The Mathematics of Retirement Investing

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Devil's Advocate
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Re: The Mathematics of Retirement Investing

Post by Devil's Advocate » Sat Aug 12, 2017 10:33 pm

At what time then would you suggest adding bonds North Texas Cajun?

DA

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tadamsmar
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Re: The Mathematics of Retirement Investing

Post by tadamsmar » Sun Aug 13, 2017 4:39 am

willthrill81 wrote:
Sat Aug 12, 2017 7:04 pm
tadamsmar wrote:
Sat Aug 12, 2017 6:37 pm
willthrill81 wrote:
Sat Aug 12, 2017 5:45 pm
tadamsmar wrote:
Sat Aug 12, 2017 5:41 pm
financialengines.com, a Monte Carlo analysis available for free to Vanguard clients, includes mean reversion.
A few MC simulations do include mean reversion, but this is a relatively new development. Most MC simulations, such as those typically used by financial advisers, do not include this important feature.

I would be interested to see how the predictions of this new analysis compare to the historic record.
A new development? Financial Engines has been around for 21 years.
I wonder why, then, most MC simulations don't incorporate this feature.
Because most MC simulations are not created by a Nobel Laureate. Just a guess. Not everyone has the time, knowledge, ability, backing to do it.

Financial Engines is proprietary, it's not available for all firms to use.

North Texas Cajun
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Re: The Mathematics of Retirement Investing

Post by North Texas Cajun » Sun Aug 13, 2017 5:45 am

Devil's Advocate wrote:
Sat Aug 12, 2017 10:33 pm
At what time then would you suggest adding bonds North Texas Cajun?

DA
Ten years before retirement. Bonds can be purchased with new savings if markets are temporarily down at that point. At some point in the last ten years of the accumulation period, markets will be up, and existing savings can be converted.

How much to convert? I think that depends on how much non-discretionary spending must be funded from the portfolio over the first ten years of retirement.

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1210sda
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Re: The Mathematics of Retirement Investing

Post by 1210sda » Sun Aug 13, 2017 7:24 am

.....

longinvest
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Re: The Mathematics of Retirement Investing

Post by longinvest » Sun Aug 13, 2017 8:05 am

North Texas Cajun wrote:
Sun Aug 13, 2017 5:45 am
Devil's Advocate wrote:
Sat Aug 12, 2017 10:33 pm
At what time then would you suggest adding bonds North Texas Cajun?

DA
Ten years before retirement. Bonds can be purchased with new savings if markets are temporarily down at that point. At some point in the last ten years of the accumulation period, markets will be up, and existing savings can be converted.

How much to convert? I think that depends on how much non-discretionary spending must be funded from the portfolio over the first ten years of retirement.
I see. At least, there's some consistency in proposing mental accounting methods: big(?) cash emergency fund during accumulation, bucket system during retirement.
:oops:
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

North Texas Cajun
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Re: The Mathematics of Retirement Investing

Post by North Texas Cajun » Sun Aug 13, 2017 8:37 am

longinvest wrote:
Sun Aug 13, 2017 8:05 am
North Texas Cajun wrote:
Sun Aug 13, 2017 5:45 am
Devil's Advocate wrote:
Sat Aug 12, 2017 10:33 pm
At what time then would you suggest adding bonds North Texas Cajun?

DA
Ten years before retirement. Bonds can be purchased with new savings if markets are temporarily down at that point. At some point in the last ten years of the accumulation period, markets will be up, and existing savings can be converted.

How much to convert? I think that depends on how much non-discretionary spending must be funded from the portfolio over the first ten years of retirement.
I see. At least, there's some consistency in proposing mental accounting methods: big(?) cash emergency fund during accumulation, bucket system during retirement.
:oops:
I never advocated a large emergency fund during the accumulation period. I think the size of such a fund is highly dependent on one's personal situation. For example, the risk of losing one's job is far more severe for a household with a housewife and children. For a childless, two-earner family, not so large. The size of an emergency fund might also vary by the quality and amount of insurance one has avilable.

In the earliest years of accumulation, the emergency fund would represent a higher portion of a household's total assets. In the middle of accumulation, probably not so much. That differs from what you seem to be proposing, in that you argued, I think, that 40% of one's assets should always be in bonds and thus available for emergencies.

I think there is a practical reason for almost all retirement savers to keep their emergency funds separate from retirement savings. In the U.S., retirement savings are primarily held in tax deferred or tax-avoidance accounts of one sort or another (401K, SEP, IRA, Roth IRA). I think all have restrictions for use and at least one is not easily accessible at most companies.

With respect to mental buckets in retirement: I think almost all planners encourage retirees to think about how they will be spending or passing on their nest eggs. The plans about spending - and the timing of that spending - should be the most important factor in determining asset allocation at each point of a planned retirement. You can refer to such planning as "mental accounting" if you wish.

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willthrill81
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Re: The Mathematics of Retirement Investing

Post by willthrill81 » Sun Aug 13, 2017 10:23 am

North Texas Cajun wrote:
Sun Aug 13, 2017 8:37 am
longinvest wrote:
Sun Aug 13, 2017 8:05 am
North Texas Cajun wrote:
Sun Aug 13, 2017 5:45 am
Devil's Advocate wrote:
Sat Aug 12, 2017 10:33 pm
At what time then would you suggest adding bonds North Texas Cajun?

DA
Ten years before retirement. Bonds can be purchased with new savings if markets are temporarily down at that point. At some point in the last ten years of the accumulation period, markets will be up, and existing savings can be converted.

How much to convert? I think that depends on how much non-discretionary spending must be funded from the portfolio over the first ten years of retirement.
I see. At least, there's some consistency in proposing mental accounting methods: big(?) cash emergency fund during accumulation, bucket system during retirement.
:oops:
I never advocated a large emergency fund during the accumulation period. I think the size of such a fund is highly dependent on one's personal situation. For example, the risk of losing one's job is far more severe for a household with a housewife and children. For a childless, two-earner family, not so large. The size of an emergency fund might also vary by the quality and amount of insurance one has avilable.

In the earliest years of accumulation, the emergency fund would represent a higher portion of a household's total assets. In the middle of accumulation, probably not so much. That differs from what you seem to be proposing, in that you argued, I think, that 40% of one's assets should always be in bonds and thus available for emergencies.

I think there is a practical reason for almost all retirement savers to keep their emergency funds separate from retirement savings. In the U.S., retirement savings are primarily held in tax deferred or tax-avoidance accounts of one sort or another (401K, SEP, IRA, Roth IRA). I think all have restrictions for use and at least one is not easily accessible at most companies.

With respect to mental buckets in retirement: I think almost all planners encourage retirees to think about how they will be spending or passing on their nest eggs. The plans about spending - and the timing of that spending - should be the most important factor in determining asset allocation at each point of a planned retirement. You can refer to such planning as "mental accounting" if you wish.
+1

Draining a 401k or an tIRA in the U.S. should be a last-ditch effort for virtually everyone. An EF needs to be more accessible, though a Roth IRA is fine since contributions can be withdrawn with no penalty at any time.

I fail to see how a mental accounting approach like the 'bucket' method used by many Bogleheads is any less arbitrary than saying that 40%, an arbitrary number, should be held in bonds. As a percentage of one's assets, the EF should almost certainly be larger when one is young and smaller, or nonexistent, when one is older and/or FI.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

longinvest
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Re: The Mathematics of Retirement Investing

Post by longinvest » Sun Aug 13, 2017 10:58 am

I wrote the first post of this thread to show that the cost of using a diversified 60/40 stocks/bonds portfolio, instead of a concentrated 100% stocks portfolio, is small enough smaller than generally believed*. That it's approximately $150 per month for someone earning a $80,000 salary.

There are many ways to describe what I was trying to achieve. Some people would say that the $150/month is the cost of portfolio insurance. Others would say that a 60/40 portfolio increases the chances of reaching one's financial goals for a low cost.

One of the implicit assumption of my first post was that I was addressing Bogleheads; people who develop a workable plan and diversify their portfolio while avoiding to bear too much risk.

In other words, I was writing for people who primarily seek to reach their financial objectives.

Unfortunately, some people have a different goal. They primarily seek to maximize the probability of accumulating a bigger retirement portfolio, without considering the consequences of being unlucky. This is actually quite common on most internet forums other than the Bogleheads; there seems to be a badge of honor to holding a 100% stocks portfolio. In the view of these people, any less-aggressive portfolio is either for mentally-weak fearful people, or for retirees who need a minimal cushion for taking withdrawals (e.g. a 100% cash bucket fed from a 100% stocks bucket using arbitrary rules).

So far, we've had tens of posts by people talking past each other, on this thread, because they primarily seek different goals.

I think that it is a huge mistake to ignore the consequences of being unlucky.

Earlier in this thread, there were references to the writings of Prof. Jeremy Siegel. Both he and Prof. Zvi Bodie had Nobel Laureate prof. Paul Samuelson as Ph.D. mentor. Here's how Prof. Bodie defines risk:
In Risk Less and Prosper, Zvi Bodie wrote: A few proposed definitions of risk that commonly surface include: the unknown; the chance that something harmful may happen; uncertain outcomes that may cause loss; and uncertainty that arouses fear.

Let’s discard the idea that risk is nothing but the unknown, because risk is more than the ordinary uncertainty that surrounds our lives. By referring to harm, loss, and fear, the next three suggestions reflect one fundamental property of risk: Somebody has to care about the consequences if uncertainty is to be understood as risk.

The notion of “caring” or “mattering” is central. It captures both the potential (objective) impact of uncertainty as well as its (subjective) bite. This brings us close to the definition we’ll adopt: Investment risk is uncertainty that matters. There are two prongs to this definition—the uncertainty, and what matters about it—and both are significant.

So, beyond the odds of hitting a rough patch, there are the consequences of loss to consider.
This last sentence is crucial. A workable plan is a plan that works even when we are unlucky.

That's what most of the arguments in favor of a concentrated 100% stocks portfolio seem to be missing. They're downplaying the consequences of the portfolio failing because of the low probability of failure.

This mistake appears beyond the realm of asset allocation discussions. Retirement withdrawals are also subject to the same mistake of ignoring the consequences of failure. The prime example of this is the prevalence of discussions about the SWR (safe withdrawal rate) withdrawal method. Discussions center on choosing the right withdrawal rate: is it 4%, 3%, or even lower to maximize the success rate? What is ignored, in all these unending discussions, is the consequence of failure, which is total ruin!

A workable plan would never allow for such a consequence in case of bad luck. It would discard off-hand the choice of such a withdrawal method. It would opt, instead, for a method that leads to milder consequences in case of bad luck. Those who have read some of my other forum posts probably know that I am a big proponent of flexible portfolio withdrawals combined with stable lifelong non-portfolio income, during retirement; a plan which has no probability of total ruin.

In summary: This thread's first post was addressed to people primarily seeking to develop a workable plan, one which works (or has milder consequences) even when one is unlucky.

I invite those who obviously have different primary objectives to start their own threads to discuss various techniques for maximizing retirement portfolios. It should have been clear, while reading the first post, that maximizing the portfolio was not the objective.

