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

[KlangFool]

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.

willthrill81,

1) I was 70/30. I adjusted my AA to 64/36 when my portfolio is big enough.

2) I plan to move to 60/40 when my AA hit another threshold.

3) So, it is just a temporary midway point before my final AA (60/40). I plan to retire on 60/40. That is my final AA.

KlangFool

[nps]

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?

It does not mitigate their volatility, it magnifies it. That said the expected value of stocks is still positive, not something that can be said for casinos (unless you own the casino).

Younger people stand to lose a smaller amount of dollars with a given allocation and have more earning years ahead to make up for any losses. A fixed allocation will put an increasing number of dollars at risk over time as contributions and earnings add to an investor's balance.

[KlangFool]

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.

bogle_rad,

+1.

It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time.

KlangFool

[willthrill81]

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.

I'm not going to address all of your points as your post is, frankly, quite condescending and presumptuous. Nowhere once have I recommended that anyone should be 100% in equities. I have only put forth historical performance with regard to returns and volatility, along with my personal interpretations of that performance, which I have carefully crouched as such.

[groovy9]

It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time.

But you do know that it always has recovered, and in fairly short order if you're in the accumulation phase of life and are holding your nose while dollar-cost averaging through it.

I'd go so far as to say most investors early in life, while gainfully employed and plenty capable of adapting to adversity, give entirely too much credence to doomsday scenarios and essentially refuse to take a daily bet in which they're likely to win $2 and unlikely to lose $1.

Edited to add: I also feel that these worst-case scenarios aren't completely thought through. If, for example, the stock market went to zero and stayed there, it would mean the US government, which would surely do everything within its power to avert such a crisis, failed to do it... Which should open up the possibility of both treasury and corporate bonds defaulting. Not to mention currency issues, hyperinflation, etc. Having 70% of your wealth in bonds and cash is no defense against the apocalypse. Personally, I'd go through most of life in 100% stocks and keep a stockpile of bullets and water.

[willthrill81]

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?

It does not mitigate their volatility, it magnifies it. How so? Historically, you are likely to experience a negative year with equities about 28% of the time. But are you not also 28% likely to lose money over a decade. Very few such decades have ever yielded a negative for stocks. That said the expected value of stocks is still positive, not something that can be said for casinos (unless you own the casino). http://observationsandnotes.blogspot.co ... arket.html

[KlangFool]

It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time.

But you do know that it always has recovered, and in fairly short order if you're in the accumulation phase of life and are holding your nose while dollar-cost averaging through it.

I'd go so far as to say most investors early in life, while gainfully employed and plenty capable of adapting to adversity, give entirely too much credence to doomsday scenarios and essentially refuse to take a daily bet in which they're likely to win $2 and unlikely to lose $1.

groovy9,

How do you know that how long you will be in the accumulation phase?

<< I'd go so far as to say most investors early in life, while gainfully employed and plenty capable of adapting to adversity, give entirely too much credence to doomsday scenarios and essentially refuse to take a daily bet in which they're likely to win $2 and unlikely to lose $1.>>

This is personal finance. You are not a statistic. What matters is whether it works out for you.

<<give entirely too much credence to doomsday scenarios >>

It happened to some people. And, they could not recover.

KlangFool

[willthrill81]

It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time.

But you do know that it always has recovered, and in fairly short order if you're in the accumulation phase of life and are holding your nose while dollar-cost averaging through it.

I'd go so far as to say most investors early in life, while gainfully employed and plenty capable of adapting to adversity, give entirely too much credence to doomsday scenarios and essentially refuse to take a daily bet in which they're likely to win $2 and unlikely to lose $1.

+1

Despite those in this thread that are jumping all over me, saying that I'm 'advocating' a risky proposition (though I'm not actually advocating anything, just questioning 'conventional' wisdom), a recent study of Millennials found that the overwhelming majority favored a guaranteed 1% investment over a portfolio with any equities at all. I would argue that the issue is not that typical Americans (not Bogleheads) are taking on too much 'risk', but rather that they are far too risk averse, to their own detriment, particularly young people can afford the volatility of equities.

The expected value of equities is positive, regardless of the length of time involved. And over a century of data has shown us that the likelihood of net gains goes up as the length of time in the market increases.

[willthrill81]

How do you know that how long you will be in the accumulation phase?

A young investor who is struggling to do nothing more than max out their IRA and investing in index funds isn't going to retire in ten years, nor in twenty, not unless their spending is incredibly low. Should they be concerned about a 50% decline in equities? Of course not. Increasing their savings should be priority #1.

