Bodie: Plan your retirement portfolio for zero real return

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bob90245
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Sun Jan 01, 2012 4:38 pm

Lbill wrote:
If an investor believes that the U.S. economy and U.S. corporations will survive and thrive just fine over, say, the next 20 years, then it follows that they will likely be rewarded with returns higher than inflation. In this scenario, it doesn't make sense to exclude an appropriate amount of stocks (like say, age in bonds) from one's long-term retirement plan -- even for your base needs.
I don't think we disagree completely except over the "base needs" part. Bodie is just saying that it makes more sense NOT to automatically assume that the best strategy is to follow conventional advice to invest in stocks even over 20+ years. Only take on equity risk to the extent you believe your basic retirement goals have been secured by a safer low-risk strategy, leaving you with a "surplus" to gamble with.
I understand this is Bodie's position. But it is not well founded. I will use your wording because I think it is good.

Scenario One: An investor believes that the U.S. economy and U.S. corporations will survive and thrive just fine over, say, the next 20 years. This may lead to the following outcomes and my estimated probabilities:

Stock investors are rewarded with return greater than inflation. Probability 75%
Stock investors are somewhat rewarded with return that merely matches inflation. Probability 20%
Stock investors are not rewarded and returns fall below inflation. Probability 5%

Scenario Two: An investor believes that the U.S. economy and U.S. corporations will stagnate over, say, the next 20 years. This may lead to the following outcomes and my estimated probabilities:

Stock investors are rewarded with return greater than inflation. Probability 5%
Stock investors are somewhat rewarded with return that merely matches inflation. Probability 20%
Stock investors are not rewarded and returns fall below inflation. Probability 75%
The US Government will be so weakened from the burden of ever-growing social programs like Social Security and Medicare that the ability to continue interest payments to bond holders will be very much weakened. Probablility 90%.
Therefore, faith in the safety of inflation-protected securities is likely misplaced.

Under Scenario One with a high probability of good equity returns, it makes sense to use a traditional stocks/bonds portfolio, even for base retirement needs.

Under Scenario Two with the low probability of good equity returns along with a fiscally weak Federal Governement, it makes sense to shun both stocks and inflation-protected securities.

What would be a better choice for saving and investment vehicles under Scenario Two?
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by umfundi » Sun Jan 01, 2012 7:50 pm

What would be a better choice for saving and investment vehicles under Scenario Two?
Gold coins, canned goods, guns and ammunition, and a mountain cabin?

You don't have to choose! You should not choose! If you do so, you are making an unfounded prediction.

Make a plan, based on the best you know: Today. Execute the plan, and make adjustments as you go. It's a 30-year journey to retirement, and a potential 30-year voyage after that.

I tried to make this point in a previous post. When I started in 1980, inflation was incredible, stock picking and market timing and interest rate predictions were the rage, and investment vehicles like money market funds, index funds, IRAs and 401(k)s did not exist. If I had followed the advice given in 1980 until now, I would be toast.

You don't have to choose. You need to plot a course and make course corrections along the way. You cannot know now which way the wind will blow for the next 30 or 60 years.

And, by the way, I am especially offended by the "gambled and won" comment. Saving 20 - 25% of your earnings for 30 years and investing according to the Boglehead principles (as they may evolve) is not gambling. It is the closest you will ever come to a dead nuts sure thing.

Keith
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by Harold » Sun Jan 01, 2012 8:16 pm

I've skimmed through most of this thread, and there's a fundamental question that comes to mind:

Given that regular folks mistakenly think that expected return means a return that they should expect to get (see a related thread on this topic), and given that regular folks mistakenly think the 401k system, not the risk they chose to take and the savings they chose not to make, disintegrated their expectations of a comfortable retirement (seems every time 401ks come up in conversation with nonprofessionals this is the underlying sentiment) -- if you don't want to give them a plan for zero real return and potentially higher savings rates, what's your reasonable suggestion?

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bob90245
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Sun Jan 01, 2012 8:39 pm

umfundi wrote:
What would be a better choice for saving and investment vehicles under Scenario Two?
Gold coins, canned goods, guns and ammunition, and a mountain cabin?

You don't have to choose! You should not choose! If you do so, you are making an unfounded prediction.

Make a plan, based on the best you know: Today. Execute the plan, and make adjustments as you go. It's a 30-year journey to retirement, and a potential 30-year voyage after that.
Perfectly reasonable. But the big question is "based on the best you know".

My impression is that Bodie and his advocates believe Schenario One is the best we know. In other words, the U.S. economy and U.S. corporations will likely survive and thrive just fine over, say, the next 20 years.

