Age in bonds,

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Chinwhisker
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Age in bonds,

Post by Chinwhisker »

Sorry for bringing this up in a conversation of its own, but I keep seeing ‘Age in bonds,’ ‘Roughly age in bonds,’ ‘110 - age in stocks’, &c. suggested, and even young investors are being told they are “Too conservative” in their asset allocation.

I have a friend who is somewhere around 30/70 at 41, another friend 65 who is 100% CDs, Dad (79)100% CDs, and Wifey (I’ll never tell ;)), 20/80. I know these folks fairly well, and know they are where they need be due to their risk adversity, even though it may seem or even prove too conservative to most.

Personally, I don’t feel any individual should hold less than 60/40 unless they are capable of arguing me down they can handle it, -- even if they were to lose 80% of their portfolio. Maybe ‘29 won’t happen again, but I would never say never. Maybe there weren’t people so invested in tech stocks they didn’t lose 80% in 2000 - 2002, and maybe most are not like my 41 year old friend that couldn’t handle losing $48,000 in a growth fund 2000 - 2002.

Quite frankly, I doubt there are many 20 year olds out there that could handle the losses from an 80/20 or 90/10 portfolio, but I believe I can at 55. Maybe they should start with 60/40 and adjust from there.

Now the real kicker, and I will say it again, and challenge those devoted to the conventional wisdom of ‘Age in bonds’ and similar to find me wrong on this. There is no empirical evidence ‘Age in bonds’ offers an economic advantage over setting your portfolio up at a fixed rate and holding it there, such as 60/40 or even 50/50.

Let me put it this way, and I haven’t even checked, but holding 50/50 from 20 to 65 should, from what I have seen, offer higher returns than ‘Age in bonds’ without putting the poor 20 year old holding a 80/20 portfolio or even worse, ‘110 - age in stocks’. Most can handle 50% in stocks at 65 better than 80% at 20; or at least I would presume.

Anyone want to challenge me on this? -- what about maybe consider it?

Chin
They think they know but don't. At least I know I don't know. (Socrates)
rich
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Post by rich »

I agree with the gist of what you are saying but I do believe higher equity holdings have higher expected returns. Despite higher expected returns, I think many people are way too aggressive and I think behaviorally they won't be able to handle the downside. If I remember correctly, there was a poll here that said the average "boglehead" is approx 114-age in stocks.

However, let me offer a bit of qualification and clarification. I think if people hold high quality bonds, i.e. treasuries or no less than munis, then the equity allocation could reasonably be somewhat higher than with lower quality bond holdings.
Best regards, | Rich
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Cb
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Post by Cb »

I think maybe people's risk tolerance varies much more than you might believe, Chin.

Some people ride motorcycles, scuba-dive, hang-glide, retire very early, start or buy businesses, marry redheaded women, etc, while others would never consider doing any of that. Who's to say the first type of person ought not exceed 60% equities?

Cb 8)
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Post by Plainsman »

I am 85/15.

Most on this forum are very conservative, which is not necessarily a good thing. 60/40 regardless of age is very conservative (for a young investor).

A higher allocation to equity will likely result in superior returns over the long term, IF one can handle the increased risk and volatility. Whether one's investment goals warrant a high equity allocation is the important question to consider.

I will not waste my time trying to convince anyone that I have the risk tolerance to hold an 85/15 portfolio.
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Re: Age in bonds

Post by grabiner »

Chinwhisker wrote:Let me put it this way, and I haven’t even checked, but holding 50/50 from 20 to 65 should, from what I have seen, offer higher returns than ‘Age in bonds’ without putting the poor 20 year old holding a 80/20 portfolio or even worse, ‘110 - age in stocks’.
This would be the case if the portfolio were static; if you have a fixed portfolio and will not be adding to it, then you will get a better risk/return profile if you split it 50/50 now than if you go from 80/20 to 20/80 over time. But most investors add to their portfolios over time, and can afford to take more risk when they have less money.

If you have 80% stock in a portfolio which will only be 1/4 of your retirement portfolio, and the market drops by 50%, you have lost 40% of your current portfolio but only 10% of what you will have when you retire. If you have 20% stock and are already retired, and the market drops by 50%, you have lost 10% of your current portfolio and also 10% of your retirement assets.

Another factor is that you can change your portfolio needs, and thus you can take more risk if you are still working. If you are ready to retire and the market drops, you can usually decide to work another year, adding more to your portfolio rather than drawing it down. If you are already retired, it is much harder to go back to work if your portfolio loses value.
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Munir
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Too rich or too poor

Post by Munir »

Isn't it true that if one is mega-rich, then one can tolerate large losses and therefore can afford to have high equity positions? The flip side of that argument is that if one doesn't have enough of a portfolio for a comfortable retirement, then one needs to take more risk in order to meet the goals being sought. Both of these scenarios seem to tolerate or require a more aggressive protfolio. Or- the very rich can say that there is no need to take risk because one has enough $ as is; and the "poor" will say that they have no cushion for any potential losses and the need is to be more conservative.

