Why go with an 80% stock / 20% bond portfolio?

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willthrill81
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Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

I've heard the long-standing advice about balanced accounts and mixing non-correlated assets classes into your portfolio as this reduces volatility. That's perfectly understandable.

However, what I cannot understand is why an investor would be attracted to a 90% or 80% equity portfolio with the rest held in bonds. Per Vanguard, the worst year for a 100% stock portfolio was 1931 with a loss of 43.1% (lost money in 25 of 90 years). The worst year for a 80/20 portfolio was also 1931 with a loss of 34.9% (lost money in 23 of 90 years). From 1926 to 2015, the 100% stock portfolio returned 10.1%, and the 80/20 portfolio returned 9.5%. (Presumably, a 90/10 portfolio, where all target date funds that I've seen begin with, would be in the middle of those losses and returns.)
https://personal.vanguard.com/us/insigh ... llocations

When I see those numbers, I really wonder whether that 8% difference between the 100% and 80/20% portfolios in the worst year, which might never happen again in an investor's lifetime, is going to be the deciding factor in whether an investor stays the course with their strategy or panics and sells at the bottom. I don't think it would for most people. If they would panic and sell at -43%, they would very likely sell at -35% as well. Further, a difference of .6% CAGR may not seem like much, but over the course of decades, most investors know that that can make a sizable difference in a portfolio.

Now before everyone starts jumping all over me about this, let me say that as someone is approaching retirement (however long you think that approach should be) and especially once someone is in retirement, I think that it makes sense to reduce the volatility of your portfolio by incorporating some bonds. But does a 90/10 or 80/20 portfolio really reduce volatility enough to achieve that goal? And, perhaps more importantly, do these portfolios really make sense for someone who is thirty or forty years from retirement? Given investors' actual behavior, which is very likely the biggest reason why most investors' returns lag far behind the market's, is the reduction of volatility we've seen in the past justified by the historically lower returns of these portfolios?

In my humble opinion, if a 100% stock portfolio is too volatile for someone, for whatever reason, then they should probably consider making stocks no more than 70% of their portfolio.

Is there something I'm missing here?
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Random Walker
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Random Walker »

I agree with pretty much everything you're saying. That being said, I think there is great value for a young investor to have modest 10-20% bonds for the sake of developing the behavioral discipline to rebalance.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by sandramjet »

Everyone is different, of course. But in my case, I have always had 80/20 since I started in the 80's, and in fact the 20 was always stable value fund. Did it make a difference? Was it the best choice? I don't know, but behaviorally it made it easy to stand all the volatility because I could always be confident that no matter how bad it got, some part of my portfolio was always getting a positive return. In hindsight, I could have stood 100%, but I didn't know that at that time...
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Ragnoth »

You make the argument that people who would get spooked at a 43% drop would probably get spoked and sell at a 35% drop as well, so the lower expected return isn't worth the risk.

But by that same reasoning, couldn't you make the same argument that people getting spooked at 35% drops are likely to get spooked at a 31% drop? Or a 27% drop? Or a 23% drop? Or a 19% drop?

By your same logic, I can boldly state that anybody who isn't comfortable with the volitility of a 60/40 portfolio shouldn't have more than a 30% allocation to stocks.

People are attracted to different stock/bond allocations based on what they "expect" their risk tolerance to be-- hence some people's attractions to 80/20 portfolios (as opposed to 70/30 or 60/40). The only "mistake" a person can really make is overestimating their own tolerance in the face of actual market downturns.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Dirghatamas »

OP
You are not missing anything. The part I would nitpick is the close to retirement stuff. In our generation with pensions basically going away and SS futures always a question mark, EVEN when close to retirement, one has to look at how much time is in front.

I started investing at age 22 always 100% in global stocks. Now at age 46, I can retire whenever I want but have no firm plans to actually do so because I enjoy my profession. So, when am I supposed to start moving away from stocks? A normal person could be accumulating for perhaps 20-40 years and then in retirement for another 20-40 years. That's a LONG time, investing career of 40-80 years and the drag from bonds will be there even in retirement (inflation rather than volatility is the likely risk over long duration).

So, my nitpick is that 100% global stocks seems like a prudent portfolio throughout, even close to retirement and even during retirement. I have not understood the whole age in bonds stuff and yes I have been through multiple bear markets.

I would agree that declining mental faculties in old age would be a good reason to move away from stocks but hopefully that occurs fairly late.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by TheEternalVortex »

Presumably some people would sell at a 43% drop but not a 35% drop. So those are those that would benefit from an 80/20 portfolio. The same argument applies for why anyone picks any allocation.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by HomerJ »

Dirghatamas wrote:So, my nitpick is that 100% global stocks seems like a prudent portfolio throughout, even close to retirement and even during retirement. I have not understood the whole age in bonds stuff and yes I have been through multiple bear markets.
You've been through multiple bear markets where you still had a job and you were still saving money each year.

It's a little different when you are pulling money from your portfolio each year, and it drops 50%. It's called sequence of returns risk.

Let's say you retire, and you are pulling 4% each year. The market drops 50%, stays down for 3-5 years before recovering, and you continue to pull the same amount of money each year.

It doesn't matter that you have the willpower to "stay the course". Those 4% withdraws really cut into your principal, and if the market stays down for an extended period, you will deplete your portfolio enough that the rebound may not be enough to get you back to even.

I think I remember from your posts that you are an extreme outlier though with a ton of extra money compared to your expenses, so yes, for you, you can stay 100% stocks if you want because even losing 50% FOREVER wouldn't impact your retirement.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by HomerJ »

TheEternalVortex wrote:Presumably some people would sell at a 43% drop but not a 35% drop. So those are those that would benefit from an 80/20 portfolio. The same argument applies for why anyone picks any allocation.
The percentages may have nothing to do with it.

If you have $1 million invested 80/20 and the market goes into a tailspin, having $200,000 sitting there fairly safe may be enough to let you "stay the course". Because that $200,000 means your kids will get fed and stay warm for multiple years, even if the market experiences an extended crash and you lose your job.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Erwin »

For me, and I assume for most, the goal of investing is not to make money but to fulfill whatever needs and desires one has. Following this logic, the issue is not whatever one can withstand this or that volatility, but rather how much risk one should take to meet the goals, and that should define the allocation.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by onourway »

It seems to me that keeping some portion of your portfolio in bonds or other less volatile instruments should ultimately prove beneficial in market downturns not necessarily for the piece of mind, but for the buying power they preserve. If the best time to buy is when markets are down, and you are already 100% stocks, you've both taken a big 'loss' and you have nothing left over to buy with during the fire sale. Having even 20% of your portfolio available to re-balance (aka buy) seems like it would be beneficial to your bottom line in the long run.

I feel like I've read articles and books that go both ways on the effectiveness of this though.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by stemikger »

willthrill81 wrote: In my humble opinion, if a 100% stock portfolio is too volatile for someone, for whatever reason, then they should probably consider making stocks no more than 70% of their portfolio.
Is there something I'm missing here?
No, you are on target and a very smart guy named Benjamin Graham agrees with you. I believe he suggested a defensive investor should have no less than 25% in stocks, but no more than 75%.

