 2:03 pm

What's a boat? :)

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by larryswedroe » Thu Dec 29, 2016 2:08 pm

Dognose
Might be a nice short chapter or appendix, but don't think merits a full book

But thought you might enjoy this piece I wrote a while back on the subject

Author Kurt Vonnegut related this story about fellow author Joseph Heller: “Heller and I were at a party given by a billionaire on Shelter Island. I said, ‘Joe, how does it make you feel to know that our host only yesterday may have made more money than your novel Catch-22 has earned in its entire history?’ Joe said, ‘I’ve got something he can never have.’ And I said, ‘What on earth could that be, Joe?’ And Joe said, ‘The knowledge that I’ve got enough.’”

In 2009, I was asked to do an investment seminar for the Tiger 21 Group. According to their website, “Tiger 21 is the nation’s premier peer-to-peer learning group for high-net-worth investors. We help members build the skill set to successfully transition from focused entrepreneurs to disciplined managers of wealth. Participating in professionally-facilitated, 12-14 person groups, our members meet monthly to harness the varied expertise and collective intelligence of their peers in high-energy, day-long sessions.”

One of the issues the group asked me to address was: How do the rich think about risk and how should they think about it? What follows is my answer.

Unless one inherits their wealth, the most common way large fortunes are created is by taking lots of risk, often concentrating that risk in a personally owned business. Thus, high net worth individuals are typically successful entrepreneurs. By definition, they are risk takers who have known success. That provides them with confidence in their ability to take risk. That confidence often creates the willingness to take risks. In addition, given that they have large fortunes, they also have the ability to take risk. And that combination typically leads people to continue to take risks.

However, the ability and willingness to take risk are only two of the three criteria one should consider when deciding on an investment policy. There is a third, often overlooked, criterion — the need to take risk. A great irony is that the very people who have the most ability and willingness to take risk, have the least need to take it.

Those with sufficient wealth to meet all their needs should consider that the strategy to get rich is entirely different than the strategy to stay rich. The strategy to get rich is to take risks, typically in one’s own business. But the strategy to stay rich is to minimize risk, diversify the risks you take and to avoid spending too much.

I explained that given that the objective of the Tiger 21 members was now to stay rich, it was important to create a new investment plan incorporating that goal. The new plan should be based on the fact that the inconvenience of going from rich to poor is unthinkable.

When deciding on the appropriate asset allocation, investors should consider their marginal utility of wealth — how much any potential incremental wealth is worth relative to the risk that must be accepted in order to achieve a greater expected return. While more money is always better than less, at some point most people achieve a lifestyle with which they are very comfortable. At that point, taking on incremental risk to achieve a higher net worth no longer makes sense: the potential damage of an unexpected negative outcome far exceeds the potential benefit gained from incremental wealth.
Each investor needs to decide at what level of wealth their unique utility of wealth curve starts flattening out and begins bending sharply to the right. Beyond this point there is little reason to take incremental risk to achieve a higher expected return. Many wealthy investors have experienced devastating losses (Does the name Madoff ring a bell?) that could easily have been avoided if they had the wisdom to know what author Joseph Heller knew.

The lesson about knowing when enough is enough can be learned from the following incident. In early 2003, I met with a 71-year old couple with financial assets of $3 million. Three years earlier their portfolio was worth $13 million. The only way they could have experienced that kind of loss was if they had held a portfolio that was almost all equities and heavily concentrated in U.S. large-cap growth stocks, especially technology stocks. They confirmed this. They then told me they had been working with a financial advisor during this period — demonstrating that while good advice does not have to be expensive, bad advice almost always costs you dearly.

I asked the couple if, instead of their portfolio falling almost 80 percent, doubling it to $26 million would have led to any meaningful change in the quality of their lives? The response was a definitive no. I stated that the experience of watching $13 million shrink to $3 million must have been very painful and they probably had spent many sleepless nights. They agreed. I then asked why they had taken the risks they did, knowing the potential benefit was not going to change their lives very much but a negative outcome like the one they experienced would be so painful. The wife turned to the husband and punched him, exclaiming, “I told you so!”

Some risks are not worth taking. Prudent investors don’t take more risk than they have the ability, willingness or need to take. The important question to ask yourself is: If you’ve already won the game, why are you still playing?

Needs vs. Desires
One reason people continue to play a game they have already won is that they convert what were once desires (nice things to have, but not necessary to enjoy life) into needs. That increases the need to take risk. That causes an increase in the required equity allocation. And, that can lead to problems when the risks show up, as they did in 1973–74, 2000–02 and again in 2007–08.