They can't know with certainty if they can retire in 40 or 50 years, but they certainly know that they won't be retiring in 10.

[NibbanaBanana]

"It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time."

Isn't it also true that you could lose 50% of your bond value at any time and you do not know when and if it will recover? Just wondering.

[KlangFool]

"It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time."

Isn't it also true that you could lose 50% of your bond value at any time and you do not know when and if it will recover? Just wondering.

NibbanaBanana,

No. And, that is the difference between bond and stock.

KlangFool

[groovy9]

groovy9,
How do you know that how long you will be in the accumulation phase?

If I remember right, even during the great crash, you'd have all your money back in under 5 years if you kept buying through it. In 2008, 1 year. 1987 was a non-event other than the one day.

I don't recall any 10-year period in which you wouldn't come out fine by dutifully buying throughout, let alone 20 or 30.

Even I won't stay 100% stocks at age 60, but at 42, my accumulation phase might as well be infinite if history is any indication.

[nisiprius]

(If Zeno never concocted a paradox about that, he should have.)

Eubulides' sorites paradox.

Thank you! I learned something today...

[groovy9]

If I remember right, even during the great crash, you'd have all your money back in under 5 years if you kept buying through it.

Yeah, I found a WSJ article about it. "According to Ibbotson data, someone who dollar cost averaged was back on level terms by 1933. And by 1936 he had doubled his money (though the crash of 1938 then knocked him back to evens for a while)."

[nisiprius]

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,...

Are Stocks Really Less Volatile in the Long Run?

According to conventional wisdom, annualized volatility of stock returns is lower over long horizons than over short horizons, due to mean reversion induced by return predictability. In contrast, we find that stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. Mean reversion contributes strongly to reducing long-horizon variance, but it is more than offset by various uncertainties faced by the investor, especially uncertainty about the expected return. The same uncertainties reduce desired stock allocations of long-horizon investors contemplating target-date funds.

[nisiprius]

If I remember right, even during the great crash, you'd have all your money back in under 5 years if you kept buying through it.

Yeah, I found a WSJ article about it. "According to Ibbotson data, someone who dollar cost averaged was back on level terms by 1933. And by 1936 he had doubled his money (though the crash of 1938 then knocked him back to evens for a while)."

Yes, but who could do that? That is the big phonus-balonus here. I've asked before whether anyone has ever seen any written accounts by anyone, literally anyone, who actually did that. On the other side, The Great Depression: A Diary, by Benjamin Roth, makes it clear that Roth, a lawyer, desperately wanted to invest in the seemingly evident bargains around him, both in stocks and in real estate, but simply didn't have the money to invest. He mentions over and over again that the Depression was brutal on "professional men." The hypothetical situation of someone who "simply" kept on dollar-cost averaging through the Great Depression belies the actual conditions at the time.

The other problem is that even if you did have all your money back in under five years, you'd then have lost half of it again in 1937, when the stock market underwent a second crash of about the same depth as 2008-2009 but somewhat longer-lasting.

[willthrill81]

groovy9,
How do you know that how long you will be in the accumulation phase?

If I remember right, even during the great crash, you'd have all your money back in under 5 years if you kept buying through it. In 2008, 1 year. 1987 was a non-event other than the one day.

I don't recall any 10-year period in which you wouldn't come out fine by dutifully buying throughout, let alone 20 or 30.

Even I won't stay 100% stocks at age 60, but at 42, my accumulation phase might as well be infinite if history is any indication.

+1

I believe that there have only been two 10 year periods where the total stock market had net losses. And the so-called 'lost decade for stocks' from 1999 through 2008 was a net gain of 79% for small-cap value, not counting the 26.8% positive return they had in 2009.

And I can sympathize with you. My choice is either to accept the volatility and uncertainty of returns or else delay retirement until I'm nearly dead. That's not much of a choice for me.

[KlangFool]

groovy9,
How do you know that how long you will be in the accumulation phase?

If I remember right, even during the great crash, you'd have all your money back in under 5 years if you kept buying through it. In 2008, 1 year. 1987 was a non-event other than the one day.

groovy9,

How does that helps you if you are one of those people that were laid off and could not find a job for one to two years? Or, you are claiming that not many people were laid off during the recession?

In my case, 50% of the employees at my location were laid off. Some of them were permanently unemployed and under-employed after that.

This is personal finance. We are not a statistic.