However in Scenario One, I estimated a probability of just 5% where TIPS would come out ahead of stocks. And a probability of 20% where TIPS and stocks would come out the same. These probabilities don't make for a compelling case to chose 100% TIPS over a traditional stocks/bonds portfolio (like age in bonds) as the preferred vehicle to put your money to cover your base retirement needs as you save during the next 20 years.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by Wagnerjb » Sun Jan 01, 2012 8:56 pm

umfundi wrote:And, by the way, I am especially offended by the "gambled and won" comment. Saving 20 - 25% of your earnings for 30 years and investing according to the Boglehead principles (as they may evolve) is not gambling. It is the closest you will ever come to a dead nuts sure thing.

Keith
I agree with you Keith. I also started investing in the early 1980's and was a Boglehead at that time too. I invested according to my risk tolerance (80% equities at that time), then gradually adjusted down to 50% today (I am in my early 50's). I invested in international stocks for diversification. I tax loss harvested religiously along the way. I used tax deferred vehicles where eligible and where available. I rebalanced as necessary. And I kept costs to a minimum every step of the way.

Maybe the references to "gambled and won" are for those who were 100% equities until retirement...but that sure doesn't describe a good Boglehead.

Best wishes.
Andy

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by umfundi » Sun Jan 01, 2012 9:01 pm

These probabilities don't make for a compelling case to chose 100% TIPS over a traditional stocks/bonds portfolio
bob,

I would say, today's knowledge does not make for a compelling case ...

I think we are in violent agreement! Let's talk next year.

Keith
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by umfundi » Sun Jan 01, 2012 9:30 pm

Wagnerjb wrote:
umfundi wrote:And, by the way, I am especially offended by the "gambled and won" comment. Saving 20 - 25% of your earnings for 30 years and investing according to the Boglehead principles (as they may evolve) is not gambling. It is the closest you will ever come to a dead nuts sure thing.

Keith
I agree with you Keith. I also started investing in the early 1980's and was a Boglehead at that time too. I invested according to my risk tolerance (80% equities at that time), then gradually adjusted down to 50% today (I am in my early 50's). I invested in international stocks for diversification. I tax loss harvested religiously along the way. I used tax deferred vehicles where eligible and where available. I rebalanced as necessary. And I kept costs to a minimum every step of the way.

Maybe the references to "gambled and won" are for those who were 100% equities until retirement...but that sure doesn't describe a good Boglehead.

Best wishes.
Andy,

That's interesting. I started out very conservative, and found that my risk tolerance increased over time. I think this is because my understanding improved.

There is another thing: My plan was always to kick that 60-yard field goal. Retire at age 50 if I wanted to or needed to. So, my plan was always to overachieve by 50% or so of what I thought I needed at age 62.

If you overachieve on your plan, you can assume more risk, leading to even more overachievement. This is not a recommendation. It is an observation based on my own experience.

Keith
Déjà Vu is not a prediction

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by 555 » Sun Jan 01, 2012 10:56 pm

Harold wrote:I've skimmed through most of this thread, and there's a fundamental question that comes to mind:

Given that regular folks mistakenly think that expected return means a return that they should expect to get (see a related thread on this topic), and given that regular folks mistakenly think the 401k system, not the risk they chose to take and the savings they chose not to make, disintegrated their expectations of a comfortable retirement (seems every time 401ks come up in conversation with nonprofessionals this is the underlying sentiment) -- if you don't want to give them a plan for zero real return and potentially higher savings rates, what's your reasonable suggestion?
Who are these "regular folks"? I don't doubt there may be some people who think like this, but is there really any evidence that these are widespread misconceptions?

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by peppers » Sun Jan 01, 2012 11:23 pm

I guess I am one of those regular folks. I got into the 401k plan at our company back in 1979. It was called the "savings and security plan" back then. Started in mutual funds and bonds prior to that. As time went on I also contributed to TIRA's and Roth. The wife did too. I am not a professional by any stretch of the imagination. Nor is she. Just average working class people who saved and invested wisely. I tell the younger people at work that they should get in to the 401k and read a book or two about investing and retirement planning. Some do and some don't. My goal was to have 7 figures by age 60. I got there, 3 years early in spite of 1982,1987,2000 and 2008,. Raised four children, 2 went on and graduated college.(Ouch). No mortgage for 6 years now.It can be done. Sorry for the long rant.
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by 555 » Sun Jan 01, 2012 11:44 pm

peppers wrote:I guess I am one of those regular folks. I got into the 401k plan at our company back in 1979. It was called the "savings and security plan" back then. Started in mutual funds and bonds prior to that. As time went on I also contributed to TIRA's and Roth. The wife did too. I am not a professional by any stretch of the imagination. Nor is she. Just average working class people who saved and invested wisely. I tell the younger people at work that they should get in to the 401k and read a book or two about investing and retirement planning. Some do and some don't. My goal was to have 7 figures by age 60. I got there, 3 years early in spite of 1982,1987,2000 and 2008,. Raised four children, 2 went on and graduated college.(Ouch). No mortgage for 6 years now.It can be done. Sorry for the long rant.
Harold was talking about something completely different by the term "regular folks".