The challenge is for those of us in-between those two extremes. With time (age) and knowledge, hopefully we can decide on the maximum equity % that still allows us to sleep well at night. I havne't found any other more objective criterion to help me in making that decision. At age 70, 43% equities seems to be the one for me.

Munir
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Post by biasion »

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Post by sport »

Chin,
A retiree, who has accumulated enough for a comfortable retirement might have the risk tolerance for a 60/40 allocation. However, she does not have the need to take that much risk, and a 40/60 or a 30/70 allocation may meet her needs without exposing her nest egg to as much risk. As Larry says, to determine an appropriate allocation, you should consider your ability, willingness, and need to take risk. IMO, an investor should not take any more risk than necessary, even if they would be comfortable with that level of risk. As a portfolio increases, the goal shifts from maximizing return toward maximizing preservation.

Best wishes,
Jeff
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Age in bonds,

Post by YDNAL »

Quite frankly, I doubt there are many 20 year olds out there that could handle the losses from an 80/20 or 90/10 portfolio, but I believe I can at 55.
Chin,

I don't have the stomach for 90/10 [never did] or 80/20. Measured against Age = Bonds, I thought I was aggressive at Age - (6 to 10) = Bonds. Posted this on another thread.

Through 30....80/20
Age 31-35....75/25
Age 36-40....70/30
Age 41-45....65/35
Age 46-50....60/40
Age 51-55....55/45 [I'm 55]
Age 56-60....50/50
Age 61-62....40/60 [retirement coincides with DW's retirement after 30 years of teaching].

We are the same age.... Why do you "believe" that you can handle the drop of a 90/10 AA?

Regards,
Landy
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Age in bonds,

Post by YDNAL »

A retiree, who has accumulated enough for a comfortable retirement might have the risk tolerance for a 60/40 allocation. However, she does not have the need to take that much risk, and a 40/60 or a 30/70 allocation may meet her needs without exposing her nest egg to as much risk.
Jeff,

If I had a gazillion dollars at 55/45, let my heirs worry about a 1/4 gazillion $ drop and get by with 3/4 gazillion dollars.

Million, billion, trillion, quadrillion, quintillion, sextillion, septillion, octillion, novillion, decillion . . . let see, a decillion is:

1,000,000,000,000,000,000,000,000,000,000,000

. . . there's really no gazillion. :wink:

Regards,
Landy
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Post by MossySF »

If I have a portfolio worth $0, a 75% drop in the market is a $0 drop in my assets. As your portfolio approaches zero, tolerance for risk should be greater and greater. Do I care about an 80% loss if I have $1 invested? What about $100? Even $1000 or $10K may be nothing if I'm contributing 20X that amount over the next decade.

So instead of 110-age = bonds, perhaps the formula should be contributions compared to portfolio progress.
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Post by Valuethinker »

MossySF wrote:If I have a portfolio worth $0, a 75% drop in the market is a $0 drop in my assets. As your portfolio approaches zero, tolerance for risk should be greater and greater. Do I care about an 80% loss if I have $1 invested? What about $100? Even $1000 or $10K may be nothing if I'm contributing 20X that amount over the next decade.

So instead of 110-age = bonds, perhaps the formula should be contributions compared to portfolio progress.
Agreed.

What you really want is a desired wealth number in there. As you approach that number, you can afford to take bigger risks.

Zvi Bodie tackles this. His argument is the investor should be 100% in TIPS (which pay a guaranteed real return) until they reach their desired level of retirement income (annuitized final wealth). Then they should use call options to gain exposure to stock markets.

What Bodie is saying is now fairly radical (and he admits that if we all did that, the TIPS market couldn't cope, there's not enough stock) but will, I think, in 20 years time, be fairly conventional.
Trev H
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Bonds ???

Post by Trev H »

Hey Chin... you said...

====

Let me put it this way, and I haven’t even checked, but holding 50/50 from 20 to 65 should, from what I have seen, offer higher returns than ‘Age in bonds’ without putting the poor 20 year old holding a 80/20 portfolio or even worse, ‘110 - age in stocks’. Most can handle 50% in stocks at 65 better than 80% at 20; or at least I would presume.

====

If you were 20 years old 01/01/1929 and saved for retirement until age 65 which happens to fall on 12/31/1974...

You started accumulating retirement savings at the start of the Worst BEAR Market in History (at least that I have data for anyway)... and you ended up your retirement accumulation phase at the end of the 73-74 Bear Market.

Murphys Law taken to the extreme !