KlangFool

[willthrill81]

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,...

Are Stocks Really Less Volatile in the Long Run?

According to conventional wisdom, annualized volatility of stock returns is lower over long horizons than over short horizons, due to mean reversion induced by return predictability. In contrast, we find that stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. Mean reversion contributes strongly to reducing long-horizon variance, but it is more than offset by various uncertainties faced by the investor, especially uncertainty about the expected return. The same uncertainties reduce desired stock allocations of long-horizon investors contemplating target-date funds.

I have clarified my statement but will do so again.

The historical likelihood of losing money in equities in any one year is roughly 28%. But over a 10 year period, the likelihood of losing money plummets to under 2%, depending on which asset class we're talking about. Extend that to 20 years, and the worst period for the S&P 500 was an annualized gain of 6.5% (1959-1978). For small-cap value, the worst period was an annualized gain of 9% from 1955-1974.

Yes, you could still lose 50% in any one year, and that does not change with one's length of time in the market. But we're not talking about one year in the market; we're talking about a decade or more.

[nps]

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?

It does not mitigate their volatility, it magnifies it. How so? Historically, you are likely to experience a negative year with equities about 28% of the time. But are you not also 28% likely to lose money over a decade. Very few such decades have ever yielded a negative for stocks. That said the expected value of stocks is still positive, not something that can be said for casinos (unless you own the casino). http://observationsandnotes.blogspot.co ... arket.html

Volatility deals with the dispersion of returns. It does not imply positive or negative direction, which is why you can still have a positive expected return.

It makes intuitive sense: if I asked you before the game started to predict the total points that would be scored in the Super Bowl by the end of the first quarter and by the end of the game, which is more likely to be correct?

[nisiprius]

...I believe that there have only been two 10 year periods where the total stock market had net losses...

According to the 2015 Ibbotson SBBI Classic Yearbook, page 49, from 1926-2014, out of 80 overlapping 10-year periods,

a portfolio of 100% large stocks lost money 4 times;
a 90/10 portfolio lost money one time;
70/30, 50/50, and 30/70 did not lose money in any ten-year period.

[willthrill81]

Volatility deals with the dispersion of returns. It does not imply positive or negative direction, which is why you can still have a positive expected return.

It makes intuitive sense: if I asked you before the game started to predict the total points that would be scored in the Super Bowl by the end of the first quarter and by the end of the game, which is more likely to be correct?

I understand what you mean, but the longer the period of time we're looking at, the more likely that the total annualized return is to regress to the mean. Dispersion from year to year doesn't change, but that's not what long-term, buy-and-hold investors are concerned with.

[willthrill81]

...I believe that there have only been two 10 year periods where the total stock market had net losses...

According to the 2015 Ibbotson SBBI Classic Yearbook, page 49, from 1926-2014, out of 80 overlapping 10-year periods,

a portfolio of 100% large stocks lost money 4 times;
a 90/10 portfolio lost money one time;
70/30, 50/50, and 30/70 did not lose money in any ten-year period.

Thanks. That's 4.4% of the time for 100% large cap and 1.1% for 90/10%.

I wonder whether there would be a difference if one looked at the total market and not just large cap.

[tennisplyr]

...I believe that there have only been two 10 year periods where the total stock market had net losses...

According to the 2015 Ibbotson SBBI Classic Yearbook, page 49, from 1926-2014, out of 80 overlapping 10-year periods,

a portfolio of 100% large stocks lost money 4 times;
a 90/10 portfolio lost money one time;
70/30, 50/50, and 30/70 did not lose money in any ten-year period.

Thanks. That's 4.4% of the time for 100% large cap and 1.1% for 90/10%.

I wonder whether there would be a difference if one looked at the total market and not just large cap.

Cool....I'm @50/50

[groovy9]

Yes, but who could do that? That is the big phonus-balonus here. I've asked before whether anyone has ever seen any written accounts by anyone, literally anyone, who actually did that.

A fair point. I suspect that with education being what it is today vs in 1930, you'd have no trouble finding an army of buyers in the next 90% drop, assuming anyone still has a job.

But that's part of my point earlier about what you can and can't assume about the shit really hitting the fan. After the great crash, I think we had deflation, so you'd have been great if you were 100% cash. But if you're in Argentina right now, it didn't matter what you had in the bank.

[roflwaffle]

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.

