Larry Swedroe: Stocks, Bonds, & Risk

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Random Walker
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Larry Swedroe: Stocks, Bonds, & Risk

Post by Random Walker » Wed Jun 14, 2017 9:37 am

http://www.etf.com/sections/index-inves ... bonds-risk

This is an outstanding, short, very Bogleheadish article by Larry. He contrasts Siegel's "Stocks For The Long Run" with Bodie's view of TIPs as the truly riskless investment. While long term allocation to equities is most likely to maximize wealth in the long run, the dispersion of outcomes, including really bad ones, is also greatest. Stocks are risky no matter what the time frame. In 3 short pages, Larry reviews weaknesses in the "Stocks For Long Run" thesis, the importance of considering alternative histories, Pascal's wager, and of course ability, willingness, need to take risk.

Dave

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by elgob.bogle » Wed Jun 14, 2017 10:03 am

Thanks! Excellent article!

elgob

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nedsaid
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by nedsaid » Wed Jun 14, 2017 10:16 am

This is an important issue, particularly for people like me who are getting closer and closer to retirement. I will be turning 58 years old pretty soon and my portfolio is still rather stock heavy. Right now, I am 2/3 stocks and 1/3 bonds and cash in my retirement portfolio. I keep asking myself the question when I should get more serious about de-risking my portfolio. I started my program of mild rebalancing in July 2013 and now I am almost five years into the program. My stocks have been reduced a bit, from 69% stocks to 67% stocks during that time, in addition to the rebalancing. My guess is that if I had done nothing that I would be up to 75% stocks now.

I have been giving this issue a whole lot of thought and I am still not sure exactly what my correct allocation should be. Vanguard's 2025 fund has 64.59% stocks right now so I am not far from what Vanguard recommends.
A fool and his money are good for business.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Random Walker » Wed Jun 14, 2017 12:05 pm

Nedsaid,
You and I are in very similar situations. I'm 54 years old, was 80/20 for many years, and started derisking about 2 years ago. But hurts a bit to just go to big dose Bonds. FWIW, I have actually done a combination of derisking and changing the risks I'm exposed to. I initially started increasing % bonds and then, as new uncorrelated products became available with higher expected returns I started adding them. I am currently 47% equities, 20% alternatives, 33% bonds. The 20% alternatives include AQR Style Premia, AQR Managed Futures, Stone Ridge Alternative Lending, Stone Ridge Reinsurance, Stone Ridge Variance Risk Premium.

Dave

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by nedsaid » Wed Jun 14, 2017 12:32 pm

Random Walker wrote:Nedsaid,
You and I are in very similar situations. I'm 54 years old, was 80/20 for many years, and started derisking about 2 years ago. But hurts a bit to just go to big dose Bonds. FWIW, I have actually done a combination of derisking and changing the risks I'm exposed to. I initially started increasing % bonds and then, as new uncorrelated products became available with higher expected returns I started adding them. I am currently 47% equities, 20% alternatives, 33% bonds. The 20% alternatives include AQR Style Premia, AQR Managed Futures, Stone Ridge Alternative Lending, Stone Ridge Reinsurance, Stone Ridge Variance Risk Premium.

Dave
Dave, you definitely are following Larry Swedroe's recommendations. Wish he was still posting.

How are you getting access to AQR and Stone Ridge products? If you don't want to publicly post, you
can PM me. Edit: I do remember that you said you were working through an advisor.
A fool and his money are good for business.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by carolinaman » Wed Jun 14, 2017 12:43 pm

This article makes me think of the statement "If you have already won the game why keep playing?" Some people have high equity allocation through their working careers and have achieved a lot of success with their investments. As they reach retirement they tend to forget that it may not always work out with a high equity allocation.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by garlandwhizzer » Wed Jun 14, 2017 1:23 pm

carolinaman wrote:
This article makes me think of the statement "If you have already won the game why keep playing?" Some people have high equity allocation through their working careers and have achieved a lot of success with their investments. As they reach retirement they tend to forget that it may not always work out with a high equity allocation.
I plead guilty. I am 70 and have been retired for 20 years. Still I am 2/3 equity and 1/3 bonds which is for me a high bond allocation, gradually increasing in recent years. It is very hard for me to load up on an asset like bonds in today's environment where expected real returns are about zero over the next decade. I realize that my heavy equity exposure is probably irrational at this point in my life. However, I keep reminding myself that without having taken on considerable investment risk throughout my career I might not be retired today. Early in a multi-decade investing life, risk taking pays off in the long run. Habits become established and are difficult to break.