Moral of the Tale
Failing to consider the need to take risk is a mistake common to many wealthy people, especially those who became wealthy by taking large risks. However, the mistake of taking more risk than needed is not limited to the very wealthy. The question you need to ask yourself is how much money buys happiness? Most people would be surprised to find that the figure is a lot less than they think. For example, psychologists have found that once you have enough money to meet basic needs like food, shelter and safety, incremental increases have little effect on your happiness. Once you have met those requirements the good things in life (the really important things) are either free or cheap. For example, taking a walk in a park with your significant other, riding a bike, reading a book, playing bridge with friends, or playing with your children/grandchildren doesn’t cost very much if anything. And whether you drink a $10 or a $100 bottle of wine, or eat in a restaurant that costs $50 or $500 for dinner for two won’t really make you any happier.

When developing your investment policy statement make sure that you have differentiated between needs and desires and then carefully considered the marginal utility of incremental wealth so that you can determine if those desires are worth the incremental risks that you will have to accept. Knowing when you have enough is one of the keys to playing the winner’s game in both life and investing.

Hope you find it helpful
Larry

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by retire57 » Thu Dec 29, 2016 2:11 pm

Thanks for sharing this thoughtful post. After reading, I'm more satisfied with our newly-retired new-to-us 50/50 AA. I had been pouting through most of this month's stock gains, but feel less petulant now.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by ignition » Thu Dec 29, 2016 2:36 pm

larryswedroe wrote:b) the arguments should always consider the marginal utility of wealth which for most people, the vast majority, tends to decline very rapidly once they have "enough"--whatever that means to them, generally supporting a lifestyle that they are comfortable with. That means they become more and more risk averse and the benefits of likely ending up with more money from a high equity allocation are FAR outweighed by the risk of the ending up with far less, and running out of money, which increase as you raise the equity allocation. In other words both tails increase as you raise equity allocations but investors care much more generally about the risk of the left tail then the opportunity for the right tail


I though the SWR studies showed that a higher equity allocation resulted in lower failure rates?

larryswedroe wrote:d) Taleb said it best that only fools judge a strategy by its outcome without considering what alternative universe might have shown up. So those who rely on US only data for example and fail to consider say the 1930s or that we might have lost WWII and the world might have looked very different for US investors are IMO making the mistake which has been called the Triumph of the Optimists. Rising equity allocations in retirement for Japanese investors would likely have turned out extremely poorly for the past 30 years. That can happen here as well.


It could happen. But valuations for Japanese stocks in 1990 were really absurd: the CAPE was over 90 if I remember correctly. I wonder what people were thinking in 1990 expecting good returns of Japanese stocks. That makes the current CAPE of US stock of 28 a lot more reasonable (although still high)

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by rapporteur » Thu Dec 29, 2016 3:04 pm

Ah, sancta simplicitas!

Dear HomerJ, it’s so good we have you. In fact, if we didn’t, I suspect we’d have to invent you. :happy

First, let me get the bad news out of the way.

You asked (inter alia),
Are you going to personally make up my losses if the above (1) actually does happen?

No, HomerJ, no one, least of all me, is going to indemnify you against the risks of living. To expect otherwise might be characterized as being ‘psychologically crippled and irrational’. :happy

You later said,
Ugh, my first impression is that there's not going to be any kind of discussion here.

The dawn breaks…

Yes, HomerJ, there are many ways of exploring a topic to try to reach the truth. Or if not Very Truth Itself (we are, after all, limited finite beings) then at least its outlines.

Discussion is one such method – and a very good one too. It is overwhelmingly the method used on this forum. But it’s NOT the only method.

There are other methods of exploring a topic and arriving at truth. One longstanding widely-used method is the adversarial one, in which one side of a question is strongly advanced with evidence and argument, while anticipating and disposing of objections, counter-arguments, and counter-evidence. This is done is the strong expectation that a champion(s) of the opposing point of view will come forth to dispute the points, and make a strong case for the opposing view(s). The adversarial method, for instance, is widely adopted by the law. The rationale is that truth, like iron, is forged between the hammer and anvil.

This method can be frightening, even offensive, to timid souls, especially if they have little experience dealing with it. They mistake its vigour for animus.