Substantial losses are difficult, but reduced lower earnings are rough too. PV puts an all stock portfolio at ~1.44x a 50/50 stock/treasury portfolio after 44 years. At some point, it's possible for the all stock portfolio to stay above the 50/50 portfolio during a downturn even with it's higher volatility.

Granted, someone can underestimate their need for that money and have to withdraw it during a low point, but I think that applies to any portfolio.

[nps]

Volatility deals with the dispersion of returns. It does not imply positive or negative direction, which is why you can still have a positive expected return.

It makes intuitive sense: if I asked you before the game started to predict the total points that would be scored in the Super Bowl by the end of the first quarter and by the end of the game, which is more likely to be correct?

I understand what you mean, but the longer the period of time we're looking at, the more likely that the total annualized return is to regress to the mean. Dispersion from year to year doesn't change, but that's not what long-term, buy-and-hold investors are concerned with.

Reversion to the mean is not the only component of volatility. Here's one take:

http://www.haas.berkeley.edu/groups/fin ... rlong2.pdf

Our conclusion that stocks are more volatile in the long run obtains despite the presence of mean reversion. We show that mean reversion is only one of five components of long-run variance:

(i) i.i.d. uncertainty [independent and identical distribution]
(ii) mean reversion
(iii) uncertainty about future expected returns
(iv) uncertainty about current expected return
(v) estimation risk (parameter uncertainty).

Whereas the mean-reversion component is strongly negative, the other components are all positive, and their combined effect outweighs that of mean reversion.

[Nick341981]

"bonds should come with a warning label" - Warren Buffett

[groovy9]

How does that helps you if you are one of those people that were laid off and could not find a job for one to two years? Or, you are claiming that not many people were laid off during the recession?

Of course I'm not. In 2017, personal finance dictates having an emergency fund before
doing anything else. And being an honest, hard worker is essential to finding a job in a recession, and as a business owner, let me tell you: they're harder to find that you might think.

Long-term investing, which I thought was the topic here, isn't the entirety of personal finance. How to protect yourself against a new depression is an issue that may or may not include someone's long-term investments (my emergency fund is a Roth IRA that's 70% bonds).

It becomes an impossible conversation if you insist that everyone's retirement funds have to be a primary defense against everything.

[KlangFool]

How does that helps you if you are one of those people that were laid off and could not find a job for one to two years? Or, you are claiming that not many people were laid off during the recession?

Of course I'm not. In 2017, personal finance dictates having an emergency fund before
doing anything else. And being an honest, hard worker is essential to finding a job in a recession, and as a business owner, let me tell you: they're harder to find that you might think.

Long-term investing, which I thought was the topic here, isn't the entirety of personal finance. How to protect yourself against a new depression is an issue that may or may not include someone's long-term investments (my emergency fund is a Roth IRA that's 70% bonds).

It becomes an impossible conversation if you insist that everyone's retirement funds have to be a primary defense against everything.

groovy9,

<<Long-term investing, which I thought was the topic here, isn't the entirety of personal finance. >>

This is a personal finance forum.

<<And being an honest, hard worker is essential to finding a job in a recession,>>

With 1+ million workers laid off in my industry over the past 10+ years, it is not good enough.

<< It becomes an impossible conversation if you insist that everyone's retirement funds have to be a primary defense against everything.>>

It is not a retirement fund unless a person can be fully employed until retirement age. So, are you claiming that everyone can be fully employed until retirement age?

KlangFool

[groovy9]

It is not a retirement fund unless a person can be fully employed until retirement age. So, are you claiming that everyone can be fully employed until retirement age?

For the purposes of this discussion, yes. Otherwise, there's no point in talking about how to invest retirement funds.

[chrischris]

I recently moved to 100% equities....

I'm 31 years old, make around $100k a year and have around $130k spread between my wife's 401k and both our Roth accounts. I have very strong job security (civil service) and have a solid pension available to me when I am eligible for retirement at 53 years old.

I feel my risk tolerance is strong. I don't log in and check my portfolio value. I hope for the market to crash so I can buy more funds. While it is true I started investing in 2009 after the crash, I realistically feel I would sleep fine if my portfolio was cut in half. I probably wouldn't be this aggressive if I didn't have my pension...

I of course plan to reevaluate my asset allocation in 9 years. I don't plan to hold this aggressive portfolio this long but based on my situation I think I can afford the risk.

Am I crazy?

[willthrill81]

How does that helps you if you are one of those people that were laid off and could not find a job for one to two years? You eliminate your debt now while you still have income, build a healthy emergency fund, and be ready to cut your spending to the level of your unemployment benefits, among other things.Or, you are claiming that not many people were laid off during the recession?