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by peppers » Sun Jan 01, 2012 11:55 pm

In Harold's post he said " regular folks" and " nonprofessionals." I was just curious as to what the thinking was.
"..the cavalry ain't comin' kid, you're on your own..."

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by Harold » Mon Jan 02, 2012 12:10 am

Don't read too much into the terms "regular folks" and "nonprofessionals". It's only meant to differentiate the financial folks posting here who know what mathematical expectations and varying definitions of risk are -- from, well pretty much everyone else.

Virtually every day, in real life and on this forum, I see people misapplying both terms to their financial decisions. And I've had hundreds of conversations since 2008 where people proclaimed their retirements as being in jeopardy because of "the market" (and were utterly dumbfounded when I pointed out that a 401k doesn't require risk-taking) -- I haven't had a single conversation with a "regular folk" where he either acknowledged the risk he was taking with his 401k, or indicated that he had chosen not to take that risk. That's just not how they think about it.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by peppers » Mon Jan 02, 2012 12:24 am

Thank you sir. I stand enlightened. Was in S.F. a long time ago and promised myself to come back someday. Beautiful city.
"..the cavalry ain't comin' kid, you're on your own..."

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by 555 » Mon Jan 02, 2012 12:26 am

(@Harold) Okay, I basically never have conversations like that, so I haven't experienced the level of misconception you describe.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by Wagnerjb » Mon Jan 02, 2012 12:53 am

richard wrote:What happens to the average American with a risky portfolio when the risk manifests?

The average American family has a net worth about $240,00, including primary residence, at age 65. That doesn't generate a lot of cash flow from investments. The average American is retiring on Social Security (and Medicare), which is essentially risk free.
Let's look at the person who has more than your example. What does he do when the risk manifests? First, he saves more. Second, he works longer. But those are probably too easy. Let's make it harder. Let's assume this couple just retired yesterday (thus, saving more isn't an option...and let's say working longer is out too). Let's make up some numbers:

The couple both worked, and they earned $120,000 while working. They saved well and have retired at age 62 with $1.7 million in financial assets. They expect to receive $30,000 from Social Security and with a 4% withdrawal rate they will generate $70,000 in pretax cash flow. Their after-tax cash flow of $85,000 is roughly equivalent to their pre-retirement spending. They own a home worth $350,000. Their nest egg is 40% equities (in taxable) and 60% fixed income (in tax deferred).

Now the worst happens. The stock market plunges by 50% in one day, and stays at that level for the next 40 years. Their $680,000 in equities just declined by $340,000. What happens to this couple? Do they eat catfood the rest of their life? Of course not. Here are some real world options:

a) Do a reverse mortgage. That makes up the entire $340,000. Problem solved.

b) Annuitize a major portion of their nest egg. This dramatically increases their withdrawal rate (at the expense of leaving an inheritance).

c) Tax loss harvest. They have a huge loss, allowing them to deduct $3,000 of income each year. In addition, they can sell shares for income and not pay income tax on any capital gains. While this doesn't make up the entire loss...it make a major dent in the problem.

d) Retract your promise to pay college costs. If it isn't too late, retract your promise to pay for college or grad school for your children.

e) Spend less. Assuming no other actions were taken, a $340,000 reduction in the nest egg would translate into a SWR reduction of $13,600 per year. For the couple with spending at $85,000 this probably means eliminating the expensive international vacation each year, driving their cars two years longer before buying a new one, and eliminating one nice restaurant dinner a month.


Notice that in (a) through (d) the effects of a market plunge actually fall on others. That's right. In many cases, your children simply inherit less...or they pay more of their own college costs today. And don't forget that Uncle Sam helps ameliorate the pain too. The Boglehead with a decent nest egg and an appropriate AA won't experience a financial catastrophe if the market has a horrible market crash.

Note that this Boglehead is actually in compliance with Bodie's ideas since his "basic needs" are met with his fixed income allocation. Between SS and the $1 million in fixed income assets, this guy can cover his true basic needs. I just think we need to consider "basic needs" to be true essentials, not the nice-to-have spending that many of us are used to.

Best wishes.
Andy

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by getRichSlower » Mon Jan 02, 2012 1:07 am

VictoriaF wrote:
momar wrote:I like that no one is considering the implications of saving half of your income and then not retiring until you are 75.
If one worked from the age of 25 to the age of 75 and saved 50% of his income, then he could conceivably live for another 50 years, from the age of 75 to the age of 125, on the same income he had while working. That's an overkill. What's more, there will be some amount of Social Security available, in addition to one's savings. Thus, the premise in the cited above statement is not discussed, because it calls for an unnecessary austerity.


Victoria
The example of living to 125 isn't as out there as you make it out to be. How do you know that within 70 years, when a 25 year old today turns 95, that we won't have cures to Alzheimers and most forms of cancer, leading to dramatically longer lifespans?