And discussion or the adversarial method by no means exhaust the possibilities. There is also, for instance, maieutics, the elenchic method of which Socrates was so fond. The back and forth might be a tad clumsy on this forum but could be quite workable in, say, a chat room.

Oh, and Happy New Year!

Regards,

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by larryswedroe » Thu Dec 29, 2016 3:20 pm

ignition
When I've looked at MCS results they almost always show lower odds of success (not running out of money) at high equity allocations, though higher odds of success than at very low levels. So typically will need to have at least a moderate equity allocation. Of course higher allocations to equity provide greater odds of having more wealth at death.

Also don't need a Japan which started at very high valuations, can just have very bad economic outcomes.

Larry

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by HomerJ » Thu Dec 29, 2016 3:22 pm

BlueEars wrote:
HomerJ wrote:
dognose wrote:...
For example, I have a boat...

Going from zero boats to one boat made me very happy.

Going from one boat to a larger boat would barely change my happiness at all.

Going from one boat to two boats would probably DIMINISH my happiness... :)

Zero boats makes me very happy. :wink:

Viva la difference.


Yeah I figured someone would make that very valid point... :)

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by HomerJ » Thu Dec 29, 2016 3:27 pm

rapporteur wrote:Ah, sancta simplicitas!

Dear HomerJ, it’s so good we have you. In fact, if we didn’t, I suspect we’d have to invent you. :happy

First, let me get the bad news out of the way.

You asked (inter alia),
Are you going to personally make up my losses if the above (1) actually does happen?

No, HomerJ, no one, least of all me, is going to indemnify you against the risks of living. To expect otherwise might be characterized as being ‘psychologically crippled and irrational’. :happy

You later said,
Ugh, my first impression is that there's not going to be any kind of discussion here.

The dawn breaks…

Yes, HomerJ, there are many ways of exploring a topic to try to reach the truth. Or if not Very Truth Itself (we are, after all, limited finite beings) then at least its outlines.

Discussion is one such method – and a very good one too. It is overwhelmingly the method used on this forum. But it’s NOT the only method.

There are other methods of exploring a topic and arriving at truth. One longstanding widely-used method is the adversarial one, in which one side of a question is strongly advanced with evidence and argument, while anticipating and disposing of objections, counter-arguments, and counter-evidence. This is done is the strong expectation that a champion(s) of the opposing point of view will come forth to dispute the points, and make a strong case for the opposing view(s). The adversarial method, for instance, is widely adopted by the law. The rationale is that truth, like iron, is forged between the hammer and anvil.

This method can be frightening, even offensive, to timid souls, especially if they have little experience dealing with it. They mistake its vigour for animus.

And discussion or the adversarial method by no means exhaust the possibilities. There is also, for instance, maieutics, the elenchic method of which Socrates was so fond. The back and forth might be a tad clumsy on this forum but could be quite workable in, say, a chat room.

Oh, and Happy New Year!

Regards,


It appears my first impression was correct. How many words did you write without answering any of my points at all? Look at all the effort you spent trying to make yourself look smart instead of discussing the topic at hand.

Ah well, I have better things to do.

Happy New Year to you too.
Last edited by HomerJ on Thu Dec 29, 2016 3:45 pm, edited 1 time in total.

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HomerJ
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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by HomerJ » Thu Dec 29, 2016 3:45 pm

larryswedroe wrote:Dognose
Might be a nice short chapter or appendix, but don't think merits a full book

But thought you might enjoy this piece I wrote a while back on the subject

Author Kurt Vonnegut related this story about fellow author Joseph Heller: “Heller and I were at a party given by a billionaire on Shelter Island. I said, ‘Joe, how does it make you feel to know that our host only yesterday may have made more money than your novel Catch-22 has earned in its entire history?’ Joe said, ‘I’ve got something he can never have.’ And I said, ‘What on earth could that be, Joe?’ And Joe said, ‘The knowledge that I’ve got enough.’”

In 2009, I was asked to do an investment seminar for the Tiger 21 Group. According to their website, “Tiger 21 is the nation’s premier peer-to-peer learning group for high-net-worth investors. We help members build the skill set to successfully transition from focused entrepreneurs to disciplined managers of wealth. Participating in professionally-facilitated, 12-14 person groups, our members meet monthly to harness the varied expertise and collective intelligence of their peers in high-energy, day-long sessions.”

One of the issues the group asked me to address was: How do the rich think about risk and how should they think about it? What follows is my answer.