I also remind myself that for those of us who are healthy at age 70 like me, there is a real chance that I will live well into my 90s and/or that unexpected events in the future might require considerably more cash than anticipated. Loading up heavily on fixed income unless it offers inflation indexed returns poses its own risks over long time horizons if progressive inflation takes hold which, granted, no one expects at present. To take inflation our of the picture you can use a a TIPS ladder, but it currently produces a guaranteed negative real yield which is hard for me to swallow with a large percentage of my portfolio. What I'm saying is that for many of us there is no risk free answer to meet the future needs of retirement. Instead, there is a need to balance risks: the stock risk of equity disaster against the bond risk of running out of money due to increased longevity and/or unexpected expenses in the long future ahead. Where that balance is set varies according to the individual: his psychological makeup, his financial circumstances, and his long term goals.

Garland Whizzer

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Day9 » Wed Jun 14, 2017 1:53 pm

Paraphrasing Mr Swedroe: A retired couple's portfolio went from $12 million to $2 million after the 2000 tech bubble burst (They were 100% invested in high-flying tech stocks). When he asked them if their life would be much better if it instead had doubled to $24 million, the husband shrugged and said "No, I guess not". The wife punched the husband in the shoulder and said "I told you so!"

I doubt anyone who reads this forum would make a mistake of this magnitude but it is still a valuable lesson. In situations like this, the consequences of the possible outcomes dominate the probabilities of the outcomes.
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by htdrag11 » Wed Jun 14, 2017 2:09 pm

Timely article. I'm also highly leveraged. Last year my tax bracket had crept up, so I'm in the process of both rebalancing and reduced my tax inefficient funds to more efficient ones in my cash account.

DW was right in punching her husband. We don't need any more since we have already won the game in our situation. My target is still 66 & 34, 8n case of high inflation.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Sammy_M » Wed Jun 14, 2017 2:17 pm

Great article, consistent with Larry's teachings on this forum. I don't think Bodie is against equity investing. He merely suggests that an investor build a TIPS/I-Bonds foundation sufficient to "get by" for the duration of one's life expectancy before investing in risky assets. Practically, I think this is challenging to do for younger investors because it is difficult to accumulate assets without taking risk. But people nearing or in retirement should seriously consider that approach.
Last edited by Sammy_M on Wed Jun 14, 2017 2:19 pm, edited 1 time in total.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Random Walker » Wed Jun 14, 2017 2:17 pm

I remember Bob Brinker long ago commenting that a 50/50 portfolio would make 80% of the gains that a 100% equity portfolio makes. I think this fits perfectly with my posts on volatility drag / portfolio efficiency.

Dave

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by clcarter » Wed Jun 14, 2017 2:23 pm

Great Article

Thanks

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by herpfinance » Wed Jun 14, 2017 3:13 pm

Clear, concise, and straight to the point.
The lesson from Pascal’s wager is that the consequences of decisions should dominate the probabilities of outcomes, no matter your estimate of the odds. That is why the prudent strategy for investors who have reached the point where their marginal utility of incremental potential wealth is low is to dominate their portfolios with high-quality fixed-income assets. There are some risks that are just not worth taking.
If you've already won, why keep playing?
"The intelligent investor is a realist who sells to optimists and buys from pessimists" - Benjamin Graham

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by hoops777 » Wed Jun 14, 2017 4:39 pm

It all comes down to how much you have and how much you really actually need to live the way you want.A lot of posters are keeping their high equity into retirement.I am betting what they do not tell you,the amount of money they have,makes
it a moot point.If you have 5 million and need 50 K a year from your investments at age 70,does it matter?The more money you have the more risk you can take without losing any sleep.
If you are in a position that you need stocks to perform well,that is very stressful on many levels and not something I want any part of if I can avoid it.An 8 year bull market combined with everything going on in the world......Pessimism or realism in the year 2017?Place your bets.
K.I.S.S........so easy to say so difficult to do.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Artsdoctor » Wed Jun 14, 2017 7:00 pm

This is where Larry's expertise comes into play.

We are all, mostly, sharing personal experiences that are based on individual experiences. That's fair, and it's very real for each of us.

However, he's managing a lot of people's financial lives. It's not anecdotal. He has been around the block for decades and has been privy to hundreds of families' financial turns over many years. Fortunately, he combines not just professional experience but personal finance data as well. When someone like that says something, I tend to listen.