There's simply no point to continue having people talk past each other in this thread.

* Modified at the suggestion of forum member #Cruncher.
Last edited by longinvest on Wed Aug 16, 2017 1:37 pm, edited 1 time in total.
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North Texas Cajun
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Re: The Mathematics of Retirement Investing

Post by North Texas Cajun » Sun Aug 13, 2017 11:32 am

longinvest wrote:I invite those who obviously have different primary objectives to start their own threads to discuss various techniques for maximizing retirement portfolios. It should have been clear, while reading the first post, that maximizing the portfolio was not the objective.
Well, longinvest, I think you pretty much invited people to comment about the relative risks of your proposal vs a 100% equity plan. This is, I think, from the second comment after your initial post:
longinvest wrote:Yet, it is important to look at the entire picture and not be mislead into taking reckless risk in our portfolios because someone somewhere shows a simplistic calculation where using a 100/0 stocks/bonds portfolio, $10,000 left to grow for 30 years results into almost 50% more than with a 60/40 portfolio (e.g. 1.069^30 / 1.055^30 - 1 = 48.5%). This is simply not a relevant calculation.
My reason for joining discussion on this thread: I disagreed with your characterization of a 100% equity portfolio as a "reckless risk". Does it matter whether we agree on the objectives of a retirement account which you set forth at the beginning? I think it was still appropriate for me to discuss your criticism of aggresive portfolios.
Last edited by North Texas Cajun on Mon Aug 14, 2017 3:25 am, edited 2 times in total.

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Re: The Mathematics of Retirement Investing

Post by North Texas Cajun » Sun Aug 13, 2017 12:06 pm

Deleted by author
Last edited by North Texas Cajun on Mon Aug 14, 2017 3:16 am, edited 4 times in total.

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#Cruncher
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Re: The Mathematics of Retirement Investing

Post by #Cruncher » Sun Aug 13, 2017 4:53 pm

longinvest wrote:
Fri Aug 11, 2017 11:33 pm
I really like the option you added in your spreadsheet to make the retirement spending something other than 100% of working spending. That can be particularly useful for people paying a mortgage during working years and retiring with a paid off house.
Your example of a mortgage made me realize that an absolute dollar amount might be more useful than a percentage. I've modified the spreadsheet from this post accordingly. Here's an example where the user specifies that retirement spending should be $10,000 less than salary less taxes:

Code: Select all

Row         Col A                                        Col B        Col C
---  -------------------------------                    ------       ------
  1  Years                                                  30
  2  Withdrawal rate                                        4%
  3  Salary                                             80,000
  4  Social Security                                    25,000
  5  Adjust working spending $ for retirement          (10,000)
  6  Retirement % of adjusted working spending            100%
  7  Base tax                                            5,226
  8  Plus marginal tax rate of                             25%
  9  On excess over                                     48,350
 10  Growth rate                                          6.9%          5.5%
 
 11  $1 grows to                                       92.7782       72.4355
 12  Withdrawal @ 4%                                    3.7111        2.8974
 13  Needed savings per year                             8,844        10,691
 14  Salary less savings                                71,156        69,309
 15  Tax                                                10,928        10,466
 16  Salary less savings less tax                       60,228        58,843  ($115 / mo difference)

 17  After 30 years savings grow to                    820,559       774,396
 18  Withdrawal @ 4%                                    32,822        30,976
 19  Plus Social Security                               57,822        55,976
 20  Tax                                                 7,594         7,133
 21  Withdrawal plus Social Security less tax           50,228        48,843
 
 22  Retirement $ versus working                       (10,000)      (10,000)
 23  Retirement percent of working                     83.396%       83.006%
Alternatively one might want to posit more spending in retirement; e.g., for travel or health related costs. I've kept the option to specify retirement spending as a percentage. If one uses both, the percentage is applied after the $ amount.

For those interested, here are the updated constants and formulas:
Select all, copy, and paste at cell A1:

Code: Select all

Years
Withdrawal rate
Salary
Social Security
Adjust working spending $ for retirement
Retirement % of adjusted working spending
Base tax
Plus marginal tax rate of
On excess over
Growth rate
$1 grows to
="Withdrawal @ "&TEXT(B2,"#0%")
Needed savings per year
Salary less savings
Tax
Salary less savings less tax
="After "&B1&" years savings grow to"
="Withdrawal @ "&TEXT(B2,"#0%")
Plus Social Security
Tax
Withdrawal plus Social Security less tax
Retirement $ versus working
Retirement percent of working
Select all, copy, and paste at cell B1:

Code: Select all

30
0.04
80000
25000
-10000
1
=10%*9325+15%*(37950-9325)
0.25
=37950+10400
0.069
=FV(B10,$B1,-1,0,0)
=$B2*B11
=($B6*($B3+$B5-$B7-$B8*($B3-$B9))-$B4+$B7+$B8*($B4-$B9))/(B12-$B8*B12+$B6*(1-$B8))
=$B3-B13
=$B7+$B8*(B14-$B9)
=B14-B15
=FV(B10,$B1,-B13,0,0)
=$B2*B17
=$B4+B18
=$B7+$B8*(B19-$B9)
=B19-B20
=B21-B16
=B21/B16
gilgamesh wrote:
Sat Aug 12, 2017 7:48 am
If only taxable account is left, ... this person would need to save 4.42% more of their monthly wages, correct?
gilgamesh wrote:
Sat Aug 12, 2017 10:41 am
Hopefully OP or #Cruncher with their prowess can come with a spreadsheet accounting for all this ...
I considered this, gilgamesh, but decided against it because it would be too complex, in my opinion. One of the nice things about longinvest's assumption that all savings are made into a tax deferred account is that taxes can be calculated -- without too much inaccuracy -- the same way during both working and retirement years. But assuming either all or some savings are made into a taxable account requires the following to be specified (you mentioned some in your post):
  • What is the yearly tax "drag". I.e., how much of income is taxed each year during the accumulation phase. Because of US tax law this in turn depends on how the savings are invested between stocks and bonds.
  • How much of the withdrawal from savings during retirement is subject to tax and at what rate.
  • How would the taxability of savings withdrawals change as the savings are drawn down.
  • If the taxable income during retirement is low enough, my assumption of tax equaling a fixed amount plus a percent of the excess over a fixed amount, might no longer be correct.
If you want to pursue this on your own, I suggest reading the thread, Is a Roth dollar worth 1.525 times a taxable dollar?; in particular this post by grabiner.

longinvest wrote:
Sun Aug 13, 2017 10:58 am
I wrote the first post of this thread to show that the cost of using a diversified 60/40 stocks/bonds portfolio, instead of a concentrated 100% stocks portfolio, is small enough. That it's approximately $150 per month for someone earning a $80,000 salary.
I agree, longinvest, that this imaginative way of looking at the cost of the more conservative portfolio should be the takeaway from your thread. Whether that cost is still too high is a question each investor needs to answer for himself. For me, it's not too high. I remember how my stomach churned during the stock market crash of 2008-2009. And that was with a 50:50 stock:bond allocation. I'd have probably developed ulcers if I'd been 100% stocks. :wink: But I understand that others' reactions might be different.

gilgamesh
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Re: The Mathematics of Retirement Investing

Post by gilgamesh » Sun Aug 13, 2017 5:45 pm

#Cruncher wrote:
Sun Aug 13, 2017 4:53 pm
gilgamesh wrote:
Sat Aug 12, 2017 7:48 am
If only taxable account is left, ... this person would need to save 4.42% more of their monthly wages, correct?
gilgamesh wrote:
Sat Aug 12, 2017 10:41 am
Hopefully OP or #Cruncher with their prowess can come with a spreadsheet accounting for all this ...
I considered this, gilgamesh, but decided against it because it would be too complex, in my opinion. One of the nice things about longinvest's assumption that all savings are made into a tax deferred account is that taxes can be calculated -- without too much inaccuracy -- the same way during both working and retirement years. But assuming either all or some savings are made into a taxable account requires the following to be specified (you mentioned some in your post):
  • What is the yearly tax "drag". I.e., how much of income is taxed each year during the accumulation phase. Because of US tax law this in turn depends on how the savings are invested between stocks and bonds.
  • How much of the withdrawal from savings during retirement is subject to tax and at what rate.
  • How would the taxability of savings withdrawals change as the savings are drawn down.
  • If the taxable income during retirement is low enough, my assumption of tax equaling a fixed amount plus a percent of the excess over a fixed amount, might no longer be correct.
If you want to pursue this on your own, I suggest reading the thread, Is a Roth dollar worth 1.525 times a taxable dollar?; in particular this post by grabiner.
Thank you for listing the factors to consider. Very much appreciate the extra reading as well, can't wait to learn more.

What if taxable is invested in ones own state's muni bonds and assume it's taxed as ordinary income upon retirement and knowing the excess savings needed each month (100% stocks vs 60% stocks) and assuming the same rate of return (5.5% real....dang! That's too much but may be ok as we are assuming it will be taxed as ordinary income) for the extra savings needed with 60% stock allocation, couldn't a formula figure how much of the withdrawal from taxable will be taxable.

I think these unrealistic assumptions should make the calculations feasible, However, such a calculation (assuming muni bond withdrawals are taxed as ordinary income plus a return of 5.5% real) is too far from truth and most likely will not be useful at all....oh well!


P.S: Just read the links you provided....decided to give up, lol.... I scratched out my idea on my initial post it self, after reading the links, I should have deleted them....anyhow, Ill just leave it there.

longinvest
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Re: The Mathematics of Retirement Investing

Post by longinvest » Sun Aug 13, 2017 9:45 pm

#Cruncher wrote:
Sun Aug 13, 2017 4:53 pm
longinvest wrote:
Fri Aug 11, 2017 11:33 pm
I really like the option you added in your spreadsheet to make the retirement spending something other than 100% of working spending. That can be particularly useful for people paying a mortgage during working years and retiring with a paid off house.
Your example of a mortgage made me realize that an absolute dollar amount might be more useful than a percentage. I've modified the spreadsheet from this post accordingly.
That's awesome!

I've fixed the link in the first post of this thread to point to this new version.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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Re: The Mathematics of Retirement Investing

Post by AlohaJoe » Mon Aug 14, 2017 7:12 am

#Cruncher wrote:
Sun Aug 13, 2017 4:53 pm
Whether that cost is still too high is a question each investor needs to answer for himself.
Agreed, there are many many kinds of risk and lots of people weigh those risks differently. Cutting expenses by 3.3% but investing in the higher growth portfolio means hitting the target portfolio size and retiring over 3 years earlier, right? According to life tables from the Social Security Administration, there is a 4% chance of dying while working those extra 3 years. Ironically, that's the nearly same of a "probability of failure" that many won't tolerate when looking at other aspects of their retirement planning :)

longinvest
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Re: The Mathematics of Retirement Investing

Post by longinvest » Mon Aug 14, 2017 9:01 am

AlohaJoe,
AlohaJoe wrote:
Mon Aug 14, 2017 7:12 am
#Cruncher wrote:
Sun Aug 13, 2017 4:53 pm
Whether that cost is still too high is a question each investor needs to answer for himself.
Agreed, there are many many kinds of risk and lots of people weigh those risks differently. Cutting expenses by 3.3% but investing in the higher growth portfolio means hitting the target portfolio size and retiring over 3 years earlier, right? According to life tables from the Social Security Administration, there is a 4% chance of dying while working those extra 3 years. Ironically, that's the nearly same of a "probability of failure" that many won't tolerate when looking at other aspects of their retirement planning :)
I took the time to write a long post, where I clearly explained the objectives of my first post, and where I also discussed Zvi Bodie's awesome definition of risk, the best definition I have ever seen. In particular, I took the time to illustrate how this definition could be transformed into actionable decisions.

