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DualCitizen
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Stocks

Post by DualCitizen »

From The Economist print edition
Last edited by DualCitizen on Wed Aug 05, 2020 6:05 pm, edited 1 time in total.
DJP
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Post by DJP »

It seems to me that the majority of investors, especially the "man on the street" with a 401k, came to believe that the stock market was an essentially risk-free 10% perpetual-motion machine.

And they came to think that "risk-tolerance" meant how much you could tolerate watching your money go down AND up. But really, it's about watching your money go down, that's the hard part. And it's more than theoretically possible to have very poor returns over very long periods of time, and to have crushing losses in short periods of time.
adubs
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Post by adubs »

This perception is behind our reliance on 401k and IRA (now) for retirement income. I think the Japan scenario is quite foreboding and exactly the "irrational exuberance" that Greenspan was referring to in his oft-quoted speech.

Everyday at work, my colleagues get worried and then settle down when they realize that someday their 401k will come back.

Japan is proving that someday is a long way away.
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Re: Stocks do not always go up (even after 30 years)

Post by celia »

DualCitizen wrote:Boglehead investors rely on the belief that over the long term (say 30 years), stocks will have a positive rate of return.

But there are some very fundamental flaws in this belief.

1. What is so magic about the number 30?
Nothing.

It is just a number you pulled out for your example. Re-read your first line.
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Post by JohnDoe2004 »

Agreed there is no guarantee that stocks will have a positive real return over the next 30 years but I believe the odds are very high. What do you think the odds are of the following scenarios, especially given that fact that we are starting from S&P 500 at 907?

-Stocks have a negative real return over the next 30 years?
-Stocks return less than cash over the next 30 years?
-Stocks return less than bonds over the next 30 years?

I guess we won't know until October 15, 2038 but I am willing to bet (indeed I am betting with 85% of my net worth) that stocks will outpace both bonds and cash.
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Post by alec »

There is nothing pre-ordained about stocks that makes them certain to beat cash, bonds, or TIPS over long periods.

To quote from Bodie + Hogan's article, "For Long-Term Investors The Focus Should Be on Risk" published in the AAII journal. [available at Hogan's website, in the library section.]
The big fallacy abroad in the land at the moment is that time horizon is a reliable and sole proxy for risk preference. In this paradigm, the longer you intend money to be invested, the higher is the appropriate risk level (i.e., stock allocation) of the portfolio.

In this paradigm, the longer you intend money to be invested, the higher is the appropriate risk level (i.e., stock allocation) of the portfolio.

But this does not tell the whole story. Stocks can be risky, even in the long run.

The fact is, lower than expected returns could happen—even for many years in a row—which is exactly what makes stock ownership a risky investment, not a certainty. Lower-than-expected returns that last for a long time and/or that are severe in nature would have the impact of dramatically lowering the ending value of your portfolio, and thus could significantly threaten your ability to meet financial goals. While the probability of such an event is low, the consequences are potentially devastating and so are worthy of careful consideration.

What the current reasoning omits is the fact that as the investor’s time horizon lengthens, the range of possible ending values for the portfolio also increases, and that these widening ranges include the low, but still positive possibility of a whoppingly low actual versus expected portfolio ending value. For the mathematically inclined, proof positive of how stocks are risky even in the long run is that if you try to insure a portfolio against a shortfall, you will find that the premium rises as the time horizon lengthens, exactly as would the price for a put option on the
termination value of the portfolio.
See also:

What practitioners need to know about Time Diversification

The Long-Term Risks of Global Stock Markets

Global Stock Markets in the Twentieth Century

Paul A. Samuelson, "The Long-Term Case for Equities: and how it can be oversold," Journal of Portfolio Management, Fall 1994, pp. 15-24.

Paul A. Samuelson, "Dogma of the Day," Bloomberg Personal Finance, 1997.

- Alec
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Post by at »

For me to invest in the stock market, I don't need stocks to have positive returns for every rolling 20-year periods. What I need to know is that, in the past:

1. stocks on average have high annualized returns.
2. stocks beat debts on the majority of rolling 20-year periods (3 quarters of the time are good enough for me).

The fact that sometimes stocks have negative returns over 30-year periods is a business risk I'm willing to take. You need to be confident but there is no need to be 100% sure.
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Post by nisiprius »

Yes, I think this is a valid and important observation. Stocks have been misrepresented and oversold to the general 401(k)-saving public.

Heck, I'm about as suspicious and skeptical as they come but I realize I have allowed them to be slightly oversold to me. To put it bluntly, up to about a year ago, I assumed that "time diversification" was a valid concept... largely because a) TIAA literature presented it that way (not by that name) and b) I trusted TIAA.

I've been trying to form a suitable mental model for equities. My provisional notion is that they should be regarded as free lottery tickets with a darn good chance of a worthwhile jackpot. That is, you have to plan as if you were 100% bonds, because over a normal retirement-savings life cycle there is a very real chance of equities not performing much better than bonds.

Asset allocation then become mostly a matter of pure personal taste. You'd be a fool not to have any of those free lottery tickets. But it is a bad mistake to exceed your risk tolerance, and exceeding it through machismo, or through casual questionnaires that "anchor" your expected response is too easy. I've discovered that my own risk tolerance is lower than I thought, and I'll bet most people would err in that direction.

Furthermore, the chance of actual nominal loss, even over the long term, shouldn't be ignored (or dismissed as implying an apocalyptic scenario), just because it hasn't occurred in the U. S. over the period of good recordkeeping.