Nothing could be sadder than someone who has amassed more than enough to live comfortably and then has lost most of it (required for necessities, no less) for no really good reason. I hope there's not a single Boglehead that experiences such a loss. I know that Larry has seen it happen, so it's definitely out there.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Jagman » Wed Jun 14, 2017 7:23 pm

To manage risk,the idea that bond allocation should increase with age makes sense. Bonds equal age minus 20 is the advice I follow. Under that formula, a 60-year old at or near retirement would have 60% stocks, 40% bonds.

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Taylor Larimore
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Probabilities and Consequences

Post by Taylor Larimore » Wed Jun 14, 2017 7:56 pm

Bogleheads:

Larry Swedrow makes an important point: Investors should consider both probabilities and consequences.

I have a simple solution which has worked for me: Money I cannot afford to lose is in safe-fixed income -- the rest is in stock mutual funds.

I sleep like a baby.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Peter Foley » Wed Jun 14, 2017 8:07 pm

Garland

If you made it through the last recession without selling while stocks were down, I think your AA is just fine!

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by knpstr » Wed Jun 14, 2017 8:13 pm

Random Walker wrote:I remember Bob Brinker long ago commenting that a 50/50 portfolio would make 80% of the gains that a 100% equity portfolio makes. I think this fits perfectly with my posts on volatility drag / portfolio efficiency.
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Roguejim » Wed Jun 14, 2017 8:22 pm

Does Larry still do financial planning, privately?

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Miriam2 » Wed Jun 14, 2017 8:38 pm

Random Walker,
Just want to thank you :happy for posting Larry's articles in his absence :(

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by TD2626 » Wed Jun 14, 2017 8:48 pm

Very interesting article. Larry Swedroe makes good points about the importance of understanding risk.

I liked the part about alternative histories. People's decisions should be judged based on how reasonable their decision was when they made it based on information available at that time. If someone made a huge bet on a micocap individual stock, they were stupidly taking on excessive uncompensated risk. They make a dumb decision regardless of if the stock soars or tanks - that is pure chance. This framework can comfort those who make sound Boglehead decisions that don't play out, though. Evaluate investing by what you did with avaliable information, not by results that happened by chance. (Particularly bad results are generally the consequence of particularly bad decisions, though.)

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Re: Probabilities and Consequences

Post by FIREchief » Wed Jun 14, 2017 10:51 pm

Taylor Larimore wrote:Bogleheads:

Larry Swedrow makes an important point: Investors should consider both probabilities and consequences.

I have a simple solution which has worked for me: Money I cannot afford to lose is in safe-fixed income -- the rest is in stock mutual funds.

I sleep like a baby.

Best wishes.
Taylor
I think Taylor said as much or more than Larry in a lot fewer words. :beer

(he also didn't have to mention academic research, professors or anything else along those lines that generally cause me to lose interest)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Probabilities and Consequences

Post by randomizer » Wed Jun 14, 2017 11:38 pm

Taylor Larimore wrote:Bogleheads:

Larry Swedrow makes an important point: Investors should consider both probabilities and consequences.

I have a simple solution which has worked for me: Money I cannot afford to lose is in safe-fixed income -- the rest is in stock mutual funds.

I sleep like a baby.

Best wishes.
Taylor
And William Bernstein makes a similar case.
87.5:12.5, EM tilt — HODL the course!

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by AlohaJoe » Thu Jun 15, 2017 12:11 am

I think that Bodie (and Swedroe) make the mistake of only counting one kind of black swan: financial black swans. They're in the news all the time. They are easy to count, the data is readily available, and it fits into nice mathematical models. So, sure, if the only black swans in the world are financial ones, you should protect against them.

But they're not.

Say your grand daughter suddenly has $50,000 in legal expenses. Or your son's house is destroyed in a hurricane -- and needs your help paying for reconstruction. Or your daughter's husband suddenly dies and it turns out they were underinsured.

You can say you've stopped "playing the game" but that doesn't mean the game has stopped. Life keeps going on. Things happen. By definition personal black swans aren't predictable.

So given that there are black swans of both kinds -- personal and financial -- what should an individual investor do?

When we look at real world retirees and their real world spending we see that they understand this. They know that they don't know what their "needs" are...and that needs can change overnight. That's why portfolios almost always grow in retirement -- which is exactly the opposite of what Bodie and his lifecycle theory says should happen. The only actual hedge against black swans is to have lots of money and hope it is enough to pay for whatever black swan happens to hit you.

But obviously tilting all the way in that direction isn't smart either.

