Why is 60/40 supposed to be the best for retirement?

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Poe22
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Why is 60/40 supposed to be the best for retirement?

Post by Poe22 »

I've asked myself why 60/40 is often recommended as retirement portfolio. Backtesting 60/40 with a portfolio of 1 Mio. and an annual withdrawal of 50'000, a 60/40 portfolio has significantly lower returns than a 100% US stock market portfolio. Of course, Sharpe ratio is a little better for 60/40, but does that really matter as long as my safe withdrawal rate works?

Of course, there have been historically low return periods for stocks (e.g. 1999-2009), but these are usually followed by better periods. Also, life expectancy after retirement is often more than 10 years, so you can sit out the bad times. And again: the safe withdrawal rate also works during the bad times, so why worry about volatility?

Here's a backtest.

https://www.portfoliovisualizer.com/bac ... tion3_2=40
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PicassoSparks
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Re: Why is 60/40 supposed to be the best for retirement?

Post by PicassoSparks »

It’s not “the best.” It’s “good enough.”

Your backtest goes back to only 1987. I’d get curious about what happened outside that range.

Try making your withdrawals inflation adjusted and playing with start dates, even in your restricted range.

1999 is an interesting year to retire on all stocks.
2000 you run out of money.
2001 is interesting again.
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Poe22
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Poe22 »

Thanks for your feedback, greatly appreciated! Limited backtesting period and inflation are fair points indeed. So I've extended the backtesting period (1978) and selected inflation-adjusted withdrawals of 50'000 annually:

https://www.portfoliovisualizer.com/bac ... tion2_1=40
PicassoSparks wrote: Fri Sep 16, 2022 4:28 am 2000 you run out of money.
Still, I don't see how I'd ever have run out of money in any period of time since 1978. And by 2022, I'd have been clearly outperforming 60/40 (both inflation-adjusted or not). Did I miss something?
woodside
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Re: Why is 60/40 supposed to be the best for retirement?

Post by woodside »

Poe22 wrote: Fri Sep 16, 2022 4:56 am Thanks for your feedback, greatly appreciated! Limited backtesting period and inflation are fair points indeed. So I've extended the backtesting period (1978) and selected inflation-adjusted withdrawals of 50'000 annually:

https://www.portfoliovisualizer.com/bac ... tion2_1=40
PicassoSparks wrote: Fri Sep 16, 2022 4:28 am 2000 you run out of money.
Still, I don't see how I'd ever have run out of money in any period of time since 1978. And by 2022, I'd have been clearly outperforming 60/40 (both inflation-adjusted or not). Did I miss something?
Your starting time is 1978. PicassoSparks's point is that if you choose the starting time at 2000, then you run out of money at 2017. See the updated
https://www.portfoliovisualizer.com/bac ... tion2_1=40
tvubpwcisla
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Re: Why is 60/40 supposed to be the best for retirement?

Post by tvubpwcisla »

The best allocation in retirement is the one that allows you to sleep comfortably at night.
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PicassoSparks
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Re: Why is 60/40 supposed to be the best for retirement?

Post by PicassoSparks »

1978 is still relatively recent history. This video narratively covers US bear markets back to 1900.
https://www.youtube.com/watch?v=Jh9Gn58r9Fw

There's been a number of times when the markets dropped and stayed down for many years in a row (this does not match what we've lived through where sudden drops have been following by steady recoveries). If this is an accumulation period that's great news! You can buy a bunch of stocks cheap! If this is a spending period, you may not have enough money left over to benefit from the recovery.

When stocks go well, they tend to go really well. When they go badly, they tend to go really badly. There's no particular award for retiring with much, much more money than you will spend, unless your posthumous legacy is important to you. So it often makes sense to give up a bunch of high score outcomes to which you should be indifferent in order to hedge against low score outcomes, which are very bad to live through.

Whether this is precisely 60/40 is a whole other question. But it's offered as a decent starting point for most people.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by mptfan »

Can you cite to a source that says 60/40 is the best for retirement?
KlangFool
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Re: Why is 60/40 supposed to be the best for retirement?

Post by KlangFool »

OP,

It has nothing to do with being the best.

A) The standard retirement portfolio size = 25 X annual expense.

B) The standard advice is to keep 10 years of expense at fixed income.

C) Combining (A) and (B), you get 60/40.

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vineviz
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Re: Why is 60/40 supposed to be the best for retirement?

Post by vineviz »

Poe22 wrote: Fri Sep 16, 2022 3:31 am I've asked myself why 60/40 is often recommended as retirement portfolio. Backtesting 60/40 with a portfolio of 1 Mio. and an annual withdrawal of 50'000, a 60/40 portfolio has significantly lower returns than a 100% US stock market portfolio. Of course, Sharpe ratio is a little better for 60/40, but does that really matter as long as my safe withdrawal rate works?
I don't know of anyone who would outright say that 60/40 is "best": that's a clearly subjective description. Without a defined metric by which "best" can be judged, it's kind of a nebulous concept.

In general, though, when you're planning for retirement it's important to remember that you only get once chance at it: YOU will experience just a single sequence of market returns during your retirement year.

So a strategy that "usually" works or works "on average" might still fail for YOU.

It's a tired analogy, but if you flip a fair coin 10,000 times you'll probably get pretty close to 50% heads and 50% tails. If you flip it only once you'll get either 100% heads or 100% tails.

The diversification of a balanced portfolio provides resilience, which is the ability to capture some level of success in a variety of situations. And a "failure", aka outliving your money, is a lot worse than dying with excess wealth is good.