Are there investors who could prudently invest into 140% stocks portfolios? Yes, they do exist. But, they're not the typical US family with a principal breadwinner earning an $80K salary.

I am aware that some members, around here, have above-median income. Please don't forget that median household income in the United States was $56,516 in 2015 (source: FRED). I write my posts primarily aiming for the majority of people.

Everywhere, on the internet and in the financial industry, we see young people pushed towards aggressive (or very-aggressive, when considering their use of leverage to buy residential real-estate) allocations, regardless of the risk (in the Zvi Bodie sense, not volatility).

This is actually very understandable, when one looks at the interests of those making the recommendation. Take a mutual-fund provider, for example. Even Vanguard is subject to market pressures; when it saw its competitors offer more aggressive target-retirement funds, it did the same, increasing the aggressiveness of its own target funds.

Did Vanguard act in self interest? I don't think so. Here's what I think Vanguard could have thought about it. (The following is pure speculation; I'm merely trying to illustrate the application of the concept of risk for different actors). Vanguard provides target-retirement funds for a lot of investors of different ages and different retirement horizons. It could think that it would best serve its customers by increasing the likelihood that most of them will have more money during retirement. An easy way to do so is to increase the stock allocation of its target funds at the beginning of their glide. While this might negatively impact some investors (those unlucky enough to end up in an unlucky specific-year target retirement fund), it will positively impact most investors (the much more numerous ones who were not in that unlucky target year).

From the individual's point of view, though, the perspective is not the same. The individual does not care about the fact that a majority of retirees will get an improved retirement, he cares about the fact that he could possibly end up, himself, with a much worse retirement, because of it.

Common wisdom, these days, argues for stock-heavy allocations for most investors, and against holding any bonds by young investors. The only small concession is for a small stash of cash (most often called an emergency fund). Even the most basic rational analysis of this common wisdom reveals its illogicality. Marketable financial securities don't exist in a void; they're traded on markets and are subject to the fundamental Law of Supply and Demand. If bonds are such awful investments, why don't their market prices drop? None of us is forced to buy these securities. So, if there is no buyer, because everyone listens to common wisdom, any bondholder wishing to sell a bond will have to lower its price until the price becomes irresistible and attracts a buyer, resulting in a higher yield to maturity thanks to mathematics. This applies to all bonds, including the safest of government bonds. It cannot be otherwise; this is how markets work.

I specifically wrote my first post in reaction to a post trying to convince readers, using a simplistic growth of a lump sum over 30 years example, that investing into a balanced 60/40 portfolio in young age would be foolish. Please go and check: follow the link from my first post to its original source, then the read the post just above it. I don't need to mention the countless other posts we see daily, in our forums, bashing bonds based on their historical returns.

You're free to fight my arguments to death, if you wish so. But, I would very much like to see people fight as forcefully all the simplistic and misleading arguments that steer young investors (and older ones) into taking way more risk than they realize.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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Re: The Mathematics of Retirement Investing

Post by #Cruncher » Mon Aug 14, 2017 11:30 pm

AlohaJoe wrote:
Mon Aug 14, 2017 7:12 am
Cutting expenses by 3.3% but investing in the higher growth portfolio means hitting the target portfolio size and retiring over 3 years earlier, right?
I think "over 3 years earlier" is optimistic, AlohaJoe. I estimate 1.3 years taking into consideration
  • If one retires earlier, one should have a larger accumulation to fund the same annual withdrawal. Somewhat arbitrarily I'll assume the 4% withdrawal would last 35 years. A 2% constant growth rate allows this to happen. (See the calculation below.) I'll use that 2% to calculate how much one needs to last 35 years plus the years one retires early.
  • To reduce sequence of returns risk, one should shift from the 100:0 (6.9%) to the 60:40 (5.5%) stock:bond portfolio some time before retirement. How long before is certainly open to debate. I'm choosing 10 years which is also what North Texas Cajun suggests in this post.
To review, as shown in this post, the annual savings using longinvest's procedure with the 60:40 portfolio is $14,112 per year. Growing at 5.5% for 30 years produces $1,022,202 which at 4% allows one to withdraw $40,888 per year upon retirement. The third row below shows how long one needs to invest that $14,112 at 6.9% (before slowing to 5.5% 10 years before retirement) in order to produce the same $40,888 annual income.

Code: Select all

Planned retirement years                      35
Necessary growth for 4% withdrawal       1.9996%  =RATE(35, 40888, -1022202, 0, 0)
Years with 100:0 portfolio               18.6925  [1]
Years with 60:40 portfolio               10.0000  [2]
Balance when shift to 60:40              507,356  =FV(6.9%, 18.6925, -14112,  0,      0)
Balance when retire                    1,048,334  =FV(5.5%, 10,      -14112, -507356, 0)
Annual withdrawal for 36.3075 years       40,888  =PMT(1.9996%, 35 + (30 - 28.6925), -1048334, 0, 0)
(Formulas above use the Excel RATE, FV, and PMT functions.) So, instead of retiring in 30 years, one can retire in 28.7 years (18.6925 + 10). One will then have accumulated $1,048,000. Investing this in a conservative portfolio growing at a constant 2% allows one to withdraw the same $40,900 per year as if one had invested in the 60:40 portfolio for 30 years.
  1. The 18.6925 years with the 100:0 portfolio is backed into using Excel's Goal Seek tool and forcing the annual withdrawal to be $40,888.
  2. For comparison, if one waits until five years before retirement before shifting to the 60:40 portfolio, one can retire in 28.1 years (23.1 + 5). If one shifts 15 years before retirement, one can retire in 29.2 years (14.2 + 15).

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Re: The Mathematics of Retirement Investing

Post by AlohaJoe » Mon Aug 14, 2017 11:58 pm

#Cruncher wrote:
Mon Aug 14, 2017 11:30 pm
I think "over 3 years earlier" is optimistic, AlohaJoe. [...]
[*]To reduce sequence of returns risk, one should shift from the 100:0 (6.9%) to the 60:40 (5.5%) stock:bond portfolio some time before retirement. How long before is certainly open to debate. I'm choosing 10 years which is also what North Texas Cajun suggests
The glide path is the entire cause of our different results. I agree that opinions vary (sometimes widely) about the usage of glide paths :happy

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Re: The Mathematics of Retirement Investing

Post by longinvest » Tue Aug 15, 2017 7:46 am

AlohaJoe wrote:
Mon Aug 14, 2017 11:58 pm
#Cruncher wrote:
Mon Aug 14, 2017 11:30 pm
I think "over 3 years earlier" is optimistic, AlohaJoe. [...]
[*]To reduce sequence of returns risk, one should shift from the 100:0 (6.9%) to the 60:40 (5.5%) stock:bond portfolio some time before retirement. How long before is certainly open to debate. I'm choosing 10 years which is also what North Texas Cajun suggests
The glide path is the entire cause of our different results. I agree that opinions vary (sometimes widely) about the usage of glide paths :happy
A glide won't protect an investor against unlucky Japan-like returns (with the crash happening just before the addition of bonds).

Let me repeat this again, as it seems to escape the discussion: my first post was about quantifying the cost of using a diversified 60/40 portfolio all along the accumulation period, instead of a more concentrated one. It wasn't about retiring earlier with a more aggressive allocation, increasing the risk of failing to reach one's objective, in the process.

  • Does anyone believe that 100% stocks investors generally retire earlier, in real life? For fun, let's look at an unfairly selected anecdote... On one side, we have our mentor, Jack Bogle, who reported, many times, using a balanced portfolio. He has been retired for a long time. On the other side, we have the most famous 100% stocks investor, Warren Buffett, who hasn't retired yet. :wink:


Maybe it escaped some readers, but my first post was not based on targeting a specific portfolio-size goal and retiring when reaching it. It was about planning to retire in a chosen horizon, and then selecting an appropriate savings rate to reach one's goal.

Personally, I find rather silly the concept of targeting a specific retirement portfolio size (such as $1,000,000) to retire. Market fluctuations are like the tides and waves of the see; a portfolio (especially a concentrated 100% stocks one) could reach a target just because of a bubble, like in 1929. I think that it is much more prudent to devise a retirement plan, save accordingly, and not let oneself be distracted by possibly temporary surges in value of one's portfolio.

In other words, a 60/40 investor targeting an earlier retirement should simply adjust his savings rate accordingly.
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Re: The Mathematics of Retirement Investing

Post by jbolden1517 » Tue Aug 15, 2017 8:57 am

longinvest wrote:
Mon Aug 14, 2017 9:01 am
Common wisdom, these days, argues for stock-heavy allocations for most investors, and against holding any bonds by young investors. The only small concession is for a small stash of cash (most often called an emergency fund). Even the most basic rational analysis of this common wisdom reveals its illogicality. Marketable financial securities don't exist in a void; they're traded on markets and are subject to the fundamental Law of Supply and Demand. If bonds are such awful investments, why don't their market prices drop? None of us is forced to buy these securities. So, if there is no buyer, because everyone listens to common wisdom, any bondholder wishing to sell a bond will have to lower its price until the price becomes irresistible and attracts a buyer, resulting in a higher yield to maturity thanks to mathematics. This applies to all bonds, including the safest of government bonds. It cannot be otherwise; this is how markets work.
I'd say this is another example of your tendency to think of the entire market of consisting of mutual fund investors with similar risk profiles. An investment can be quite awful for an unleveraged mutual fund investor and quite good when held under different conditions. Someone, who can borrow at bank interest rates, like say a bank, might get tremendous returns from holding 1 year treasuries by leveraging up 20::1. That doesn't make them a good investment at 1::1 leverage. The futures market is often the best example of this. There are quite a few futures trading at billions of dollars per year which have negative expected returns year after year after year. Their buyers are people who hold exactly the opposite corresponding risk. They get bought because their investors can substantially decrease their risk profile in exchange for holding those futures.

What you get paid for in investing is taking on various risks. Everyone has risks that correlate with their life. For those risks they might very well want to pay to offset them. For other risks that don't correlate build a basket of different types of risks that don't correlate with each other and take them on. Young mutual fund investors have little leverage in their retirement accounts and an incredibly long investment horizon. Both of which are not true of the average corporation. They are perfectly positioned to offset some investment risks and be compensated for it.