Swedroe's formula -- ability, willingness, and need -- sounds appealing but in reality no one knows their willingness (and it changes over time and we only know it in retrospect) or their actual need. Solving a single equation with two unknowns is decidedly tricky.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by FIREchief » Thu Jun 15, 2017 12:18 am

Excellent post AlohaJoe. I couldn't agree more. You've introduced the very important variable of thinking about the needs of others in this process. That obviously causes "problems" for many of the popular approaches.
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by herpfinance » Thu Jun 15, 2017 4:44 am

Random Walker wrote:I remember Bob Brinker long ago commenting that a 50/50 portfolio would make 80% of the gains that a 100% equity portfolio makes. I think this fits perfectly with my posts on volatility drag / portfolio efficiency.

Dave
Unless he was implying on a CAGR-basis, that seems highly questionable to me.

Do you have a source?
"The intelligent investor is a realist who sells to optimists and buys from pessimists" - Benjamin Graham

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by AlohaJoe » Thu Jun 15, 2017 5:16 am

herpfinance wrote:
Random Walker wrote:I remember Bob Brinker long ago commenting that a 50/50 portfolio would make 80% of the gains that a 100% equity portfolio makes. I think this fits perfectly with my posts on volatility drag / portfolio efficiency.

Dave
Unless he was implying on a CAGR-basis, that seems highly questionable to me.

Do you have a source?
Seems like a reasonable enough claim.

An 80/20 portfolio would have gotten 5.9% real CAGR from 1871-2016. A 50/50 portfolio would have gotten 4.7%.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by herpfinance » Thu Jun 15, 2017 5:20 am

AlohaJoe wrote:
herpfinance wrote:
Random Walker wrote:I remember Bob Brinker long ago commenting that a 50/50 portfolio would make 80% of the gains that a 100% equity portfolio makes. I think this fits perfectly with my posts on volatility drag / portfolio efficiency.

Dave
Unless he was implying on a CAGR-basis, that seems highly questionable to me.

Do you have a source?
Seems like a reasonable enough claim.

An 80/20 portfolio would have gotten 5.9% real CAGR from 1871-2016. A 50/50 portfolio would have gotten 4.7%.
Exactly, it depends on how you define "gains". From Random Walker's post, I inferred that a total return perspective was what was implied, but that cannot be so.
"The intelligent investor is a realist who sells to optimists and buys from pessimists" - Benjamin Graham

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by AlohaJoe » Thu Jun 15, 2017 5:31 am

herpfinance wrote:
AlohaJoe wrote:
herpfinance wrote:
Random Walker wrote:I remember Bob Brinker long ago commenting that a 50/50 portfolio would make 80% of the gains that a 100% equity portfolio makes. I think this fits perfectly with my posts on volatility drag / portfolio efficiency.

Dave
Unless he was implying on a CAGR-basis, that seems highly questionable to me.

Do you have a source?
Seems like a reasonable enough claim.

An 80/20 portfolio would have gotten 5.9% real CAGR from 1871-2016. A 50/50 portfolio would have gotten 4.7%.
Exactly, it depends on how you define "gains". From Random Walker's post, I inferred that a total return perspective was what was implied, but that cannot be so.
Ah, I see what you mean. Yes, that "80% of CAGR" adds up over the years. It is the difference between $1 turning into $700 and $1 turning into $3,000. You certainly don't end up with a portfolio that is 80% the size; you end up with one that is 25% of the size.

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Re: Probabilities and Consequences

Post by magneto » Thu Jun 15, 2017 5:53 am

Taylor Larimore wrote:Bogleheads:
..........
I have a simple solution which has worked for me: Money I cannot afford to lose is in safe-fixed income -- the rest is in stock mutual funds.

I sleep like a baby.

Best wishes.
Taylor

Thanks Taylor for this good advice and the insights in previous posts telling us about the Larimore family financial troubles 1929 on. Those reminiscences certainly struck home with this investor.

What troubles a little in Larry's excellent article is the 'elephant in the room'. Valuations :!:
When actively contributing, Larry did confirm at least on one occasion, the view that Valuations impacted on Expected Returns.

The article is worth taking on board by the 100% Stockers :!:
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Random Walker » Thu Jun 15, 2017 7:55 am

A big point of the article was the issue of alternative histories. Siegel's book and data is based on one sample, the U.S over one long 200 year period. Larry comments that the earlier data is perhaps sketchy and we really only have a good US sample of perhaps 90 years. The U.S. is the winner. I believe most other countries have not had the same stock market success. Larry frequently asks us to think about stocks for the long run from the point of view of a Japanese investor. I think that is an excellent mind experiment. Also, Rick Ferri used to use the 1973-74 bear market mind experiment as a tool to determine one's AA.