I also, don't think it is a bad idea to just have the average investor no matter what age to be 60/40 for life.

Good Post.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by nisiprius »

If you don't believe there's a limit to your risk tolerance, then you shouldn't be stopping at 100% stocks. If you don't know what your risk tolerance is, then there's no basis for thinking that 100% is the right number for you.

Depending on various controversies about to judge the optimum, you either should be leveraged up to the hilt, or, according to some peoples' analyses using the "Kelly criterion," perhaps there's an objective, psychology-free way to say you should limit yourself to "only" 140% stocks.

If you think 100% is right for you, then you need to explain why, exactly, 100.000%. You can't escape the decision. There is nothing special about the number "100" (any more than there is about "60/40").

The "argument from continuity" (80% isn't detectably different from 100%) has already been discussed, but it's fallacious; the existence of orange doesn't make red and yellow the same. (It's rather like the story of Milo of Croton, the Greek wrestler who supposedly began lifting a certain calf every day, and in just a few years was able to lift the weight of a full-grown bull. Logically, it doesn't seem possible that the incremental weight gain from day to day could ever make the difference between "can lift" and "can't lift," therefore as long as you make the increases small enough there's no limit to how much weight you can lift.) (If Zeno never concocted a paradox about that, he should have.)

The existence of four LifeStrategy funds, as well as (typically) four "sample portfolios" in books like A Random Walk Down Wall Street and The Only Guide to Winning Investment Strategy You'll Ever Need suggests that most authorities think that, for most people, a 20% difference in stock allocation is detectable and meaningful in terms of risk tolerance--you can choose intelligently between 80/20 and 60/40, for example.

100% smacks of some kind of psychological attachment to a round number, some kind of vague association with 100% effort or total faithfulness... as if you had an emotional relationship with stocks and they don't like if they see you two-timing you with some other asset class.

I would add another argument, but you won't like it. If you have allocations to both stocks and bonds, then, year by year, it is easy to make incremental adjustments. I think people who do this by gut feeling frequently do find that their risk tolerance decreases with age--as rational analysis based on "human capital" suggests that it should--and end up with something like a traditional more-conservative balance at the time when most gurus think it is appropriate to have it. People who are 100% stocks get slightly locked into that number, and are reluctant to ever begin adding bonds because the transition from zero to non-zero feels like a big one and it never seems like "the right time."

We certainly have had people post in this forum who have arrived at retirement age with 100% stocks and feels extremely uncomfortable because they now feel unacceptably jittery about being 100% stocks in retirement, yet also feel unacceptably jittery about a great big all-at-once purchase of bonds at what might not be "the right time."
Last edited by nisiprius on Sun Feb 05, 2017 8:52 am, edited 4 times in total.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by bottlecap »

You may decide it's not worth, but if you are missing anything, you are only looking at one year. Why not look at the best o e year period and make the decision?

I think you have to look at the whole picture and then make your decision.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Swelfie »

There is a free lunch here normally. A diversified portfolio on non correlated assets with expected positive returns may very well have higher returns than a pure portfolio of the superior asset. We just don't know what proportions will have the better returns in advance. For that reason, personally, from historical returns, I'm always going at least 80/20 and I would never recommend less bonds than 90/10. But I think it would be actually foolish to go less than 5% bonds because the diversification gains are greatest with the first addition to the portfolio, and 5% is barely anything, so might as well take it.

/This also depends on which bonds you are talking about. Total bond vs. short term treasuries vs. long term treasuries are all very different if you only want diversification.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Erwin »

I assume that you want a higher allocation of equities because you expect better performance than bonds. However, have you given any thought that there is a decent possibility that the price you pay in higher volatility will not yield the fruits you expect. You may need the money at the wrong time, or even worse, if you believe Bogle, Swedroe, and other smart investors, the long term performance of equities, specially US, will be nothing to write home about it.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by nps »

nisiprius wrote:If you don't believe there's a limit to your risk tolerance, then you shouldn't be stopping at 100% stocks.

Depending on various controversies about to judge the optimum, you either should be leveraged up to the hilt, or, according to some peoples' analyses using the "Kelly criterion," perhaps there's an objective, psychology-free way to say you should limit yourself to "only" 140% stocks.

If you think 100% is right for you, then you need to explain why, exactly, 100.000%. You can't escape the decision. There is nothing special about the number "100" (any more than there is about "60/40").
Nisi, I agree it might be a good mental exercise for someone at 100 percent stocks to explore what is stopping them from buying more, but there is a step function involved in the level of risk being assumed when going higher than 100 percent.

In fact, your signature block contains a similar observation.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Crushtheturtle »

nisiprius wrote:
If you think 100% is right for you, then you need to explain why, exactly, 100.000%. You can't escape the decision. There is nothing special about the number "100" (any more than there is about "60/40").

100.000% is the maximum one can allocate to stocks without incurring the risk associated with borrowing to invest more.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by jstash »

nisiprius wrote:(If Zeno never concocted a paradox about that, he should have.)
Eubulides' sorites paradox.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Dirghatamas »

nisiprius wrote: If you think 100% is right for you, then you need to explain why, exactly, 100.000%. You can't escape the decision. There is nothing special about the number "100" (any more than there is about "60/40").
Sorry but that is just not true and you obviously know it. Going to 100% is simple and easy in any investment account. Beyond that is a step function. In my tax deferred/retirement accounts, there is no simple way (I am aware of) to do a global stock cap weighted investment at low cost and exceed 100%. In taxable brokerage account, yes it is possible but the interest rate is far beyond 0. So there is a step function. You get exposed to margin calls. 100% is very different from say 120% or 140% and is indeed a step function.

The starting point in your assumption is that people who do 100% stocks are some big risk takers in their psychology. Nothing could be further (taking me as example). I am an extremely cautious and frugal person by nature. Before I would go beyond 100% and take margin accounts, the rational thing to do would be to NOT fully pay one's mortgage and instead invest that one. There are tax benefits. Yet, I am psychologically mortified about debt, as a cautious person, so I could never do it and paid my mortgage in my 20s just for my peace of mind. I knew fully well that paying mortgage so early was a bad financial decision but I was losing too much sleep worrying about what could happen if I lose my job or something else. Having a paid for house felt so much better psychologically and I haven't regretted it. I could never do a margin account.

I think the difference is the perception of risk. Many are treating volatility as risk while I have always figured inflation over long term as the risk. So, 100% global cap weighted stock index has always appeared to me the CONSERVATIVE/Safe choice rather than the risky one. Note that I would freak out if I had 100% stocks ONLY in one country or concentrated in a few companies or sectors.

People also talk about sequence of return risk early in retirement. My viewpoint is different. Because I am so cautious, I don't know how long I will live and have to prepare for it. That means the SWR has to be MUCH lower than what many advocate. Basically, I want the portfolio to be a perpetual portfolio because I may live to be 60 or 80 or 100..so the only way out is to reduce SWR.