In retirement accounts young investors don't have enough margin available to them to take on a lot of bond risk (some specific vehicles excluded which do allow for this). They can however easily do so indirectly by overweighting various financials stocks. If good quality bonds are a good investment, that seems like the best way for them to do it. If high quality government bonds are good why hold $10k in bonds directly when you can get most of the return from $100k in bonds by investing in them indirectly? Conversely high yield bonds, very long duration bonds (like strips), EM bond those do have the potential for the kinds of returns that young investors with a long term horizon can benefit from because they aren't priced for investors to hold on lots of leverage.

A bad 60/40 portfolio holds up a lot better than a bad 100/0 portfolio. So in general for most TSM type investors I'd agree with you on bonds. But that's not because bonds are a particularly good investment right now but rather because any kind of diversification away from TSM is going to boost returns.

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Re: The Mathematics of Retirement Investing

Post by willthrill81 » Tue Aug 15, 2017 10:36 am

longinvest wrote:
Tue Aug 15, 2017 7:46 am
AlohaJoe wrote:
Mon Aug 14, 2017 11:58 pm
#Cruncher wrote:
Mon Aug 14, 2017 11:30 pm
I think "over 3 years earlier" is optimistic, AlohaJoe. [...]
[*]To reduce sequence of returns risk, one should shift from the 100:0 (6.9%) to the 60:40 (5.5%) stock:bond portfolio some time before retirement. How long before is certainly open to debate. I'm choosing 10 years which is also what North Texas Cajun suggests
The glide path is the entire cause of our different results. I agree that opinions vary (sometimes widely) about the usage of glide paths :happy
A glide won't protect an investor against unlucky Japan-like returns (with the crash happening just before the addition of bonds).
Such an investor would have not even begun their glidepath yet, so saying that it couldn't protect them in such an instance is rather obvious. Pretty much the entire reason for glidepaths is to reduce the risk of a poor sequence of returns, both leading up to the point of retirement and for the first decade or so after it.
longinvest wrote:
Tue Aug 15, 2017 7:46 am
Personally, I find rather silly the concept of targeting a specific retirement portfolio size (such as $1,000,000) to retire. Market fluctuations are like the tides and waves of the see; a portfolio (especially a concentrated 100% stocks one) could reach a target just because of a bubble, like in 1929. I think that it is much more prudent to devise a retirement plan, save accordingly, and not let oneself be distracted by possibly temporary surges in value of one's portfolio.
That's Boglehead advice 101 and with good reason. How can I possibly know what my goal is without at least an approximate target portfolio size?

To your point about temporary fluctuations, there are a couple of things to be said. First, market fluctuations are the price we pay for returns higher than CDs and the like. Even bonds are subject to them. Second, to quote William Bernstein, "If you've won the game, stop playing." When a 100% stock investor (or any very aggressive AA) has reached her needed portfolio size, she should strongly consider changing her AA to something more balanced, at least for the first decade or so of her retirement to address the sequence of returns risk referred to above. What the factors are that led up to her achieving that portfolio, such as a 'bubble', are largley irrelevant to her.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: The Mathematics of Retirement Investing

Post by Admiral » Tue Aug 15, 2017 12:39 pm

Very interesting thread and analysis, longinvest!

One of the age-old problems this thread addresses is this: investing cannot be separated from human nature and human emotions. Humans are wired to be much more risk averse than risk taking...all the psychological research shows that the pain of losses is much worse than the pleasure from gains.

Even if one strongly believes in the theoretical idea that a 100/0 portfolio will outperform a 60/40 (or 70/30, or whatever) portfolio over decades, for most investors (perhaps not Bogleheads) it becomes emotionally impossible to stay the course when faced with steep losses. Knowing this, most investors are willing to trade some (theoretical) added gain for more security (both financial and emotional). It seems a reasonable tradeoff. Life isn't just about money or dying with the biggest portfolio. We still need to be able to function day to day.

Sure, there do seem to be investors and posters on this thread who stand by their 100 percent equity AA and won't change their views. But what longinvest has shown (very well) is that the delta between high volatility (and thus presumably increased emotional stress) and lower volatility (and less stress) is in fact not very large, when one crunches the numbers.

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Re: The Mathematics of Retirement Investing

Post by willthrill81 » Tue Aug 15, 2017 1:32 pm

Admiral wrote:
Tue Aug 15, 2017 12:39 pm
Even if one strongly believes in the theoretical idea that a 100/0 portfolio will outperform a 60/40 (or 70/30, or whatever) portfolio over decades, for most investors (perhaps not Bogleheads) it becomes emotionally impossible to stay the course when faced with steep losses.
It's not theoretical, it's a historical fact. Now whether that will continue into the future is unknown, but I've not heard anyone in this thread or otherwise provide a sound theoretical argument for the premium in returns of stocks over bonds to suddenly change in the near future.
Admiral wrote:
Tue Aug 15, 2017 12:39 pm
Knowing this, most investors are willing to trade some (theoretical) added gain for more security (both financial and emotional). It seems a reasonable tradeoff. Life isn't just about money or dying with the biggest portfolio. We still need to be able to function day to day.

Sure, there do seem to be investors and posters on this thread who stand by their 100 percent equity AA and won't change their views. But what longinvest has shown (very well) is that the delta between high volatility (and thus presumably increased emotional stress) and lower volatility (and less stress) is in fact not very large, when one crunches the numbers.
I don't think that a 100% allocation to stocks is appropriate for most investors, but that doesn't mean that it's inappropriate for all investors. For those with a long investment horizon and who don't mind volatility (what difference should it really make to me if I don't need the money for 20-30 years?), it's historically provided higher returns than 'balanced' portfolios over the long-term.

And I wouldn't call a 1.4% difference in returns (historic difference between 100/0 & 60/40 according to Vanguard) over decades a small difference.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

simple man
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Re: The Mathematics of Retirement Investing

Post by simple man » Tue Aug 15, 2017 5:04 pm

As I say in my line of work, predictions of risk are based on probabilities. The actual result is binary. That is when it is determined if you are brilliant or a fool.

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Re: The Mathematics of Retirement Investing

Post by Admiral » Tue Aug 15, 2017 5:47 pm

willthrill81 wrote:
Tue Aug 15, 2017 1:32 pm
Admiral wrote:
Tue Aug 15, 2017 12:39 pm
Even if one strongly believes in the theoretical idea that a 100/0 portfolio will outperform a 60/40 (or 70/30, or whatever) portfolio over decades, for most investors (perhaps not Bogleheads) it becomes emotionally impossible to stay the course when faced with steep losses.
It's not theoretical, it's a historical fact. Now whether that will continue into the future is unknown, but I've not heard anyone in this thread or otherwise provide a sound theoretical argument for the premium in returns of stocks over bonds to suddenly change in the near future.
Admiral wrote:
Tue Aug 15, 2017 12:39 pm
Knowing this, most investors are willing to trade some (theoretical) added gain for more security (both financial and emotional). It seems a reasonable tradeoff. Life isn't just about money or dying with the biggest portfolio. We still need to be able to function day to day.

Sure, there do seem to be investors and posters on this thread who stand by their 100 percent equity AA and won't change their views. But what longinvest has shown (very well) is that the delta between high volatility (and thus presumably increased emotional stress) and lower volatility (and less stress) is in fact not very large, when one crunches the numbers.
I don't think that a 100% allocation to stocks is appropriate for most investors, but that doesn't mean that it's inappropriate for all investors. For those with a long investment horizon and who don't mind volatility (what difference should it really make to me if I don't need the money for 20-30 years?), it's historically provided higher returns than 'balanced' portfolios over the long-term.

And I wouldn't call a 1.4% difference in returns (historic difference between 100/0 & 60/40 according to Vanguard) over decades a small difference.
You are wrong: it is theoretical, because you're assuming the future will be like the past. Since nobody's time horizon for investing is infinite, much of your 30 years of gains over a more balanced portfolio could be wiped out in an instant with a huge market decline. i.e. bad luck. As longinvest noted, we only have one life, not 1,000 tries at this.

But, that aside, I did not say that a 100% stock allocation was inappropriate, for anyone, or appropriate, for anyone. What I did say is that one cannot separate human nature and human emotions from investing. If you are an investor who has no issues with high volatility and can sleep well with a 100/0 allocation, then that's fine. You know yourself. What I am suggesting is that I don't believe (which means this is my opinion) the vast majority of investors are like you. They are fearful. They sell at the worst possible time. Then they miss the recovery because they are fearful.

Therefore--and to longinvest's point--if a small change in expenses or investments can get them to the same retirement portfolio size with less volatility, angst, and worry, then that strikes me as a reasonable tradeoff. Nobody is here to convince you, only to present other views. I have read your posts and know that your portfolio was fairly small in 2008. You benefitted from a very quick market recovery, which (IMO) has influenced your investing style. You may think that "it doesn't make a difference because I won't need the money for 20-30 years" but guess what...life throws you curveballs all the time.

All I can tell you is that others who were older and had more in the market learned a valuable lesson about asset allocation and volatility, and about their own emotions and appetite for risk. Yes, markets recover. But not always quickly.

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Nearing_Destination
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Re: The Mathematics of Retirement Investing

Post by Nearing_Destination » Tue Aug 15, 2017 6:16 pm

In reading this thread, those that suggest 100% equities I sort of liken to those that might suggest that there is no need for insurance-- the likelihood of payoff over the long haul is negative. However, I've seen those that have suffered losses due to fire, tornadoes, etc and the consequences for the few that didn't have insurance was quite serious.
I posit that the lack of bonds is not dissimilar -- especially if one needed the funds in, say early 2001 or 2008, when the values of those equity positions were at their lower range. I knew those who lost their jobs while their portfolio also cratered-- much better to have a source of funds in the portfolio that doesn't drop as significantly during market turbulence.

While I was in accumulation (starting in the '80's including the '87 crash) I was largely 80-20 or 75-25 , then adjusting to 55-45 or 50-50, and now 45-45-10 in retirement (prior to SS). ( I expect upward adjustment to 55-45 or 50-50 after SS). For me, the lower variability helped-- but we had such a higher savings rate toward the end we probably would have succeeded in either case.
(We also were in a higher earnings, and tax bracket, than the case illustrated)

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Re: The Mathematics of Retirement Investing

Post by North Texas Cajun » Tue Aug 15, 2017 6:19 pm

Admiral wrote:
Tue Aug 15, 2017 5:47 pm
But, that aside, I did not say that a 100% stock allocation was inappropriate, for anyone, or appropriate, for anyone. What I did say is that one cannot separate human nature and human emotions from investing. If you are an investor who has no issues with high volatility and can sleep well with a 100/0 allocation, then that's fine. You know yourself. What I am suggesting is that I don't believe (which means this is my opinion) the vast majority of investors are like you. They are fearful. They sell at the worst possible time. Then they miss the recovery because they are fearful.

Therefore--and to longinvest's point--if a small change in expenses or investments can get them to the same retirement portfolio size with less volatility, angst, and worry, then that strikes me as a reasonable tradeoff. Nobody is here to convince you, only to present other views. I have read your posts and know that your portfolio was fairly small in 2008. You benefitted from a very quick market recovery, which (IMO) has influenced your investing style. You may think that "it doesn't make a difference because I won't need the money for 20-30 years" but guess what...life throws you curveballs all the time.