The financial industry is the master of the cleverly qualified statement, and I think "blaming the victim" is inappropriate. There is so much subtle spin, all, all, all in the same direction. Even a little bar with "more risk, more reward" at one end sends a message. It does not say "guaranteed more reward if you hang in there," but everyone knows darn well that's what people are going to infer.

I'm not a sophisticated investor--I think I'm below median among forum posters here--but I'm really bothered by what I hear from e.g. colleagues at work. Just yesterday: "I'm not all stocks, I have some international." I have some idea of the difference in investment characteristics between stocks and bonds and am amazed at how few people seem to grasp this. I wonder how many 401(k) investors have ever consciously formulated the question "what percentage of bonds should I have?"

Target retirement funds (from all companies) have a lot to answer for, in my opinion. I discovered yesterday that the T. Rowe Price 2035 fund, i.e. for a 38-year-old, is 91.5% stocks. I don't know how financial advisors work, but there is no way that the average 38-year-old couple, if given a sincere, probing interview to determine their risk tolerance, with an unbiassed presentation of the benefits and the real risks of stocks, would choose that high a percentage.

Is 30 years long enough? 20? I don't know, but one of the things that needs to be drummed into the general public is that "long term" does not mean "five years." That you cannot get the risk premium without the risk. That the risk is always there.
Last edited by nisiprius on Thu Oct 16, 2008 9:11 pm, edited 4 times in total.
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Post by guest42 »

I agree, I have been sold a "truth" - and that "truth" is based on 80 years, not even a mere 30 years.

See Vanguard asset allocation, model portfolio's:
https://personal.vanguard.com/us/planni ... ontent.jsp

Where I once had 40 to 50 years to invest, I now have 10, maybe 20 if I'm lucky. How does investing in a 10 or 20 year period stack up? When the financial industry wants to sell me on 80 years of data?

While I subscribe to many of the principles of Biglehead investing, my investing is not pure Boglehead. I sold 10% into Mondays rally, on the assumption the market will give me lower prices to buy back into. It may, or it may not. I only regret today, that I didn't sell more into Mondays rally. But investing success is not measured in days, it is measured in decades. I applied a distinctly non-Boglehead principle "buy low, sell high".

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To Infinity and Beyond

Post by bobcat2 »

The Economist magazine article, To Infinity and Beyond was discussed earlier this year in a Boglehead thread.
Link to earlier thread:
http://www.bogleheads.org/forum/viewtop ... nal#165154

Bob K
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
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Post by MOBoglehead »

This is academic and it is interesting. But what can we do, really ? No sane person would advocate investing in money market accounts for 30 years. Such a position would guarantee failure, due to inflation and taxes.

Studies like this merely reinforce the importance of broad diversification across asset class, size and region. If you have a mix of large, small, domestic, international, fixed income and maybe a little gold / commodities, there really is not much else you can do.

Stay the course.
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Post by muddlehead »

our current situation couldn't be any easier to decipher. if you think we are another japan, don't invest in the us stock market.
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Post by redbeard »

MOBoglehead wrote:This is academic and it is interesting. But what can we do, really ? No sane person would advocate investing in money market accounts for 30 years. Such a position would guarantee failure, due to inflation and taxes.

Studies like this merely reinforce the importance of broad diversification across asset class, size and region. If you have a mix of large, small, domestic, international, fixed income and maybe a little gold / commodities, there really is not much else you can do.

Stay the course.
A comparison of results from available alternatives does seem to be lacking in any analysis of stock market risk. The article sited cases where countries experienced revolutions as examples of equity risk, but I'm betting bonds didn't fare any better in those cases. For the oft cited Japan scenario, I'd love to see some data comparing equities to available bonds, etc. And while it would be interesting to compare a Japanese long bond heavy portfolio vs a stock heavy portfolio starting from the market peak to present, this isn't entirely instructive as it would have relied on perfectly timing the markets. And from what I understand, Japanese long term bonds, short term bonds, and MM funds probably did very poorly in the interim as well. As I recall, Japan flirted with the idea of negative interest rates not too long ago.

Summing up what you already said, everything has risk. To the extend that the risks are uncorrelated diversification can be a great help.
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Post by Rodc »

Part of the problem as I see it is too many people want a plan for retirement that is 100% safe, or close to it. I think for most people the world simply does not make such an offer, no matter what you do. Life has never carried that level of safety and likely won't.

Is a 30 year horizon enough to make equities a completely safe bet? No. So what, nothing else offers complete safety either.

You could plan using nothing but TIPS or bond yields. But you may be forced into early retirement so you need to plan for a relatively short period of savings and a relatively long period of retirement. This means you'd need to save in the ball park of 50% of your income, maybe more. For the vast majority of people this would lead to some pretty heavy deprivation. The risk then is you sacrificed your youth for a safe retirement when odds are good you did not need to. Moreover, a retirement that might never come.

People in general crave certainty. The world does not offer certainty. It does not matter if we are talking investments or any other aspect of your life: you hedge what you reasonably can, and you take your best calculated or estimated odds, and you go about your life and adjust as best you can if things don't work out as you hoped.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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Post by redbeard »

Great point Rodc.