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by Wagnerjb » Mon Jan 02, 2012 1:45 am

jenny345 wrote:I'm guessing Bodie's advice is geared more towards the middle class. If someone has 200K in a 401K and loses $100K at age 65 plus they will have a hard time ever making up that money.
Are you assuming the couple has 100% of his nest egg in equities at age 65? How else would he lose 50% of his nest egg?

The couple at age 65 who has $200K in their 401k will have $70,000 in equities and $130,000 in fixed income. Let's start here...and see what happens when the market tanks. I don't care to debate the effects on couples who take unreasonable risks, as neither Bodie nor a typical Boglehead would advocate such risk taking.
They'd now have to get a 100% return in stocks to even be back to where they were
To get back to where they were, the stock market would have to rise by the same dollar amount that it fell.

Best wishes.
Andy

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by tadamsmar » Mon Jan 02, 2012 1:45 am

bob90245 wrote:I guess where I don't agree with Bodie is his premise. Bodie thinks that over the long term, stocks are not likely to offer a positive real return. So he would rather be resigned to match inflation.

His premise doesn't match historical stock market data. There were less than a handful of instances when systematically investing in stocks over, say, 20 years barely matched inflation. Here is one example. The following chart shows real values for contributing $1000 every year for 20 years. Click image for full size.

Image
Source: http://www.bobsfinancialwebsite.com/DCA.html
You are showing trailing returns from the single most successful large national stock market.

Now, if you would just show us how to pick the single most successful large national stock market in the future, then we probably can do better that Bodie suggests!

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by HomerJ » Mon Jan 02, 2012 2:23 am

Lbill wrote:
For the 17-year period from 1966-1982, the real return from stocks was almost precisely zero (very slightly negative)
....and for the 13-year period 1999-2011 we have about a zero real return from stocks (and counting). Fortunately, I was TIPPED off.
Yep, but you know that historical figure of 6%-7% real annual returns for the stock market?

Those INCLUDE long periods of 0% real return.

It's basically been 15-20 years of 0% followed by 15-20 years of 14% for the last 100 years or so...

Will it continue? Maybe not... But a stretch of 13 years right after a 18 year bull market is perfectly normal so far...

Guess we'll have to see if another bull market starts in 2018 or 2020... Or maybe never. Luckily I'm not betting my retirement on 100% stocks... Being 50/50, if the stock market never booms again (highly unlikely in my opinion), I'll still retire and live quite comfortably... just not on a lake with a couple of jet skis and a pontoon boat like I planned.

But I'm pretty sure there is some water-skiing still in my future :)

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William Bernstein critiques Bodie

Post by pkcrafter » Mon Jan 02, 2012 5:28 am

William Bernstein critiques Bodie's TIPs recommendation.
The grim reality is that improvements in intermediation of the sort suggested by Bodie, while helpful, cannot avoid being overwhelmed by the twin bogeymen of human financial nature and demographics. The quantity of long-dated inflation-protected debt required by the mass-market core-TIPS approach is simply not feasible and, even if it were, bond yields would not be adequate to support the retirement needs of the looming wave of boomers
.

http://www.efficientfrontier.com/ef/903/bodie.htm

Nuff said about Bodie.

A lot of the investing recommendations and strategies we are hearing today smacks of recency bias as if the past 10 years were the entirety of market history. Balance my friends, always balance risk and safety.


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by mithrandir » Mon Jan 02, 2012 8:22 am

Perhaps we should adjust our equity risk premium expectations down from the "historical" 5-6% to 2-2.5% or whatever is accepted as the general "productivity growth" rate.

When I think about the math I get frustrated by those 5-6% real excess returns. They can't be sustainable long-term values. Otherwise consider that if you could give a newborn $1,000 and have them invest in a "stock market" vehicle free of expenses and tax considerations, by the age of 75 that $1,000 would have grown to nearly $39,000. And that's real, not nominal! It's just not possible, wealth simply cannot be created like that as if by magic.

Productivity growth (even if it is an imperfect measure like the CPI) reflects true real growth. And productivity does not improve by 5-6% annually.

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Re: William Bernstein critiques Bodie

Post by VictoriaF » Mon Jan 02, 2012 9:01 am

pkcrafter wrote:William Bernstein critiques Bodie's TIPs recommendation.
The grim reality is that improvements in intermediation of the sort suggested by Bodie, while helpful, cannot avoid being overwhelmed by the twin bogeymen of human financial nature and demographics. The quantity of long-dated inflation-protected debt required by the mass-market core-TIPS approach is simply not feasible and, even if it were, bond yields would not be adequate to support the retirement needs of the looming wave of boomers
.

http://www.efficientfrontier.com/ef/903/bodie.htm

Nuff said about Bodie.

A lot of the investing recommendations and strategies we are hearing today smacks of recency bias as if the past 10 years were the entirety of market history. Balance my friends, always balance risk and safety.