Dave

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by nova1968 » Thu Jun 15, 2017 8:27 am

Good article that reemphasizes reducing holdings in equities as retirement approaches. I am currently 64% equity, 33% bonds and 3% cash at age 55 and 1 year from retirement. At the end of the year I will reallocate to 60/40 and 50/50 at age 60. Not sure about the alternatives funds ,although it is an option for some to consider. I prefer to keep it simple and stick to the 3 fund portfolio of U.S equities, international and bond funds with a 10% tilt towards small cap.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by gilgamesh » Thu Jun 15, 2017 8:54 am

Loved the article as my plan calls for derisking with TIPS, but I am also interested in this paragraph...anyone else want to chime in on this?

"And the bear market of 2008 demonstrated that even 40 years may not be a sufficient horizon to be sure stocks would outperform bonds. From 1969 through 2008, the S&P 500 Index returned 8.98%, barely outperforming the 8.92% return on 20-year Treasury bonds."

This is an issue if you invested everything you will ever invest in 1969 and then sold everything in 2008. No one does that....that's why risk ( standard deviation) increasing over time made no sense to me in terms of real life application. People in real life spend through a long period, risk being huge at one certain point in time (applicable to call options etc and thus their pricing structure) doesn't matter for an individual. Through a range in time, stocks will be less risky, no?

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Random Walker » Thu Jun 15, 2017 9:06 am

Nova1968,
Did you know that a 60/40 portfolio has about 85-90% of its risk on the equity side? I too am a huge fan of passive investing and adhering to a plan. That being said, I wonder if you might be better off during this critical period in your financial life customizing your AA glidepath a bit rather than dogmatically making changes at predetermined ages. Over time financial needs, wants, goals become much more clear. You can look at where you are with goals, past returns, future expected returns and sort of take risk off the table in an ongoing personalized fashion. I'm a huge fan of Monte Carlo Simulation for helping make these decisions.
I'm not far behind you. FWIW, I'm 54 and have been taking some risk off the table (based on MCS projections) for the last two years. I'm currently 47% equities.

Dave

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Random Walker » Thu Jun 15, 2017 9:12 am

Gilgamesh,
That statement got my attention as well. I certainly think it is true that the longer the holding period, the more likely a positive outcome and the greater expected terminal wealth. But the dispersion of outcomes is way bigger! Moreover, we all tend to anchor on where we are now or what the maximal value of our portfolio was at a given point in time. From that perspective, stocks are always risky. At any point in time they can drop 50% in a year. Since we only look forward from where we are at now, from that perspective stocks are always risky no matter what the timeframe.

Dave

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by gilgamesh » Thu Jun 15, 2017 10:21 am

Random Walker wrote:Gilgamesh,
That statement got my attention as well. I certainly think it is true that the longer the holding period, the more likely a positive outcome and the greater expected terminal wealth. But the dispersion of outcomes is way bigger! Moreover, we all tend to anchor on where we are now or what the maximal value of our portfolio was at a given point in time. From that perspective, stocks are always risky. At any point in time they can drop 50% in a year. Since we only look forward from where we are at now, from that perspective stocks are always risky no matter what the timeframe.

Dave
Dave...thanks for responding, but I just noticed there's another thread active on this topic. So, don't want to get this thread take a wrong angle, but have to say this... I agree with everything you've mentioned except what I've bolded above.

I know standard deviation increases over time, yet intuitively that doesn't jive well with me. Over the long term, the expected upside is so great, there has to be a point where even a 50% decline will not bring it down beyond a certain point as compared to the starting balance and a rate of return to that date. So, the downside dispersion should minimize over time.

Say a $1 in bonds grew to $30, but at the same time the $1 in stocks grew to $90, even a 50% drop will bring it down to only $45, still higher than the bond return. I think this difference will exaggerate over time and thus limit the downward dispersion.

This is just my intuition, mathematically I could be wrong.

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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by dbr » Thu Jun 15, 2017 11:09 am

gilgamesh wrote:
Random Walker wrote:Gilgamesh,
That statement got my attention as well. I certainly think it is true that the longer the holding period, the more likely a positive outcome and the greater expected terminal wealth. But the dispersion of outcomes is way bigger! Moreover, we all tend to anchor on where we are now or what the maximal value of our portfolio was at a given point in time. From that perspective, stocks are always risky. At any point in time they can drop 50% in a year. Since we only look forward from where we are at now, from that perspective stocks are always risky no matter what the timeframe.

Dave
Dave...thanks for responding, but I just noticed there's another thread active on this topic. So, don't want to get this thread take a wrong angle, but have to say this... I agree with everything you've mentioned except what I've bolded above.