Several months ago I read a paper linked from a post on this site which basically said that retirees shouldn't expect to be immune from economic impacts that everyone else has to confront. A poor economy hurts everyone, retirees included. We can and should do what is within our ability to mitigate such impacts through proper AA, but in the end we can't expect to come out unscathed in retirement if the whole country (or world) is suffering. I hadn't really thought of it this way before reading that paper. The concept is comforting to me in a very strange way.
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Post by MossySF »

Rodc wrote:You could plan using nothing but TIPS or bond yields. But you may be forced into early retirement so you need to plan for a relatively short period of savings and a relatively long period of retirement. This means you'd need to save in the ball park of 50% of your income, maybe more. For the vast majority of people this would lead to some pretty heavy deprivation. The risk then is you sacrificed your youth for a safe retirement when odds are good you did not need to. Moreover, a retirement that might never come.
My parents went this route. They saved 50% of their income and was able to meet their retirement goals using CDs and rental income. Of course, to hit their 50% savings goals during their working life, they:

had no car
never went on vacations
never ate out at restaurants
never celebrated xmas/birthdays

But since they were 1st generation immigrants, this lifestyle was still 10X better than what they were used to back in the home country. If you don't have the ability (mindset) to save at this rate, then you have no choice but to take some risk. Without the possible of returns (whether short term or long term) not meeting expectations, there would be no risk-reward premium.
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Post by unclemick »

1948 The Norwegian widow had the big bucks to pay those kids who mowed her lawn, weeded her flower beds, painted her fence, etc.

Her secret - dividends. But of course this time it is different.

Right? :lol: :lol: :lol:

heh heh heh - why don't you get on the payroll right after you buy the stock. :wink:
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Re: Stocks do not always go up (even after 30 years)

Post by Sunny Sarkar »

DualCitizen wrote:Boglehead investors rely on the belief that over the long term (say 30 years)....

So why do Bogleheads have so much faith.... ?
It's not about faith and/or belief, Bogleheads invest based on statistical probabilities calculated from tons of empirical evidence.
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Post by simplesimon »

I didn't know only Bogleheads invest in the stock market.
muddlehead wrote:our current situation couldn't be any easier to decipher. if you think we are another japan, don't invest in the us stock market.
+1


And to expand on what Sunny said, Boglehead investing is about low-cost.
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Post by nisiprius »

MOBoglehead wrote:This is academic and it is interesting. But what can we do, really ? No sane person would advocate investing in money market accounts for 30 years. Such a position would guarantee failure, due to inflation and taxes.
Not money market accounts, but Zvi Bodie does in fact advocate investing in 100% TIPS, or nearly so, and as far as I know he's sane. The book is Worry-free Investing: Zvi Bodie and Michael J. Clowes, (2003), Prentice-Hall, ISBN 978-0130499271.

And such a position certainly wouldn't guarantee failure at all. You just need to take a realistic position with regard to savings rate and spending rate in retirement. If you begin by encouraging people to choose an unrealistic goal (like "replacing 70% of preretirement income") and choose too low a savings rate, then you've made the goal unattainable by definition. If you set up the premises to guarantee failure, then you've guaranteed failure.

Simple solution: change the goal.

In point of fact, if you can't achieve a goal with 100% bonds, then you can't achieve it with stocks in a bad market either.
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Post by peter71 »

nisiprius wrote:Yes, I think this is a valid and important observation. Stocks have been misrepresented and oversold to the general 401(k)-saving public.

Heck, I'm about as suspicious and skeptical as they come but I realize I have allowed them to be slightly oversold to me. To put it bluntly, up to about a year ago, I assumed that "time diversification" was a valid concept... largely because a) TIAA literature presented it that way (not by that name) and b) I trusted TIAA.

I've been trying to form a suitable mental model for equities. My provisional notion is that they should be regarded as free lottery tickets with a darn good chance of a worthwhile jackpot. That is, you have to plan as if you were 100% bonds, because over a normal retirement-savings life cycle there is a very real chance of equities not performing much better than bonds.

Asset allocation then become mostly a matter of pure personal taste. You'd be a fool not to have any of those free lottery tickets. But it is a bad mistake to exceed your risk tolerance, and exceeding it through machismo, or through casual questionnaires that "anchor" your expected response is too easy. I've discovered that my own risk tolerance is lower than I thought, and I'll bet most people would err in that direction.

Furthermore, the chance of actual nominal loss, even over the long term, shouldn't be ignored (or dismissed as implying an apocalyptic scenario), just because it hasn't occurred in the U. S. over the period of good recordkeeping.

The financial industry is the master of the cleverly qualified statement, and I think "blaming the victim" is appropriate. There is so much subtle spin, all, all, all in the same direction. Even a little bar with "more risk, more reward" at one end sends a message. It does not say "guaranteed more reward if you hang in there," but everyone knows darn well that's what people are going to infer.

I'm not a sophisticated investor--I think I'm below median among forum posters here--but I'm really bothered by what I hear from e.g. colleagues at work. Just yesterday: "I'm not all stocks, I have some international." I have some idea of the difference in investment characteristics between stocks and bonds and am amazed at how few people seem to grasp this. I wonder how many 401(k) investors have ever consciously formulated the question "what percentage of bonds should I have?"

Target retirement funds (from all companies) have a lot to answer for, in my opinion. I discovered yesterday that the T. Rowe Price 2035 fund, i.e. for a 38-year-old, is 91.5% stocks. I don't know how financial advisors work, but there is no way that the average 38-year-old couple, if given a sincere, probing interview to determine their risk tolerance, with an unbiassed presentation of the benefits and the real risks of stocks, would choose that high a percentage.