Of course I'm not. In 2017, personal finance dictates having an emergency fund before
doing anything else. And being an honest, hard worker is essential to finding a job in a recession, and as a business owner, let me tell you: they're harder to find that you might think.

Long-term investing, which I thought was the topic here, isn't the entirety of personal finance. How to protect yourself against a new depression is an issue that may or may not include someone's long-term investments (my emergency fund is a Roth IRA that's 70% bonds).

It becomes an impossible conversation if you insist that everyone's retirement funds have to be a primary defense against everything.

groovy9,

<<Long-term investing, which I thought was the topic here, isn't the entirety of personal finance. >>

This is a personal finance forum. Yes. That doesn't change the point. Investing for retirement implies that the #1 goal is investing for retirement, which is a long-term proposition for most of us. Everything else is of lesser importance when it comes to those investments.

<<And being an honest, hard worker is essential to finding a job in a recession,>>

With 1+ million workers laid off in my industry over the past 10+ years, it is not good enough. It sounds like it may be time to find a new industry to work in.

<< It becomes an impossible conversation if you insist that everyone's retirement funds have to be a primary defense against everything.>>

It is not a retirement fund unless a person can be fully employed until retirement age. So, are you claiming that everyone can be fully employed until retirement age? Full employment to retirement age is not a prerequisite to building a retirement portfolio and leaving it intact. And that's one of the contingencies I'm planning for. Within the next three to four years, my plan is to have enough invested to be able to not make any additional contributions but still have a solid probability, based on the conservative side of historical returns, of achieving at least a modest retirement. And by that time, I should be 100% debt free as well, which dramatically reduces the negative impact of unemployment; my income could easily be cut by then by 70% without it really hurting us.

KlangFool

[KlangFool]

It is not a retirement fund unless a person can be fully employed until retirement age. So, are you claiming that everyone can be fully employed until retirement age?

For the purposes of this discussion, yes. Otherwise, there's no point in talking about how to invest retirement funds.

groovy9,

That is the whole point.

Many people assume that they can be fully employed until retirement age. But, it turns out not to be true. So, it is not a retirement fund. But, why that is a problem? We can still invest the money. We just do not assume that we have 20 to 30 years until retirement.

KlangFool

[nisiprius]

...I understand what you mean, but the longer the period of time we're looking at, the more likely that the total annualized return is to regress to the mean. Dispersion from year to year doesn't change, but that's not what long-term, buy-and-hold investors are concerned with...

Reversion to the mean is not the only component of volatility. Here's one take: http://www.haas.berkeley.edu/groups/fin ... rlong2.pdf
Our conclusion that stocks are more volatile in the long run obtains despite the presence of mean reversion...

Yes, that's the same Pastor and Stambaugh paper I quoted upthread, which willthrill81 seems to have tuned out. I was disappointed that Jeremy Siegel didn't even mention this paper, let alone try to address it, in the fifth edition of Stocks for the Long Run.

[VaR]

A couple of questions and observations:
1. OP, are you saying that an 80/20 portfolio is irrational or BSC (crazy)? I don't think so.
2. Is 100/0 irrational or BSC? I don't think people are saying that.
3. OP, are you suggesting that risk tolerance is a step function? That is, that there are no gradations of risk tolerance where I might be comfortable with 80/20 and you might be comfortable with 100/0?
4. I will also observe that it should be the case that people with lower incomes closer to the poverty level should have lower risk tolerance. By the same tokens high income people can afford to have higher risk tolerance. This is because the cost of failure is lower - I'm just not going to be able to retire in style or leave my kids a enough money for their retirement.
5. OP, you need to be cautious about using the single 1925-2016 mean variance returns. I hope you're not expecting a 100% equity portfolio to return 10.1%. In a similar vein, by using that particular set of returns you're expecting stocks to outperform bonds by an annualized 4.7%. If we're going to analyze risk-reward of 100/0 vs 80/20, we should spend some time to make sure we're using reasonable expectations.