I know standard deviation increases over time, yet intuitively that doesn't jive well with me. Over the long term, the expected upside is so great, there has to be a point where even a 50% decline will not bring it down beyond a certain point as compared to the starting balance and a rate of return to that date. So, the downside dispersion should minimize over time.

Say a $1 in bonds grew to $30, but at the same time the $1 in stocks grew to $90, even a 50% drop will bring it down to only $45, still higher than the bond return. I think this difference will exaggerate over time and thus limit the downward dispersion.

This is just my intuition, mathematically I could be wrong.
It is not intuition. It is fact. What is going on here is that you can't get a helpful answer until you ask the right question. There is more to the behavior of investments than what is the standard deviation of returns. If you know how or can find the right article you can get results to answer whatever question you think you are interested in.

Note this does not mean the academic definition of risk as volatility specificially measured as standard deviation of annual returns is to be discarded. That data is used to derive the other results. In other words long term behavior is the compounded result of short term behavior.

Your last sentence above illustrates asking the right question, namely if I want $45, which is the investment to be in. However, your statement about the dispersion may not be correct. The stock investment could fall anywhere between $45 and $450 (making up a kind of illustration of worst and best outcomes) so the dispersion is not reduced unless by that you meant the fraction of the outcome below some lower bound -- and that is indeed reduced if that lower bound is below the result of the expected return.

Random Walker
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Random Walker » Thu Jun 15, 2017 12:30 pm

Dbr,
You and I are in agreement. I'm just pointing out that as years progress, the investor will anchor on his current investment value or maximum value, and that could drop at any time. In the present, the investor is not thinking about where he started. Rather, he is thinking about where he currently is. If he turns $500 into $1mil over 3 decades, if he then loses 50% he's not gonna be happy! He'll be thinking way more about turning 1mil into 500K than $500 into 1mil.

Dave

gilgamesh
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by gilgamesh » Thu Jun 15, 2017 12:35 pm

dbr wrote:
gilgamesh wrote:
Random Walker wrote:Gilgamesh,
That statement got my attention as well. I certainly think it is true that the longer the holding period, the more likely a positive outcome and the greater expected terminal wealth. But the dispersion of outcomes is way bigger! Moreover, we all tend to anchor on where we are now or what the maximal value of our portfolio was at a given point in time. From that perspective, stocks are always risky. At any point in time they can drop 50% in a year. Since we only look forward from where we are at now, from that perspective stocks are always risky no matter what the timeframe.

Dave
Dave...thanks for responding, but I just noticed there's another thread active on this topic. So, don't want to get this thread take a wrong angle, but have to say this... I agree with everything you've mentioned except what I've bolded above.

I know standard deviation increases over time, yet intuitively that doesn't jive well with me. Over the long term, the expected upside is so great, there has to be a point where even a 50% decline will not bring it down beyond a certain point as compared to the starting balance and a rate of return to that date. So, the downside dispersion should minimize over time.

Say a $1 in bonds grew to $30, but at the same time the $1 in stocks grew to $90, even a 50% drop will bring it down to only $45, still higher than the bond return. I think this difference will exaggerate over time and thus limit the downward dispersion.

This is just my intuition, mathematically I could be wrong.
It is not intuition. It is fact. What is going on here is that you can't get a helpful answer until you ask the right question. There is more to the behavior of investments than what is the standard deviation of returns. If you know how or can find the right article you can get results to answer whatever question you think you are interested in.

Note this does not mean the academic definition of risk as volatility specificially measured as standard deviation of annual returns is to be discarded. That data is used to derive the other results. In other words long term behavior is the compounded result of short term behavior.

Your last sentence above illustrates asking the right question, namely if I want $45, which is the investment to be in. However, your statement about the dispersion may not be correct. The stock investment could fall anywhere between $45 and $450 (making up a kind of illustration of worst and best outcomes) so the dispersion is not reduced unless by that you meant the fraction of the outcome below some lower bound -- and that is indeed reduced if that lower bound is below the result of the expected return.
Dispersion definitely increases over time, like your $45-$450 tries to convey. I don't think anyone will question that.

I am indeed talking about a predetermined lower bound, and this lower bound is not necessarily expected stock return, it's expected stock return minus equity risk premium, or in other words expected bond return. I am saying the longer the time, stock returns will have a dispersion where the lower bound of stock return dispersion will be higher and higher than the expected bond return.

gilgamesh
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by gilgamesh » Thu Jun 15, 2017 1:01 pm

Random Walker wrote:Dbr,
You and I are in agreement. I'm just pointing out that as years progress, the investor will anchor on his current investment value or maximum value, and that could drop at any time. In the present, the investor is not thinking about where he started. Rather, he is thinking about where he currently is. If he turns $500 into $1mil over 3 decades, if he then loses 50% he's not gonna be happy! He'll be thinking way more about turning 1mil into 500K than $500 into 1mil.