Using the Data from the Data Junkies Post (TAM asset site)...

CRSP D1-10 US Cap Weighted Market (for equity)
5 Year Treasury Notes (for bonds)

50% US Market
50% 5 Yr T Notes
(yearly rebalancing)

Initial investment 1,000.00 and yearly contributions made on the last day of the year and increased by 3% annually.

As of year end 1974 you invested a total of 100,396.50
The portfolio value was 438,544.50
StDev 11.08

If I change the portfolio to 80% US Market/20% 5 Yr T Notes

You invested the exact same amount...
The Portfolio value was 678,552.68
StDev 17.85

If I change the portfolio to 100% US Market/0% 5 Yr T Notes

You invested the exact same amount...
The Portfolio value was 879,726.59
StDev 22.45

If I S&D a bit holding Market + F/F Small Value
(sorry International not available back that far)

60% US Market
40% F/F Small Value

1,709,090.38
StDev 29.30

S&D with Bonds

40% US Market
20% F/F Small Value
40% 5 Yr T Notes

729,252.84
StDev 16.64

Sorry... but it would be a real pain to tweak my spreadsheet to do something like incrementing the age in bonds thing...

But it is fairly obvious (to me at least) that bonds have not benefitted any 20 year old that saved for retirement until 65 (not since 1929 anyway)... except for reducing volatility. Bonds do that for sure... but they also reduce returns and as Nick has pointed out several times... the relationship is linear... the more you increase bonds the more you reduce returns (talking long term here)... but that is what you were asking about - a 20 year old that saved until 65).

Trev H
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Post by sscritic »

Trev:

I am not sure what you were responding to since it is clear that chin did not finish the sentence you quoted.
Let me put it this way, and I haven’t even checked, but holding 50/50 from 20 to 65 should, from what I have seen, offer higher returns than ‘Age in bonds’ without putting the poor 20 year old holding a 80/20 portfolio or even worse, ‘110 - age in stocks’.
Note that the clause "without putting" is not completed. Without putting them into the poor house? Without putting them into great risk? Without putting them into a place where they never invest in stocks again?

Since neither of us know what chin intended to write after "without putting," neither of us can refute his statement. My guess is that whatever it was was related to volatility.

In conclusion you wrote
But it is fairly obvious (to me at least) that bonds have not benefitted any 20 year old that saved for retirement until 65 (not since 1929 anyway)... except for reducing volatility.
If my guess about chin's intentions is correct, you just made his point. It's all about volatility.
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Re: Age in bonds

Post by Chinwhisker »

grabiner wrote:
Chinwhisker wrote:Let me put it this way, and I haven’t even checked, but holding 50/50 from 20 to 65 should, from what I have seen, offer higher returns than ‘Age in bonds’ without putting the poor 20 year old holding a 80/20 portfolio or even worse, ‘110 - age in stocks’.
This would be the case if the portfolio were static; if you have a fixed portfolio and will not be adding to it, then you will get a better risk/return profile if you split it 50/50 now than if you go from 80/20 to 20/80 over time. But most investors add to their portfolios over time, and can afford to take more risk when they have less money.
Hi grabiner,

Thanks for even considering what I am saying, but actually it is just the opposite. It has been a year or few since I looked at this, but from CRS memory, there was an advantage of around 0.2% from starting out with say a 70/30 at age 30 and going down to 40/60 at age 60. What reduced the advantage to no increase in portfolio size (on average 1928 - 2002) was increasing income and the percentage of income you invested.

I used my Social Security records for my income changes and memory for my increasing of income, for a check against my own personal savings habits. Then I set it up with 3% inflation and an increase of 4% in installments (inflation plus additional increase in savings) for a systematic way of checking it.

I used rolling 30 year periods and different starting ages, and it came out, once again on average, no increase in return. There were some periods that offered an increase in return, but all-in-all there was no evidence that systematically increasing bonds as you aged even offered an increase in return.

However, I have backed off of this statement as it is too difficult for folks to consider. I haven’t even been able to get anyone to set up their own spreadsheet and check it for themselves. What I said above looks a bit more believable, and if I can get some folks to check it, they themselves will be the ones declaring ‘Age in bonds’ does not work.

Clever, huh? 8)

Chin
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Post by Chinwhisker »

Trev H wrote:Hey Chin... you said...

====

Let me put it this way, and I haven’t even checked, but holding 50/50 from 20 to 65 should, from what I have seen, offer higher returns than ‘Age in bonds’ without putting the poor 20 year old holding a 80/20 portfolio or even worse, ‘110 - age in stocks’. Most can handle 50% in stocks at 65 better than 80% at 20; or at least I would presume.

====

. . . Sorry... but it would be a real pain to tweak my spreadsheet to do something like incrementing the age in bonds thing... . . .