Unless one inherits their wealth, the most common way large fortunes are created is by taking lots of risk, often concentrating that risk in a personally owned business. Thus, high net worth individuals are typically successful entrepreneurs. By definition, they are risk takers who have known success. That provides them with confidence in their ability to take risk. That confidence often creates the willingness to take risks. In addition, given that they have large fortunes, they also have the ability to take risk. And that combination typically leads people to continue to take risks.

However, the ability and willingness to take risk are only two of the three criteria one should consider when deciding on an investment policy. There is a third, often overlooked, criterion — the need to take risk. A great irony is that the very people who have the most ability and willingness to take risk, have the least need to take it.

Those with sufficient wealth to meet all their needs should consider that the strategy to get rich is entirely different than the strategy to stay rich. The strategy to get rich is to take risks, typically in one’s own business. But the strategy to stay rich is to minimize risk, diversify the risks you take and to avoid spending too much.

I explained that given that the objective of the Tiger 21 members was now to stay rich, it was important to create a new investment plan incorporating that goal. The new plan should be based on the fact that the inconvenience of going from rich to poor is unthinkable.

When deciding on the appropriate asset allocation, investors should consider their marginal utility of wealth — how much any potential incremental wealth is worth relative to the risk that must be accepted in order to achieve a greater expected return. While more money is always better than less, at some point most people achieve a lifestyle with which they are very comfortable. At that point, taking on incremental risk to achieve a higher net worth no longer makes sense: the potential damage of an unexpected negative outcome far exceeds the potential benefit gained from incremental wealth.
Each investor needs to decide at what level of wealth their unique utility of wealth curve starts flattening out and begins bending sharply to the right. Beyond this point there is little reason to take incremental risk to achieve a higher expected return. Many wealthy investors have experienced devastating losses (Does the name Madoff ring a bell?) that could easily have been avoided if they had the wisdom to know what author Joseph Heller knew.

The lesson about knowing when enough is enough can be learned from the following incident. In early 2003, I met with a 71-year old couple with financial assets of $3 million. Three years earlier their portfolio was worth $13 million. The only way they could have experienced that kind of loss was if they had held a portfolio that was almost all equities and heavily concentrated in U.S. large-cap growth stocks, especially technology stocks. They confirmed this. They then told me they had been working with a financial advisor during this period — demonstrating that while good advice does not have to be expensive, bad advice almost always costs you dearly.

I asked the couple if, instead of their portfolio falling almost 80 percent, doubling it to $26 million would have led to any meaningful change in the quality of their lives? The response was a definitive no. I stated that the experience of watching $13 million shrink to $3 million must have been very painful and they probably had spent many sleepless nights. They agreed. I then asked why they had taken the risks they did, knowing the potential benefit was not going to change their lives very much but a negative outcome like the one they experienced would be so painful. The wife turned to the husband and punched him, exclaiming, “I told you so!”

Some risks are not worth taking. Prudent investors don’t take more risk than they have the ability, willingness or need to take. The important question to ask yourself is: If you’ve already won the game, why are you still playing?

Needs vs. Desires
One reason people continue to play a game they have already won is that they convert what were once desires (nice things to have, but not necessary to enjoy life) into needs. That increases the need to take risk. That causes an increase in the required equity allocation. And, that can lead to problems when the risks show up, as they did in 1973–74, 2000–02 and again in 2007–08.

Moral of the Tale
Failing to consider the need to take risk is a mistake common to many wealthy people, especially those who became wealthy by taking large risks. However, the mistake of taking more risk than needed is not limited to the very wealthy. The question you need to ask yourself is how much money buys happiness? Most people would be surprised to find that the figure is a lot less than they think. For example, psychologists have found that once you have enough money to meet basic needs like food, shelter and safety, incremental increases have little effect on your happiness. Once you have met those requirements the good things in life (the really important things) are either free or cheap. For example, taking a walk in a park with your significant other, riding a bike, reading a book, playing bridge with friends, or playing with your children/grandchildren doesn’t cost very much if anything. And whether you drink a $10 or a $100 bottle of wine, or eat in a restaurant that costs $50 or $500 for dinner for two won’t really make you any happier.

When developing your investment policy statement make sure that you have differentiated between needs and desires and then carefully considered the marginal utility of incremental wealth so that you can determine if those desires are worth the incremental risks that you will have to accept. Knowing when you have enough is one of the keys to playing the winner’s game in both life and investing.

Hope you find it helpful
Larry


This needs to be bookmarked somewhere... One of the best posts I've ever read on this board.