Paul
Bernstein's arguments come down to three issues:
1. People will not accept psychologically the zero-to-low real rates of inflation-indexed securities.
2. There are not enough TIPS to make a public policy out of Bodie's recommendations.
3. People will not be able to retire on the zero-to-low rates of the accumulation of their savings.

The psychological part (1) is important, but it changes with the experience. In the 1990's everybody wanted to be in stocks. In 2008, everybody was dumping stocks. If in 2008-2009, the investment community (both academics and advisers) had adopted the post-Great Depression (1930s) attitude to investing (e.g., safe investments for widows and orphans), there would be more acceptance of Bodie's theory now.

You call it recency bias. But Bodie is not biased, he was saying the same thing before 2007.
If one takes the psychology of investing seriously, one should also take seriously the concept of not wasting a good crisis.

I cannot comment on the public policy (2). As many here I am frustrated that even I-Bond investment opportunities are now cut in half.

The ability to retire after investing at very low portfolio growth rates (3) is what has been discussed in the previous hundred messages in this thread, as well as in other related threads. It comes down to a simple principle:
If you cannot afford to lose it, you cannot afford to invest it in stocks.

Victoria
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by HomerJ » Mon Jan 02, 2012 11:42 am

jenny345 wrote:Bodie's plan of zero real is probably too conservative, but I personally don't see planning for the worst and hoping for better as a bad strategy. You'd be better off than the people on the news stories who planned for the best, didn't see the worst coming and now can't retire or even hold out financially until they are eligible for Social Security.
I plan for the worst, but I'm invested 50/50 so I can take advantage if the better comes along.

The problem with Bodie's plan is that you're planning for the worst AND stuck with the worst... no matter what. If the stock market does recover and go through another boom time, you don't get any of it. There's no "hoping for the better" with Bodie's plan.

It's terrible.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Mon Jan 02, 2012 11:51 am

tadamsmar wrote:
bob90245 wrote:I guess where I don't agree with Bodie is his premise. Bodie thinks that over the long term, stocks are not likely to offer a positive real return. So he would rather be resigned to match inflation.

His premise doesn't match historical stock market data. There were less than a handful of instances when systematically investing in stocks over, say, 20 years barely matched inflation. Here is one example. The following chart shows real values for contributing $1000 every year for 20 years. Click image for full size.

Image
Source: http://www.bobsfinancialwebsite.com/DCA.html
You are showing trailing returns from the single most successful large national stock market.

Now, if you would just show us how to pick the single most successful large national stock market in the future, then we probably can do better that Bodie suggests!
These are comments are quite strange. First, I will grant the US stock market was successful in that it had returns greater than inflation (somewhere like 6 to 7 percent average real returns going back to 1926).

Second, I don't think it is necessary to "pick the single most successful large national stock market in the future". You merely have to believe that, over say the next 20 years for the person saving for retirement, the US and World economies and the corporations that operate in them will thrive and produce profits and provide returns to investors greater than inflation. Taking that belief into an investing plan, you would invest in a traditional stocks/bonds portfolio (like age in bonds). That would be better than the Bodie plan of investing in inflation-protected securities with the goal of merely matching inflation.

Now, if you don't believe that this Scenario One will come to pass, you likely are of the belief in Scenario Two. Under Scenaraio Two, an investor believes that the U.S. economy and U.S. corporations will stagnate over, say, the next 20 years. This may lead to the following outcomes and my estimated probabilities:

Stock investors are rewarded with return greater than inflation. Probability 5%
Stock investors are somewhat rewarded with return that merely matches inflation. Probability 20%
Stock investors are not rewarded and returns fall below inflation. Probability 75%
The US Government will be so weakened from the burden of ever-growing social programs like Social Security and Medicare that the ability to continue interest payments to bond holders will be very much weakened. Probablility 90%.
Therefore, faith in the safety of inflation-protected securities is likely misplaced.

Under Scenario Two with the low probability of good equity returns along with a fiscally weak Federal Governement, it makes sense to shun both stocks and inflation-protected securities. And as the poster "umfundi" suggested (perhaps tongue in cheek) a better choice for saving and investment vehicles under Scenario Two might be Gold coins, canned goods, guns and ammunition, and a mountain cabin.
Last edited by bob90245 on Mon Jan 02, 2012 12:37 pm, edited 1 time in total.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by dmcmahon » Mon Jan 02, 2012 11:54 am

frose2 wrote:if you live in America and realistically want to retire, you must work for the government.
The truth of this statement has yet to fully penetrate the collective conciousness.

Even (state and local) government employees need to consider that their pension funds have the same array of zero-return investments to choose from, and taxpayers (most of whom don't have good pension schemes) will at some point rebel against funding the shortfalls.