I feel like there should be many threads rehashing 100/0 vs 80/20. Here are some:
viewtopic.php?t=46189
viewtopic.php?t=194754
viewtopic.php?t=115929
viewtopic.php?t=182950
viewtopic.php?t=132095
viewtopic.php?t=126002
viewtopic.php?t=148021
viewtopic.php?t=142825
viewtopic.php?t=4683
viewtopic.php?t=160825
Or here's the the Google search for all 100/0 threads:
https://www.google.com/search?q=boglehe ... eheads.org

[willthrill81]

...I understand what you mean, but the longer the period of time we're looking at, the more likely that the total annualized return is to regress to the mean. Dispersion from year to year doesn't change, but that's not what long-term, buy-and-hold investors are concerned with...

Reversion to the mean is not the only component of volatility. Here's one take: http://www.haas.berkeley.edu/groups/fin ... rlong2.pdf
Our conclusion that stocks are more volatile in the long run obtains despite the presence of mean reversion...

Yes, that's the same Pastor and Stambaugh paper I quoted upthread, which willthrill81 seems to have tuned out. I was disappointed that Jeremy Siegel didn't even mention this paper, let alone try to address it, in the fifth edition of Stocks for the Long Run.

I haven't tuned it out, but I don't treat it as gospel either. Being a publishing Ph.D. myself, I've learned not to bet the farm on any single study, especially those that challenge conventional wisdom. There is a strong bias toward papers with statistically significant results, even though such results are often not replicated by those coming after. And that paper hasn't even been peer-reviewed.

Further, very simple, easy to understand analysis is often FAR more robust than all the advanced statistical techniques employed in such papers. It's why those conducting experiments still prefer a simple ANOVA, in which the means of different groups are compared to each other, to any other technique for investigating causality.

All that being said, their results do not match with the last century of U.S. stock market returns, which I've already addressed. The longer the time frame investigated, the smoother the total annualized return.

""Historical evidence suggests that longer investment horizons typically produce better results," says Oppenheimer's chief investment strategist Brian Belski. Belski's data show that while average annual returns since 1950 are quite similar regardless of how long you hold your stocks, the range of returns differs markedly. Short-term holding periods are far more volatile. In short, it's easier to hit home runs if you hold your stocks for, say, one year. But you also risk losing your shirt if the market tanks. In contrast, returns are smoothed out over longer periods."
http://usatoday30.usatoday.com/money/pe ... ting_n.htm

[NibbanaBanana]

It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time.

But you do know that it always has recovered, and in fairly short order if you're in the accumulation phase of life and are holding your nose while dollar-cost averaging through it.

I'd go so far as to say most investors early in life, while gainfully employed and plenty capable of adapting to adversity, give entirely too much credence to doomsday scenarios and essentially refuse to take a daily bet in which they're likely to win $2 and unlikely to lose $1.

Edited to add: I also feel that these worst-case scenarios aren't completely thought through. If, for example, the stock market went to zero and stayed there, it would mean the US government, which would surely do everything within its power to avert such a crisis, failed to do it... Which should open up the possibility of both treasury and corporate bonds defaulting. Not to mention currency issues, hyperinflation, etc. Having 70% of your wealth in bonds and cash is no defense against the apocalypse. Personally, I'd go through most of life in 100% stocks and keep a stockpile of bullets and water.

Have to agree. A stock represents a share in a company and a claim on a proportion of it's future earnings. Usually some of the earnings are paid back in dividends and the rest are left for management to reinvest in the business. It's ownership of a tangible business. If stocks lose the majority of their value and never recover then that would be a reflection of US businesses, the US economy, and the country in general. And my guess is that the bond market wouldn't be spared either. I don't know what would happen to stocks, or bonds for that matter, if we got into a shootin' war with China or Russia tomorrow and they got the upper hand. Not a nice prospect for either.

[willthrill81]

A couple of questions and observations:
1. OP, are you saying that an 80/20 portfolio is irrational or BSC (crazy)? I don't think so. I'm not saying that at all. I just don't think that it's likely to achieve its intended purpose for most investors.
2. Is 100/0 irrational or BSC? I don't think people are saying that. Several are saying almost exactly that.
3. OP, are you suggesting that risk tolerance is a step function? That is, that there are no gradations of risk tolerance where I might be comfortable with 80/20 and you might be comfortable with 100/0? Of course there are gradations to risk tolerance. And I've said that repeatedly in this thread. But I also know enough about concepts such as the "just meaningful difference" to know that small changes are highly unlikely to cause changes in human behavior. Granted, some humans are more sensitive to such changes, but many are not.
4. I will also observe that it should be the case that people with lower incomes closer to the poverty level should have lower risk tolerance. By the same tokens high income people can afford to have higher risk tolerance. This is because the cost of failure is lower - I'm just not going to be able to retire in style or leave my kids a enough money for their retirement.
5. OP, you need to be cautious about using the single 1925-2016 mean variance returns. I hope you're not expecting a 100% equity portfolio to return 10.1%. In a similar vein, by using that particular set of returns you're expecting stocks to outperform bonds by an annualized 4.7%. If we're going to analyze risk-reward of 100/0 vs 80/20, we should spend some time to make sure we're using reasonable expectations.I know that the future won't look exactly like the past, and my own projections going forward are significantly more conservative than 10.1%. But I view the likelihood of bonds beating stocks over the next 20 years as minimal.