All I can tell you is that others who were older and had more in the market learned a valuable lesson about asset allocation and volatility, and about their own emotions and appetite for risk. Yes, markets recover. But not always quickly.
Well, Admiral, I was one of the "older" ones in 2008. I'm 66 now. My retirement portfolio was 100% equities from 1983 to 2013. I'm not counting an emergency fund which grew from 0 to 12 months income over that period, so maybe my choices were not as reckless as longinvest describes a 100% portfolio.

For what it's worth, I know of even older investors who were 100% or near 100% equities in 2008 and did not panic. They learned a different lesson than you did.

History is on the side of willthrill81 and me. As Jeremy Siegel has pointed out, no investor holding a 100% equity portfolio of the broad U.S. market would have been washed out with a buy and hold strategy over the past 200 years. Even those who retired in 2009 would still have been OK - unless they spent their entire portfolio in 24 months. Of course, no one that I have read suggests holding a 100% equity portfolio right up to the day they retire. 100% equity portfolios are appropriate for the first two decades of accumulation.

You can argue all you wish that there is no guarantee that the 200 year long term success of the US equity markets is guaranteed for the future. I believe that all that history is more relevant than the assumptions which are built into Monte Carlo models.

IMO, the reason more investors did not hold onto their equities after 2008 was their acceptance of the argument that "this time it's different". They certainly had support from a lot of gloom and doom prophets.

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Re: The Mathematics of Retirement Investing

Post by Admiral » Tue Aug 15, 2017 6:34 pm

North Texas Cajun wrote:
Tue Aug 15, 2017 6:19 pm

Well, Admiral, I was one of the "older" ones in 2008. I'm 66 now. My retirement portfolio was 100% equities from 1983 to 2013. I'm not counting an emergency fund which grew from 0 to 12 months income over that period, so maybe my choices were not as reckless as longinvest describes a 100% portfolio.
North Texas Cajun,

That's fortunate...for you, and your small sample size. As I noted, I was speaking of the larger pool of average Joe investors who are perhaps not quite so sanguine in the face of massive market losses. Those are the kinds of investors who can benefit from decreased volatility. And, again, I would point out that this was a quick recovery and not a Japan-style lost decade.

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Re: The Mathematics of Retirement Investing

Post by North Texas Cajun » Tue Aug 15, 2017 7:13 pm

Admiral wrote:
Tue Aug 15, 2017 6:34 pm
North Texas Cajun wrote:
Tue Aug 15, 2017 6:19 pm

Well, Admiral, I was one of the "older" ones in 2008. I'm 66 now. My retirement portfolio was 100% equities from 1983 to 2013. I'm not counting an emergency fund which grew from 0 to 12 months income over that period, so maybe my choices were not as reckless as longinvest describes a 100% portfolio.
North Texas Cajun,

That's fortunate...for you, and your small sample size. As I noted, I was speaking of the larger pool of average Joe investors who are perhaps not quite so sanguine in the face of massive market losses. Those are the kinds of investors who can benefit from decreased volatility. And, again, I would point out that this was a quick recovery and not a Japan-style lost decade.
I have no problem with people having different opinions and different levels of risk aversion. The only reason I joined this thread was because I disagree greatly when someone describes a 100% equity portfolio as "reckless". It is not reckless to have a different view about whether U.S. historical returns are relevant, to have a different view about whether one should sacrifice great upside potential for what some believe is certainty, to have a dissenting opinion about the value of Monte Carlo simulations.

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Re: The Mathematics of Retirement Investing

Post by jbolden1517 » Tue Aug 15, 2017 7:15 pm

North Texas Cajun wrote:
Tue Aug 15, 2017 6:19 pm
IMO, the reason more investors did not hold onto their equities after 2008 was their acceptance of the argument that "this time it's different". They certainly had support from a lot of gloom and doom prophets.
FWIW retail investors not only held they bought in 2008 as they did in 2001. The people who sold in 2008 were leveraged institutional investors who were selling stocks they believed to be undervalued because they desperately needed money right now and the credit markets were locked up.

There is this weird myth of retail selling. Many retail investors after 2008 shifted to a more conservative asset allocation but to a large degree they did what they were supposed to, they held through the worst of it, captured some gains on the upside and then adjusted after the recovery.

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Re: The Mathematics of Retirement Investing

Post by longinvest » Wed Aug 16, 2017 12:33 am

North Texas Cajun wrote:
Tue Aug 15, 2017 7:13 pm
The only reason I joined this thread was because I disagree greatly when someone describes a 100% equity portfolio as "reckless". It is not reckless to have a different view about whether U.S. historical returns are relevant, to have a different view about whether one should sacrifice great upside potential for what some believe is certainty, to have a dissenting opinion about the value of Monte Carlo simulations.
This is a misrepresentation of what I wrote and what I meant. Here's what I wrote:
longinvest wrote:
Fri Aug 11, 2017 3:11 pm
Yet, it is important to look at the entire picture and not be mislead into taking reckless risk in our portfolios because someone somewhere shows a simplistic calculation [... followed by an example of misleading simplistic calculation...]
I meant exactly what I wrote: One should not let oneself be mislead into taking reckless risk based on a misleading simplistic calculation.

I then provided an example of misleading simplistic calculation which fit the situation of the first post's example which was about someone starting his retirement savings on the late, at age 35, and retiring at age 65 on a $80K salary. It was left to the reader to imagine reasons why this person started saving and investing no earlier than 35; possibly he had student loans to payback, a house downpayment to make, medical bills, or some early-life financial misfortune.

One could see this as a generalization of all kinds of near-median income situations. Sometimes people start saving earlier, only to hit a period of unemployment. Anyway, the example was clearly of a saving period of only 30 years, with no assumption of paid-off house on the side, or family able to provide financial support in case of hardship.

So, did I mean that nobody could prudently select a 100% stocks portfolio? I never wrote that. At least, I never meant that. I thought that I had already made that clear at least twice, earlier in this thread. Yet, I'm repeating it here, just so that it's clear:

Some people can prudently select a 100% stocks portfolio. But, too often, people are mislead into taking more risk than they realize.

Is that clear enough?

While repeating things, let me also repeat a wish I expressed earlier in this thread:

I would very much like to see people fight, as forcefully as they fought my posts, all the simplistic and misleading arguments that steer young investors (and older ones) into taking way more risk than they realize.

Really! Don't make an exception for me; if I have to clarify my statements, so that they don't mislead others, that's all for the better. But, please, don't stop with me; look at other posts and fight, when they mislead readers.

Misleading and simplistic statements are being made, in our forums, to drive investors away from balanced index portfolios. As an example of this, it might be useful to know I did not write my first post in a void; I wrote it specifically to fight false and misleading claims made in another thread. Let me cite the exact post in question:
jbolden1517 wrote:
Fri Aug 11, 2017 12:21 pm
The difference between 10.1% and 8.7% over 30 years is 51%. That's a lot of extra savings the 60/40 investor has to do over their lifetime.
My first post shows that the "51%" figure is false and that the "a lot of extra savings the 60/40 investor has to do over their lifetime" statement is misleading; it is more relevant to consider that one only needs to reduce spending by 3.3% representing $153/month on an $80K salary.

I reiterate my invitation to those who wish to discuss 100% stocks portfolios to start their own threads. The topic of this thread is about the cost of using a balanced portfolio.
Last edited by longinvest on Wed Aug 16, 2017 7:54 am, edited 12 times in total.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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Re: The Mathematics of Retirement Investing

Post by jbolden1517 » Wed Aug 16, 2017 6:35 am

longinvest wrote:
Wed Aug 16, 2017 12:33 am
jbolden1517 wrote:
Fri Aug 11, 2017 12:21 pm
The difference between 10.1% and 8.7% over 30 years is 51%. That's a lot of extra savings the 60/40 investor has to do over their lifetime. And that number would be a lot worse without rebalancing.
My first post shows that the "51%" figure is false and that the "a lot of extra savings the 60/40 investor has to do over their lifetime" statement is misleading; it is more relevant to consider that one only needs to reduce spending by 3.3% representing $153/month on an $80K salary. Finally, the "worse with rebalancing" statement is also false; 8.7% is the historical average compound growth rate of a rebalanced 60/40 portfolio (source: Vanguard).

So, can we move back to the topic of this thread, which is about the cost of using a balanced portfolio?
First off I said without rebalancing not with. "With rebalancing" was in the quote above before you went off on your rant.

Second, you didn't show anything of the sort. You had the same 51%, you just threw out a lot of extra unnecessary numbers to obscure the fact.
If future annual returns in the upcoming 30 years were exactly 6.9% real for a 100% stocks portfolio, and 5.5% real for a 60/40 stocks/bond portfolio

1.069^30 = 7.4
1.055^30 = 4.9
The same 51%. That's not false. It can't be false: ((a/x)/(b/x))^c = a^c/b^c. I have no idea why you add unnecessary numbers to every calculation other than to obfuscate the same numbers that everyone always talks about. Getting even slightly worse returns is extremely damaging. It is equally damaging if the reason is bad expense ratios, bad timing on the part of the fund investor or bad portfolio design. Your entire thread is a lot of handwaving justifying bad returns and then arguing that if you compensate for bad returns with extra savings that it does no harm. Well of course that's the case. If the investor were paying an advisor 140 basis points and covering the advisor's expenses out of pocket then the advisory fees would be doing no harm to the portfolio.

Young investors have a long time horizon. Young investors should be in high volatility assets for which they get compensated. Even assuming no mean reversion annual volatility impacts at the square root of the time horizon. Or to put it another way, the damage from annual volatility is decreasing by the square root of the time horizon. The square root of 30 is 5.4. Which is to say if they can they should be in a portfolio 3.15x as volatile as someone who needs to focus on 3 year returns, something like the typical income oriented portfolio. 60/40 is a good portfolio for a person in their 60s not a person in the 30s. (And incidentally even assuming only USA assets 65/35 is the highest survivability portfolio, so even for retirees the 60/40 portfolio appears potentially a hair too conservative).

All this makes perfect sense. For young people their biggest asset is themselves, their future wages. Their primary asset is locked up (illiquid) in a future stream of wages they can't access directly. To compensate for this they should be borrowing against that future stream of wages if possible to take on high returning volatile assets. Which incidentally they often do by buying a house at 5::1 leverage. The last thing they should be doing is lending against the current wages to highly safe borrowers like the federal government or A rated corporates over a short time frame taking on essentially no credit risk and only limited duration risk. That's decreasing risk when they need return. If they want to lend they should be lending to people who are more risky than themselves and playing the spread. Equity investing is the most common way to do that, but things like EM bonds are also a good way.

100% TSM is a bad portfolio because it takes on unnecessary volatility and it is possible to get higher returns with much less volatility. But if it were the only stock portfolio around it makes far more sense for someone holding what amounts to an extremely large annuity position paying out $80k/yr for 30 years to be adding as much stock to that large annuity position as they can as quickly as they can.
Last edited by jbolden1517 on Wed Aug 16, 2017 6:40 am, edited 1 time in total.