Overall, my viewpoint about personal finance is to be very conservative: try to earn a fair bit in one's career, spend a very small fraction of it, don't let expenses go up as income goes up, shoot for very conservative (less than 1%) SWR, anticipate a very long life (worst for SWR) and invest in the safest LONG TERM assets. Exact opposite of a risk taker profile and yet that thinking has always led me to 100% stocks.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by lgs88 »

willthrill81 wrote:...
I accept that I'm an irrational market participant.

Is my 15% in intermediate-term treasuries going to make much difference in terms of maximum drawdown or total return?

No, probably not. But it makes me feel good to hold them. Probably the cheapest "feel-good" spending I'll ever do! I suspect that panic selling in times of market crisis has as much to do with people kicking themselves -- "My gosh, how could I have been so cavalier to risk it all on stocks? Better cut my losses now, so I don't regret it even more later." -- than with the actual numbers on the screen.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

Ragnoth wrote:
The only "mistake" a person can really make is overestimating their own tolerance in the face of actual market downturns.
Ragnoth,

The most common and biggest mistake that a person can make is assuming they can be fully employed continuously for 20 to 30 years. This has nothing to do with their tolerance. This has to be with their ability to take risks.

A person in the 20s and 30s will have different level of ability to take risk depending on

A) They can be fully employed continuously for the next 30 to 40 years. Aka, all the way up to the 62/65/67.

versus

B) They will be permanently unemployed or under-employed after 40s and 50s.

Many of my peers in 40s and 50s discovered their mistake but it was too late for them.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by groovy9 »

willthrill81 wrote:Is there something I'm missing here?
No, I don't think so. In my humble opinion, much of the conventional wisdom when it comes to asset allocation amounts to defending against all manner of extremely unlikely but still possible events by very likely giving up a significant long-term rate of return - enough to amount to millions of dollars for many people.

We have a lot of psychological quirks, one of which is being more averse to losing than interested in winning. If you can find a way around that, there's a lot more money to be had at retirement, I think.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

HomerJ wrote:
TheEternalVortex wrote:Presumably some people would sell at a 43% drop but not a 35% drop. So those are those that would benefit from an 80/20 portfolio. The same argument applies for why anyone picks any allocation.
The percentages may have nothing to do with it.

If you have $1 million invested 80/20 and the market goes into a tailspin, having $200,000 sitting there fairly safe may be enough to let you "stay the course". Because that $200,000 means your kids will get fed and stay warm for multiple years, even if the market experiences an extended crash and you lose your job.
+1.

I am at 64/36 because even if I lose my jobs and permanently unemployed, I can survive for 5 years without selling any stock with that AA. If the market stays down for 5 years, we will have a bigger problem than worrying about the stock market. I intended to be among last survivors even if the ship is sinking.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by arcticpineapplecorp. »

One thing I haven't seen discussed directly, but I feel like Klang Fool is sorta talking about is that the drawdown is only one part of the problem the OP mentions. The other part is how long recovery takes and this can be just as difficult for investors (especially newbies without much experience with declines/recoveries). For instance, I believe Vanguard put out a paper showing that a 50/50 portfolio would have been back to its starting point by the end of 2010. Whereas a 100% stock portfolio wouldn't have gotten back to break even until I believe March 2012.

So even if one doesn't panic and sell in a downturn, a long slog might cause investors to bail before they get back to where they started. That's one of the benefits in bonds (though in truth bonds had nice returns out of the Great recession because of falling rates, which might have helped those with bonds recover faster).

Anyway, a 20% decline takes a 25% gain to break even, whereas a 50% decline takes 100% to break even. One reason why 20% in bonds might be helpful (less losses might lead to quicker recoveries). Just a thought.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

Random Walker wrote:I agree with pretty much everything you're saying. That being said, I think there is great value for a young investor to have modest 10-20% bonds for the sake of developing the behavioral discipline to rebalance.

Dave
The question is whether that behavioral discipline that might be cultivated with a 90/10 portfolio is worth the very possible tens of thousands of dollars over a lifetime.
sandramjet wrote:Everyone is different, of course. But in my case, I have always had 80/20 since I started in the 80's, and in fact the 20 was always stable value fund. Did it make a difference? Was it the best choice? I don't know, but behaviorally it made it easy to stand all the volatility because I could always be confident that no matter how bad it got, some part of my portfolio was always getting a positive return. In hindsight, I could have stood 100%, but I didn't know that at that time...
Thank you for a very insightful post. You make an excellent point that knowing one's risk tolerance precisely in advance is essentially impossible. In retrospect, you could have handled more volatility, but you didn't know that early on.
Ragnoth wrote:You make the argument that people who would get spooked at a 43% drop would probably get spoked and sell at a 35% drop as well, so the lower expected return isn't worth the risk.

But by that same reasoning, couldn't you make the same argument that people getting spooked at 35% drops are likely to get spooked at a 31% drop? Or a 27% drop? Or a 23% drop? Or a 19% drop?

By your same logic, I can boldly state that anybody who isn't comfortable with the volitility of a 60/40 portfolio shouldn't have more than a 30% allocation to stocks.

People are attracted to different stock/bond allocations based on what they "expect" their risk tolerance to be-- hence some people's attractions to 80/20 portfolios (as opposed to 70/30 or 60/40). The only "mistake" a person can really make is overestimating their own tolerance in the face of actual market downturns.
That's true. But unless the investor is extremely skittish, no one is recommending that a 20 year old go 50/50 or even 60/40, so those portfolio models can be largely disregarded in this kind of analysis.
TheEternalVortex wrote:Presumably some people would sell at a 43% drop but not a 35% drop. So those are those that would benefit from an 80/20 portfolio. The same argument applies for why anyone picks any allocation.
"Presumably," that's true. If they know it in advance, that's great. But most don't.
HomerJ wrote:
Dirghatamas wrote:So, my nitpick is that 100% global stocks seems like a prudent portfolio throughout, even close to retirement and even during retirement. I have not understood the whole age in bonds stuff and yes I have been through multiple bear markets.
You've been through multiple bear markets where you still had a job and you were still saving money each year.

It's a little different when you are pulling money from your portfolio each year, and it drops 50%. It's called sequence of returns risk.

Let's say you retire, and you are pulling 4% each year. The market drops 50%, stays down for 3-5 years before recovering, and you continue to pull the same amount of money each year.

It doesn't matter that you have the willpower to "stay the course". Those 4% withdraws really cut into your principal, and if the market stays down for an extended period, you will deplete your portfolio enough that the rebound may not be enough to get you back to even.