The "optimal" mix of stocks and bonds will depend on a lot of factors, including your level of loss aversion and the amount of other income you have (e.g. Social Security) relative to your needs. But for MOST people, a portfolio somewhere between 50/50 and 90/10 will maximize their retirement income without exceeding their capacity to risk running out of money. As I said, though, it depends on the person and their circumstances.
Last edited by vineviz on Fri Sep 16, 2022 7:27 am, edited 1 time in total.
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Logan Roy
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Logan Roy »

Poe22 wrote: Fri Sep 16, 2022 3:31 am I've asked myself why 60/40 is often recommended as retirement portfolio. Backtesting 60/40 with a portfolio of 1 Mio. and an annual withdrawal of 50'000, a 60/40 portfolio has significantly lower returns than a 100% US stock market portfolio. Of course, Sharpe ratio is a little better for 60/40, but does that really matter as long as my safe withdrawal rate works?

Of course, there have been historically low return periods for stocks (e.g. 1999-2009), but these are usually followed by better periods. Also, life expectancy after retirement is often more than 10 years, so you can sit out the bad times. And again: the safe withdrawal rate also works during the bad times, so why worry about volatility?

Here's a backtest.

https://www.portfoliovisualizer.com/bac ... tion3_2=40
Not disagreeing with you. But I think the huge flaw with backtests over this period is they only really cover one broad macroeconomic trend – which is mostly falling rates and inflation:

Image

This has provided a perpetual safety net and cushion for stock market returns – rates could always go lower, and inflation stopped being a risk. It also, however, provided endless upside for bonds – this has been a 40 year bond bull market - so this should've been the ideal environment for 60:40, and I think that's heavily influenced how it became a default recommendation. I think in Bogle's era, there was also the issue of practicality: there weren't really many other options (certainly low cost).

But I think what you find is that putting too much in stocks is inherently unstable. Personally, I don't think bonds are the solution. I think TIPS make more sense (but haven't been available very long, so don't really factor into the backtested view of things very much yet). I think real assets in general (gold to infrastructure) make sense as ways to avoid too much concentration in stocks. And I also think overweighting defensive stock sectors (Consumer Staples, Healthcare, Utilities ETFs) might be a significantly overlooked way of managing risk within stocks.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by livesoft »

I don't know about "best", but your own backtest shows that the Max Drawdown of the 100% stock portfolio is more than 50% while that of the 60/40 portfolios is much less. Sometimes it is about psychology. Maybe you are used to routinely losing a million or more dollars, but as a member of that club that's a financial milestone that I have not gotten used to yet.
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Poe22
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Poe22 »

woodside wrote: Fri Sep 16, 2022 5:37 am Your starting time is 1978. PicassoSparks's point is that if you choose the starting time at 2000, then you run out of money at 2017. See the updated
https://www.portfoliovisualizer.com/bac ... tion2_1=40
Oh boy, this is a true eye-opener, I feel slightly embarrassed. Losing the game (going to zero) is of course the worst of all outcomes. Thanks for explaining, all of you!

If I entered 1.5 Mio. starting off, I wouldn't be wiped out by 2017. But 100% US stocks would be horrendously lagging behind a 60/40 portfolio by 2022.
PicassoSparks wrote: Fri Sep 16, 2022 6:59 am There's been a number of times when the markets dropped and stayed down for many years in a row (this does not match what we've lived through where sudden drops have been following by steady recoveries). If this is an accumulation period that's great news! You can buy a bunch of stocks cheap! If this is a spending period, you may not have enough money left over to benefit from the recovery.
Very true. So there's no way around distinguishing your accumulation and decumulation portfolios after all, I guess.

Regarding the extended bad periods for 100% stock portfolios, isn't it incredibly risky to wait with switching from your stock-only portfolio to a 60/40 portfolio until you're 10 or even less years from retirement?
Last edited by Poe22 on Fri Sep 16, 2022 8:12 am, edited 1 time in total.
dbr
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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

1. The idea that some particular asset allocation is the best or is recommended is silly. There is lots of silly stuff around that can be dealt with by ignoring it.

2. My guess is that 60/40 gets that mention because safe withdrawal rate studies tend to show a slight and meaningless maximum at an asset allocation of around 60/40.

3. You mention a better return in a certain scenario for 100/0 over 60/40. If return is your objective and figure of merit then 100/0 would be a better choice. That is a pretty standard result. Note that measure is expected or average return but the uncertainty in what you get is also greater at 100/0. A more detailed view of what that has looked like historically is here: https://engaging-data.com/visualizing-4-rule/

4. The first step in investing is to be sure you understand what you are trying to do. It is meaningless to just ask what is the "best" portfolio.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by woodside »

Poe22 wrote: Fri Sep 16, 2022 7:35 am If I entered 1.5 Mio. starting off, I wouldn't be wiped out by 2017. But 100% US stocks would be horrendously lagging behind a 60/40 portfolio by 2022.
Yes, if your withdrawal rate is not 5% (50K/1M), but now 3.33% (50K/1.5M), you would have a little better outcome. The % of stocks in the asset allocation is always depending on the withdrawal rate. Say you have 50X of annual expense, you only need a 2% withdrawal rate, 100/0 will probably be better than 60/40 in most situations. I believe KlangFool mentioned that most people retired at 25X (4% withdrawal rate), if wanting the money protected for 10 years, then the asset allocation is 60/40
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Re: Why is 60/40 supposed to be the best for retirement?

Post by revhappy »

I am more of a safety 1st proponent. So I like to have a bond floor of an absolute amount and then beyond that take risk. So for example, if my portfolio is 2 million, I want to have 500k safe and then remaining in equity. If I have 1 million, I still want to have 500k safe and remaining in equity. The safe bond floor allows you to keep your allocation and take risk with the remaining part of your portfolio.