Nicely written, Larry.

Jcraz13
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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by Jcraz13 » Thu Dec 29, 2016 3:52 pm

larryswedroe wrote:Dognose
Might be a nice short chapter or appendix, but don't think merits a full book

But thought you might enjoy this piece I wrote a while back on the subject

Author Kurt Vonnegut related this story about fellow author Joseph Heller: “Heller and I were at a party given by a billionaire on Shelter Island. I said, ‘Joe, how does it make you feel to know that our host only yesterday may have made more money than your novel Catch-22 has earned in its entire history?’ Joe said, ‘I’ve got something he can never have.’ And I said, ‘What on earth could that be, Joe?’ And Joe said, ‘The knowledge that I’ve got enough.’”

In 2009, I was asked to do an investment seminar for the Tiger 21 Group. According to their website, “Tiger 21 is the nation’s premier peer-to-peer learning group for high-net-worth investors. We help members build the skill set to successfully transition from focused entrepreneurs to disciplined managers of wealth. Participating in professionally-facilitated, 12-14 person groups, our members meet monthly to harness the varied expertise and collective intelligence of their peers in high-energy, day-long sessions.”

One of the issues the group asked me to address was: How do the rich think about risk and how should they think about it? What follows is my answer.

Unless one inherits their wealth, the most common way large fortunes are created is by taking lots of risk, often concentrating that risk in a personally owned business. Thus, high net worth individuals are typically successful entrepreneurs. By definition, they are risk takers who have known success. That provides them with confidence in their ability to take risk. That confidence often creates the willingness to take risks. In addition, given that they have large fortunes, they also have the ability to take risk. And that combination typically leads people to continue to take risks.

However, the ability and willingness to take risk are only two of the three criteria one should consider when deciding on an investment policy. There is a third, often overlooked, criterion — the need to take risk. A great irony is that the very people who have the most ability and willingness to take risk, have the least need to take it.

Those with sufficient wealth to meet all their needs should consider that the strategy to get rich is entirely different than the strategy to stay rich. The strategy to get rich is to take risks, typically in one’s own business. But the strategy to stay rich is to minimize risk, diversify the risks you take and to avoid spending too much.

I explained that given that the objective of the Tiger 21 members was now to stay rich, it was important to create a new investment plan incorporating that goal. The new plan should be based on the fact that the inconvenience of going from rich to poor is unthinkable.

When deciding on the appropriate asset allocation, investors should consider their marginal utility of wealth — how much any potential incremental wealth is worth relative to the risk that must be accepted in order to achieve a greater expected return. While more money is always better than less, at some point most people achieve a lifestyle with which they are very comfortable. At that point, taking on incremental risk to achieve a higher net worth no longer makes sense: the potential damage of an unexpected negative outcome far exceeds the potential benefit gained from incremental wealth.
Each investor needs to decide at what level of wealth their unique utility of wealth curve starts flattening out and begins bending sharply to the right. Beyond this point there is little reason to take incremental risk to achieve a higher expected return. Many wealthy investors have experienced devastating losses (Does the name Madoff ring a bell?) that could easily have been avoided if they had the wisdom to know what author Joseph Heller knew.

The lesson about knowing when enough is enough can be learned from the following incident. In early 2003, I met with a 71-year old couple with financial assets of $3 million. Three years earlier their portfolio was worth $13 million. The only way they could have experienced that kind of loss was if they had held a portfolio that was almost all equities and heavily concentrated in U.S. large-cap growth stocks, especially technology stocks. They confirmed this. They then told me they had been working with a financial advisor during this period — demonstrating that while good advice does not have to be expensive, bad advice almost always costs you dearly.

I asked the couple if, instead of their portfolio falling almost 80 percent, doubling it to $26 million would have led to any meaningful change in the quality of their lives? The response was a definitive no. I stated that the experience of watching $13 million shrink to $3 million must have been very painful and they probably had spent many sleepless nights. They agreed. I then asked why they had taken the risks they did, knowing the potential benefit was not going to change their lives very much but a negative outcome like the one they experienced would be so painful. The wife turned to the husband and punched him, exclaiming, “I told you so!”

Some risks are not worth taking. Prudent investors don’t take more risk than they have the ability, willingness or need to take. The important question to ask yourself is: If you’ve already won the game, why are you still playing?