I think I remember from your posts that you are an extreme outlier though with a ton of extra money compared to your expenses, so yes, for you, you can stay 100% stocks if you want because even losing 50% FOREVER wouldn't impact your retirement.
Granted, a 100% stock portfolio may have had historical periods where a 4% WR would have failed, but if we adjust that to 3.5%, I do not believe that a 100% portfolio of US and international would, historically have ever failed. And on average, you would finish with much more money than with a 50/50 portfolio, for instance.
HomerJ wrote:
TheEternalVortex wrote:Presumably some people would sell at a 43% drop but not a 35% drop. So those are those that would benefit from an 80/20 portfolio. The same argument applies for why anyone picks any allocation.
The percentages may have nothing to do with it.

If you have $1 million invested 80/20 and the market goes into a tailspin, having $200,000 sitting there fairly safe may be enough to let you "stay the course". Because that $200,000 means your kids will get fed and stay warm for multiple years, even if the market experiences an extended crash and you lose your job.
My retirement fund is not my emergency fund, but I understand that many treat it that way.

But even if a 100% equity portfolio declines by 50% in that instance, you would still have $500k.
onourway wrote:It seems to me that keeping some portion of your portfolio in bonds or other less volatile instruments should ultimately prove beneficial in market downturns not necessarily for the piece of mind, but for the buying power they preserve. If the best time to buy is when markets are down, and you are already 100% stocks, you've both taken a big 'loss' and you have nothing left over to buy with during the fire sale. Having even 20% of your portfolio available to re-balance (aka buy) seems like it would be beneficial to your bottom line in the long run.

I feel like I've read articles and books that go both ways on the effectiveness of this though.
Swelfie wrote:There is a free lunch here normally. A diversified portfolio on non correlated assets with expected positive returns may very well have higher returns than a pure portfolio of the superior asset. We just don't know what proportions will have the better returns in advance. For that reason, personally, from historical returns, I'm always going at least 80/20 and I would never recommend less bonds than 90/10. But I think it would be actually foolish to go less than 5% bonds because the diversification gains are greatest with the first addition to the portfolio, and 5% is barely anything, so might as well take it.

/This also depends on which bonds you are talking about. Total bond vs. short term treasuries vs. long term treasuries are all very different if you only want diversification.
Vanguard's portfolio models assume rebalancing, and the 100% equity portfolio has greater total returns than the 80/20. Rebalancing does not really improve your returns; it maintains your desired risk tolerance.
stemikger wrote:No, you are on target and a very smart guy named Benjamin Graham agrees with you. I believe he suggested a defensive investor should have no less than 25% in stocks, but no more than 75%.

I also, don't think it is a bad idea to just have the average investor no matter what age to be 60/40 for life.

Good Post.
Thanks! It's good to hear that at least one expert out there agrees with me.
nisiprius wrote:If you don't believe there's a limit to your risk tolerance, then you shouldn't be stopping at 100% stocks. If you don't know what your risk tolerance is, then there's no basis for thinking that 100% is the right number for you.

Depending on various controversies about to judge the optimum, you either should be leveraged up to the hilt, or, according to some peoples' analyses using the "Kelly criterion," perhaps there's an objective, psychology-free way to say you should limit yourself to "only" 140% stocks.

If you think 100% is right for you, then you need to explain why, exactly, 100.000%. You can't escape the decision. There is nothing special about the number "100" (any more than there is about "60/40").

The "argument from continuity" (80% isn't detectably different from 100%) has already been discussed, but it's fallacious; the existence of orange doesn't make red and yellow the same.
I'm not arguing that the portfolios are the same. I'm arguing that most investors are unlikely to react differently to a 100% equity portfolio than an 80/20% portfolio.

And the reason I'm not going beyond 100% can be explained in two words: margin calls.
Crushtheturtle wrote:
nisiprius wrote:
If you think 100% is right for you, then you need to explain why, exactly, 100.000%. You can't escape the decision. There is nothing special about the number "100" (any more than there is about "60/40").

100.000% is the maximum one can allocate to stocks without incurring the risk associated with borrowing to invest more.
+1
Dirghatamas wrote:
nisiprius wrote: If you think 100% is right for you, then you need to explain why, exactly, 100.000%. You can't escape the decision. There is nothing special about the number "100" (any more than there is about "60/40").
Sorry but that is just not true and you obviously know it. Going to 100% is simple and easy in any investment account. Beyond that is a step function. In my tax deferred/retirement accounts, there is no simple way (I am aware of) to do a global stock cap weighted investment at low cost and exceed 100%. In taxable brokerage account, yes it is possible but the interest rate is far beyond 0. So there is a step function. You get exposed to margin calls. 100% is very different from say 120% or 140% and is indeed a step function.
+1
lgs88 wrote:I accept that I'm an irrational market participant.

Is my 15% in intermediate-term treasuries going to make much difference in terms of maximum drawdown or total return?

No, probably not. But it makes me feel good to hold them. Probably the cheapest "feel-good" spending I'll ever do! I suspect that panic selling in times of market crisis has as much to do with people kicking themselves -- "My gosh, how could I have been so cavalier to risk it all on stocks? Better cut my losses now, so I don't regret it even more later." -- than with the actual numbers on the screen.
Your explanation makes perfect sense. You believe that an 85/15 portfolio fits your risk profile, and that's great. I think that you're probably in the minority, but that's irrelevant for you. :)
groovy9 wrote:No, I don't think so. In my humble opinion, much of the conventional wisdom when it comes to asset allocation amounts to defending against all manner of extremely unlikely but still possible events by very likely giving up a significant long-term rate of return - enough to amount to millions of dollars for many people.

We have a lot of psychological quirks, one of which is being more averse to losing than interested in winning. If you can find a way around that, there's a lot more money to be had at retirement, I think.
I think that you're spot on. I think that 80/20 allocations have more to do with trying to deal with highly unlikely events and loss aversion than anything else. But if that keeps an investor from panicking during a downturn, that's great.
Erwin wrote:I assume that you want a higher allocation of equities because you expect better performance than bonds. However, have you given any thought that there is a decent possibility that the price you pay in higher volatility will not yield the fruits you expect. You may need the money at the wrong time, or even worse, if you believe Bogle, Swedroe, and other smart investors, the long term performance of equities, specially US, will be nothing to write home about it.
Just look at Vanguard's portfolio models going back over 90 years. I trust history over what some (though certainly not all) experts predict about the future.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

arcticpineapplecorp. wrote:One thing I haven't seen discussed directly, but I feel like Klang Fool is sorta talking about is that the drawdown is only one part of the problem the OP mentions. The other part is how long recovery takes and this can be just as difficult for investors (especially newbies without much experience with declines/recoveries). For instance, I believe Vanguard put out a paper showing that a 50/50 portfolio would have been back to its starting point by the end of 2010. Whereas a 100% stock portfolio wouldn't have gotten back to break even until I believe March 2012.

So even if one doesn't panic and sell in a downturn, a long slog might cause investors to bail before they get back to where they started. That's one of the benefits in bonds (though in truth bonds had nice returns out of the Great recession because of falling rates, which might have helped those with bonds recover faster).