Is 30 years long enough? 20? I don't know, but one of the things that needs to be drummed into the general public is that "long term" does not mean "five years." That you cannot get the risk premium without the risk. That the risk is always there.
Interesting. Personally I'm very skeptical of how stocks have been marketed but, absent concerns about valuations (certainly pertinent in the Japanese case), not at all skeptical of the basic idea behind time diversification. Terminal wealth dispersion of risky assets only strikes me as meaningful insofar as there are alternatives to risky assets that are themselves at a favorable point along that terminal wealth distribution, and I've never seen a truly long-term analysis that suggests that they are.

All best,
Pete
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Post by HerbertSitz »

MOBoglehead wrote:But what can we do, really ? No sane person would advocate investing in money market accounts for 30 years. Such a position would guarantee failure, due to inflation and taxes.
and
Rodc wrote:Part of the problem as I see it is too many people want a plan for retirement that is 100% safe, or close to it. I think for most people the world simply does not make such an offer, no matter what you do. Life has never carried that level of safety and likely won't.
I agree with you guys completely, and with others who have emphasized the idea of investing as essentially risk management.

Everyone is in a risky position no matter what they do. Keeping 100% of our money in a mattress or in tbills runs great risk of having value eroded by inflation. Stocks are best protection against risk of inflation but involve other risks of their own. 100% in TIPS can to some extent guarantee that you keep pace with inflation, but most people's projected needs for retirement require a return that outpaces inflation. Nobody can avoid risk; all you can do is elect a balancing of the risks that makes the most sense for you.
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Post by MTTrek »

Czechoslovakia, 1953:
The night before the deadline, the president of Czechoslovakia Antonín Zápotocký made a radio speech, in which he strictly denied any possibility of a reform and quieted down the inhabitants, though he had to know that he was lying to the nation. The next day, people (that were lucky enough not to fit into the category of "capitalistic elements", a pejorative category to which the intelligence agency used to blacklist certain individuals) were allowed to change up to 1500 old korun for new korun at the rate of 5 old to 1 new koruna and the rest at the rate of 50 to 1. All insurance stock, state obligations and other commercial papers were nullified.
from wikipedia

Could never happen in the U.S., right? I would not be so confident. Similarly, catastrophic events such as wars, epidemics or the force of nature can wreak havoc on a currency and financial markets. The best thing probably is to try to erect as many pillars as possible (e.g. personal retirement funds across multiple currencies, maximize SS payments, secure pensions, own real estate and other hard assets). Invest (save) a lot when times are good, you never know how long they'll last. Don't consume like Paris Hilton, but don't stop living, either. The other part is to keep oneself employable through continuing education or development of special expertise should you need it just in case. Then hope for a little bit of luck and most of all, good health.

Life's a gift you won't know its expiration date until it's too late.
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Post by dmcmahon »

MOBoglehead wrote: This is academic and it is interesting. But what can we do, really ? No sane person would advocate investing in money market accounts for 30 years. Such a position would guarantee failure, due to inflation and taxes.
This is absolutely correct. Moreover, many of us simply cannot save enough money to retire on within the current IRA/401k annual limits, so some portion of the retirement portfolio must be taxable, and this means finding an investment that doesn't get eaten alive by the twin destructive effects of taxes and inflation. We must find investments that produce income in the form of capital gains, the taxation of which can be deferred until the income is needed in retirement. There aren't a lot of choices...
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Post by arbogast777 »

I have no doubt that stocks will return enough for me to grow my wealth over long periods of time because we, as Americans, like to make money, we like to make money on stocks, and if we aren't making money on stocks, we fix the problem causing that to happen.
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Post by alec »

dmcmahon wrote:
MOBoglehead wrote: This is academic and it is interesting. But what can we do, really ? No sane person would advocate investing in money market accounts for 30 years. Such a position would guarantee failure, due to inflation and taxes.
This is absolutely correct. Moreover, many of us simply cannot save enough money to retire on within the current IRA/401k annual limits, so some portion of the retirement portfolio must be taxable, and this means finding an investment that doesn't get eaten alive by the twin destructive effects of taxes and inflation. We must find investments that produce income in the form of capital gains, the taxation of which can be deferred until the income is needed in retirement. There aren't a lot of choices...
dude, you need to find another employer. My whole family [save me and DW] has nothing for retirement but SS and 403(B)'s and IRAs, as have millions of professors/educators in the US. And somehow they can retire. My parents have nothing but their 403(b)s and SS, and they'll be retiring in their mid-late 60's soon, rather comfortably I might add.

- Alec
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Post by alec »

HerbertSitz wrote:
MOBoglehead wrote:But what can we do, really ? No sane person would advocate investing in money market accounts for 30 years. Such a position would guarantee failure, due to inflation and taxes.
and
Rodc wrote:Part of the problem as I see it is too many people want a plan for retirement that is 100% safe, or close to it. I think for most people the world simply does not make such an offer, no matter what you do. Life has never carried that level of safety and likely won't.
I agree with you guys completely, and with others who have emphasized the idea of investing as essentially risk management.