In the ideal situation, by the time your retire, you should have the 'ability' to risk but definitely you shouldnt have the 'need' to take excessive risk. That will allow you the 'willingness'to take risk ;)
strummer6969
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Re: Why is 60/40 supposed to be the best for retirement?

Post by strummer6969 »

You could do a lot worse than 60/40 over a multi-decade timeframe. Add a bit of commodities over time to make it more robust. Other than that, it's still a fine portfolio for passive investment. You just happen to be in a period where everything is getting beaten up. Having a pension and/or cash equivalents to draw from during this period might serve you well.

(not financial advice, just my 2 cents)
Last edited by strummer6969 on Fri Sep 16, 2022 9:17 am, edited 1 time in total.
martincmartin
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Re: Why is 60/40 supposed to be the best for retirement?

Post by martincmartin »

Poe22 wrote: Fri Sep 16, 2022 3:31 am I've asked myself why 60/40 is often recommended as retirement portfolio. Backtesting 60/40 with a portfolio of 1 Mio. and an annual withdrawal of 50'000, a 60/40 portfolio has significantly lower returns than a 100% US stock market portfolio.
Try it at cFIREsim. Look in particular at the great depression, when stocks lost 90% but, thanks to deflation, the purchasing power of bonds went up significantly.
Random Walker
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Random Walker »

60/40 has about 85-90% of its risk wrapped up in a single factor, market beta.

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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

martincmartin wrote: Fri Sep 16, 2022 8:54 am
Poe22 wrote: Fri Sep 16, 2022 3:31 am I've asked myself why 60/40 is often recommended as retirement portfolio. Backtesting 60/40 with a portfolio of 1 Mio. and an annual withdrawal of 50'000, a 60/40 portfolio has significantly lower returns than a 100% US stock market portfolio.
Try it at cFIREsim. Look in particular at the great depression, when stocks lost 90% but, thanks to deflation, the purchasing power of bonds went up significantly.
Right. 60/40 has been the location of a historical small optimum in safe withdrawal rate because SWR depends on avoiding worst worse cases and that works with 60/40 in 1929. When nothing worked was the late '60s and that tends to be the defining case for SWR. If a person's objectives are not defined by SWR it is hardly likely 60/40 will be uniquely better than other choices. It is reasonable to contemplate how one would like what a 100/0 portfolio might do, a 0/100 portfolio, or a 50/50 portfolio, or any of the options in between.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by smitcat »

KlangFool wrote: Fri Sep 16, 2022 7:10 am OP,

It has nothing to do with being the best.

A) The standard retirement portfolio size = 25 X annual expense.

B) The standard advice is to keep 10 years of expense at fixed income.

C) Combining (A) and (B), you get 60/40.

KlangFool
"C) Combining (A) and (B), you get 60/40."
What happens when you start to get more than 10 years of future expenses in fixed income - do you add to the stock portion?
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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

Random Walker wrote: Fri Sep 16, 2022 8:59 am 60/40 has about 85-90% of its risk wrapped up in a single factor, market beta.

Dave
That is interesting but the significance of that depends on what the investor is trying to do and what the effect might be of finding a portfolio the risk of which is attributed significantly differently to something else. A portfolio of all TIPS funds has its risk mainly tied up in term risk and might be more suitable to someone. A TIPS declining ladder I suppose has only longevity risk and might be suitable to a different person.

It might be reasonable to dispute that 60/40 is much different from 70/30 all the way to 100/0. One could open the can of worms of spreading risk to other factors than market beta, but it might be hard to show that anyone's purpose is significantly aided by that.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

smitcat wrote: Fri Sep 16, 2022 9:06 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am OP,

It has nothing to do with being the best.

A) The standard retirement portfolio size = 25 X annual expense.

B) The standard advice is to keep 10 years of expense at fixed income.

C) Combining (A) and (B), you get 60/40.

KlangFool
"C) Combining (A) and (B), you get 60/40."
What happens when you start to get more than 10 years of future expenses in fixed income - do you add to the stock portion?
No, you give it away because charity is rewarding. This is not a facetious answer.

More responsively, a person who is committed to a plan to maintain a rebalanced asset allocation would rebalance to 60/40. That does not directly answer the question regarding why 60/40 in the first place. It also ignores that people who commit to rebalanced asset allocations probably do not go by 10 years of expenses in fixed income rules to start with.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by WoodSpinner »

smitcat wrote: Fri Sep 16, 2022 9:06 am
"C) Combining (A) and (B), you get 60/40."
What happens when you start to get more than 10 years of future expenses in fixed income - do you add to the stock portion?

Smitcat,

What you do at that point is part if personal finance (I suspect you are well aware of this….). This is the good and bad of having enough. You have to decide.

For us, we start with our Retirement priorities and work from there.

For instance:
- We increased our Travel spending
- Increased gifts to family
- Increased Charitable donations
- Kept our AA the same

Others may reasonably decide on a different course.

WoodSpinner
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Re: Why is 60/40 supposed to be the best for retirement?

Post by sailaway »

KlangFool wrote: Fri Sep 16, 2022 7:10 am

B) The standard advice is to keep 10 years of expense at fixed income.


KlangFool
You call it standard advice, but I rarely see it outside of your posts.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by woodside »

smitcat wrote: Fri Sep 16, 2022 9:06 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am OP,

It has nothing to do with being the best.

A) The standard retirement portfolio size = 25 X annual expense.

B) The standard advice is to keep 10 years of expense at fixed income.

C) Combining (A) and (B), you get 60/40.