Anyway, a 20% decline takes a 25% gain to break even, whereas a 50% decline takes 100% to break even. One reason why 20% in bonds might be helpful (less losses might lead to quicker recoveries). Just a thought.
arcticpineapplecorp,

The 100/0 people count on the fact that in the "long run", it will work out. But, the problem is in the real life, they have no way to predict or forecast whether their own career/life circumstances allow them to wait and/or survive that long.

And, what is "long run" anyhow? 10 years? 20 years? 30 years? 40 years? Can a person really confidently say that they are extremely lucky that they will be fully employed and no health and/or any issues that prevent full employment over the next 10, 20, 30, 40 years? Life happened! I am old enough and seen enough to know that those are unknowable.

Planning on being extremely lucky than normal people is not a good planning strategy.

KlangFool
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

KlangFool wrote:
Ragnoth wrote:
The only "mistake" a person can really make is overestimating their own tolerance in the face of actual market downturns.
Ragnoth,

The most common and biggest mistake that a person can make is assuming they can be fully employed continuously for 20 to 30 years. This has nothing to do with their tolerance. This has to be with their ability to take risks.

A person in the 20s and 30s will have different level of ability to take risk depending on

A) They can be fully employed continuously for the next 30 to 40 years. Aka, all the way up to the 62/65/67.

versus

B) They will be permanently unemployed or under-employed after 40s and 50s.

Many of my peers in 40s and 50s discovered their mistake but it was too late for them.

KlangFool
That's why I'm working to pay off my mortgage in roughly 3.5 years. If I have no debt, it doesn't take much for us to live. We have a good emergency fund. I could go work at a burger joint and keep a roof over our heads and food in our stomachs. And given my credentials in business, if I can't even find a job doing that, there are bigger problems for us than my retirement account. We also keep about a year's supply of food on hand. And if the economy did implode, I've taken steps to mitigate at least some of issues that would create.

So given all that, I'm totally fine going with 100% equities.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

KlangFool wrote:The 100/0 people count on the fact that in the "long run", it will work out. But, the problem is in the real life, they have no way to predict or forecast whether their own career/life circumstances allow them to wait and/or survive that long.

And, what is "long run" anyhow? 10 years? 20 years? 30 years? 40 years? Can a person really confidently say that they are extremely lucky that they will be fully employed and no health and/or any issues that prevent full employment over the next 10, 20, 30, 40 years? Life happened! I am old enough and seen enough to know that those are unknowable.

Planning on being extremely lucky than normal people is not a good planning strategy.

KlangFool
If a 100% equity portfolio would fail you in that instance, do you think that an 80/20% portfolio would not as well?

What do you think the likelihood of bonds outperforming stocks for 30 years is? Or even improving the return of a portfolio over that time period?

I have health insurance, disability insurance, life insurance, and an emergency fund. I'm not betting on everything going smoothly for 30 years. But that's not the point. My retirement fund is not my emergency fund, and I know of no one but through hearsay who has been genuinely forced to raid their retirement accounts in order to survive. Most people don't have them to raid in the first place, and yet they haven't died as a result.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

willthrill81 wrote:
That's why I'm working to pay off my mortgage in roughly 3.5 years. If I have no debt, it doesn't take much for us to live. We have a good emergency fund. I could go work at a burger joint and keep a roof over our heads and food in our stomachs. And given my credentials in business, if I can't even find a job doing that, there are bigger problems for us than my retirement account. We also keep about a year's supply of food on hand. And if the economy did implode, I've taken steps to mitigate at least some of issues that would create.

So given all that, I'm totally fine going with 100% equities.
willthrill81,

Why? It does not make any sense to me in term of risk-adjusted return. 100/0 is a lousy bet. It is not worth the risk.

https://personal.vanguard.com/us/insigh ... about-risk

From 1926 to 2013

For 100/0, the average return is 10.2%. The worst year is - 43.1%
For 90/10, the average return is 9.9%. The worst year is -39%

So, you take the risk of down 4% extra versus 90/10 in order to gain additional 0.3% per year? If you hit one of the worst years, it will take you 4% /0.3% = 13 years to beat 90/10?

For 80/20, the average return is 9.6%. The worst year is -34.9%. Versus 90/10, you take an additional 4.1% risk in order to gain 0.3% per year on the average?

The increases of average return do not justify the additional risk. It is just a lousy bet. The risk is not rewarded.

The sweet spot in term of risk-adjusted return is between 75/25 to 25/75. That is the efficient frontier.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

willthrill81 wrote:
KlangFool wrote:The 100/0 people count on the fact that in the "long run", it will work out. But, the problem is in the real life, they have no way to predict or forecast whether their own career/life circumstances allow them to wait and/or survive that long.

And, what is "long run" anyhow? 10 years? 20 years? 30 years? 40 years? Can a person really confidently say that they are extremely lucky that they will be fully employed and no health and/or any issues that prevent full employment over the next 10, 20, 30, 40 years? Life happened! I am old enough and seen enough to know that those are unknowable.

Planning on being extremely lucky than normal people is not a good planning strategy.

KlangFool
If a 100% equity portfolio would fail you in that instance, do you think that an 80/20% portfolio would not as well?

What do you think the likelihood of bonds outperforming stocks for 30 years is?
.
willthrill81,

Can you guarantee you or anyone that the person has 30 years? Then, you could not use 30 years as the benchmark. I have a 64/36 portfolio. It is designed that I would be doing as well as I could even if I am permanently unemployed tomorrow.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

KlangFool wrote:
willthrill81 wrote:
That's why I'm working to pay off my mortgage in roughly 3.5 years. If I have no debt, it doesn't take much for us to live. We have a good emergency fund. I could go work at a burger joint and keep a roof over our heads and food in our stomachs. And given my credentials in business, if I can't even find a job doing that, there are bigger problems for us than my retirement account. We also keep about a year's supply of food on hand. And if the economy did implode, I've taken steps to mitigate at least some of issues that would create.

So given all that, I'm totally fine going with 100% equities.
willthrill81,

Why? It does not make any sense to me in term of risk-adjusted return. 100/0 is a lousy bet. It is not worth the risk.

https://personal.vanguard.com/us/insigh ... about-risk

From 1926 to 2013

For 100/0, the average return is 10.2%. The worst year is - 43.1%
For 90/10, the average return is 9.9%. The worst year is -39%

So, you take the risk of down 4% extra versus 90/10 in order to gain additional 0.3% per year? If you hit one of the worst years, it will take you 4% /0.3% = 13 years to beat 90/10?

For 80/20, the average return is 9.6%. The worst year is -34.9%. Versus 90/10, you take an additional 4.1% risk in order to gain 0.3% per year on the average?

The increases of average return do not justify the additional risk. It is just a lousy bet. The risk is not rewarded.

The sweet spot in term of risk-adjusted return is between 75/25 to 25/75. That is the efficient frontier.

KlangFool
$1000 per month over 30 years @ 10.2%, compounded annually = $2,050,201.35

$1000 per month over 30 years @ 9.9%, compounded annually = $1,936,936.93

$1000 per month over 30 years @ 9.6%, compounded annually = $1,830,359.60

That's a difference of $113,264.42 with 100 vs. 90/10 and $219,841.75. That might not seem like much to you, but it does to me.