My problem with Brodie's advice is that unless I assume some supplemental source of income, I can't square the circle with TIPS alone because of the limits placed on annual contributions to 401k/IRA vehicles. And that's leaving aside the fact that the limits were much lower for most of my career, TIPS didn't exist for about half of it, and, um, I can't get those years back! But even a young worker IMO faces a challenge. Over a 40-year career, a worker might save approximately $750k in a 401k. That's in constant dollars and assumes zero return. That will produce a $30k income at a 4% WR. Now the $750k is based on saving the max each year (e.g. $17k-$22k) - so our hypothetical worker has to have had an income in the $100k range. This is a pretty income big drop. Perhaps our worker gets SS of, say, $35k. My point is that our worker has to save like a maniac, work a full 40 years, gamble that his SS benefits won't be reduced, and still faces a pretty big income drop at the end. Throw in $5k/year for a back-door roth and $5k/year in I-bonds and you can push the kitty up to $1.1-1.2 million, but he still faces a problem. Annuitize the final balance and he can push his income a bit higher (though only by taking insurance-company credit risk, and also by facing some inflation risk). My conclusion is that beyond a moderate income level, my hypothetical worker will have to save additional funds in taxable accounts. Here, he must run against the full force of the taxflation system. It's extremely difficult to progress against that headwind, and impossible with bonds. In his early career, he might save enough out of his pay to more than make up for the loss of purchasing power net of taxes that have eroded his savings during a working year. By the middle of his career, unless his income has skyrocketed, this becomes mathematically impossible except at 0% inflation. At this point, purchasing power is leaking out the bottom of the taxflation bucket faster than he can possibly pour it in.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Mon Jan 02, 2012 12:49 pm

jenny345 wrote:
rrosenkoetter wrote:
jenny345 wrote:Bodie's plan of zero real is probably too conservative, but I personally don't see planning for the worst and hoping for better as a bad strategy. You'd be better off than the people on the news stories who planned for the best, didn't see the worst coming and now can't retire or even hold out financially until they are eligible for Social Security.
I plan for the worst, but I'm invested 50/50 so I can take advantage if the better comes along.

The problem with Bodie's plan is that you're planning for the worst AND stuck with the worst... no matter what. If the stock market does recover and go through another boom time, you don't get any of it. There's no "hoping for the better" with Bodie's plan.

It's terrible.
What Bodie really said -

http://books.google.com/books?id=zQZ5Z3 ... &q&f=false

"In this chapter we consider the key factors in deciding how much of your money to invest in the stock market."

Neither Bodie nor anyone else on this forum is telling people here not to invest in stocks. All he is ever said is never invest more than what you can afford to lose. No one is telling you or Warren Buffet not to invest in stocks.

In the Boglehead methodology, aren't you supposed to own your age in bonds? Isn't that because your portfolio should be less risky / have more bonds and less stocks when you are at the age you can't afford to lose as much? Isn't that a similar concept? It is just that the Bogleheads are drawing the line at age regardless of income, and Bodie is drawing the line at income requirements regardless of age.
Perhaps we should return to the Opening Post and use that as the basis for our discussion. I am assuming the following correctly reflects Bodie's "key factors" to prepare a plan to save for retirement.
Lbill wrote:Long an advocate for minimizing risk in retirement investing, Zvi Bodie in his latest book "Risk less and Prosper" still recommends that investors follow this "safety first" plan:
1. Determine your minimum retirement income goal.
2. Determine your required savings rate based on assuming a 0% real rate of return (i.e., that you can match inflation but no more).
3. Consider working, at least part-time, beyond the conventional retirement age in order to achieve your retirement savings goal.
4. Your primary retirement investments should be TIPS and I-Bonds.
5. Add riskier investments, such as stocks, only if you are unable to meet your minimum retirement goal based on 1-4 above, and then add only the minimum allocation necessary. Recognize that, even though riskier investments might allow you to reach your retirement goal sooner, or even exceed your goal, there is a significant chance you can fall short of your goal and that this risk does not decrease over long-run investment horizons.

http://www.marketwatch.com/video/asset/ ... 1586E397A4
So I take it that Bodie is telling people not to invest in stocks before meeting one's miniumum retirement goal. By contrast, the Boglehead approach doesn't make the distinction about "minimum retirement goal".
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by getRichSlower » Mon Jan 02, 2012 1:52 pm

How do the people who suggest that 0% or below real returns are impossible explain Japan? Isn't someone who retired in 1990 in Japan still with a -50% cumulative real return on domestic equities since 1990? Since people are taking withdrawals over time, their realized returns are even worse than the -50% return.
Last edited by getRichSlower on Mon Jan 02, 2012 2:04 pm, edited 1 time in total.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by saurabhec » Mon Jan 02, 2012 1:58 pm

getRichSlower wrote:How do the people who suggest that 0% or below real returns are impossible explain Japan? Isn't someone who retired in 1990 in Japan still with a -50% cumulative real return since 1990? Since people are taking withdrawals over time, their realized returns are even worse than the -50% return.
Nobody is saying 0% real returns are impossible with equities or bonds. There are several notable examples in the US for this happening over long stretches.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by getRichSlower » Mon Jan 02, 2012 2:03 pm

bob90245 wrote: In that scenario, I don't think TIPS will be very safe, either. A stagnant economy generating very little real corporate profits will mean that the government will be taking in less in taxes from the corporate sector. And little or no real growth in corporate profits will mean that workers incomes will also stagnate. And this will further crimp the amount of taxes the government can take in from employee wages. So with tax receipts to the US government staganting or falling, the ability to support ever growing social programs like Social Security and Medicare and to continue interest payments to bond holders will be very much weakened.