Everyone is in a risky position no matter what they do. Keeping 100% of our money in a mattress or in tbills runs great risk of having value eroded by inflation. Stocks are best protection against risk of inflation but involve other risks of their own. 100% in TIPS can to some extent guarantee that you keep pace with inflation, but most people's projected needs for retirement require a return that outpaces inflation. Nobody can avoid risk; all you can do is elect a balancing of the risks that makes the most sense for you.
Herb,

I beg to differ. Using Bodie's Worry Free Calculator, if I'm 25, plan on retiring when I'm 65, living to 100, earn $50,000, need 70% of that, and get $15,000 from SS, I only need to save 11% of my income every year at a 3% real interest rate, which LT TIPS are currently paying. Doesn't seem very hard and I'm not in a risky position except that I have to reinvest those 3% real yields on unknown future interest rates. Oh, stripped TIPS, where art thou?

There is certainly nothing wrong with being 100% stocks when you're young, as long as you realize that if things don't turn out as you expect, you'll either have to (1) accept a lower level of consumption in retirement than planned, (2) save more, or (3) work longer. To quote from Samuelson's 1994 article:
...Bodie, W. Samuelson, and Merton [1992] have cogently deduced an argument for rationally biasing your holdings towards equities when you are young - for the reason that you can hope to work harder later to compensate for unlucky common stock losses. (Warning: This is not the fallacious point that losses incurred when young can be made up by a longer time remaining in which the market might come back.)
- Alec
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Post by dothemontecarlo »

Nice to see all the closet pessimists coming out. I'm with you. :(
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Post by avalpert »

alec wrote:
HerbertSitz wrote:
MOBoglehead wrote:But what can we do, really ? No sane person would advocate investing in money market accounts for 30 years. Such a position would guarantee failure, due to inflation and taxes.
and
Rodc wrote:Part of the problem as I see it is too many people want a plan for retirement that is 100% safe, or close to it. I think for most people the world simply does not make such an offer, no matter what you do. Life has never carried that level of safety and likely won't.
I agree with you guys completely, and with others who have emphasized the idea of investing as essentially risk management.

Everyone is in a risky position no matter what they do. Keeping 100% of our money in a mattress or in tbills runs great risk of having value eroded by inflation. Stocks are best protection against risk of inflation but involve other risks of their own. 100% in TIPS can to some extent guarantee that you keep pace with inflation, but most people's projected needs for retirement require a return that outpaces inflation. Nobody can avoid risk; all you can do is elect a balancing of the risks that makes the most sense for you.
Herb,

I beg to differ. Using Bodie's Worry Free Calculator, if I'm 25, plan on retiring when I'm 65, living to 100, earn $50,000, need 70% of that, and get $15,000 from SS, I only need to save 11% of my income every year at a 3% real interest rate, which LT TIPS are currently paying. Doesn't seem very hard and I'm not in a risky position except that I have to reinvest those 3% real yields on unknown future interest rates. Oh, stripped TIPS, where art thou?

There is certainly nothing wrong with being 100% stocks when you're young, as long as you realize that if things don't turn out as you expect, you'll either have to (1) accept a lower level of consumption in retirement than planned, (2) save more, or (3) work longer. To quote from Samuelson's 1994 article:
...Bodie, W. Samuelson, and Merton [1992] have cogently deduced an argument for rationally biasing your holdings towards equities when you are young - for the reason that you can hope to work harder later to compensate for unlucky common stock losses. (Warning: This is not the fallacious point that losses incurred when young can be made up by a longer time remaining in which the market might come back.)
- Alec
Not so risky? You are assuming a 3% real rate on TIPS over 40 years, what is the historical data to support that? And you are assuming almost 50% of your income will come from a social security system that may or may not exist in its same form - you don't consider that a risk?
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Post by alec »

avalpert wrote:Not so risky? You are assuming a 3% real rate on TIPS over 40 years, what is the historical data to support that? And you are assuming almost 50% of your income will come from a social security system that may or may not exist in its same form - you don't consider that a risk?
1) Historical Data:In the 18th century, bonds had real returns of slightly over 5%, see Only Two Centuries of Data. From 1900-1980, real returns on bonds was nil. After 1980, real returns on bonds was higher than 3%.

2) The expected future return on a bond is its YTM, which is currently around 3% for LT TIPS. Do you have a better way to forecast the future expected return on a bond?

Sure SS income is a risk, as is my pension. But, IMO, a smaller risk than equities. And I'm certainly not going to try and jack up my risk, and potential return, by allocating more to equities b/c I think SS may not be there. I'd rather just contribute more and/or work longer.

- Alec
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Post by avalpert »

alec wrote:
1) Historical Data:In the 18th century, bonds had real returns of slightly over 5%, see Only Two Centuries of Data. From 1900-1980, real returns on bonds was nil. After 1980, real returns on bonds was higher than 3%.

2) The expected future return on a bond is its YTM, which is currently around 3% for LT TIPS. Do you have a better way to forecast the future expected return on a bond?
No, but that is the expected return on the LT TIPS today, it is not what the expected return on a bond bought next year, or the year after, or the year after is. Your model needs it to be 3% until retirement not just is this particularly erratic environment. Maybe TIPS will return that much but I don't think it is less risky then thinking equites will pay more over that horizon.
Sure SS income is a risk, as is my pension. But, IMO, a smaller risk than equities. And I'm certainly not going to try and jack up my risk, and potential return, by allocating more to equities b/c I think SS may not be there. I'd rather just contribute more and/or work longer.