Trev H
Hi Trev,

Yes, it was a bit of a pain, but it wasn’t originally set up to show the results I found. I originally set it up to see how long I could go 100% equities and safely capture the return from 100% equities prior to adjusting for retirement. This might have been a little more stimulating than checking to see if there is any reward for the risk of ‘Age in bonds’, huh?

To me it means something though; at least if you think bonds offer some risk reduction.

Whether the data going back to ‘29 is relevant in today’s economy would be a different concept than what I am offering. It’s an interesting thought, but doesn’t fit in this conversation, if you don't mind.

Chin
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Post by Chinwhisker »

sscritic wrote:Trev:

Since neither of us know what chin intended to write after "without putting," neither of us can refute his statement. My guess is that whatever it was was related to volatility.
Hi sscritic,

This is a thought. Maybe I should just challenge the math whizzes to refute my statement.

Thanks,

Chin
They think they know but don't. At least I know I don't know. (Socrates)
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Re: Age in bonds,

Post by Chinwhisker »

YDNAL wrote: . . . We are the same age.... Why do you "believe" that you can handle the drop of a 90/10 AA? . . .

Regards,
Landy
Hi Landy,

What I was saying was I could handle it better than a 20 year old, that is unless of course the 20 year old was more knowledgeable than I would suspect.

I have more perceived knowledge, more experience, and have been setting up my portfolio to weather inflation as well as bear markets. Bonds are not that great covering inflation.

Chin
They think they know but don't. At least I know I don't know. (Socrates)
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Post by Chinwhisker »

Hi again,

I probably don’t need to reply to the rest of the posts, as I do not disagree with what you are saying. If there is anything in particular you do want me to reply to, let me know.

Chin
They think they know but don't. At least I know I don't know. (Socrates)
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Post by DaleMaley »

Here is the %stocks = 114 - Age results taken from a Bogleheads poll:

Image
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sport
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Re: Age in bonds,

Post by sport »

YDNAL wrote:
A retiree, who has accumulated enough for a comfortable retirement might have the risk tolerance for a 60/40 allocation. However, she does not have the need to take that much risk, and a 40/60 or a 30/70 allocation may meet her needs without exposing her nest egg to as much risk.
Jeff,

If I had a gazillion dollars at 55/45, let my heirs worry about a 1/4 gazillion $ drop and get by with 3/4 gazillion dollars.
Landy,
If someone has much more than they need for retirement, such as Bill Gates or Warren Buffet, it does not matter what their allocation is. If they lose even 90% of their portfolio value, it will not impact their standard of living in retirement. They can any allocation they wish to have. However, if a retiree needs 1 million for a secure retirement and has accumulated a little more than that, such as 1.1 million, that retiree's primary concerns are capital preservation and inflation protection. Maximizing return is a distant third. Accordingly, for this retiree aged 60 to 65, a 40/60 or 30/70 allocation is appropriate, regardless of the retiree's risk tolerance.

Best wishes,
Jeff
Trev H
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Took the Time...

Post by Trev H »

.
Hey Folks...

I finally took the time to figure out how to setup a sheet where the stock/bond allocation can shift by a % yearly to allow for "age in bonds" type situations...

First a Table that shows the results for "Fixed Allocation" portfilio's...

Again The Worst Case Situation for a 20 Year Old that accumulated retirement savings until Age 65.

Starting on 01/01/1929 and ending on 12/31/1974
Taking on two of the worst BEAR markets in history at the start and end of the accumulation phase.

1000.00 initial investment with additional investments made each year end and increased by 3% annually.

Again the total invested was 100,396.50.

For Equities... CRSP D1-10 (US Cap Weighted Market)
For Bonds.... 5 Year Treasury Notes

MKT/BND....Ending Value......StDev
========================
100/00..........879,726.59......22.45
90/10............775,684.12......20.15
80/20............678,552.68......17.85
70/30............589,569.85......15.57
60/40............509,469.60......13.31
50/50............438,544.50......11.07
40/60............376,717.85......08.89
30/70............323,619.95......06.81
20/80............278,663.70......04.95
10/90............241,115.50......03.68
00/100..........210,158.38......03.67
========================

If you start out with a Equity/Bond AA of 80/20 in 1929 you end up with 35/65 in 1974 (decreasing equity 1% yearly, increasing bonds 1% yearly).

If you start out with 90/10 you end up 45/55
If you start out with 100/00 you end up 65/45

.80/20--35/60...523,215.36....14.47
.90/10--45/55...609,747.80....16.65
100/00--65/45...707,711.01...18.87

The table below is a mix of the "fixed allocation" portfolio's and the variable allocation portfolio's sorted by ending portfolio value.