[willthrill81]

It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time.

But you do know that it always has recovered, and in fairly short order if you're in the accumulation phase of life and are holding your nose while dollar-cost averaging through it.

I'd go so far as to say most investors early in life, while gainfully employed and plenty capable of adapting to adversity, give entirely too much credence to doomsday scenarios and essentially refuse to take a daily bet in which they're likely to win $2 and unlikely to lose $1.

Edited to add: I also feel that these worst-case scenarios aren't completely thought through. If, for example, the stock market went to zero and stayed there, it would mean the US government, which would surely do everything within its power to avert such a crisis, failed to do it... Which should open up the possibility of both treasury and corporate bonds defaulting. Not to mention currency issues, hyperinflation, etc. Having 70% of your wealth in bonds and cash is no defense against the apocalypse. Personally, I'd go through most of life in 100% stocks and keep a stockpile of bullets and water.

Have to agree. A stock represents a share in a company and a claim on a proportion of it's future earnings. Usually some of the earnings are paid back in dividends and the rest are left for management to reinvest in the business. It's ownership of a tangible business. If stocks lose the majority of their value and never recover then that would be a reflection of US businesses, the US economy, and the country in general. And my guess is that the bond market wouldn't be spared either. I don't know what would happen to stocks, or bonds for that matter, if we got into a shootin' war with China or Russia tomorrow and they got the upper hand. Not a nice prospect for either.

+1

[HomerJ]

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.

Oh well then you are safe... If it never happened in the past, it's impossible for it to happen in the future.

[HomerJ]

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.

No, you're not getting it... You apparently haven't lived through a bear market yet.

You don't get to "know" that the market is "only" going to drop 50%.

In 2008-2009, I was 65/35 stocks/bonds... We had $500,000 in stocks, $250,000 in bonds. The stock portion dropped nearly 50%, and our portfolio lost $250,000.. which represented about 6-7 years of savings at the time. As far as we could tell, the Great Depression II was around the corner (and it fact, it could have happened that way), and we were looking at a 80% drop.

Since we still owed $200,000 on the house, and our jobs were not secure, that $250,000 in bonds had a huge impact on keeping us from panicing.

I know you're young, and you're sure your nerves are made of steel.. Go 100% stocks... It's very likely to pay off very well for you. But you'll probably make enough to retire early even if you do stick some bonds in there, and it might be easier on the heart.

[HomerJ]

I'm prepared and preparing for contingencies apart from my retirement fund.

That's why I'm working to pay off my mortgage in roughly 3.5 years. We have a good emergency fund.

Oh, okay, so you're not 100% stocks.

One part of your money is 100% stocks, and another part of your money is not.

And if you put it all together, we might find that you are 90/10, 80/20 or even 70/30... After all, the equity in your house is not in stocks. Shouldn't it be? Over 30 years, you'll likely do better with all that mortgage money in stocks instead of in your house. But you choose to play it safe there, because it gives you security to know, with the house paid off, that your bills are much lower, and you can survive a job loss or bad economic times.

So you're just like many of us after all.

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.

Oh, your original post asked why anyone would be less than 100% stocks... But I see you DO understand why some of us might be... Because we're closer to retirement... Sure, if you have 20-30 years, go ahead and be 100% stocks.

If equities drop, I'll do my invest to increase my savings rate even more.

Just FYI, the odds of you losing your job are HIGHER during a general economic recession. So stocks dropping at the same time you lose the ability to save more (or at all) are two events that are somewhat correlated.

[HomerJ]

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!

That's market timing, not rebalancing. And it rarely works. How do you know when "market prices are high"?

Many people have tried to quantify this and failed.

Better to just to pick an asset allocation you can live with for years and years no matter what the market does.

[Valuethinker]

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?

Bear markets tend to last more than 1 year. In the case of the 1930s, despite rallies, it lasted the decade (I am counting the 1938 crash in the same crash as the 1929 one-- I think for most equity investors that was a realistic call).