- Alec
Personally, I assume 0 social security in retirement (and if we ever get a politician with any guts in the white house it should be 0 for people with signficant wealth) when calculating my retirement needs. Does this cause me to take on too much risk, I don't think so my allocation is not that risky by historical standards and I would suggest less risky than 100% bonds would be.
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Post by MossySF »

alec wrote:I beg to differ. Using Bodie's Worry Free Calculator, if I'm 25, plan on retiring when I'm 65, living to 100, earn $50,000, need 70% of that, and get $15,000 from SS, I only need to save 11% of my income every year at a 3% real interest rate, which LT TIPS are currently paying. Doesn't seem very hard and I'm not in a risky position except that I have to reinvest those 3% real yields on unknown future interest rates. Oh, stripped TIPS, where art thou?
The biggest risk in your scenario is neither the dependence on social security nor the 3% TIPS yield. Iinstead, it's the working 25 to 65 assumption. The days of cradle to grave jobs are over. My personal feeling is for folks starting out today, 30 to 55 is probably what they should plan for as their saving periods -- unless they are stars in their fields.
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Post by DSInvestor »

Alec,

If someone is 25 today and wishes to retire in 40 yrs at age 65, your projection of 70% of 50K (35K) to live on is low. If you plan your savings based on needing 35K - 15K Social security or 20K per year, you may severely underfund your retirement. the trick is not to use a percentage of anticipated income at retirement, but an estimate of what costs will be at retirement and beyond.

If we assume inflation of 3.5%, costs will double every 20 yrs. If your expenses today are 20K, they'd be 80K in 40 yrs.

Working backwards 35K expenses in 40 yrs is like living on 8.5K per year today. Can you live comfortably on 8.5K per year today?

Now factor in health and medical requirements if you're older. What will be the cost of health insurance between the time that you retire and the time that you qualify for Medicare? Your health insurance premiums today at age 63 could be more than 8.5K.

Even if you're healthy, your property tax could easily approach 8.5K in many parts of the country. Look at New York State and Texas.

If we assume 4% withdrawal rate on retirement savings, your scenario of 20K expenses implies 500K of assets at retirement. If we assume 80K of expenses (fully funded by our savings alone), we're now talking $2M at retirement.

500K is relatively easy to achieve in 40 yrs.
Starting from ZERO, assume straight line growth of 8%, annual contributions of $1800 would get you to 500K in 40 yrs.

$2M is much harder to achieve in 40 yrs.
Starting from ZERO, assuming 8% growth, annual contributions of 7500 are needed.

The picture gets more grim if the investor waits to start saving.
To achieve $2M in 30 yrs at 8% growth, annual contributions of 16.5K are needed.

If investor starts even later, to achieve $2M in 20 yrs, at 8% growth, annual contributions of 41K are required.

This why some posters suggest that retirement plan contributions are inadequate for achieve our goals. When we're young we have low incomes relative to expenses. We may not put much away. When our incomes start rising so do our expenses, we may get married, buy a house, have children. If we start saving late, we run into the problems of shorter time horizon to reach the investment goal. If we accumulate debt we're in even worse shape.

Remember, we can't control returns in our investments. The elements we can control are the annual contributions, the allocation of the investments and the risk we take. The larger the contributions we can afford to make, the earlier we make those contributions, the less risk we need to take, the greater the probability of success. Such is the magic of compounding.

If we're a little short of retirement asset goal, we may be able to postpone retirement or try to trim expenses. Trimming expenses significantly may be tough late in life, especially if you still have a mortgage or are in poor health.

DS
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Post by alec »

DSInvestor,

The calculations I did were all in real terms, so I can ignore inflation. So your income would rise with inflation, as would your savings.

- Alec
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Post by alec »

avalpert wrote:
alec wrote:
1) Historical Data:In the 18th century, bonds had real returns of slightly over 5%, see Only Two Centuries of Data. From 1900-1980, real returns on bonds was nil. After 1980, real returns on bonds was higher than 3%.

2) The expected future return on a bond is its YTM, which is currently around 3% for LT TIPS. Do you have a better way to forecast the future expected return on a bond?
No, but that is the expected return on the LT TIPS today, it is not what the expected return on a bond bought next year, or the year after, or the year after is. Your model needs it to be 3% until retirement not just is this particularly erratic environment. Maybe TIPS will return that much but I don't think it is less risky then thinking equites will pay more over that horizon.
Let's see I could get b/w 1-3% real return from TIPS, or anywhere b/w -2 to 7% real return from equities over the next 30-40 years. Gee, I wonder which is "safer?" btw, as I said above, with a whole lot of TIPS, I'd be at some reinvestment risk, as I would be with any bonds or stock. Which is why I asked [nicely] for stripped TIPS.
Sure SS income is a risk, as is my pension. But, IMO, a smaller risk than equities. And I'm certainly not going to try and jack up my risk, and potential return, by allocating more to equities b/c I think SS may not be there. I'd rather just contribute more and/or work longer.

- Alec
Personally, I assume 0 social security in retirement (and if we ever get a politician with any guts in the white house it should be 0 for people with signficant wealth) when calculating my retirement needs. Does this cause me to take on too much risk, I don't think so my allocation is not that risky by historical standards and I would suggest less risky than 100% bonds would be.
First, risky by historical standards is one of the things Samuelson was arguing against. Just b/c stocks did a whole lot better than safer investments in the 1900's does not mean that they will do better in the future. For example, take a look at the 1800's in the link above.

Now you may be perfectly okay with saving for your "must have or I'll starve" expenses in stocks, but I'm definitely not okay with that. I'd much rather use TIPS.