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Re: The Mathematics of Retirement Investing

Post by longinvest » Wed Aug 16, 2017 6:37 am

jbolden1517 wrote:
Wed Aug 16, 2017 6:35 am
First off I said without rebalancing not with.
True; it's effectively what you wrote. I fixed my post.

As for simplistic mathematics, here's what they say. First, in nominal terms:
1.101^30 = 17.9
1.087^30 = 12.2
(17.9 / 12.2) - 1 = 47%

Next, assuming 3% inflation and rounding of the annual growth rates:
1.069^30 = 7.4
1.055^30 = 5.0
(7.4 / 5.0) - 1 = 48%

Without rounding, both calculations would yield: 46.80...%

This represents what happens to a lump sum invested for 30 years. It does not represent what happens to retirement investing through regular contributions over 30 years. It is thus an incorrect calculation. Worse, younger workers usually have lower salaries (due to lower experience) and face additional financial obligations (house down payment, mortgage payments, school and college costs, etc.). Older workers, near-retirement, usually have higher abilities to save and invest, with higher salaries and lower financial obligations.

You can triple-check the calculations of my first post and verify that:
  1. One needs to save 28% more to accumulate the same amount with a 5.5% instead of a 6.9% growth rate over 30 years.
  2. Given an $80K salary and a $25K future Social Security pension, one needs to save 21% more to keep equal pre-retirement and post-retirement spending with a 5.5% instead of a 6.9% growth rate over 30 years.
  3. Given an $80K salary and a $25K future Social Security pension, one needs to spend 3.3% less representing $153/month to keep equal pre-retirement and post-retirement spending with a 5.5% instead of a 6.9% growth rate over 30 years.
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Re: The Mathematics of Retirement Investing

Post by jbolden1517 » Wed Aug 16, 2017 8:01 am

longinvest wrote:
Wed Aug 16, 2017 6:37 am

This represents what happens to a lump sum invested for 30 years. It does not represent what happens to retirement investing through regular contributions over 30 years.
True. If you make the contributions periodic the decreased rate of return does less damage. But if you have regular contributions over 30 years then you get some substantial DCA advantages especially if one believes in mean reversion. Up to crazy high limits the more volatile the better. Just to make the math more extreme imagine an asset whose intrinsic value compounds at 1% annually but that sells for either 100x or 1% of intrinsic value every year. And contrast that with a 5% smooth asset. An investor with any kind of reasonable time horizon wants that 10,000 multiplier on any part of their money and could care less about the low rate of compounding. An optimal portfolio of course would mix the two to be able to rebalance ...
longinvest wrote:
Wed Aug 16, 2017 6:37 am
Worse, younger workers usually have lower salaries (due to lower experience) and face additional financial obligations (house down payment, mortgage payments, school and college costs, etc.). Older workers, near-retirement, usually have higher abilities to save and invest, with higher salaries and lower financial obligations.
I agree. But you are making the case for what younger workers should do with their portfolio during the years where they are going to be saving what they can. Those act like lump sum investments. That they are potentially small lump sum investments doesn't change the math. They do the most good if they compound quickly. They do little at all if they compound slowly.
longinvest wrote:
Wed Aug 16, 2017 6:37 am
You can triple-check the calculations of my first post and verify that:
  1. One needs to save 28% more to accumulate the same amount with a 5.5% instead of a 6.9% growth rate over 30 years.
  2. Given an $80K salary and a $25K future Social Security pension, one needs to save 21% more to keep the same spending before and after retirement with a 5.5% instead of a 6.9% growth rate over 30 years.
  3. Given an $80K salary and a $25K future Social Security pension, one needs to spend 3.3% less representing $153/month to keep the same spending before and after retirement with a 5.5% instead of a 6.9% growth rate over 30 years.
I'm not disagreeing with that. A marginal decrease in current standard of living results in tremendous benefits later in life. Investing works. But there is no reason to conflate portfolio design and the financial benefits of being frugal. Moreover the frugal are often too risk adverse. Not uncommonly they reduce lifetime utility too far. The spendthrift who are not too impatient, are often quite good investors, they just have little to invest with.

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Re: The Mathematics of Retirement Investing

Post by #Cruncher » Wed Aug 16, 2017 12:01 pm

longinvest wrote:
Sun Aug 13, 2017 10:58 am
I wrote the first post of this thread to show that the cost of using a diversified 60/40 stocks/bonds portfolio, instead of a concentrated 100% stocks portfolio, is small enough. That it's approximately $150 per month for someone earning a $80,000 salary.
I would restate this slightly to say "smaller than generally believed" instead of "small enough". I think this should be the main takeaway of your thread, longinvest. Unfortunately it has received little attention in this thread compared to the back-and-forth over the merits of a 100:0 stock:bond allocation.

To try and remedy this, let me summarize how your "cost" of the 60:40 portfolio compares to other ways of computing its "cost". The table below starts with the largest cost and moves through various stages to the smallest cost which is the one your first post derives. The notations in the "Orig Post" column refer to the original post. The numbers in the "Table Row" column refer to the row numbers in the first table in my first post where I put your analysis into a spreadsheet (and corrected the tax computation).

Code: Select all

     Orig Table  Stock:bond allocation --------->    100:0     60:40
Row  Post  Row   Growth rate ------------------->     6.9%      5.5%    % Chg  $ Chg/mo
---  ----  ---                                      -------   -------   -----  --------
  1              In 30 years $1 grows to             7.4017    4.9840   48.5%	
  2   A-3   10   In 30 years $1 per year grows to   92.7782   72.4355   28.1%	
  3   A-4   12   Needed savings per year             11,674    14,112   20.9%     203 
  4         13   $80K Salary less savings            68,326    65,888   -3.6%    -203
  5   A-5   15   $80K Salary less savings less tax   58,105    56,277   -3.1%    -152
Now I'll discuss each of the "stages" 1 through 5:
  • Stage 1: While accurate, to say that the same one-time investment will grow to 48.5% more with the 100:0 portfolio, is irrelevant and possibly misleading for a typical investor saving for retirement. This is because he normally won't have just a single lump sum to invest for thirty years.
  • Stage 2: The 28.1% higher ending value of the 100:0 portfolio after 30 years of regular investment is relevant because this represents how the saver will actually be investing during the thirty years. Assuming a fixed withdrawal percentage, this naturally means he could withdraw 28.1% more each year during retirement.
  • Stage 3: The 20.1% higher savings needed according to longinvest's calculation represents, in my opinion, the ingenious and most noteworthy part of his analysis. Instead of assuming a fixed withdrawal each year, he changes the objective to be making salary less savings while working the same as spending while retired. But be aware of what's happening here. At 6.9% $11,674 per year grows to $1,083,000 in 30 years; while at 5.5% $14,122 grows to only $1,022,000. Instead of being able to withdraw $43,300 each year at 4%, one can withdraw only $40,900. There is no "free lunch" here.
  • Stage 4: The change from 20.1% in stage 3 to 3.6% in stage 4 is due to two factors. Primarily it is just changing the base against which the percent change is calculated from the amount saved to the amount of salary less the amount saved. (Note that the $203 per month is the same for stages 3 and 4.) The other reason is that Social Security is considered in determining how much needs to be saved. If it were $0 instead of $25,000, the -3.6% would be -5.6% and the $-203 would be $-295..
  • Stage 5: The change from 3.6% in stage 4 to 3.1% in state 5 is due to taxes. longinvest assumes a 25% marginal tax rate and also that savings are entirely tax deductible while working and withdrawals are entirely taxable while retired. (He calculates taxes incorrectly in the original post, so I'm showing results from my own calculation in my post. This makes the reduction at 3.1% even "better" than the 3.3% he reports in the original post.)

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Re: The Mathematics of Retirement Investing

Post by sreynard » Wed Aug 16, 2017 1:40 pm

So Bogle was basically wrong. A 1% expense ratio is no big deal. Just save a couple hundred dollars more a month and it pretty much comes out in the wash. :twisted:

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Re: The Mathematics of Retirement Investing

Post by longinvest » Wed Aug 16, 2017 1:57 pm

sreynard wrote:
Wed Aug 16, 2017 1:40 pm
So Bogle was basically wrong. A 1% expense ratio is no big deal. Just save a couple hundred dollars more a month and it pretty much comes out in the wash. :twisted:
Good joke! :)

For those who didn't catch it; there's a significant difference. A 100% total US stock market fund with a 1.0% expense ratio will cost 1% more than Vanguard's Total Stock Market Index Fund - Admiral Shares (VTSAX) which has a 0.0% expense ratio*. This additional 1% provides no benefit whatsoever to the investor. In particular, it will not reduce portfolio volatility. Its only impact is to reduce portfolio returns and increase the money given to the fund provider; what Bogle calls the "tyranny of compounding costs".

* It is 0.04% which, when rounded becomes 0.0%.

A 60:40 portfolio, on the other hand, will provide a significantly less volatile portfolio. In other words, the investor is getting something in exchange for the cost. Some investors might consider this cost too high for a service they don't think they need. Other investors will consider that it is a reasonable cost to pay to lower the volatility of their portfolio and reduce the risk of failure of their retirement plan. Other investors will think other things, too. I wasn't exhaustive.

:sharebeer
Last edited by longinvest on Thu Aug 17, 2017 9:04 am, edited 5 times in total.
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Re: The Mathematics of Retirement Investing

Post by fozzy fosbourne » Wed Aug 16, 2017 2:05 pm

Other investors will consider that it is a reasonable cost to pay to lower the volatility of their portfolio and reduce the risk of failure of their retirement plan.
It seems like there is another type of risk of failure for retirement plans -- the risk of not hitting a post-retirement income target by the date one needs/desires to retire. For example, let's say someone knew the absolute minimum income they needed in order to retire. If 100% equities gave them a higher probability of meeting this target by the date that they need to retire, while 60/40 gave them a lower chance, then isn't that another type of risk?

Quoting Siamond from a thread about Living Off Your Money:
PS. I was sold after reading that the author perceives risk (for retirees) as loss of income (over the entire retirement period) instead of loss of value (of one's portfolio at one point in time). Loss of income vs loss of value. There is so much wisdom (and factual truth) to this simple statement.

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Re: The Mathematics of Retirement Investing

Post by longinvest » Wed Aug 16, 2017 2:17 pm

Dear Fozzy fosbourne,

This thread is not about the advantages and drawbacks of a 60:40 portfolio against a 100:0 portfolio. We went over that, earlier in this thread. You're welcome to read earlier posts and discover why I am insisting to keep such a discussion for other threads.

This thread is about reasonably quantifying the "cost" of using a 60:40 portfolio during the accumulation period.

I my last post, I was just explaining that it would be unfair to compare this "cost" to a high expense ratio.