As I said before, in the scenario with corporations not generating profits or returns to investors greater than inflation over an extended period of, say, 20 years, how much you have saved up for retirement might be the least of your concerns.
^It certainly seems like some people are saying that 0% real returns on equities are impossible.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by saurabhec » Mon Jan 02, 2012 2:14 pm

getRichSlower wrote:
bob90245 wrote: In that scenario, I don't think TIPS will be very safe, either. A stagnant economy generating very little real corporate profits will mean that the government will be taking in less in taxes from the corporate sector. And little or no real growth in corporate profits will mean that workers incomes will also stagnate. And this will further crimp the amount of taxes the government can take in from employee wages. So with tax receipts to the US government staganting or falling, the ability to support ever growing social programs like Social Security and Medicare and to continue interest payments to bond holders will be very much weakened.

As I said before, in the scenario with corporations not generating profits or returns to investors greater than inflation over an extended period of, say, 20 years, how much you have saved up for retirement might be the least of your concerns.
^It certainly seems like some people are saying that 0% real returns on equities are impossible.
I doubt that there are any folks on this board who consider 0% real returns on equities to be impossible even over long periods. However it does seem like equities have better odds of generating positive real returns than Treasuries over the long term. I don't think it is controversial to say that at all.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bobcat2 » Mon Jan 02, 2012 2:26 pm

bob90245 wrote.
So I take it that Bodie is telling people not to invest in stocks before meeting one's miniumum retirement goal. By contrast, the Boglehead approach doesn't make the distinction about "minimum retirement goal".
Part of the advice is pretty close to that.

Bodie is telling people to safely fund the minimum retirement income target. You can be investing in stocks at the same time, however, but not to meet the retirement minimum income amount.

Bodie is the strongest proponent of applying the life-cycle finance approach to real world personal finance decisions. Life-cycle finance is the standard economics approach to personal finance. So Bodie's approach is not specific to Bodie, but instead the standard economics approach to personal finance decision making. One of the proponents of life-cycle finance among financial professionals is the well known financial planner Paula Hogan. In a recent Quarterly Note on her website Hogan pointed out some of the key differences between the conventional approach to financial planning vs. the life-cycle approach.
The Scientific Approach to Personal Wealth Management

From popular culture, one might think that personal wealth management is a question of personal taste and that all you really need to do is figure out your risk tolerance, build a portfolio that reflects that risk tolerance, and then hang on, expecting the best. Sometimes that works.

However, there is a different approach, one rooted in several fundamentally important core principles. When building a financial plan according to these core principles, you are following the scientific approach, not the personal taste approach. In other words, you are basing strategy on principles that have been well developed in the academic
world through a rigorous peer review process and that have also stood the test of time. The scientific approach to the management of personal wealth reflects a central concern for risk management. A key insight is that you can’t control returns, but you have some control over risk….

In practice, it can be difficult to tell the difference between the scientific, risk management perspective and the more pop culture, hope‐for‐the‐best approach to financial planning. However, take a look at the following core planning principles behind the scientific approach and begin to see the fundamental differences.

CORE PLANNING PRINCIPLES OR A SCIENTFIC APPROACH TO PLANNING

People care most about their lifetime standard of living, not wealth. For example, as you
consider your own planning, are you targeting a specific portfolio amount in retirement,
or are you thinking about a desired lifestyle (living standard)? That’s a key question….

Risk is goal dependent. In general, the more strongly you care about a financial goal, the
less risk you’ll want to take in financing that goal. For example, your base lifetime
standard of living, the lifestyle that you do not want to go below, is most appropriately
funded with a safe investment that offers lifetime inflation protected income.

Stocks are risky, even if held for a long time, and so are not appropriate when safe financing is
required. In popular culture, there is a deeply rooted, but fundamentally incorrect belief that if
you have a long time horizon you can and should own stocks because stocks aren’t risky if held
for the long-term.

In the scientific world‐view that belief is a jaw dropper for the following very specific reason.
Shortfall risk—the risk that the portfolio will not be at least equal to a specified level—increases
with time. Need convincing? Try buying portfolio shortfall insurance: the longer the time period the
higher the premium….