To be clear, I'm not saying that you have to be 100% stocks or 100% TIPS. Just that I'm rather scared to have the money I absolutely need to have in retirement to live not in poverty in equities, commodities, etc. I'd rather have that savings, which is only a portion of my retirement savings, in TIPS.

- Alec
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Post by alec »

MossySF wrote:
alec wrote:I beg to differ. Using Bodie's Worry Free Calculator, if I'm 25, plan on retiring when I'm 65, living to 100, earn $50,000, need 70% of that, and get $15,000 from SS, I only need to save 11% of my income every year at a 3% real interest rate, which LT TIPS are currently paying. Doesn't seem very hard and I'm not in a risky position except that I have to reinvest those 3% real yields on unknown future interest rates. Oh, stripped TIPS, where art thou?
The biggest risk in your scenario is neither the dependence on social security nor the 3% TIPS yield. Iinstead, it's the working 25 to 65 assumption. The days of cradle to grave jobs are over. My personal feeling is for folks starting out today, 30 to 55 is probably what they should plan for as their saving periods -- unless they are stars in their fields.
You don't need the same job from 25 to 65. In my example, the person just worked from 25 to 65. Also, they don't need to save the same amount over that time period. They can dissave at points in their life when they need to, and the save more at points in their life when they can. I'd bet this is more what people do - can't save much until they're 30, and then save from 30-retirement.

- Alec
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Post by redbeard »

alec wrote:First, risky by historical standards is one of the things Samuelson was arguing against. Just b/c stocks did a whole lot better than safer investments in the 1900's does not mean that they will do better in the future. For example, take a look at the 1800's in the link above.
From the link you reference, real returns of stocks exceeded real returns of bonds in the 1800s. So this data actually proves the opposite point.

While it is certainly possible at any given starting point in time for long term bonds to outperform stocks over a 30 year period, there are strong reasons why this out performance is highly unlikely to be sustained. This isn't just because equity investors want a risk premium. Corporate management has a fiduciary responsibility to only issue bonds if doing so is expected to increase the risk adjusted return on equity ("leverage"). If interest rates are higher than expected ROE, issuing (or keeping existing) debt will lower risk adjusted ROE. So not only would we expect equity investors to stop purchasing stock if this gets out of whack, but corporations would stop borrowing and where possible even call existing bonds as well (issuing more shares to do so). This reaction by corporations would lead to lower interest rates for both corporate and government debt (since the two markets are linked).

The only way you will see sustained periods where bonds outperform equity is if both equity investors and corporate management continue to overestimate future profitability by a large amount during that time period. Certainly this can happen for intermediate periods of time, but over the long term it is very unlikely.
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Post by MossySF »

alec wrote:You don't need the same job from 25 to 65. In my example, the person just worked from 25 to 65. Also, they don't need to save the same amount over that time period. They can dissave at points in their life when they need to, and the save more at points in their life when they can. I'd bet this is more what people do - can't save much until they're 30, and then save from 30-retirement.
All I'm saying is even the above is rather wishful thinking in today's employment environment. If you get downsized at 50, it's a slow march to folding clothes at Walmart. So while you're not taking equities risk, now you're taking employer risk, your industry risk, the local/national/global economy risk. This means instead of using that calculator and spitting out 11%, you probably need to alter the parameters to spit out 25%.
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Post by alec »

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Post by alec »

redbeard wrote:
alec wrote:First, risky by historical standards is one of the things Samuelson was arguing against. Just b/c stocks did a whole lot better than safer investments in the 1900's does not mean that they will do better in the future. For example, take a look at the 1800's in the link above.
From the link you reference, real returns of stocks exceeded real returns of bonds in the 1800s. So this data actually proves the opposite point.

While it is certainly possible at any given starting point in time for long term bonds to outperform stocks over a 30 year period, there are strong reasons why this out performance is highly unlikely to be sustained. This isn't just because equity investors want a risk premium. Corporate management has a fiduciary responsibility to only issue bonds if doing so is expected to increase the risk adjusted return on equity ("leverage"). If interest rates are higher than expected ROE, issuing (or keeping existing) debt will lower risk adjusted ROE. So not only would we expect equity investors to stop purchasing stock if this gets out of whack, but corporations would stop borrowing and where possible even call existing bonds as well (issuing more shares to do so). This reaction by corporations would lead to lower interest rates for both corporate and government debt (since the two markets are linked).

The only way you will see sustained periods where bonds outperform equity is if both equity investors and corporate management continue to overestimate future profitability by a large amount during that time period. Certainly this can happen for intermediate periods of time, but over the long term it is very unlikely.
Good catch!! I really need to work on my reading comprehension, eh? In fact, I think the real world data may even more against my argument that riskier assets [like equities] don't always outperform safer assets [like bonds, T-bills, etc]. However, this is just my recollection from talking with people who read Siegel's "Stocks for the long run" and "Triumph of the Optimists."

Yesterday and last night I kept asking myself, if equities are such a sure bet over long periods of time over safe assets, like T-bills, someone should be willing to insure that the opposite doesn't happen. Also, if this surety increases with the passage of time, the premium for this insurance should go down. Well, alas I reminded mysef of Bodie's refutation of this theory in 1995. To quote the 1997 Samuelson article:
...Still unconvinced? Let's go from academic mathematics to practical insurance. Dr. Zvi Bodie of Boston University, acclaimed pension expert, will be our guide in buying portfolio insurance to cover any shortfall of outcome below the 5 percent safe rate of total return available from past money market funds. What insurance premium must that one-year investor pay to be guaranteed against ending up with less than the safe 5 percent of a money market fund? And what premium N must investors pay for time horizons of N+2, or 10, or 40 to ensure they do not go below the safe rate? The Black-Scholes options formula , Dr. Bodie points out, must be used by any insurance firm that you can count on to stay solvent. Does premium N to down as N grows - as the current dogma (with its misunderstanding of the Law of Large numbers) implies?