When it seems that I'm around 10 years from retirement, I'll back down to probably 70/30 or 60/40. But the historical likelihood of finishing better after 20 years from now with 90/10 or 80/20 rather than 100% is very low. Between now and then, the volatility is pretty much irrelevant to me. If equities drop, I'll do my invest to increase my savings rate even more.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

OP,

Risk-adjusted return. I am willing to take the risk if the return justifies the risk.

I have a 5% or less play money. I gambled on the stocks that have the potential of returning 1000% to 3000% over a few years. The stock may drop down to zero. That is a good bet in term of risk-adjusted return.

0.3% to 0.4% average return for an additional potential 4% to 5% loss is a lousy bet. It only takes one lousy year to wipe out 13+ years of return. Why bother?

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

KlangFool wrote:
willthrill81 wrote:If a 100% equity portfolio would fail you in that instance, do you think that an 80/20% portfolio would not as well?

What do you think the likelihood of bonds outperforming stocks for 30 years is?
.
willthrill81,

Can you guarantee you or anyone that the person has 30 years? Then, you could not use 30 years as the benchmark. I have a 64/36 portfolio. It is designed that I would be doing as well as I could even if I am permanently unemployed tomorrow.

KlangFool
If my portfolio was large enough to support my financial needs right now, then I would certainly back way off from 100%. But until I get at least remotely close to that point, I need growth, and that's where equities beat bonds hands down over multiple decades.

Are you saying that you would recommend a 60/40 portfolio to a 20 year old?

Of course I don't know how long I'll have. But if I become disabled, I've got good insurance for that. Within a few years, I won't need much income to survive if that's what it comes down to. I'm prepared and preparing for contingencies apart from my retirement fund.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

willthrill81 wrote:
$1000 per month over 30 years @ 10.2%, compounded annually = $2,050,201.35

$1000 per month over 30 years @ 9.9%, compounded annually = $1,936,936.93

$1000 per month over 30 years @ 9.6%, compounded annually = $1,830,359.60

That's a difference of $113,264.42 with 100 vs. 90/10 and $219,841.75. That might not seem like much to you, but it does to me.

When it seems that I'm around 10 years from retirement, I'll back down to probably 70/30 or 60/40. But the historical likelihood of finishing better after 20 years from now with 90/10 or 80/20 rather than 100% is very low. Between now and then, the volatility is pretty much irrelevant to me. If equities drop, I'll do my invest to increase my savings rate even more.
willthrill81,

<< When it seems that I'm around 10 years from retirement, I'll back down to probably 70/30 or 60/40. But the historical likelihood of finishing better after 20 years from now with 90/10 or 80/20 rather than 100% is very low. >>

Unless you have 40 years, you cannot use the 30 years number. So, how many years do you have?

You are an individual. You are not a statistic. You are subject to the sequence of return risk.

Let's say you have 20 years. In year 10, the stock market crashes. The 100/0 will do worse than 90/10 and/or 80/20 on the average.

<< When it seems that I'm around 10 years from retirement,>>

How do you know when you will be 10 years from retirement? You would not know anyhow until you are retired. So, how does that statement helps you?

The market could be doing so well that you retired early. Or, the market is doing badly and you retire later. You would not know one way or another.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Good Listener »

Erwin wrote:For me, and I assume for most, the goal of investing is not to make money but to fulfill whatever needs and desires one has. Following this logic, the issue is not whatever one can withstand this or that volatility, but rather how much risk one should take to meet the goals, and that should define the allocation.
Count me as one who is not part of "most" as you refer to. The ONLY reason I , and I would venture most, people invest is to make money, period. They may or may not need it for the reasons you state. Many have enough to do what you prefer to but still invest. Why do we do so? To make money.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

willthrill81 wrote:
KlangFool wrote:
willthrill81 wrote:If a 100% equity portfolio would fail you in that instance, do you think that an 80/20% portfolio would not as well?

What do you think the likelihood of bonds outperforming stocks for 30 years is?
.
willthrill81,

Can you guarantee you or anyone that the person has 30 years? Then, you could not use 30 years as the benchmark. I have a 64/36 portfolio. It is designed that I would be doing as well as I could even if I am permanently unemployed tomorrow.

KlangFool
If my portfolio was large enough to support my financial needs right now, then I would certainly back way off from 100%. But until I get at least remotely close to that point, I need growth, and that's where equities beat bonds hands down over multiple decades.

Are you saying that you would recommend a 60/40 portfolio to a 20 year old?

Of course I don't know how long I'll have. But if I become disabled, I've got good insurance for that. Within a few years, I won't need much income to survive if that's what it comes down to. I'm prepared and preparing for contingencies apart from my retirement fund.
willthrill81,

<<Are you saying that you would recommend a 60/40 portfolio to a 20 year old?>>

Balance is the key. The sweet spot in term of risk-adjusted return is between 75/25 to 25/75. A person should pick a number within that range. It is not necessary and not worthwhile to go beyond that.

<< But until I get at least remotely close to that point, I need growth, and that's where equities beat bonds hands down over multiple decades.>>

Given that you do not know how long you have, you had taken the risks with minimal additional return (0.4% for each 10% of stock). And, it only works out if you are lucky for 10+ years for each unlucky year that you get. Why bother?

KlangFool
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by duckcalldan »

I am age 53 and am retiring in 5 days.

I am at 70/27/3 and feel good about that AA. Enough cash and ST bonds to avoid liquidating in a down market, but a high enough equity % for hopefully 40+ years of a healthy retirement.

I was considering 60/40 but don't feel comfortable with a higher FI % given the current interest rate scenario.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Kingtriton10 »

I think Klangfool and Willthrill are both making very good points here... However, I have to ask could you play it both ways?

Go 75%/25% Stocks to CDs whenever market prices are high , then rebalance to 100% when the market is low? Sorry newbie here!
Last edited by Kingtriton10 on Sun Feb 05, 2017 5:04 pm, edited 1 time in total.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

OP,

This is a 1 to 10 bet. Why would you take it?

Every year, you could get 0.4% more return on the average versus 90/10. Or, you could lose 4% more than 90/10 portfolio. Only if you do not hit one of the 4% years over 10 years, you make money to cover the risk. Why is this a good bet?

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

Kingtriton10 wrote:I think Klangfool and Willthrill are both making very good points here... However, I have to ask could you play it both ways?

Go 75%/25% Stocks to CDs whenever market prices are high (volatile) , then rebalance to 100% when the market is low? Sorry newbie here!
Kingtriton10,

Why do I need to do that in order to "sell high and buy low"?

If I keep my AA fixed at 75/25 and follow my rebalancing rule, I will always sell high and buy low. If the stock goes up and exceeds 75%, I sell stock and buy the bond. And, vice versa.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Tier1Capital »

Max loss of 43% over rolling calendar years doesn't reflect the reality of living through real-world bear markets. The top 3 S&P 500 drawdowns are 86% (33 months), 60% (63 months) & 57% (17 months). The 57% drawdown was 2007-09. The 9 month period from the early 2009 market bottom was almost -47%.