Thanks for your understanding.
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Re: The Mathematics of Retirement Investing

Post by willthrill81 » Wed Aug 16, 2017 2:32 pm

In my situation, if my returns were 5.5% instead of 6.9%, over a not too long-term period of 16 years, I would need to increase my gross savings rate from 50% to 63% in order to reach the same ending ending amount. That would require a lot of additional sacrifice for us, especially since all of our tax advantaged accounts will already be maxed out and since I'm in the 25% bracket.
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Re: The Mathematics of Retirement Investing

Post by longinvest » Wed Aug 16, 2017 2:52 pm

willthrill81 wrote:
Wed Aug 16, 2017 2:32 pm
In my situation, if my returns were 5.5% instead of 6.9%, over a not too long-term period of 16 years, I would need to increase my gross savings rate from 50% to 63% in order to reach the same ending ending amount. That would require a lot of additional sacrifice for us, especially since all of our tax advantaged accounts will already be maxed out and since I'm in the 25% bracket.
I don't know about the U.S., but in Canada, someone with a $200,000/year salary pays over $80,000 in taxes (federal + provincial). If he was to put $100,000 in savings (50% savings rate), he would be living on $200,000 - $80,000 - $100,000 = $20,000/year. In other words, he would be saving 500% of his after-tax expenses, each year.

To get $20,000 after taxes, in retirement, with no pension and no Social Security, he would need a yearly gross income of $26,635. Assuming he is targeting a retirement at age 65 (to use the 25 X expenses rule of thumb), he needs to accumulate a 25 X $26,635 = $665,875 portfolio.

At a real growth rate of 6.9%, he would need to work and save for less than 6 years, starting with a $0 portfolio, to reach his objectives with a 100:0 portfolio.

From $0 to retired in less than 6 years! Kudos!
:sharebeer

Note: Technically, this post is off topic. But, I was so flabbergasted by the 50% and higher savings rates that I just couldn't resist.
Last edited by longinvest on Wed Aug 16, 2017 5:58 pm, edited 3 times in total.
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Re: The Mathematics of Retirement Investing

Post by willthrill81 » Wed Aug 16, 2017 3:14 pm

longinvest wrote:
Wed Aug 16, 2017 2:52 pm
willthrill81 wrote:
Wed Aug 16, 2017 2:32 pm
In my situation, if my returns were 5.5% instead of 6.9%, over a not too long-term period of 16 years, I would need to increase my gross savings rate from 50% to 63% in order to reach the same ending ending amount. That would require a lot of additional sacrifice for us, especially since all of our tax advantaged accounts will already be maxed out and since I'm in the 25% bracket.
I don't know about the U.S., but in Canada, someone with a $200,000/year salary pays over $80,000 in taxes.
It's a substantially lower than that here. Federal income tax, including FICA, would be roughly $53k on $200k of taxable income for a married couple filing jointly.
longinvest wrote:
Wed Aug 16, 2017 2:52 pm
If he was to put $100,000 in savings (50% savings rate), he would be living on $200,000 - $80,000 - $100,000 = $20,000/year. In other words, he would be saving 500% of his after-tax expenses, each year.

To get $20,000 after taxes, in retirement, with no pension and no Social Security, he would need a yearly gross income of $26,635. Assuming he is targeting a retirement at age 65 (to use the 25 X expenses rule of thumb), he needs to accumulate a 25 X $26,635 = $665,875 portfolio.

At a real growth rate of 6.9%, he would need to work and save for less than 6 years, starting with a $0 portfolio, to reach his objectives with a 100:0 portfolio.

From $0 to retired in less than 6 years! Kudos!
I like this calculator to compute time to retirement. Taxes throw off the exact numbers somewhat, but it's still fairly accurate. It indicates that a 50% savings rate, assuming 4% withdrawals and 5% real growth, leads to FI in 16.6 years. A 67% savings rate leads to FI in just 10 years. But if you're only making $50k a year, that means you'd be living on $16.5k annually. Jacob Fisker, the 'extreme' early retiree, could do it, and others as well I'm sure, but I couldn't; I certainly wouldn't want to. I think that a savings rate much above 30% pretty much necessitates an above average income.

Something you might find interesting as well regarding the calculator is that at high savings rates (>30%), increasing your savings rate has a markedly larger impact on your time to FI than does your rate of return. With low savings rates, the reverse is true.
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Re: The Mathematics of Retirement Investing

Post by ray.james » Wed Aug 16, 2017 3:20 pm

LongInvest, this is a great thread. It took a little while to grasp what you are arriving at. And Crucher last post helped in grasping finer points.

A number of retirement articles from CNBC to everywhere else which start with headline:
"what happens if you save 1% more each year or 1 K more each year"
Yeah they will all end up with lot more money, but few focus on net impact of missed income on current life. 1K post tax per month impact on budget is minimal at 80k level income. Most would not miss this.

Now this is where, you went further ahead with equating the risk/reward curve from extra savings VS much higher retirement number. The reason this analysis was hard to comprehend was because you are not looking at equal numbers like in most calculations. crucher highlighted this much better
But be aware of what's happening here. At 6.9% $11,674 per year grows to $1,083,000 in 30 years; while at 5.5% $14,122 grows to only $1,022,000.
You are looking at net cost flow impact which I think is actually brilliant for normal people loading up on stocks without understanding risk. It also show how after tax spending vs pre tax saving compounded can have bring a lot of magic in numbers- "small enough". Thank you and Cruncher for a great discussion.
When in doubt, http://www.bogleheads.org/forum/viewtopic.php?f=1&t=79939

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Re: The Mathematics of Retirement Investing

Post by bigred77 » Wed Aug 16, 2017 4:09 pm

willthrill81 wrote:
Wed Aug 16, 2017 2:32 pm
In my situation, if my returns were 5.5% instead of 6.9%, over a not too long-term period of 16 years, I would need to increase my gross savings rate from 50% to 63% in order to reach the same ending ending amount. That would require a lot of additional sacrifice for us, especially since all of our tax advantaged accounts will already be maxed out and since I'm in the 25% bracket.
One other thing to consider, and this I suspect would be much harder to quantify but it's something I've been think about often, is that if you know you are taking less risk with your portfolio of risky assets you can take on risks in other other areas that may be more efficient.

For example, I know you are a proponent of 100% equities in accumulation, you subscribe to the school of thought of having a dedicated emergency fund separate from your 100% equity portfolio (perhaps over 1 years worth of expenses?) , and I think I saw in previous posts you plan to pay off your mortgage early? I'm not trying to put words in your mouth so please correct me if I'm wrong.

Well we know the efficient frontier typically curves, correct (or at least do most of us accept that)? At the extreme end, going from 100/0 to 90/10 in AA typically sees a greater jump in sharp ratio than going from 60/40 to 50/50. The more equity heavy my portfolio is the more volatility I can cut and the lower my reduction in expected returns are by moving that marginal 10% of the portfolio from equities to bonds?

So if I give up some expected return for my portfolio for a significant cut to volatility (like going from 100/0 to 60/40 since that's what's been discussed, I would prefer a smaller jump, like to 75/25 but I digress) perhaps I've freed up the ability take risk in other areas that can let me keep my spending constant and add to the funds I invest in my now more conservative portfolio. Specifically maybe I now decide I don't need a dedicated Emergency fund at all, I can just invest all free capital. Maybe I also don't see the need to pay off my mortgage ahead of schedule now since I feel better about less severe draw downs during a recession where I might need to tap my funds?

Essentially I'm suggesting no cash drag and a leveraged portfolio of stocks and bonds instead of having competing priorities for your free cash flow, especially for young investors, between mortgage pay down and building a cash cushion. Instead of saving X with a percentage of X going to pay off your mortgage and a percentage of X to build a cash cushion, just invest ALL of X from much earlier age.

I suspect either approach has different pro's and con's and the risks one bears are certainly different kinds of risks. Obviously I've been contemplating this because I basically take the second approach because I think it's a little more efficient because I've diversified the types of risks I'm exposed to (adding liquidity and leverage risks in low amounts instead of loading up strictly on market risk).

I suspect even though you are 100% equities with your non-cash financial assets and I am 75/25, we probably have a very similar risk tolerance.

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Re: The Mathematics of Retirement Investing

Post by willthrill81 » Wed Aug 16, 2017 5:14 pm

bigred77 wrote:
Wed Aug 16, 2017 4:09 pm
willthrill81 wrote:
Wed Aug 16, 2017 2:32 pm
In my situation, if my returns were 5.5% instead of 6.9%, over a not too long-term period of 16 years, I would need to increase my gross savings rate from 50% to 63% in order to reach the same ending ending amount. That would require a lot of additional sacrifice for us, especially since all of our tax advantaged accounts will already be maxed out and since I'm in the 25% bracket.
One other thing to consider, and this I suspect would be much harder to quantify but it's something I've been think about often, is that if you know you are taking less risk with your portfolio of risky assets you can take on risks in other other areas that may be more efficient.

For example, I know you are a proponent of 100% equities in accumulation, you subscribe to the school of thought of having a dedicated emergency fund separate from your 100% equity portfolio (perhaps over 1 years worth of expenses?) , and I think I saw in previous posts you plan to pay off your mortgage early? I'm not trying to put words in your mouth so please correct me if I'm wrong.

Well we know the efficient frontier typically curves, correct (or at least do most of us accept that)? At the extreme end, going from 100/0 to 90/10 in AA typically sees a greater jump in sharp ratio than going from 60/40 to 50/50. The more equity heavy my portfolio is the more volatility I can cut and the lower my reduction in expected returns are by moving that marginal 10% of the portfolio from equities to bonds?
I'm not personally concerned with the efficient frontier or risk-adjusted returns; my concern regards absolute returns. I can't 'eat' a risk-adjusted return, only a real one. Plus, since I have an EF and a currently very stable job (under a three year contract right now), I don't really care about volatility with funds that I won't need for 20 years.
bigred77 wrote:
Wed Aug 16, 2017 4:09 pm
So if I give up some expected return for my portfolio for a significant cut to volatility (like going from 100/0 to 60/40 since that's what's been discussed, I would prefer a smaller jump, like to 75/25 but I digress) perhaps I've freed up the ability take risk in other areas that can let me keep my spending constant and add to the funds I invest in my now more conservative portfolio. Specifically maybe I now decide I don't need a dedicated Emergency fund at all, I can just invest all free capital. Maybe I also don't see the need to pay off my mortgage ahead of schedule now since I feel better about less severe draw downs during a recession where I might need to tap my funds?

Essentially I'm suggesting no cash drag and a leveraged portfolio of stocks and bonds instead of having competing priorities for your free cash flow, especially for young investors, between mortgage pay down and building a cash cushion. Instead of saving X with a percentage of X going to pay off your mortgage and a percentage of X to build a cash cushion, just invest ALL of X from much earlier age.

I suspect either approach has different pro's and con's and the risks one bears are certainly different kinds of risks. Obviously I've been contemplating this because I basically take the second approach because I think it's a little more efficient because I've diversified the types of risks I'm exposed to (adding liquidity and leverage risks in low amounts instead of loading up strictly on market risk).

I suspect even though you are 100% equities with your non-cash financial assets and I am 75/25, we probably have a very similar risk tolerance.
My primary reasons for paying off my mortgage early have to do primarily with concerns for long-term job security and the desires of my DW.