KlangFool
"C) Combining (A) and (B), you get 60/40."
What happens when you start to get more than 10 years of future expenses in fixed income - do you add to the stock portion?
Putting away the extra money into the stock should be good. If you want to reduce the risk, you can also invest the new money with the 60/40 plan.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

sailaway wrote: Fri Sep 16, 2022 9:49 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am

B) The standard advice is to keep 10 years of expense at fixed income.


KlangFool
You call it standard advice, but I rarely see it outside of your posts.
I think you can find that sort of thing in a number of places, but I agree it is not the more common advice of holding a rebalanced portfolio of stocks and bonds at some asset allocation target. I think it might be Bill Bernstein is one of the ones who has tended to talk about X years of income in "safe" assets, but he mooted 20X but X of absolutely essential spending and not total spending. A more important point is that 10X on 25X at 60/40 comes to about the same thing. The reason why 10 in the 10X might need more discussion.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by vineviz »

sailaway wrote: Fri Sep 16, 2022 9:49 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am

B) The standard advice is to keep 10 years of expense at fixed income.


KlangFool
You call it standard advice, but I rarely see it outside of your posts.
We could even call it sub-standard advice, since it doesn't take into account many of the most relevant circumstances a retiree faces.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Random Walker »

dbr wrote: Fri Sep 16, 2022 9:08 am
It might be reasonable to dispute that 60/40 is much different from 70/30 all the way to 100/0. One could open the can of worms of spreading risk to other factors than market beta, but it might be hard to show that anyone's purpose is significantly aided by that.
I believe that Monte Carlo Simulations would show higher success rates when risks are spread more evenly. The huge issue is sequence of returns risk, especially early in retirement.

Dave
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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

Random Walker wrote: Fri Sep 16, 2022 10:53 am
dbr wrote: Fri Sep 16, 2022 9:08 am
It might be reasonable to dispute that 60/40 is much different from 70/30 all the way to 100/0. One could open the can of worms of spreading risk to other factors than market beta, but it might be hard to show that anyone's purpose is significantly aided by that.
I believe that Monte Carlo Simulations would show higher success rates when risks are spread more evenly. The huge issue is sequence of returns risk, especially early in retirement.

Dave
Some time back I asked Larry Swedroe if the "Larry" portfolio of all SCV diluted more in bonds intended to cut downside risk should also result in a higher SWR, and he thought it should, but data there was not.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Random Walker »

dbr wrote: Fri Sep 16, 2022 10:58 am
Random Walker wrote: Fri Sep 16, 2022 10:53 am
dbr wrote: Fri Sep 16, 2022 9:08 am
It might be reasonable to dispute that 60/40 is much different from 70/30 all the way to 100/0. One could open the can of worms of spreading risk to other factors than market beta, but it might be hard to show that anyone's purpose is significantly aided by that.
I believe that Monte Carlo Simulations would show higher success rates when risks are spread more evenly. The huge issue is sequence of returns risk, especially early in retirement.

Dave
Some time back I asked Larry Swedroe if the "Larry" portfolio of all SCV diluted more in bonds intended to cut downside risk should also result in a higher SWR, and he thought it should, but data there was not.
We can only invest looking forward. We formulate expected returns for different asset classes and can get a feel with MCS. But no telling which history will play out

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Re: Why is 60/40 supposed to be the best for retirement?

Post by martincmartin »

sailaway wrote: Fri Sep 16, 2022 9:49 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am

B) The standard advice is to keep 10 years of expense at fixed income.


KlangFool
You call it standard advice, but I rarely see it outside of your posts.
Agreed. And if you back test it, using a SWR/Trinity style analysis, you find it performs poorly. It's a falling equity glide path, since once you're 10 years from the end of retirement, you're all fixed income. So it's not a fixed 60/40 in retirement at all.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

martincmartin wrote: Fri Sep 16, 2022 11:23 am
sailaway wrote: Fri Sep 16, 2022 9:49 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am

B) The standard advice is to keep 10 years of expense at fixed income.


KlangFool
You call it standard advice, but I rarely see it outside of your posts.
Agreed. And if you back test it, using a SWR/Trinity style analysis, you find it performs poorly. It's a falling equity glide path, since once you're 10 years from the end of retirement, you're all fixed income. So it's not a fixed 60/40 in retirement at all.
I doubt the 10X advice means to always keep the fixed income at that amount. I think it is more a starting point at the beginning. But the question there is what is the advice as time goes on. X/Y rebalanced tells one what to do the whole way through.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by AlwaysLearningMore »

sailaway wrote: Fri Sep 16, 2022 9:49 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am

B) The standard advice is to keep 10 years of expense at fixed income.


KlangFool
You call it standard advice, but I rarely see it outside of your posts.
Is this a variation of that advice?

Q. How much do people need to save to ensure success?

Your target should be to save 25 years of residual living expenses, which is the amount that isn't covered by Social Security and a pension, if you get one. Say you need $70,000 to live on, and your Social Security and pension amount to $30,000. You'll have to come up with $40,000 to pay your remaining expenses. To produce that income, you'll need a safe portfolio of $1 million, assuming a 4% withdrawal rate.


William Bernstein interview https://money.com/to-invest-for-retirem ... of-stocks/
Retirement is best when you have a lot to live on, and a lot to live for. * None of what I post is investment advice.
dbr
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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

AlwaysLearningMore wrote: Fri Sep 16, 2022 11:29 am
sailaway wrote: Fri Sep 16, 2022 9:49 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am

B) The standard advice is to keep 10 years of expense at fixed income.


KlangFool
You call it standard advice, but I rarely see it outside of your posts.
Is this a variation of that advice?