That said, I generally agree with OP's point about 100/0 and where volatility is reduced enough to bother with bonds.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by Kingtriton10 »

KlangFool wrote:
Kingtriton10 wrote:I think Klangfool and Willthrill are both making very good points here... However, I have to ask could you play it both ways?

Go 75%/25% Stocks to CDs whenever market prices are high (volatile) , then rebalance to 100% when the market is low? Sorry newbie here!
Kingtriton10,

Why do I need to do that in order to "sell high and buy low"?

If I keep my AA fixed at 75/25 and follow my rebalancing rule, I will always sell high and buy low. If the stock goes up and exceeds 75%, I sell stock and buy the bond. And, vice versa.

KlangFool
I was just viewing it from Willthrill's point of view in terms of missing out on potential future earnings. Thought it could at least provide some sort of "possible'' safe guard. I do see what your getting at though.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by David Jay »

OP:

I was 100% stocks into my early 50s. I rode out each downturn since the "black Monday" (1987) with grin-and-bear-it fortitude. About 3 years ago I added some bonds. During a small downturn last year I hit my rebalancing band and I can tell you that it feels really great to be able to "buy low" during a downturn. So much better than just toughing it out. I now recommend at least 10% bonds for even the earliest investor.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

KlangFool wrote:Unless you have 40 years, you cannot use the 30 years number. So, how many years do you have? Using your logic below, that is unknowable. :wink: My plan is 20 years, but I'm quite flexible there. If the market did tank 10 years from now, I would be perfectly fine with delaying retirement for five years.

You are an individual. You are not a statistic. You are subject to the sequence of return risk. I understand that full well. Any portfolio is subject to sequence of return risk, including bond portfolios.

Let's say you have 20 years. In year 10, the stock market crashes. The 100/0 will do worse than 90/10 and/or 80/20 on the average. You do not know that. The market may suddenly tank and then recoup all of that quickly. Look at 1987. Look at the flash crash in 2015.

How do you know when you will be 10 years from retirement? You would not know anyhow until you are retired. So, how does that statement helps you? I would base that estimation on the historical performance of portfolios with my specific AA across the various asset classes.

The market could be doing so well that you retired early.If so, that's fine. At that point, I'll swing into bonds, as I've already said.

Or, the market is doing badly and you retire later.That's fine too.

You would not know one way or another. How does a 90/10 or 80/20 portfolio help you there?
Look, this is why it's called personal finance. Different people value risk differently. You place more value on risk than I do. It's as simple as that. But you cannot objectively say that any portfolio incorporating more than 75% equities is worse than a 75/25 portfolio. That is your subjective opinion, albeit I'm sure that it's based on your analysis of a lot of data. So is mine. We are just interpreting what the data mean to us personally in a different way. I'm not going to convince you to go 100% equity, and you're not going to convince me to go 64/36.
Last edited by willthrill81 on Sun Feb 05, 2017 5:34 pm, edited 1 time in total.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by bogle_rad »

I'm not entirely certain, but I think the OP is a believer that holding equities for longer time periods reduces their risk.
John Norstad disabused me of that notion:
http://www.norstad.org/finance/risk-and-time.html

In my opinion, it is simply speculative to think that holding 100% equities for longer and longer time frames will result in only above-median returns. If one is willing to reduce her withdrawal rate to very low levels to compensate for below-median returns near or after retirement, ok - fine, that's one solution. But why put oneself in that situation when once you have "won" by achieving whatever amount you equate with "financial independence," then continuing to risk it all on stocks? I know the OP has stated they would back off 100% equities near or during retirement, which supports the notion that bonds are meant to preserve wealth and negate the corrosion of inflation. With lower allocations to stocks in that way, one can maintain a more consistent withdrawal rate during retirement and hopefully avoid making drastic changes in withdrawal rates based on stock fluctuations.

Furthermore, as a practical point and response to the original post, one might choose an 80/20 allocation as a starting point with a commitment to annual rebalancing based on "age in bonds" or maybe a glide path similar to Target Date funds. Presuming regular contributions over time, this is a commitment to reduce risk over time.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

bogle_rad wrote:I'm not entirely certain, but I think the OP is a believer that holding equities for longer time periods reduces their risk.
John Norstad disabused me of that notion:
http://www.norstad.org/finance/risk-and-time.html
If holding equities over long periods of time does not mitigate their volatility, then investing in equities is little better than going to the casino. If this isn't true, then why does virtually everyone recommend that younger people have greater proportions of their portfolios in equities than retirees?

Of course there is always the risk that your equity index could drop 50% in value, no matter how long you've held it. But over time, that risk is offset by their higher returns than investments like bonds. So what's the point in Norstad's argument?
bogle_rad wrote:But why put oneself in that situation when once you have "won" by achieving whatever amount you equate with "financial independence," then continuing to risk it all on stocks?
I explicitly addressed that scenario, so I don't see why you're framing this question as though I did. Later in your post, you affirm that I didn't say that.
bogle_rad wrote:Furthermore, as a practical point and response to the original post, one might choose an 80/20 allocation as a starting point with a commitment to annual rebalancing based on "age in bonds" or maybe a glide path similar to Target Date funds. Presuming regular contributions over time, this is a commitment to reduce risk over time.
Certainly such a strategy reduces risk, but it does so at the expense of returns. Is the risk reduction achieved with an 80/20 portfolio adequately compensated by the risk in return? Over long periods of time, as in decades, I would argue that it does not, but that's my subjective assessment of the situation. As this thread clearly illustrates, some agree with my assessment, and others do not. That's why it's called personal finance.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

willthrill81 wrote:
Look, this is why it's called personal finance. Different people value risk differently. You place more value on risk than I do. It's as simple as that. But you cannot objectively say that any portfolio incorporating more than 75% equities is worse than a 75/25 portfolio. That is your subjective opinion, albeit I'm sure that it's based on your analysis of a lot of data. So is mine. We are just interpreting what the data mean to us personally in a different way. I'm not going to convince you to go 100% equity, and you're not going to convince me to go 64/36.
willthrill81,

<< But you cannot objectively say that any portfolio incorporating more than 75% equities is worse than a 75/25 portfolio.>>

Let's start with the basic. Historically, the stock could lose 50% of its value at any point of the time. This does not apply to bond. So, if you go with 100/0, you are taking the risk of losing 50% of its value at any time. It may or may not recover. You may or may not be able to wait and/or survive long enough for the recovery. That is the risk that you pay for the higher return of the stock.

So, the question is do you get enough additional return to justify taking the risk? Aka, risk-adjusted return.

I assume that you agree with the number. The average return of the 90/10 is 0.4% lower for 4% to 5% lower risk of the worst year. If you agree with the number, I would ask you this question. Why is this a good bet? Think like a gambler. This is a 1 to 10 bet. You take the risk 4% to 5% additional loss in every year in order to get to get 0.4% additional average return.