Of course then there's Japan, where it has lasted 25 years plus.

Sitting around for a 2nd or 3rd year watching your wealth tick away is *not* pleasant. Remembering 2000-2002 (it actually bottomed in March 2003) I can tell you this.

The additional gain to returns from the last 20% in equities is surprisingly small. And you lose the chance to rebalance into a bear market.

[nps]

All that being said, their results do not match with the last century of U.S. stock market returns, which I've already addressed. The longer the time frame investigated, the smoother the total annualized return.

Again, that's not what volatility means, at least as applied to your actual returns. If you buy and hold an index fund for 30 years, do you believe that you have more certainty of its balance at the end of the 30 years than you do after 5 years?

The Pastor and Stambaugh paper was eventually peer-reviewed, you can probably find it through your school or public library database. To address Nisi's comment on Siegel, turns out he wasn't a fan either:

https://www.nytimes.com/2009/03/29/your ... 9stra.html

[NibbanaBanana]

"It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time."

Isn't it also true that you could lose 50% of your bond value at any time and you do not know when and if it will recover? Just wondering.

NibbanaBanana,

No. And, that is the difference between bond and stock.

KlangFool

Interesting. I might be wrong, but it was my understanding that the global financial crisis that we just experienced was caused by worthless bonds. Or near worthless at least. Called mortgaged backed securities. Just bundles of worthless mortgages packaged together by banks and sold to satisfy the huge demand of bond investors. In this case the bond holders were bailed out by the taxpayers. Not sure if that will always be the case though. Might be wrong on this but that's my understanding.

[qwertyjazz]

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

I think we have to seperate out risk perception and risk tolerance, which you have helped me to see (thank you). I have trouble seeing how from a risk perception 80-100 percent stock allocation would make a difference. Risk tolerance is being debated on the thread (time horizon may be less than expected) and true risk (stocks may be risky over long term). But I think the OP point of risk perception not varying along a range may be true. Need, willingness and ability always seemed shallow to me and you recently helped me see why. If you lose 30 vs 40 percent and hear the news and talk to colleagues, the change in risk perception might not materially alter by that decision a decade earlier if having a few percent of bonds.

Thank you
QJ

[KlangFool]

"It is a very simple but hard concept to believe and understand. You could lose 50% of your stock value at any time and you do not know when and if it will recover. This does not change even over a long period of time."

Isn't it also true that you could lose 50% of your bond value at any time and you do not know when and if it will recover? Just wondering.

NibbanaBanana,

No. And, that is the difference between bond and stock.

KlangFool

Interesting. I might be wrong, but it was my understanding that the global financial crisis that we just experienced was caused by worthless bonds. Or near worthless at least. Called mortgaged backed securities. Just bundles of worthless mortgages packaged together by banks and sold to satisfy the huge demand of bond investors. In this case the bond holders were bailed out by the taxpayers. Not sure if that will always be the case though. Might be wrong on this but that's my understanding.

NibbanaBanana,

If you lose your job, would you stop paying your mortgage? You won't because if you do, you will lose your house.

If you own stock and the company is not making money, it may have to stop paying the dividend. But, the company cannot stop paying its bond unless it is bankrupted. So, if the company is not doing well, who is more likely to get paid: stock owner or bond holder? Who is taking more risk? The stock holders or the bond holders?

KlangFool

[KlangFool]

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

I think we have to seperate out risk perception and risk tolerance, which you have helped me to see (thank you). I have trouble seeing how from a risk perception 80-100 percent stock allocation would make a difference. Risk tolerance is being debated on the thread (time horizon may be less than expected) and true risk (stocks may be risky over long term). But I think the OP point of risk perception not varying along a range may be true. Need, willingness and ability always seemed shallow to me and you recently helped me see why. If you lose 30 vs 40 percent and hear the news and talk to colleagues, the change in risk perception might not materially alter by that decision a decade earlier if having a few percent of bonds.

Thank you
QJ

QJ,

My point which hopefully is understandable to some people is: regardless of the risk perception, risk tolerance (ability to take the risk) override risk perception.

Many people assume that they will be fully employed continuously for 30 to 40 years until retirement age. And, they can confidently know when they need to withdraw that money. That assumption is flawed. Hence, they may not have the time to recover from some downturn. So, the statement of 100% stock will do better over 30 years is meaningless since many of us do not know whether we have 30 years.

KlangFool