And two-thirds of my EF is invested in Wellesley Income fund (35/65), so I have little cash drag right now.

I will not 'dispose' of my EF until I'm FI primarily because I want that cushion until I can comfortable live off my assets, plus I don't want to pay a 10% withdrawal penalty (virtually all of my invested assets now and in the future will be in tax deferred accounts).
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: The Mathematics of Retirement Investing

Post by North Texas Cajun » Wed Aug 16, 2017 6:06 pm

longinvest wrote:
Wed Aug 16, 2017 2:17 pm
Dear Fozzy fosbourne,

This thread is not about the advantages and drawbacks of a 60:40 portfolio against a 100:0 portfolio. We went over that, earlier in this thread. You're welcome to read earlier posts and discover why I am insisting to keep such a discussion for other threads.

This thread is about reasonably quantifying the "cost" of using a 60:40 portfolio during the accumulation period.

I my last post, I was just explaining that it would be unfair to compare this "cost" to a high expense ratio.

Thanks for your understanding.
Longinvest,

I really do not understand why you continue to scold folks about this. You were the person who initiated the comparison of a 60/40 and 100/0 portfolios in this thread. You described the all equity portfolio as reckless. Given that statement from you, why is it not appropriate for someone else to point out the relative advantages and disadvantages of the two portfolios?

One more thing I do not understand: is there some unwritten or written rule that gives to the OP the right to control where a discussion leads on a post he initiates? If someone else believes
a point is relevant to the discussion, does the OP automatically become a moderator?

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Re: The Mathematics of Retirement Investing

Post by bigred77 » Wed Aug 16, 2017 6:15 pm

willthrill81 wrote:
Wed Aug 16, 2017 5:14 pm
bigred77 wrote:
Wed Aug 16, 2017 4:09 pm
willthrill81 wrote:
Wed Aug 16, 2017 2:32 pm
In my situation, if my returns were 5.5% instead of 6.9%, over a not too long-term period of 16 years, I would need to increase my gross savings rate from 50% to 63% in order to reach the same ending ending amount. That would require a lot of additional sacrifice for us, especially since all of our tax advantaged accounts will already be maxed out and since I'm in the 25% bracket.
One other thing to consider, and this I suspect would be much harder to quantify but it's something I've been think about often, is that if you know you are taking less risk with your portfolio of risky assets you can take on risks in other other areas that may be more efficient.

For example, I know you are a proponent of 100% equities in accumulation, you subscribe to the school of thought of having a dedicated emergency fund separate from your 100% equity portfolio (perhaps over 1 years worth of expenses?) , and I think I saw in previous posts you plan to pay off your mortgage early? I'm not trying to put words in your mouth so please correct me if I'm wrong.

Well we know the efficient frontier typically curves, correct (or at least do most of us accept that)? At the extreme end, going from 100/0 to 90/10 in AA typically sees a greater jump in sharp ratio than going from 60/40 to 50/50. The more equity heavy my portfolio is the more volatility I can cut and the lower my reduction in expected returns are by moving that marginal 10% of the portfolio from equities to bonds?
I'm not personally concerned with the efficient frontier or risk-adjusted returns; my concern regards absolute returns. I can't 'eat' a risk-adjusted return, only a real one. Plus, since I have an EF and a currently very stable job (under a three year contract right now), I don't really care about volatility with funds that I won't need for 20 years.
bigred77 wrote:
Wed Aug 16, 2017 4:09 pm
So if I give up some expected return for my portfolio for a significant cut to volatility (like going from 100/0 to 60/40 since that's what's been discussed, I would prefer a smaller jump, like to 75/25 but I digress) perhaps I've freed up the ability take risk in other areas that can let me keep my spending constant and add to the funds I invest in my now more conservative portfolio. Specifically maybe I now decide I don't need a dedicated Emergency fund at all, I can just invest all free capital. Maybe I also don't see the need to pay off my mortgage ahead of schedule now since I feel better about less severe draw downs during a recession where I might need to tap my funds?

Essentially I'm suggesting no cash drag and a leveraged portfolio of stocks and bonds instead of having competing priorities for your free cash flow, especially for young investors, between mortgage pay down and building a cash cushion. Instead of saving X with a percentage of X going to pay off your mortgage and a percentage of X to build a cash cushion, just invest ALL of X from much earlier age.

I suspect either approach has different pro's and con's and the risks one bears are certainly different kinds of risks. Obviously I've been contemplating this because I basically take the second approach because I think it's a little more efficient because I've diversified the types of risks I'm exposed to (adding liquidity and leverage risks in low amounts instead of loading up strictly on market risk).

I suspect even though you are 100% equities with your non-cash financial assets and I am 75/25, we probably have a very similar risk tolerance.
My primary reasons for paying off my mortgage early have to do primarily with concerns for long-term job security and the desires of my DW.

And two-thirds of my EF is invested in Wellesley Income fund (35/65), so I have little cash drag right now.

I will not 'dispose' of my EF until I'm FI primarily because I want that cushion until I can comfortable live off my assets, plus I don't want to pay a 10% withdrawal penalty (virtually all of my invested assets now and in the future will be in tax deferred accounts).
I guess maybe we just won't find common ground here but I can't reconcile your desire for liquidity (keeping an emergency fund), concerns about long term job security, and being such a staunch proponent of 100% equities and focusing on absolute returns.

In percentage terms, how are your emergency fund and portfolio currently allocated (if that's not too intrusive?) with the total balance of both being the denominator? Is it something like 20% Wellington, 10% Cash and 70% Portfolio? Because then I would understand better, you might view your portfolio with the 100% equity allocation in isolation, irrespective of it's proportion against your sum of total assets.

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Re: The Mathematics of Retirement Investing

Post by longinvest » Wed Aug 16, 2017 6:19 pm

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Last edited by longinvest on Wed Aug 16, 2017 7:31 pm, edited 1 time in total.
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willthrill81
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Re: The Mathematics of Retirement Investing

Post by willthrill81 » Wed Aug 16, 2017 6:30 pm

bigred77 wrote:
Wed Aug 16, 2017 6:15 pm
I guess maybe we just won't find common ground here but I can't reconcile your desire for liquidity (keeping an emergency fund), concerns about long term job security, and being such a staunch proponent of 100% equities and focusing on absolute returns.
Given the choice between the two, if I suddenly lost my job, I'd rather have no mortgage than a correspondingly higher 401k balance if for other reasons than cash flow and avoiding early withdrawal penalties.

Again, if my wife wasn't so for it, I probably wouldn't be paying off my mortgage early. But she is, and a happy wife means a happy life. :wink:

Also, considering that it's not taking us long (about four years total) to do so, there isn't a big opportunity cost involved. It might delay my retirement by a year or two at most. I'll still have enough tax advantaged space to absorb the freed up cash flow once its paid off, so there's no problem there.

My EF is there not so much for an unexpected job loss as for a car suddenly dying, needing to help family members, etc. My EF is only about three months of expenses, and I don't plan on increasing it beyond that. Since I started budgeting and saving for irregular expenses several years ago, we've had no 'emergencies'. Funny how that works. 8-)
bigred77 wrote:
Wed Aug 16, 2017 6:15 pm
In percentage terms, how are your emergency fund and portfolio currently allocated (if that's not too intrusive?) with the total balance of both being the denominator? Is it something like 20% Wellington, 10% Cash and 70% Portfolio? Because then I would understand better, you might view your portfolio with the 100% equity allocation in isolation, irrespective of it's proportion against your sum of total assets.
Compared to my retirement assets, my EF is about 6% as large, and two-thirds of that (4%) is in Wellesley Income. The remaining one-third (2%) is in cash. All of my retirement assets are in equities.

My home equity is currently about 55% as large as my retirement assets.

My retirement assets represent about 60% of my net worth.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: The Mathematics of Retirement Investing

Post by North Texas Cajun » Wed Aug 16, 2017 6:56 pm

bigred77 wrote:
Wed Aug 16, 2017 4:09 pm
Well we know the efficient frontier typically curves, correct (or at least do most of us accept that)? At the extreme end, going from 100/0 to 90/10 in AA typically sees a greater jump in sharp ratio than going from 60/40 to 50/50. The more equity heavy my portfolio is the more volatility I can cut and the lower my reduction in expected returns are by moving that marginal 10% of the portfolio from equities to bonds?
I think the Sharpe ratio for a 100/0 portfolio changes dramatically as the horizon extends from, say, 5 years to 25 or 30 years. Isn't that right? The standard deviation for such a portfolio comes way down. In his book, "Stocks for the Long Run", Jeremy Siegel shows that the SD for real U.S. Equity returns drops from 18% to 7.5% to 1.8% as the horizon extends from 1 to 5 to 30 years. At that SD, are you sure you can cut very much volatility by moving from stocks to bonds?

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Re: The Mathematics of Retirement Investing

Post by bigred77 » Wed Aug 16, 2017 7:07 pm

willthrill81 wrote:
Wed Aug 16, 2017 6:30 pm
bigred77 wrote:
Wed Aug 16, 2017 6:15 pm
I guess maybe we just won't find common ground here but I can't reconcile your desire for liquidity (keeping an emergency fund), concerns about long term job security, and being such a staunch proponent of 100% equities and focusing on absolute returns.
Given the choice between the two, if I suddenly lost my job, I'd rather have no mortgage than a correspondingly higher 401k balance if for other reasons than cash flow and avoiding early withdrawal penalties.

Again, if my wife wasn't so for it, I probably wouldn't be paying off my mortgage early. But she is, and a happy wife means a happy life. :wink:

Also, considering that it's not taking us long (about four years total) to do so, there isn't a big opportunity cost involved. It might delay my retirement by a year or two at most. I'll still have enough tax advantaged space to absorb the freed up cash flow once its paid off, so there's no problem there.

My EF is there not so much for an unexpected job loss as for a car suddenly dying, needing to help family members, etc. My EF is only about three months of expenses, and I don't plan on increasing it beyond that. Since I started budgeting and saving for irregular expenses several years ago, we've had no 'emergencies'. Funny how that works. 8-)
bigred77 wrote:
Wed Aug 16, 2017 6:15 pm
In percentage terms, how are your emergency fund and portfolio currently allocated (if that's not too intrusive?) with the total balance of both being the denominator? Is it something like 20% Wellington, 10% Cash and 70% Portfolio? Because then I would understand better, you might view your portfolio with the 100% equity allocation in isolation, irrespective of it's proportion against your sum of total assets.
Compared to my retirement assets, my EF is about 6% as large, and two-thirds of that (4%) is in Wellesley Income. The remaining one-third (2%) is in cash. All of my retirement assets are in equities.

My home equity is currently about 55% as large as my retirement assets.

My retirement assets represent about 60% of my net worth.
Fair enough.

I can see how with such a high savings rate, a job under contract for a few years, and house scheduled for pay off soon your need for liquidity is low. You like market risk. You bear market risk. Market risk is usually quite rewarding to those who accept it.

I prioritize risk adjusted returns, which means it's tough for us to see eye to eye, but that's perfectly alright.

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