Q. How much do people need to save to ensure success?

Your target should be to save 25 years of residual living expenses, which is the amount that isn't covered by Social Security and a pension, if you get one. Say you need $70,000 to live on, and your Social Security and pension amount to $30,000. You'll have to come up with $40,000 to pay your remaining expenses. To produce that income, you'll need a safe portfolio of $1 million, assuming a 4% withdrawal rate.


William Bernstein interview https://money.com/to-invest-for-retirem ... of-stocks/
It is the same flavor. There are some inconsistencies in the above mainly related to use of the word "safe."

The general arrangement of income comes from SS and pensions and then the rest from withdrawing no more than 4% inflation indexed from a portfolio is the conventional if simplistic phrasing supported by safe withdrawal rate studies. (Note it could matter a lot whether or not the pension is fixed or inflation indexed and that SS is not delayed.)

"Safe" portfolio is ambiguous. If by safe we mean fixed income and not stocks, then SWR studies show that all bond portfolios don't support a withdrawal rate of 4% but more like less than 3%. If the objective is 4% then a 60/40 portfolio is "safe."
toddthebod
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Re: Why is 60/40 supposed to be the best for retirement?

Post by toddthebod »

The flaw with your original analyses is that your results will be entirely dependent on the performance of the stock market in the first few years after you retire (and to a much lesser extent on bond returns). That's why you need to run this type of analysis on many different starting points.

To the larger point, consider it this way: you are given a choice, Portfolio A guarantees a certain standard of living every year until you die, but you get no extra money along the way and have nothing left to leave your kids. Portfolio B gives you a 50% chance of dying with millions of dollars in the bank, a 30% chance of making it comfortably through retirement with minimal left over, and a 20% chance of ending up sleeping on the streets eating out of garbage cans, which portfolio would you choose?
Backtests without cash flows are meaningless. Returns without dividends are lies.
smitcat
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Re: Why is 60/40 supposed to be the best for retirement?

Post by smitcat »

dbr wrote: Fri Sep 16, 2022 9:12 am
smitcat wrote: Fri Sep 16, 2022 9:06 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am OP,

It has nothing to do with being the best.

A) The standard retirement portfolio size = 25 X annual expense.

B) The standard advice is to keep 10 years of expense at fixed income.

C) Combining (A) and (B), you get 60/40.

KlangFool
"C) Combining (A) and (B), you get 60/40."
What happens when you start to get more than 10 years of future expenses in fixed income - do you add to the stock portion?
No, you give it away because charity is rewarding. This is not a facetious answer.

More responsively, a person who is committed to a plan to maintain a rebalanced asset allocation would rebalance to 60/40. That does not directly answer the question regarding why 60/40 in the first place. It also ignores that people who commit to rebalanced asset allocations probably do not go by 10 years of expenses in fixed income rules to start with.
We are putting it into stock but I was wondering what Klang was doing after his 25X because of the rule(s) he is using (not 60/40)
smitcat
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Re: Why is 60/40 supposed to be the best for retirement?

Post by smitcat »

WoodSpinner wrote: Fri Sep 16, 2022 9:38 am
smitcat wrote: Fri Sep 16, 2022 9:06 am
"C) Combining (A) and (B), you get 60/40."
What happens when you start to get more than 10 years of future expenses in fixed income - do you add to the stock portion?

Smitcat,

What you do at that point is part if personal finance (I suspect you are well aware of this….). This is the good and bad of having enough. You have to decide.

For us, we start with our Retirement priorities and work from there.

For instance:
- We increased our Travel spending
- Increased gifts to family
- Increased Charitable donations
- Kept our AA the same

Others may reasonably decide on a different course.

WoodSpinner
We are putting the 'excess' into stock but are curious what Klang was doing since he has a different rule he is following (not 60/40)
km91
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Re: Why is 60/40 supposed to be the best for retirement?

Post by km91 »

Logan Roy wrote: Fri Sep 16, 2022 7:25 am Not disagreeing with you. But I think the huge flaw with backtests over this period is they only really cover one broad macroeconomic trend – which is mostly falling rates and inflation:

Image

This has provided a perpetual safety net and cushion for stock market returns – rates could always go lower, and inflation stopped being a risk. It also, however, provided endless upside for bonds – this has been a 40 year bond bull market - so this should've been the ideal environment for 60:40, and I think that's heavily influenced how it became a default recommendation. I think in Bogle's era, there was also the issue of practicality: there weren't really many other options (certainly low cost).

But I think what you find is that putting too much in stocks is inherently unstable. Personally, I don't think bonds are the solution. I think TIPS make more sense (but haven't been available very long, so don't really factor into the backtested view of things very much yet). I think real assets in general (gold to infrastructure) make sense as ways to avoid too much concentration in stocks. And I also think overweighting defensive stock sectors (Consumer Staples, Healthcare, Utilities ETFs) might be a significantly overlooked way of managing risk within stocks.
I think too much focus is given to falling rates as the primary driver of the 40 year bull market in bonds when the more important driver was the relatively high starting yields. If you bought the 30yr in the 90's you'd still be clipping 8% coupons today. Ultimately higher yields are good for long term savers and arguably the prospects of 60/40 are looking a lot better than they did a year or two ago when bonds were yielding next to nothing. Agreed that TIPS deserve a large role in the bond allocation of a portfolio, real assets I'm undecided on. If you own a home you probably already have a heavy concentration in a real asset. Gold is currently performing horribly during a time where we have high inflation and heightened geopolitical risk, so it certainly hasn't hedged any of the risks we were lead to believe it could hedge
smitcat
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Re: Why is 60/40 supposed to be the best for retirement?