No. And no. The premium N grows with N, and when N gets really big the premium eats up 100 percent of your excess gain. Some bargain. Total risk grows rather than diminishes with the time horizon. Whenever you pay the needed premium to cover any losses that go below the modest safe rate, you are left only with that safe rate
Now redbeard did not say that stocks will definitely always outperform safer assets over long periods of time, just that it was very likely. Again, I'd rather not bet my "need to eat and heat my house money" on a very likely probability. I want 100% safety for this money. Now, for the money with which to go to the movies or buy a nicer car I'd probably be willing to bet that stocks will beat safer assets.

- Alec
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Post by alec »

MossySF wrote:All I'm saying is even the above is rather wishful thinking in today's employment environment. If you get downsized at 50, it's a slow march to folding clothes at Walmart. So while you're not taking equities risk, now you're taking employer risk, your industry risk, the local/national/global economy risk. This means instead of using that calculator and spitting out 11%, you probably need to alter the parameters to spit out 25%.
I was thinking about this last night, and you know what, MossySF is probably right for a good portion of the population. Because of job insecurity, a person might not be able to work 40 years, he/she may only be able to work 20, 25, or 30 years. As such, he/she may have to save more than 10 or 11% of his/her salary every year, which only a person with a very safe job [i.e. tenured prof or fed gov't employee] may be able to do. However, fear not, b/c if you have a riskier job [i.e. tenured prof or fed gov't employee] you should be compensated with higher compensation. So, while you may have to save a greater % of your salary for a shorter period of time, your consumption can probably be about the same as the tenured prof or fed gov't employee.

As dmcmahon noted above, people saving more than 20% of their income will probably have to use taxable account. And currently equity returns are taxed much more favorably than bond returns. Unfortunately, the flip side of this is that if you have a risky job [and risky human capital] from which you might be downsized at a moment's notice, you probably shouldn't be invested a good deal in assets that correlate with your job, like equities.

- Alec
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Post by alec »

I thought I'd leave on a thought provoking quote from Samuelson's 1997 article:
... Most of the time the buy and hold common stock investors do beat their more cautious neighbors; and, as the time horizon N becomes larger, the odds do grow that the bold holders of stock will win the duel. But it is also true that a longer time horizon brings bigger losses when an inevitable loss does occur.

Canny risk averters should always keep in mind, in a rational, nonparanoid way, the pains they will feel in those probability-calculated bad outcome scenarios. (As yourself: Will stepping down toward a poverty level, when that rarely but inevitably does happen, outweigh for me the pleasures that occur in those likely outcomes when my equity nest egg does increase?) When we each do that, those of us who truly are more risk averse will rationally hedge our bets by limiting our exposure to volatile equities.
- Alec
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The past 30 years...

Post by Trev H »

.
01/01/1979-10/17/2008 (the past 30 years).


US Cap Weighted Market
====
StDev
17.52
CAGR
10.88

Total International (85%EAFE/15%EM)
====
StDev
23.70
CAGR
9.92

Total Bond
=======
StDev
6.02
CAGR
8.22

T-Bills
====
StDev
3.19
CAGR
5.70


Oh well, since we are at a rather extreme low point for stocks, just checking to see if Stocks did go up the past 30 years.

What do you know - they did :-)

And how bonds/cash performed.

Trev H
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Post by alec »

MossySF wrote:All I'm saying is even the above is rather wishful thinking in today's employment environment. If you get downsized at 50, it's a slow march to folding clothes at Walmart. So while you're not taking equities risk, now you're taking employer risk, your industry risk, the local/national/global economy risk. This means instead of using that calculator and spitting out 11%, you probably need to alter the parameters to spit out 25%.
I was thinking about this last night, and you know what, MossySF is probably right for a good portion of the population. Because of job insecurity, a person might not be able to work 40 years, he/she may only be able to work 20, 25, or 30 years. As such, he/she may have to save more than 10 or 11% of his/her salary every year, which only a person with a very safe job [i.e. tenured prof or fed gov't employee] may be able to do. However, fear not, b/c if you have a riskier job [i.e. tenured prof or fed gov't employee] you should be compensated with higher compensation. So, while you may have to save a greater % of your salary for a shorter period of time, your consumption can probably be about the same as the tenured prof or fed gov't employee.

However, in reality the tenured prof or fed gov't employee is already probably saving 20% of his/her income b/c the school and/or gov't is forcing them to save through the school/govt's contributions to retirement plans [either DB or DC]. So the tenured prof or fed gov't worker will probably be able to retire in less time than 40 years. In my case, I'm probably saving about 20% of my income through my and my employers contributions to my retirement plans both DB and DC]. So I suppose the compensation gap is that wide.

As dmcmahon noted above, people saving a lot of their income, probably b/c of riskier jobs, will probably have to use taxable account. And currently equity returns are taxed much more favorably than bond returns. Unfortunately, the flip side of this is that if you have a risky job [and risky human capital] from which you might be downsized at a moment's notice, you probably shouldn't be invested a good deal in assets that correlate with your job, like equities.

- Alec
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