MKT/BND......Ending Value......StDev
=========================
100/00............879,726.59......22.45
90/10..............775,684.12......20.15
100/00-65/45..707,711.01.....18.87 **
80/20..............678,552.68......17.85
90/10-45/55....609,747.80.....16.65 **
70/30..............589,569.85......15.57
80/20-35/60....523,215.36.....14.47 **
60/40..............509,469.60......13.31
50/50..............438,544.50......11.07
40/60..............376,717.85......08.89
30/70..............323,619.95......06.81
20/80..............278,663.70......04.95
10/90..............241,115.50......03.68
00/100............210,158.38......03.67
========================

Looks to me like they fall about where you would expect into the "fixed allocation" lineup based on volatility and returns...

More exposure to equity and you ended up with more accumulated for retirement... at the cost of a more volatile portfolio. More Risk = More Return.

More exposure to bonds... and you ended up with less accumulated for retirement... with a + of a less volatile portfolio... Less Risk = Less return.

Trev H
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If you delay...

Post by Trev H »

.
Going a bit past the 100/00 start point...

If you went all Equity from 1929-1945 and in the last 20 years decreased your equity allocation and increased your bond allocation by 2.5% yearly... you end up with a 50/50 allocation.

1,055,847.66 StDev 20.95

If you stayed all equity until the last 10 years and shifted from stocks to bonds 5% yearly the last 10 years you end up 50/50.

1,178,438.87 StDev 21.51

Both of these (late exit from equity) options bested the 100/00 and 90/10 fixed portfolio's... since they stayed in equites longer and then shifted to bonds before the 73-74 bear hit.

Interesting...

Trev H
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Chin, interesting points

Post by krelihan »

Chin, besides the issue of individual risk tolerance, there is also the issue of assuming one should become more conservative with age (the age-bond formula you have suggested). I question the sagacity of shifting towards more bonds with age, particularly given increasing lifespans. Personally, I treat my portfolio like an endowment with an indefinite time horizon. I would argue most people are better off keeping a stable portfolio allocation and either delaying social security and/or buying longevity insurance or immediate annuities to avoid an adverse financial situation late in life (in the event of a market meltdown).
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Post by Chinwhisker »

Hi Trev,

I cranked up the ole eMachine which has the spreadsheets I did on this, and found a spreadsheet where I didn’t increase savings as you aged. What I got was an ending value of $172,643 for 90/10 - 60/40, and $152,226 for 60/40, 1929 - 1958. I used inflation to increase (and decrease) the periodic installments. I had also done this for 10 year rolling periods, and found a 0.55% increase in returns going from 90/10 to 60/40 as opposed to starting our at 60/40. That is without savings as you age. The differences in portfolio balances decrease if you increase the percentage of income saved as you age, which I think is more realistic.

In this;
Trev H wrote:.
Going a bit past the 100/00 start point...

If you went all Equity from 1929-1945 and in the last 20 years decreased your equity allocation and increased your bond allocation by 2.5% yearly... you end up with a 50/50 allocation.

1,055,847.66 StDev 20.95

If you stayed all equity until the last 10 years and shifted from stocks to bonds 5% yearly the last 10 years you end up 50/50.

1,178,438.87 StDev 21.51

Both of these (late exit from equity) options bested the 100/00 and 90/10 fixed portfolio's... since they stayed in equites longer and then shifted to bonds before the 73-74 bear hit.

Interesting...

Trev H
I found similar results.

I think you can realistically calculate how long you will need to add bonds prior to your retirement date to reach your set allocation by this date. What I found was by doing this, you managed on average 95% of the return you would have received by staying 100% equities while reducing the allocation down to 60/40.

Now, on the standard deviation, you have to realize you started in 1929 adding $1,000 per year, with no balance prior to 1929. New money reduced the SD for 1929 - 1932. However, this is a find in itself. The same holds true if you look at increasing savings as opposed to just the 3% inflation; or at least I think this is why we got different results. New money in the later years decreases the SD as well.

What I did originally was used my Social Security wages, but then set it up with a 0.5% and 1% increase in percentage of wages as well as wages increasing 1% above inflation. The wages increasing 1% above inflation may not be realistic for all, but the increasing of the percentage of wages as savings offers some other results which are easy to comprehend -- if you increase from 10% savings to 40% savings, this reduces the income you depend on to live comfortable systematically, without much effort. This reduces you’re the annual income you have learned to live on to 60% of your salary, not including the fact that you no longer have to pay FICA & MICA.

50% of your salary will replace the income you have learned to live on.

Boy! Can I ramble or what!!!

After all that, even not considering increasing the percentages of income going to savings, can I ask if you find that the actual percentage of return lost is more like 0.5% as opposed to the 2% those like Peter Bernstein claim by starting with the asset allocation you will end with?

Thanks for all your work on this. It feels good to have someone else look at it.