Post by smitcat »

woodside wrote: Fri Sep 16, 2022 9:55 am
smitcat wrote: Fri Sep 16, 2022 9:06 am
KlangFool wrote: Fri Sep 16, 2022 7:10 am OP,

It has nothing to do with being the best.

A) The standard retirement portfolio size = 25 X annual expense.

B) The standard advice is to keep 10 years of expense at fixed income.

C) Combining (A) and (B), you get 60/40.

KlangFool
"C) Combining (A) and (B), you get 60/40."
What happens when you start to get more than 10 years of future expenses in fixed income - do you add to the stock portion?
Putting away the extra money into the stock should be good. If you want to reduce the risk, you can also invest the new money with the 60/40 plan.
We are putting the 'excess' into stock but are curious what Klang was doing since his rule(s) was not based on 60/40.

"If you want to reduce the risk, you can also invest the new money with the 60/40 plan"
Which risks are reduced? Earnings, capital, inflationary, not so clear at times where the real risks may come from.
dbr
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Joined: Sun Mar 04, 2007 9:50 am

Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

km91 wrote: Fri Sep 16, 2022 12:52 pm

I think too much focus is given to falling rates as the primary driver of the 40 year bull market in bonds when the more important driver was the relatively high starting yields.
I keep thinking the same thing. When people come up with that point of indifference when higher rates get you to better than where you would have been they don't add that falling rates eventually get you to worse than you would have been.

I do recall some real wailing and gnashing of teeth when people spending 5% interest on CDs had to renew at 1% interest.
Logan Roy
Posts: 417
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Logan Roy »

km91 wrote: Fri Sep 16, 2022 12:52 pm
Logan Roy wrote: Fri Sep 16, 2022 7:25 am Not disagreeing with you. But I think the huge flaw with backtests over this period is they only really cover one broad macroeconomic trend – which is mostly falling rates and inflation:

Image

This has provided a perpetual safety net and cushion for stock market returns – rates could always go lower, and inflation stopped being a risk. It also, however, provided endless upside for bonds – this has been a 40 year bond bull market - so this should've been the ideal environment for 60:40, and I think that's heavily influenced how it became a default recommendation. I think in Bogle's era, there was also the issue of practicality: there weren't really many other options (certainly low cost).

But I think what you find is that putting too much in stocks is inherently unstable. Personally, I don't think bonds are the solution. I think TIPS make more sense (but haven't been available very long, so don't really factor into the backtested view of things very much yet). I think real assets in general (gold to infrastructure) make sense as ways to avoid too much concentration in stocks. And I also think overweighting defensive stock sectors (Consumer Staples, Healthcare, Utilities ETFs) might be a significantly overlooked way of managing risk within stocks.
I think too much focus is given to falling rates as the primary driver of the 40 year bull market in bonds when the more important driver was the relatively high starting yields. If you bought the 30yr in the 90's you'd still be clipping 8% coupons today. Ultimately higher yields are good for long term savers and arguably the prospects of 60/40 are looking a lot better than they did a year or two ago when bonds were yielding next to nothing. Agreed that TIPS deserve a large role in the bond allocation of a portfolio, real assets I'm undecided on. If you own a home you probably already have a heavy concentration in a real asset. Gold is currently performing horribly during a time where we have high inflation and heightened geopolitical risk, so it certainly hasn't hedged any of the risks we were lead to believe it could hedge
I think the real driver of both falling rates and high starting yields was inflation. And behind inflation we've got some combination of trends in productivity, demographics, debt and policy. It's said that every investing decision reduces to a bet on inflation.

A lot of portfolio managers class TIPS as a 'real asset'. I think it makes some sense to do so. I'd say gold's actually held up very well, and performed similarly to how it did in the 1970s, so far. What's distorting the view of gold is the strong dollar – which has been one of the best assets, globally, this year (as we anticipate higher rates). That was the same in the 70s – gold lost value relative to the dollar during tightening, and bounced back strongly when things were looser. And if we were in for a prolonged period of stagflation, we'd probably get quite a lot of both.

I'd say the property you live in is more liability than asset. As inflation goes up, the only effect we're likely to feel is higher heating and electricity costs. Commodities have been a great inflation hedge, but markets didn't waste time pricing a lot of future inflation in – of which those prices are now vulnerable to a global slowdown. I think TIPS, gold and infrastructure are pretty good ways to hedge inflation over long periods.
km91
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Re: Why is 60/40 supposed to be the best for retirement?

Post by km91 »

dbr wrote: Fri Sep 16, 2022 1:04 pm
km91 wrote: Fri Sep 16, 2022 12:52 pm

I think too much focus is given to falling rates as the primary driver of the 40 year bull market in bonds when the more important driver was the relatively high starting yields.
I keep thinking the same thing. When people come up with that point of indifference when higher rates get you to better than where you would have been they don't add that falling rates eventually get you to worse than you would have been.

I do recall some real wailing and gnashing of teeth when people spending 5% interest on CDs had to renew at 1% interest.
Exactly. Yes, bond prices rose for 40 years, but every time you went to roll old bonds into new bonds the yields got lower and lower
km91
Posts: 277
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Re: Why is 60/40 supposed to be the best for retirement?

Post by km91 »

Logan Roy wrote: Fri Sep 16, 2022 1:27 pm
km91 wrote: Fri Sep 16, 2022 12:52 pm
Logan Roy wrote: Fri Sep 16, 2022 7:25 am Not disagreeing with you. But I think the huge flaw with backtests over this period is they only really cover one broad macroeconomic trend – which is mostly falling rates and inflation:

Image

This has provided a perpetual safety net and cushion for stock market returns – rates could always go lower, and inflation stopped being a risk. It also, however, provided endless upside for bonds – this has been a 40 year bond bull market - so this should've been the ideal environment for 60:40, and I think that's heavily influenced how it became a default recommendation. I think in Bogle's era, there was also the issue of practicality: there weren't really many other options (certainly low cost).