Dave
Doesn't this sentence in the article apply in this case?

"The need to take risk is based on the rate of return necessary to achieve your financial goals as well as your marginal utility of wealth."

'Better equity return in the long term' resets instantaneously, it has no memory. If today you have $1M, it doesn't matter it took you 30 years to get there, the clock starts again. You will have a better return starting now, if you keep it long term.

Yes, this investor could lose 50% tomorrow, and that is not long term...his Investement horizon of the $1mil is not 30 years plus 1 day, it was just one day. If he is equity heavy with $1M and 100% equity, he better have long term starting today. The essence of utility of wealth and Investement time horizon.

He may not be happy that his $1M went down to $500k, but he better have a long term horizon for it to recover. Otherwise he never gave equity the long term to perform better. He gave one day, that's not long term. He gave his $500 30 years plus 1 day, but only 1 day for his $1M

Hope this makes sense.

NibbanaBanana
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by NibbanaBanana » Thu Jun 15, 2017 1:18 pm

"That is why the prudent strategy for investors who have reached the point where their marginal utility of incremental potential wealth is low is to dominate their portfolios with high-quality fixed-income assets. There are some risks that are just not worth taking."

That is very true. But there is an implicit assumption underlying this whole article. And that is in his statement that over the past 40 years stocks and bonds have returned essentially identically. Great. I'll take as many bonds paying 8.5% as you have. Well, bonds are paying 230 now. And according to John Bogle, that's the best estimate of their long tern return.

For wealthy individuals, it doesn't really matter. But for the average person having enough trouble paying the bills and struggling to invest a few hundred dollars a month, a 230 bp return on their investment is probably not going to provide much in the end. I assume this is why Bogle has been upping his recommended stock allocation.

Seasonal
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Seasonal » Thu Jun 15, 2017 1:27 pm

It seems stocks have returned more than bonds over many time periods because they are riskier and need to have higher expected returns to attract investors. If stocks were a sure bet, then why would they need higher returns?

Put another way, stocks are priced with a risk premium. If risk means anything in this context, it's the possibility of doing much worse than the alternatives. There's no such thing as a free lunch, even if we really need one and have a high degree of discipline. Either that or the market is irrational, but it's rather dangerous to invest based on the belief we're more rational than the market.

dbr
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by dbr » Thu Jun 15, 2017 1:29 pm

NibbanaBanana wrote:"That is why the prudent strategy for investors who have reached the point where their marginal utility of incremental potential wealth is low is to dominate their portfolios with high-quality fixed-income assets. There are some risks that are just not worth taking."

That is very true. But there is an implicit assumption underlying this whole article. And that is in his statement that over the past 40 years stocks and bonds have returned essentially identically. Great. I'll take as many bonds paying 8.5% as you have. Well, bonds are paying 230 now. And according to John Bogle, that's the best estimate of their long tern return.

For wealthy individuals, it doesn't really matter. But for the average person having enough trouble paying the bills and struggling to invest a few hundred dollars a month, a 230 bp return on their investment is probably not going to provide much in the end. I assume this is why Bogle has been upping his recommended stock allocation.
If you are withdrawing money from your portfolio to live on then you need to do a withdrawal model analysis. The short answer is that for moderate withdrawal rates and long times not enough in stocks leads to a high rate of running out of money too soon. Not enough in stocks might be less than 30%-40%. That problem might be even worse right now as one is starting at such low returns for bonds.

I don't know where Bogle is upping his recommended stock allocation. The only recommendation I have ever heard from him is age in bonds with SS as a bond.

NibbanaBanana
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by NibbanaBanana » Thu Jun 15, 2017 1:43 pm

dbr wrote:
NibbanaBanana wrote:"That is why the prudent strategy for investors who have reached the point where their marginal utility of incremental potential wealth is low is to dominate their portfolios with high-quality fixed-income assets. There are some risks that are just not worth taking."

That is very true. But there is an implicit assumption underlying this whole article. And that is in his statement that over the past 40 years stocks and bonds have returned essentially identically. Great. I'll take as many bonds paying 8.5% as you have. Well, bonds are paying 230 now. And according to John Bogle, that's the best estimate of their long tern return.