Chin
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Re: Chin, interesting points

Post by Chinwhisker »

krelihan wrote:Chin, besides the issue of individual risk tolerance, there is also the issue of assuming one should become more conservative with age (the age-bond formula you have suggested). I question the sagacity of shifting towards more bonds with age, particularly given increasing lifespans. Personally, I treat my portfolio like an endowment with an indefinite time horizon. I would argue most people are better off keeping a stable portfolio allocation and either delaying social security and/or buying longevity insurance or immediate annuities to avoid an adverse financial situation late in life (in the event of a market meltdown).
Hi krelihan,

Thanks, this is pretty much what I am saying, and trying to show the fact there is not, at least much of, an economic advantage to starting with high allocations to stocks, as well as what you are pointing at. Not all 65 year olds are going to see any reason to reduce their stock exposure to 35% or even the 45% ‘110 - age in stocks’ or the Diehard ‘114 - age in stocks.’ (Thanks Dale)

My main point though, and the one that aggravates me most, is we should not tell young investors they are too conservative in their allocations. Economically, whether you figure they are losing 0.5% or less, it doesn’t make sense to put them into a more risky portfolio than they can handle.

I have seen this happen too often, and it concerns me.

If they want to challenge a Lion-hearted investor, fine, but for the timid, maybe they sould be in higher allocaitons of fixed income.

Chin
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Post by Chinwhisker »

DaleMaley wrote:Here is the %stocks = 114 - Age results taken from a Bogleheads poll:

Image
Hi Dale,

You think maybe this is because they have been told 'Age in bonds' is best? -- and adjusted from there?

Chin
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cdelena
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Post by cdelena »

Thanks to all for a good discussion... Trev, I really appreciate that you shared your spreadsheet results.

I am a great believer that this is a personal decision that should be discussed and that the standard percentage offered based on age can be a disservice to those that accept it without question.

I am 59 and retired but find 75/25 works well for me, while my son is most comfortable with 100/0, a brother at 55 likes 50/50 and my 85 year old mother favors 60/40.

IMO your personal situation, portfolio, and outlook are critical factors... age less so.
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Post by DaleMaley »

You think maybe this is because they have been told 'Age in bonds' is best? -- and adjusted from there?

Chin
Chin:

I don't know why or how people chose their asset allocation.

I would like to see some serious research into financial aspects of people's lives.......so we could better understand some things.....including:

1. Do living expenses go down during retirement as people move through
the 3 stages of retirement?

2. Why did people choose the asset allocation they did chose?

3. What is the compounded return that various people have actually earned?

Unfortunately, behavioral finance issues cause many people to self-report more positive financial results that they actually achieve on surveys. It would cost some serious money to randomly select 1200 Americans........and then validate their financial life through tax returns, investing account statements, actual expenses, etc.

:lol:
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Re: Chin, interesting points

Post by tnlsea »

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Post by Chinwhisker »

DaleMaley wrote:
You think maybe this is because they have been told 'Age in bonds' is best? -- and adjusted from there?

Chin
Chin:

I don't know why or how people chose their asset allocation.

I would like to see some serious research into financial aspects of people's lives.......so we could better understand some things.....including:

1. Do living expenses go down during retirement as people move through
the 3 stages of retirement?

2. Why did people choose the asset allocation they did chose?

3. What is the compounded return that various people have actually earned?

Unfortunately, behavioral finance issues cause many people to self-report more positive financial results that they actually achieve on surveys. It would cost some serious money to randomly select 1200 Americans........and then validate their financial life through tax returns, investing account statements, actual expenses, etc.

:lol:
Hi Dale & Tom,

What I meant by the remark was that I think people are imitative. They see, hear, read, whatever, remarks enough times, they tend to believe it true.

I have heard Jack Bogle say, “ . . . approximately age in bonds,” but I have also heard him say “Bunk!”

I personally liked it better when he said “Bunk!”

To be honest, I wouldn’t trust the results of any survey, as I cannot comprehend the type individual who would submit to a survey without some kind of compensation, and feel surveys can be worded or even promise a reward for certain answers.

The only survey that counts is an honest answer that comes from and to within. Being honest with your self will most likely offer the greatest opportunity for success in anything. Doing it because someone says it is the right thing to do only works until someone or some event changes that view. The event is of course the most dangerous, but trusting in others cannot offer the same security as searching within.

Tom’s ‘worrier’ will be more successful than the bulk of investors always open to the new truths as evidenced by the popular opinion -- imitators.

That’s all I meant.

What you think?