But I think what you find is that putting too much in stocks is inherently unstable. Personally, I don't think bonds are the solution. I think TIPS make more sense (but haven't been available very long, so don't really factor into the backtested view of things very much yet). I think real assets in general (gold to infrastructure) make sense as ways to avoid too much concentration in stocks. And I also think overweighting defensive stock sectors (Consumer Staples, Healthcare, Utilities ETFs) might be a significantly overlooked way of managing risk within stocks.
I think too much focus is given to falling rates as the primary driver of the 40 year bull market in bonds when the more important driver was the relatively high starting yields. If you bought the 30yr in the 90's you'd still be clipping 8% coupons today. Ultimately higher yields are good for long term savers and arguably the prospects of 60/40 are looking a lot better than they did a year or two ago when bonds were yielding next to nothing. Agreed that TIPS deserve a large role in the bond allocation of a portfolio, real assets I'm undecided on. If you own a home you probably already have a heavy concentration in a real asset. Gold is currently performing horribly during a time where we have high inflation and heightened geopolitical risk, so it certainly hasn't hedged any of the risks we were lead to believe it could hedge
I think the real driver of both falling rates and high starting yields was inflation. And behind inflation we've got some combination of trends in productivity, demographics, debt and policy. It's said that every investing decision reduces to a bet on inflation.

A lot of portfolio managers class TIPS as a 'real asset'. I think it makes some sense to do so. I'd say gold's actually held up very well, and performed similarly to how it did in the 1970s, so far. What's distorting the view of gold is the strong dollar – which has been one of the best assets, globally, this year (as we anticipate higher rates). That was the same in the 70s – gold lost value relative to the dollar during tightening, and bounced back strongly when things were looser. And if we were in for a prolonged period of stagflation, we'd probably get quite a lot of both.

I'd say the property you live in is more liability than asset. As inflation goes up, the only effect we're likely to feel is higher heating and electricity costs. Commodities have been a great inflation hedge, but markets didn't waste time pricing a lot of future inflation in – of which those prices are now vulnerable to a global slowdown. I think TIPS, gold and infrastructure are pretty good ways to hedge inflation over long periods.
Certainly the last 10 years with hardly any inflation contributed to low rates but the source is unclear to me. Aging global demographics and slower population growth suggest deflation is a long term trend. People spent the last 10 years saying the size of the debt and deficit was bound to lead to runaway inflation eventually but it took a global economic shutdown before we started to see the signs of it. Are we now in for an age of persistently high inflation, I don't know.

I'm not disagreeing with TIPS as a real asset, they certainly are as they are pegged to real purchasing power. I think from a portfolio allocation standpoint most investors should probably think of TIPS as part of their bond allocation since the risk and return profile is similar. My problem with gold is whether its a currency or a store of value. If it's a currency to be viewed against the dollar I don't see why we should expect it to hedge any of the financial system risks it is supposed to.

I guess it would depend on whether you view your home as a portfolio asset or not, or whether you have rental properties. In terms of net worth, property is probably the most valuable asset most people own, and they typically own it leveraged
Topic Author
Poe22
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Poe22 »

Wow, as usual I'm quite overwhelmed by the cumulative knowledge of you guys in this forum. It's truly awesome that you're sharing your thoughts with all of us. So thanks to you all :happy
Logan Roy wrote: Fri Sep 16, 2022 1:27 pm I think TIPS, gold and infrastructure are pretty good ways to hedge inflation over long periods.
Do I get this right: 40%/10x in bonds shouldn't be regarded as "safe" part of the portfolio, because bond prices/rates can drop significantly? Actually, we should think about reconstructing the "safe" part of our retirement portfolios to include the cited assets? What about this:

60 stocks
10 long term treasuries
10 TIPS
10 gold
10 infrastructure

or is it rather the following (if we aren't sure about gold & infrastructure):

60 stocks
20 long term treasuries
20 TIPS

Would either one have outperformed 60 stocks / 40 bonds historically?
strummer6969
Posts: 408
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Re: Why is 60/40 supposed to be the best for retirement?

Post by strummer6969 »

km91 wrote: Fri Sep 16, 2022 12:52 pm
Logan Roy wrote: Fri Sep 16, 2022 7:25 am Not disagreeing with you. But I think the huge flaw with backtests over this period is they only really cover one broad macroeconomic trend – which is mostly falling rates and inflation:

Image

This has provided a perpetual safety net and cushion for stock market returns – rates could always go lower, and inflation stopped being a risk. It also, however, provided endless upside for bonds – this has been a 40 year bond bull market - so this should've been the ideal environment for 60:40, and I think that's heavily influenced how it became a default recommendation. I think in Bogle's era, there was also the issue of practicality: there weren't really many other options (certainly low cost).

But I think what you find is that putting too much in stocks is inherently unstable. Personally, I don't think bonds are the solution. I think TIPS make more sense (but haven't been available very long, so don't really factor into the backtested view of things very much yet). I think real assets in general (gold to infrastructure) make sense as ways to avoid too much concentration in stocks. And I also think overweighting defensive stock sectors (Consumer Staples, Healthcare, Utilities ETFs) might be a significantly overlooked way of managing risk within stocks.
Gold is currently performing horribly during a time where we have high inflation and heightened geopolitical risk, so it certainly hasn't hedged any of the risks we were lead to believe it could hedge
To me, gold is insurance against monetary policy failure when there's absolutely nowhere left to hide. All assets to varying degrees are sensitive to rate hikes. People think the Fed can tame inflation without a major recession. If we eventually settle on a much higher than 2% inflation and the economy isn't holding up, that'll be a perfect environment for gold to break out. Wasn't that the case in the 70s? Gold didn't do great until the 2nd half of the inflation battle.