For wealthy individuals, it doesn't really matter. But for the average person having enough trouble paying the bills and struggling to invest a few hundred dollars a month, a 230 bp return on their investment is probably not going to provide much in the end. I assume this is why Bogle has been upping his recommended stock allocation.
If you are withdrawing money from your portfolio to live on then you need to do a withdrawal model analysis. The short answer is that for moderate withdrawal rates and long times not enough in stocks leads to a high rate of running out of money too soon. Not enough in stocks might be less than 30%-40%. That problem might be even worse right now as one is starting at such low returns for bonds.

I don't know where Bogle is upping his recommended stock allocation. The only recommendation I have ever heard from him is age in bonds with SS as a bond.
I think it was in a MS interview. I really can't remember the details though. I'd have to go back. Maybe I'm thinking of what he said in "Bogle on Mutual Funds". Nothing about counting SS there. I can say that Vanguard says that the traditional 50/50 allocation for retirement may not be appropriate any more due to the very low rates. I am 90% equity now and would love to have more bonds. But I am very afraid that 230 bp is going to be a high probability of failure if that's all the return I get.

am
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by am » Thu Jun 15, 2017 4:20 pm

So what is the take away or actionable point?

Stock market can crash at any time and stay down for lengthy time periods.

Early accumulator- jump up for joy and keep investing

Mid accumulator- ? Adjust allocation for this possibility

Near retirement and retirement- enough cash/fixed income to support desired years of spending or amount in equities = % tolerable losses?

Or just ignore this possibility and hope for the best? Keep working if it happens.

hoops777
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by hoops777 » Thu Jun 15, 2017 4:36 pm

June 2017 is probably one of the worst times to retire in recent memory.Stocks at an all time high with so many global issues and fixed income at pretty much an all time low.Of course I just retired :D An almost impossible situation for so many.Pick your poison.
K.I.S.S........so easy to say so difficult to do.

am
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by am » Thu Jun 15, 2017 4:44 pm

hoops777 wrote:June 2017 is probably one of the worst times to retire in recent memory.Stocks at an all time high with so many global issues and fixed income at pretty much an all time low.Of course I just retired :D An almost impossible situation for so many.Pick your poison.

Stock market is often trading at/near highs. Markets always disappointing. Either too high, going sideways or dropping :) Guess that is why we are told to stay the course.

hoops777
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by hoops777 » Thu Jun 15, 2017 5:17 pm

Honestly do not remember a situation like this with all due respect.
K.I.S.S........so easy to say so difficult to do.

Case59
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Re: Larry Swedroe: Stocks, Bonds, & Risk

Post by Case59 » Thu Jun 15, 2017 5:38 pm

NibbanaBanana wrote:"That is why the prudent strategy for investors who have reached the point where their marginal utility of incremental potential wealth is low is to dominate their portfolios with high-quality fixed-income assets. There are some risks that are just not worth taking."

That is very true. But there is an implicit assumption underlying this whole article. And that is in his statement that over the past 40 years stocks and bonds have returned essentially identically. Great. I'll take as many bonds paying 8.5% as you have. Well, bonds are paying 230 now. And according to John Bogle, that's the best estimate of their long tern return.

For wealthy individuals, it doesn't really matter. But for the average person having enough trouble paying the bills and struggling to invest a few hundred dollars a month, a 230 bp return on their investment is probably not going to provide much in the end. I assume this is why Bogle has been upping his recommended stock allocation.
This is the point I keep stumbling over when I read articles like Larry's (whose articles I enjoy, btw, always find thought-provoking, and I was very sad when he left the forum.) I'm retired at 64, roughly 70/30 stock index funds/bond funds, living on about 3-3.5% withdrawal rate. No pension. There are good genes in my family, and I'm looking at maybe a 30-40 year horizon. According to Firecalc, portfoliocharts.com, the early retirement guide, and so on I'm in good shape. Perhaps even I've "won the game." But if I were to start shifting my portfolio to large doses of TIPS and other "safe" low-return vehicles, the failure rate skyrockets.

See, for example, viewtopic.php?f=10&t=221225&newpost=3409781 How can you have a reasonable withdrawal when the return on a 30 year is 1%, before inflation?

(As an aside, I also don't see how you plan with TIPS, since you don't know what the full payment will be year to year.)

Pretty much everything I know (or think I know) about retirement investing I've learned from this forum over the last few years, so I posing this as a question, not as a challenge. Is what I've posted above a sensible way to evaluate all this, or am I missing something big time?

Thanks
Last edited by Case59 on Thu Jun 15, 2017 6:14 pm, edited 1 time in total.
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