Chin
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Re: Age in bonds

Post by grabiner »

Chinwhisker wrote:
grabiner wrote:
Chinwhisker wrote:Let me put it this way, and I haven’t even checked, but holding 50/50 from 20 to 65 should, from what I have seen, offer higher returns than ‘Age in bonds’ without putting the poor 20 year old holding a 80/20 portfolio or even worse, ‘110 - age in stocks’.
This would be the case if the portfolio were static; if you have a fixed portfolio and will not be adding to it, then you will get a better risk/return profile if you split it 50/50 now than if you go from 80/20 to 20/80 over time. But most investors add to their portfolios over time, and can afford to take more risk when they have less money.
Thanks for even considering what I am saying, but actually it is just the opposite. It has been a year or few since I looked at this, but from CRS memory, there was an advantage of around 0.2% from starting out with say a 70/30 at age 30 and going down to 40/60 at age 60. What reduced the advantage to no increase in portfolio size (on average 1928 - 2002) was increasing income and the percentage of income you invested.
This is true for returns, but not for risk, which was the other half of my point. If your bond allocation increases from 20% to 80% as your portfolio size increases, then you should expect lower returns than with a static 50/50 portfolio, because you have more than half the portfolio in bonds when it is larger.

However, the risk is the other important factor, as it is an economic risk rather than a psychological risk. Losing 20% of a portfolio which will be only 1/4 of your final retirement portfolio reduces your retirement portfolio by 5%; losing the same 20% when you are already retired reduces the portfolio by a full 20%, and thus is much more likely to affect your standard of living. Thus you can afford to have a riskier portfolio when you are young.

(If a 20% loss won't affect your standard of living because you intend to leave half the portfolio to your heirs, then you can afford to take the same risk even when you are retired. But in that case, it isn't your own age that matters; you are investing half the portfolio for your own retirement, and the other half for your son's retirement and your granddaughter's college education.)
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Simple analysis

Post by smithdad »

I broke it down to a real simple analysis. Assume just flat average returns and look at the difference. As you would figure, it all depends on the foward risk premium of stocks over bonds. This is a very simple analysis to prove the point - I think it is a mistake to ignore your duration of time that the money will be invested within an asset class... Although volatility was not considered below (for simplicity), it seems intuitive that volatility shakes itself out the longer your duration.

I figured from 20 yr old to 60 yr old and compared Age-10 versus static 50-50 allocation. Age-10 is used so that at 60, you have an equal 50-50 allocation either way. Stocks assumed real return of 5% and bonds 3%. Rebalance every year and you end up with the following at 60...

1. 10k invested each year
Age-10 - 1072616
50-50 - 998265
Age-10 gets you about 7%

2. 1000000 Lump sum at 20 yr old
Age-10 - 5843522
50-50 - 4993061
Age-10 gets you about 17%

Obviously, if the risk premium increases, you do better. For 6% stock returns and 3% bond returns, you get the following...

1. 10k invested each year
Age-10 - 1261686
50-50 - 1128467
Age-10 gets you about 12%

2. 1000000 Lump sum at 20 yr old
Age-10 - 7684397
50-50 - 6078101
Age-10 gets you about 26%

Granted, we will probably not be so fortunate in the future, but if you look at the same analysis with 1926-2006 returns of about 7.8% for stocks and 2.2% for bonds...

1. 10k invested each year
Age-10 - 1588500
50-50 - 1278398
Age-10 gets you about 24%

2. 1000000 Lump sum at 20 yr old
Age-10 - 11411423
50-50 - 7391988
Age-10 gets you about 54%
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Re: Age in bonds

Post by Chinwhisker »

grabiner wrote:
Chinwhisker wrote:
grabiner wrote:
Chinwhisker wrote:Let me put it this way, and I haven’t even checked, but holding 50/50 from 20 to 65 should, from what I have seen, offer higher returns than ‘Age in bonds’ without putting the poor 20 year old holding a 80/20 portfolio or even worse, ‘110 - age in stocks’.
This would be the case if the portfolio were static; if you have a fixed portfolio and will not be adding to it, then you will get a better risk/return profile if you split it 50/50 now than if you go from 80/20 to 20/80 over time. But most investors add to their portfolios over time, and can afford to take more risk when they have less money.
Thanks for even considering what I am saying, but actually it is just the opposite. It has been a year or few since I looked at this, but from CRS memory, there was an advantage of around 0.2% from starting out with say a 70/30 at age 30 and going down to 40/60 at age 60. What reduced the advantage to no increase in portfolio size (on average 1928 - 2002) was increasing income and the percentage of income you invested.
This is true for returns, but not for risk, which was the other half of my point. If your bond allocation increases from 20% to 80% as your portfolio size increases, then you should expect lower returns than with a static 50/50 portfolio, because you have more than half the portfolio in bonds when it is larger.

However, the risk is the other important factor, as it is an economic risk rather than a psychological risk. Losing 20% of a portfolio which will be only 1/4 of your final retirement portfolio reduces your retirement portfolio by 5%; losing the same 20% when you are already retired reduces the portfolio by a full 20%, and thus is much more likely to affect your standard of living. Thus you can afford to have a riskier portfolio when you are young.