Edit: I don't own any gold right now, but just saying that's the type of 'doomsday' scenario for which some people hold gold.
Last edited by strummer6969 on Fri Sep 16, 2022 3:33 pm, edited 1 time in total.
dbr
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Re: Why is 60/40 supposed to be the best for retirement?

Post by dbr »

You can't fix the unpredictable outcomes of stocks and bonds by mixing in other things that have unpredictable outcomes or by super-selecting specific stocks or specific bonds that also still have unpredictable outcomes.

You can certainly tabulate historical results if you can find the data to do it, but you still can't know for sure what will happen in a future period.

The idea that some particular asset allocation is best for retirement is ill considered and trying to find it is tilting at windmills, that is assuming you even know what the definition of best is. Asset allocation is important for investing not because results are highly dependent on asset allocation but because there is a wide range over which asset allocation can be chosen. Even then a property of retirement withdrawal is that the outcome is dominated on the first place by the luck of when you do it, which is not mostly an available choice, and then by how much you try to withdraw. For low enough withdrawals any asset allocation works and for high enough withdrawals there is no asset allocation that can be nearly guaranteed to work.

You can change the conversation considerably by positing that this, that, or the other asset allocation is likely to be just as good enough as many others.

I would say that asset allocation in retirement is an example of one of those things that because there is a choice we make the false assumption that the choice matters.

It might be informative to look here https://engaging-data.com/visualizing-4-rule/ and change around the asset allocation and other inputs and decide what differences you can see. Note this tool does not have options to include TIPS or to be specific about what bonds to use other than a choice for cash.
Kinetic Currency
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Kinetic Currency »

Dear Poe22,
Your subject title caught my attention since I have been actively researching this topic on my own. I believe that the the ratio of 60 to 40 has to do with the difference in historical volatility between stocks and bonds. I am beginning to appreciate that the more volatile the investment, the more prone it becomes to “volatility drag.” Using a coin toss analogy, a volatile coin flip that drops your $100 investment by 50% takes you to $50, but another flip that gives you a 50% rise from $50 does not return you back to $100. I think that is why so much emphasis is placed on the sharpe ratio, since volatility drags your portfolio’s performance. Fortunately, the geometrical average has been positive for the S&P in recent times so stocks have compensated for their volatility drag. Bonds (TIPS or gold or cash) have a different volatility profile and thus they serve to tamper the drag effect. I believe the Kelly criterion was established to figure out the ideal ratio of investments that maximize return and apparently the 60:40 ratio has been the rule for the past 30 years. Admittedly, I’m no expert on this as I am also trying to figure it out for myself. But I do know that the mathematical answer is much more complex than the assertion that the ratio has to do with you sleeping comfortably at night.
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Jack FFR1846 »

mptfan wrote: Fri Sep 16, 2022 7:04 am Can you cite to a source that says 60/40 is the best for retirement?
This. I've never thought of 60/40 as being some magical "best" for retirement. Everyone is going to have their own risk tolerance. I've been set at 50/50 for several years and have zero plans to ever change that.
Bogle: Smart Beta is stupid
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JoeRetire
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Re: Why is 60/40 supposed to be the best for retirement?

Post by JoeRetire »

KlangFool wrote: Fri Sep 16, 2022 7:10 am A) The standard retirement portfolio size = 25 X annual expense.

B) The standard advice is to keep 10 years of expense at fixed income.

C) Combining (A) and (B), you get 60/40.
:confused
Can you explain the math behind this conclusion? I'm not seeing it yet.

Is the "standard advice" to keep 10 years of expenses in fixed income? I've never heard that.
Oh, noooooo! I'm so sorry, it's the moops! The correct answer is 'the moops'.
Logan Roy
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Re: Why is 60/40 supposed to be the best for retirement?

Post by Logan Roy »

Poe22 wrote: Fri Sep 16, 2022 2:41 pm Wow, as usual I'm quite overwhelmed by the cumulative knowledge of you guys in this forum. It's truly awesome that you're sharing your thoughts with all of us. So thanks to you all :happy
Logan Roy wrote: Fri Sep 16, 2022 1:27 pm I think TIPS, gold and infrastructure are pretty good ways to hedge inflation over long periods.
Do I get this right: 40%/10x in bonds shouldn't be regarded as "safe" part of the portfolio, because bond prices/rates can drop significantly? Actually, we should think about reconstructing the "safe" part of our retirement portfolios to include the cited assets? What about this:

60 stocks
10 long term treasuries
10 TIPS
10 gold
10 infrastructure

or is it rather the following (if we aren't sure about gold & infrastructure):

60 stocks
20 long term treasuries
20 TIPS

Would either one have outperformed 60 stocks / 40 bonds historically?
Your second reminds me of David Swensen's recommended portfolio – with the bonds split between treasuries and TIPS, 15% each, plus a chunk in REITs (as real assets).
Personally, I don't hold treasuries, and my own 'work' suggests they don't make for optimal portfolios. But this is just me. I might go something like:

25% Stocks
25% Defensive Stocks (Staples, Healthcare, Utilities, at 4:4:2)
10% Infrastructure/property
30% TIPS
10% Gold/cash

Image
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