Needs vs. Desires
One reason people continue to play a game they have already won is that they convert what were once desires (nice things to have, but not necessary to enjoy life) into needs. That increases the need to take risk. That causes an increase in the required equity allocation. And, that can lead to problems when the risks show up, as they did in 1973–74, 2000–02 and again in 2007–08.

Moral of the Tale
Failing to consider the need to take risk is a mistake common to many wealthy people, especially those who became wealthy by taking large risks. However, the mistake of taking more risk than needed is not limited to the very wealthy. The question you need to ask yourself is how much money buys happiness? Most people would be surprised to find that the figure is a lot less than they think. For example, psychologists have found that once you have enough money to meet basic needs like food, shelter and safety, incremental increases have little effect on your happiness. Once you have met those requirements the good things in life (the really important things) are either free or cheap. For example, taking a walk in a park with your significant other, riding a bike, reading a book, playing bridge with friends, or playing with your children/grandchildren doesn’t cost very much if anything. And whether you drink a $10 or a $100 bottle of wine, or eat in a restaurant that costs $50 or $500 for dinner for two won’t really make you any happier.

When developing your investment policy statement make sure that you have differentiated between needs and desires and then carefully considered the marginal utility of incremental wealth so that you can determine if those desires are worth the incremental risks that you will have to accept. Knowing when you have enough is one of the keys to playing the winner’s game in both life and investing.

Hope you find it helpful
Larry


+ 1 one of the best posts ever. What a great thread ..who started it ? :)

onthecusp
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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by onthecusp » Thu Dec 29, 2016 3:53 pm

retire57 wrote:Thanks for sharing this thoughtful post. After reading, I'm more satisfied with our newly-retired new-to-us 50/50 AA. I had been pouting through most of this month's stock gains, but feel less petulant now.


Does this illustrate the flip side of the oft discussed risk tolerance?

If I have too much in stocks and can't stomach a decline without jumping out, I could also have too much in bonds and jump in to stocks after seeing months or years of relative poor performance.

What would we call this? A lack of safety tolerance?

JoinToday
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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by JoinToday » Thu Dec 29, 2016 4:33 pm

larryswedroe wrote:Dognose
....

When deciding on the appropriate asset allocation, investors should consider their marginal utility of wealth — how much any potential incremental wealth is worth relative to the risk that must be accepted in order to achieve a greater expected return. While more money is always better than less, at some point most people achieve a lifestyle with which they are very comfortable. At that point, taking on incremental risk to achieve a higher net worth no longer makes sense: the potential damage of an unexpected negative outcome far exceeds the potential benefit gained from incremental wealth.
Each investor needs to decide at what level of wealth their unique utility of wealth curve starts flattening out and begins bending sharply to the right. Beyond this point there is little reason to take incremental risk to achieve a higher expected return. Many wealthy investors have experienced devastating losses (Does the name Madoff ring a bell?) that could easily have been avoided if they had the wisdom to know what author Joseph Heller knew.

The lesson about knowing when enough is enough can be learned from the following incident. In early 2003, I met with a 71-year old couple with financial assets of $3 million. Three years earlier their portfolio was worth $13 million. The only way they could have experienced that kind of loss was if they had held a portfolio that was almost all equities and heavily concentrated in U.S. large-cap growth stocks, especially technology stocks. They confirmed this. They then told me they had been working with a financial advisor during this period — demonstrating that while good advice does not have to be expensive, bad advice almost always costs you dearly.

I asked the couple if, instead of their portfolio falling almost 80 percent, doubling it to $26 million would have led to any meaningful change in the quality of their lives? The response was a definitive no. I stated that the experience of watching $13 million shrink to $3 million must have been very painful and they probably had spent many sleepless nights. They agreed. I then asked why they had taken the risks they did, knowing the potential benefit was not going to change their lives very much but a negative outcome like the one they experienced would be so painful. The wife turned to the husband and punched him, exclaiming, “I told you so!”

Some risks are not worth taking. Prudent investors don’t take more risk than they have the ability, willingness or need to take. The important question to ask yourself is: If you’ve already won the game, why are you still playing?

Needs vs. Desires
One reason people continue to play a game they have already won is that they convert what were once desires (nice things to have, but not necessary to enjoy life) into needs. That increases the need to take risk. That causes an increase in the required equity allocation. And, that can lead to problems when the risks show up, as they did in 1973–74, 2000–02 and again in 2007–08.