(If a 20% loss won't affect your standard of living because you intend to leave half the portfolio to your heirs, then you can afford to take the same risk even when you are retired. But in that case, it isn't your own age that matters; you are investing half the portfolio for your own retirement, and the other half for your son's retirement and your granddaughter's college education.)
Yes, I did get confused. Adding to your portfolio does reduce risk, and drawing from does increase the risk.

Chin
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Post by Chinwhisker »

Hi smithdad,

Maybe it is just my day to be confused. Lump some or not is not what I am saying.

Chin
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comparison

Post by smithdad »

The comparison is between having your age minus 10% in bonds and slowly increasing your bond allocation as you age versus just keeping a whole life of 50% bonds, 50% equities.

I did the lump sum in addition to the investing over time just to see if having the money up front made that much of a difference. The comparison numbers above are for the Age-10 allocation at 60 years old and the 50-50 allocation at 60 years old.
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Re: comparison

Post by Chinwhisker »

smithdad wrote:The comparison is between having your age minus 10% in bonds and slowly increasing your bond allocation as you age versus just keeping a whole life of 50% bonds, 50% equities.

I did the lump sum in addition to the investing over time just to see if having the money up front made that much of a difference. The comparison numbers above are for the Age-10 allocation at 60 years old and the 50-50 allocation at 60 years old.
Hi smithdad,

I guess if we invested $100k for a 10 year old (or 20), they’d have it made, huh? 8)

Don’t get me wrong. I do appreciate you looking at this.

Your results for 1926 - 2006 are about the same as Gummy data 1928 - 2001. It comes out to 0.55% CAGR additional return. Of course when I used the data from Ibbotson SBBI 2003 (1928 - 2002) it came out lower ending on the bear market.

This 0.55% additional CAGR is a bit low for starting out with the extreme risk for a young investor, don’t you think? -- and as you pointed to, this was a 5.6% equity risk premium for stocks -- the 0.55% might be on the high end. This in itself is enough to make the point.

I wonder if you told the 20 year old if she started at 10% bonds and increased the bonds as she aged till she hit 50/50 at 60, she would receive an additional 0.55% return, would she think it worth the risk? Would you advise your 20 year old (if you had one) to do this?

I don’t know, but it seems to me starting out 60/40 makes more sense. 80/20 to 60/40 would offer half the additional percentage to the portfolio total, right?

Chin
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Post by DaleMaley »

Unfortunately, behavioral finance issues cause many people to self-report more positive financial results that they actually achieve on surveys. It would cost some serious money to randomly select 1200 Americans........and then validate their financial life through tax returns, investing account statements, actual expenses, etc.
In my earlier posting, I suggested that financial data must be validated.

Part of the reason that I suggested validation is.......

In one of my MBA classes.....circa 1990, you had to pick a research topic. One group decided to try to determine how big the spread in interest rates had to be....in order for people to choose a variable versus fixed rate loan.

The students decided to survey people at a local shopping mall. They prepared a short survey and asked people a few questions.......about their current mortgage rate........and variable rate questions.

They tried to statistically analyze their survey results......and found no statistically significant results.

They presented their project to the entire class.......plus a couple of guest professors. One of the professors chastised the mortgage rate team. He said that if they had done some research........they would have found that surveys about financial matters have been found to be notoriously unreliable......and they should have never even attempted their project in the manner they did.

Recent behavioral finance research has also indicated that people's memories are much more positive than reality.

:lol:
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Post by Chinwhisker »

Hi Dale,

I didn’t know you were an MBA. You might find some good mind candy here;
http://pages.stern.nyu.edu/~adamodar/

Chin
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Post by DaleMaley »

Chin:

Yes, I have an Engineering degree and an MBA.

I'm a full time Engineer, part-time financial planner, part-time author, and a full-fledged Diehard/Boglehead. :wink:

thanks for link to web site.......some interesting stuff there :lol:
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Dale Maley -- A true Boglehead

Post by Taylor Larimore »

Hi Dale:
"I'm a full time Engineer, part-time financial planner, part-time author, and a full-fledged Diehard/Boglehead."
May we take this belated opportunity to thank you for your glowing (#1) Review when our book was published.

http://www.amazon.com/Bogleheads-Guide- ... 0470067365

The book is now free at most libraries.

Best wishes.
Taylor
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Post by DaleMaley »

Taylor:

You are welcome :lol:

I didn't realize my review of the Bogleheads book was the Most Helpful review on Amazon!

I have also written about 10 short stories about various investment topics for Amazon.......and I recommend the Boglehead's book in just about every short story I write.

:lol:
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett
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