It is like flipping a coin 10 times. You have to do great 10 times for every one time that it goes bad. Are you that lucky? Will you do great all 10 times?

Tell me why do you think 100/0 is better than 90/10?

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by KlangFool »

willthrill81 wrote:
bogle_rad wrote:I'm not entirely certain, but I think the OP is a believer that holding equities for longer time periods reduces their risk.
John Norstad disabused me of that notion:
http://www.norstad.org/finance/risk-and-time.html
If holding equities over long periods of time does not mitigate their volatility, then investing in equities is little better than going to the casino. If this isn't true, then why does virtually everyone recommend that younger people have greater proportions of their portfolios in equities than retirees?

Of course there is always the risk that your equity index could drop 50% in value, no matter how long you've held it. But over time, that risk is offset by their higher returns than investments like bonds. So what's the point in Norstad's argument?
bogle_rad wrote:But why put oneself in that situation when once you have "won" by achieving whatever amount you equate with "financial independence," then continuing to risk it all on stocks?
I explicitly addressed that scenario, so I don't see why you're framing this question as though I did. Later in your post, you affirm that I didn't say that.
bogle_rad wrote:Furthermore, as a practical point and response to the original post, one might choose an 80/20 allocation as a starting point with a commitment to annual rebalancing based on "age in bonds" or maybe a glide path similar to Target Date funds. Presuming regular contributions over time, this is a commitment to reduce risk over time.
Certainly such a strategy reduces risk, but it does so at the expense of returns. Is the risk reduction achieved with an 80/20 portfolio adequately compensated by the risk in return? Over long periods of time, as in decades, I would argue that it does not, but that's my subjective assessment of the situation. As this thread clearly illustrates, some agree with my assessment, and others do not. That's why it's called personal finance.
willthrill81,

You had admitted that you do not have 30 years. At most 25 years. So, you do not have the time to pursue 100/0.

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Re: Why go with an 80% stock / 20% bond portfolio?

Post by willthrill81 »

KlangFool wrote:
willthrill81 wrote:
Look, this is why it's called personal finance. Different people value risk differently. You place more value on risk than I do. It's as simple as that. But you cannot objectively say that any portfolio incorporating more than 75% equities is worse than a 75/25 portfolio. That is your subjective opinion, albeit I'm sure that it's based on your analysis of a lot of data. So is mine. We are just interpreting what the data mean to us personally in a different way. I'm not going to convince you to go 100% equity, and you're not going to convince me to go 64/36.
Let's start with the basic. Historically, the stock could lose 50% of its value at any point of the time. This does not apply to bond. So, if you go with 100/0, you are taking the risk of losing 50% of its value at any time. It may or may not recover. Isn't the market near all time highs? It might not recover during the time frame I would need it to, which is what you seem to be referring to. But the likelihood of my well diversified portfolio tanking with no recovery over a decade is so low that I'm not concerned about it. You may or may not be able to wait and/or survive long enough for the recovery. That is the risk that you pay for the higher return of the stock.

So, the question is do you get enough additional return to justify taking the risk? Aka, risk-adjusted return.

I assume that you agree with the number. The average return of the 90/10 is 0.4% lower for 4% to 5% lower risk of the worst year. If you agree with the number, I would ask you this question. Why is this a good bet? Think like a gambler. This is a 1 to 10 bet. You take the risk 4% to 5% additional loss in every year in order to get to get 0.4% additional average return. You're comparing apples to oranges. The very worst year out of over a hundred saw that 4% difference between 100% equity and 90/10%. Ergo, it was lower than that in all other years. So it is not a 1 to 10 bet, not by a long shot. Assuming that the single worst year for stocks was -43%, and their long-term return is 10.1%, you would call that a 1 to 4.3 bet, which makes it seem that the odds are stacked against you. If so, why are you in equities at all? Your analogy is flawed.

Tell me why do you think 100/0 is better than 90/10? The bottom line: higher returns, which you do not dispute.
Your 64/36 portfolio has greater risk than a 60/40 portfolio. Why do you think it is better? Based on history, it is more volatile. Why not a 70/30 portfolio? Based on history, it has higher returns.

This is a personal assessment, not an objective one.
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Re: Why go with an 80% stock / 20% bond portfolio?

Post by pkcrafter »

Will wrote: However, what I cannot understand is why an investor would be attracted to a 90% or 80% equity portfolio with the rest held in bonds.

Will, you are not the first who felt compelled to ask this question or to recommend 100% stock to investors you know nothing about. All of the posters who have blindly recommended 100% stock do not understand why others would want something less. It doesn't matter if you don't understand it, but it does matter if you tell anybody reading your posts that they shuld be 100% stock. It is the 100 percenters that are in the minority.


When I see those numbers, I really wonder whether that 8% difference between the 100% and 80/20% portfolios in the worst year, which might never happen again in an investor's lifetime, is going to be the deciding factor in whether an investor stays the course with their strategy or panics and sells at the bottom.

Not your decision to make.

I don't think it would for most people. If they would panic and sell at -43%, they would very likely sell at -35% as well. Further, a difference of .6% CAGR may not seem like much, but over the course of decades, most investors know that that can make a sizable difference in a portfolio.

We don't know that. Don't surmise what other investors are gong to do.

Now before everyone starts jumping all over me about this, let me say that as someone is approaching retirement (however long you think that approach should be) and especially once someone is in retirement, I think that it makes sense to reduce the volatility of your portfolio by incorporating some bonds. But does a 90/10 or 80/20 portfolio really reduce volatility enough to achieve that goal? And, perhaps more importantly, do these portfolios really make sense for someone who is thirty or forty years from retirement? Given investors' actual behavior, which is very likely the biggest reason why most investors' returns lag far behind the market's, is the reduction of volatility we've seen in the past justified by the historically lower returns of these portfolios?

Will, you've gotten a lot of replies in the thread precisely because everyone sees their personal need, ability, and tolerance to take risk differently. You can make broad statements/suggestions for new investors, but you have to be careful about being too specific about allocation and how much risk to take. You don't know, and if they are new they probably don't know either.

Some people have a risk-taking gene, and those that do seem to not be able to understand the reasoning/rational and allocation choice of those that don't. So, they tell them they are wrong to think that way.


In my humble opinion, if a 100% stock portfolio is too volatile for someone, for whatever reason, then they should probably consider making stocks no more than 70% of their portfolio.

Is there something I'm missing here?

Yes, and it is this: you simply cannot tell others what their asset allocation "should" be unless you also provide the +/- to using that allocation. Some risk averse investors cannot hold 70%, even if it makes the most sense according to need and ability.

By the way, your reason for not going above 100% stock makes sense, and you mentioned risk. Can I assume there is no risk in 100% stocks if we don't use leverage? By risk, I mean risk that would result in having to significantly alter your lifestyle and future plans. I would assume you are investing in factors to increase returns where no leverage is involved.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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