Moral of the Tale
Failing to consider the need to take risk is a mistake common to many wealthy people, especially those who became wealthy by taking large risks. However, the mistake of taking more risk than needed is not limited to the very wealthy. The question you need to ask yourself is how much money buys happiness? Most people would be surprised to find that the figure is a lot less than they think. For example, psychologists have found that once you have enough money to meet basic needs like food, shelter and safety, incremental increases have little effect on your happiness. Once you have met those requirements the good things in life (the really important things) are either free or cheap. For example, taking a walk in a park with your significant other, riding a bike, reading a book, playing bridge with friends, or playing with your children/grandchildren doesn’t cost very much if anything. And whether you drink a $10 or a $100 bottle of wine, or eat in a restaurant that costs $50 or $500 for dinner for two won’t really make you any happier.

When developing your investment policy statement make sure that you have differentiated between needs and desires and then carefully considered the marginal utility of incremental wealth so that you can determine if those desires are worth the incremental risks that you will have to accept. Knowing when you have enough is one of the keys to playing the winner’s game in both life and investing.

Hope you find it helpful
Larry


Larry: I did find this helpful, but I have one question for you & the group: When you do have more than enough, what do you recommend for investments?

Lets say someone has 50x or 100x their yearly spending, or 200x their basic needs (or perhaps a pension + SS covers all spending). My belief is having equity between 40% and 60% of your investments is the sweet spot for risk & return, and I am currently holding 60% equity based on Peter Bernstein's article "The 60/40 Solution". But when I read Larry's post, I get the feeling I should dial back the equity.

I want a simple 3 or 4 fund portfolio (wisdom from Taylor) -- Vanguard total stock market, total international stock market, and 1 or 2 bond funds.

[FWIW: I would be sick to my stomach if my net worth dropped from $13M to $3M in Larry's story. For my 60% equity allocation, I am thinking I could tolerate a 30% drop in my portfolio]
I wish I had learned about index funds 25 years ago

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by larryswedroe » Thu Dec 29, 2016 5:05 pm

JoinToday
I'll tell you what I have done. And what I have recommended to the high net worth clients we work with. To begin I recommend they consider the Larry Portfolio which allows them to hold much less equity risk and cuts the tail risk. So the equities are about 50% US and 50% international and basically all SV.

Then my portfolio is dominated by a very large allocation to individual very high quality municipal bonds, basically in ladder with average maturity tending to be in the 4-5 years.

As my assets continued to grow I felt I could take a bit more risk since I had the large muni bond portfolio which was alone more than I would ever need. So I started to diversify across other factors that have premiums and are uncorrelated with stocks and have less risk than stocks. So funds like QSPRX. So the additional risk of the fund over munis was somewhat mitigated by the low correlation with the rest of the portfolio.

I then added more recently investments in two Stone Ridge products which have more risk than bonds but much less risk than stocks and also have low to no correlation with the rests of the portfolio. The two are LENDX which IMO has an expected return of about 8% currently with only a 2 year duration and even in a 2008 would have about broken even, and SRRIX a reinsurance investment which has IMO an expected return of about 7% and an SD about half of stocks and totally uncorrelated to anything. They consist now of about 10% of my portfolio and would be higher if had more room in tax advantaged accounts.

So my portfolio is still dominated by the munis but less so now. And now more investing for the next generation while still wanting to sleep well.

Hope that helps
larry

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FIREchief
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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by FIREchief » Thu Dec 29, 2016 5:17 pm

larryswedroe wrote: I then added more recently investments in two Stone Ridge products which have more risk than bonds but much less risk than stocks and also have low to no correlation with the rests of the portfolio. The two are LENDX which IMO has an expected return of about 8% currently with only a 2 year duration and even in a 2008 would have about broken even, and SRRIX a reinsurance investment which has IMO an expected return of about 7% and an SD about half of stocks and totally uncorrelated to anything. They consist now of about 10% of my portfolio and would be higher if had more room in tax advantaged accounts.


I took a peek at the prospectus. This stuff sounds real scary. :shock:
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: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by larryswedroe » Thu Dec 29, 2016 7:10 pm

Firechief
Which sounds scary? If referring to LENDX, banks that invested in those type loans in 2008 basically broke even, in the worst environment since the Great Depression. And certainly less risky than stocks, with the same expected return. And I'm a very conservative investor, and one who ran the credit risk for one of the largest mortgage originator in the country Prudential Home Mortgage. And I can proudly say that no investor buying an investment grade security we issued ever lost one penny. So I think I know a bit about credit risk.
As to SRRIX, its basically in the same business as Warren Buffett's General Re.
Both have SDs way below that of equities yet with similar returns expected. Compared to these equities are what should scare you.
Larry

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by mcgarrett » Thu Dec 29, 2016 7:44 pm

I am very interested in SRRIX, and maybe a bit less so in LENDX, as diversifiers in my Larry Portfolio. However, although the SD's are low, and the expected returns are similar to equities with presumably very low correlation to equities, the ER's for these funds is rather high (SSRX 2.42%, LENDX 1.5%). Is this taken into consideration in projecting the expected returns? And I was hoping to ask Larry if the ~10% allocation to these funds was taken from his equity allocation, or by harvesting gains, or by some of the muni's reaching maturity.

Thanks to all for a very interesting thread.

McGarrett

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by matto » Thu Dec 29, 2016 7:48 pm

mcgarrett wrote:I am very interested in SRRIX, and maybe a bit less so in LENDX, as diversifiers in my Larry Portfolio. However, although the SD's are low, and the expected returns are similar to equities with presumably very low correlation to equities, the ER's for these funds is rather high (SSRX 2.42%, LENDX 1.5%). Is this taken into consideration in projecting the expected returns? And I was hoping to ask Larry if the ~10% allocation to these funds was taken from his equity allocation, or by harvesting gains, or by some of the muni's reaching maturity.

Thanks to all for a very interesting thread.

McGarrett


He said they were in tax deferred.

And he is quoting the post expense ratio expected returns. Consider the alternative to LENDX is probably a bank, traditionally, and banks have quite high effective expense ratios.

I might be interested in these, but as neither fund is available to retail investors, it doesn't seem like it matters too much to a lot of us. I'm not willing to jump through hoops/pay a % AUM advisor in order to get access to these.

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by larryswedroe » Thu Dec 29, 2016 8:06 pm

mcgarrett
They are both in tax deferred accounts as they are tax inefficient, all ordinary income basically. And yes of course the expected return is after expenses.

The ERs are high because not investing in an "index fund" but in the management team that is basically running a bank and a reinsurance company for you. And you want top talent to control the credit risks and manage the insurance risks.

FWIW while SRRIX is a better diversifier IMO the Sharpe ratio for lendx is likely to be much higher and its SD about half or less of SRRIX.

There is an alternative retail investors can consider. We looked at River North as option as bit cheaper than LENDX but like the management at Stone Ridge and cheapest isn't always best. And here credit risk and culture should dominate that decision IMO. But it's worth considering
Larry

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by mcgarrett » Thu Dec 29, 2016 8:23 pm

Thanks, matto. I read but didn't register the tax-deferred location mention. I appreciate your pointing it out.

If the expected return is after fees, that reduces my anxiety about these high-ish ER's.

I currently work with an advisor and could get access to these funds and might direct a portion of my portfolio into one or both. The reinsurance fund SRRIX only has limited dates when investments can be made, and this also brings up a possible hitch with reduced liquidity compared to most mutual funds.

The virtual non-correlation with equities has made me focus on these two alternative investments even more than the QSPRX that is already part of my portfolio.

Thank you, Larry, for adding some additional details about how these funds may differ and I also am leaning towards the SRRIX. I have to decide whether to add SRRIX and keep the QSPRX or replace it, and how this might affect my overall AA of equities/FI (primarily muni's and some TIPS).

McGarrett

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Re: Bernstein-"To Make Money They Didn't Need".....and Pascal's Wager

Post by matto » Thu Dec 29, 2016 8:25 pm

larryswedroe wrote:mcgarrett
They are both in tax deferred accounts as they are tax inefficient, all ordinary income basically. And yes of course the expected return is after expenses.

The ERs are high because not investing in an "index fund" but in the management team that is basically running a bank and a reinsurance company for you. And you want top talent to control the credit risks and manage the insurance risks.

FWIW while SRRIX is a better diversifier IMO the Sharpe ratio for lendx is likely to be much higher and its SD about half or less of SRRIX.

There is an alternative retail investors can consider. We looked at River North as option as bit cheaper than LENDX but like the management at Stone Ridge and cheapest isn't always best. And here credit risk and culture should dominate that decision IMO. But it's worth considering
Larry


I believe the River North fund you are referring to is: RMPLX

Unfortunately, it looks like there is a $1MM minimum for this fund, so out of reach for most retail investors. Would be grateful if you had any advice on how to access or other easily accessible funds.

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