Saving does not boost your lifetime standard of living, but instead smoothes your
standard of living. Savings shifts income from times of high earned income to lower
earned income and from times of favorable life conditions to the more difficult personal
times, for example of unemployment, disability, or death of the breadwinner.
Saving and insuring are strategies for resolving the reality that the rhythm of
income rarely matches the rhythm of spending.

Useful risk management strategies include not just precautionary saving and diversification,
but also hedging and insuring. Hedging means to sell the upside potential of an asset in return
for downside price protection. Insuring means to pay a known price to protect against the possibility
of a larger loss on some risky asset while keeping the upside potential for the investment return on that asset.

When you plan from a risk management perspective it is much more likely that you will
decide to use insurance‐based investment products, e.g. long term care insurance and
immediate annuities….

BE WARY:

Be wary if someone tells you to increase risk because you ‘need’ a higher return to meet your goals.

Be wary of retirement solutions that depend upon particular stock returns, even if the
returns are ‘on average’ or ‘over the long term’ or ‘guaranteed’.

Be wary of any suggestion to fund a very highly held personal goal with a risky asset such as stocks. You don’t live ‘on average’; neither should your financial plan.

Be wary if someone tells you that your portfolio is safe simply because it is diversified.
Diversified risky investments are still risky.

Be wary if safe investments are discouraged as being boring or too low returning.

Be wary if someone tells you that stocks are a reliable inflation hedge or says that you
can afford to invest in stocks because ‘you have a long time horizon’.


BE GLAD!

Be glad when the proposed retirement solution is expressed in terms of lifetime,
inflation‐protected income and when the key variables under discussion are your expected
minimum income in retirement, the chance of successfully securing this
income, the necessary savings rate to create that lifetime income, and how long you will
work.

Be glad if your advisor begins scenario planning assuming first that goals are funded
purely with safe investments, and then shows you the expected impact on your
lifetime income if you take more risk, work longer, and/or save more.
Link:http://www.paulahogan.com/main.cfm?acti ... 11&s=hogan

BobK
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Mon Jan 02, 2012 2:36 pm

getRichSlower wrote:
bob90245 wrote:In that scenario, I don't think TIPS will be very safe, either. A stagnant economy generating very little real corporate profits will mean that the government will be taking in less in taxes from the corporate sector. And little or no real growth in corporate profits will mean that workers incomes will also stagnate. And this will further crimp the amount of taxes the government can take in from employee wages. So with tax receipts to the US government staganting or falling, the ability to support ever growing social programs like Social Security and Medicare and to continue interest payments to bond holders will be very much weakened.

As I said before, in the scenario with corporations not generating profits or returns to investors greater than inflation over an extended period of, say, 20 years, how much you have saved up for retirement might be the least of your concerns.
^It certainly seems like some people are saying that 0% real returns on equities are impossible.
If you are referring to me, I don't think you read all of my posts on this thread. I will repeat probabilities I estimated:

http://www.bogleheads.org/forum/viewtop ... 5#p1263605
bob90245 wrote:Scenario One: An investor believes that the U.S. economy and U.S. corporations will survive and thrive just fine over, say, the next 20 years. This may lead to the following outcomes and my estimated probabilities:

Stock investors are rewarded with return greater than inflation. Probability 75%
Stock investors are somewhat rewarded with return that merely matches inflation. Probability 20%
Stock investors are not rewarded and returns fall below inflation. Probability 5%

Scenario Two: An investor believes that the U.S. economy and U.S. corporations will stagnate over, say, the next 20 years. This may lead to the following outcomes and my estimated probabilities:

Stock investors are rewarded with return greater than inflation. Probability 5%
Stock investors are somewhat rewarded with return that merely matches inflation. Probability 20%
Stock investors are not rewarded and returns fall below inflation. Probability 75%
The US Government will be so weakened from the burden of ever-growing social programs like Social Security and Medicare that the ability to continue interest payments to bond holders will be very much weakened. Probablility 90%.
Therefore, faith in the safety of inflation-protected securities is likely misplaced.

Under Scenario One with a high probability of good equity returns, it makes sense to use a traditional stocks/bonds portfolio (like age in bonds), even for base retirement needs.

Under Scenario Two with the low probability of good equity returns along with a fiscally weak Federal Governement, it makes sense to avoid both stocks and inflation-protected securities.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Mon Jan 02, 2012 2:54 pm

BobK,

I acknowledge that Bodie and others prefer the so-called Life-cycle approach to investing. However, I don't see it gaining adherents in the mainstream. I'm sure investing experts like John Bogle, Larry Swedroe, Rick Ferri and William Bernstein have looked it this and many other approaches to investing. If Bogle, et al, found merit in the Life-cyle approach to investing, they would have altered their message by now.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bobcat2 » Mon Jan 02, 2012 3:27 pm

Hi Bob,

We disagree. I believe the life-cycle approach, which is the mainstream in economics, is gaining adherents in the world of world of financial professionals. Nor do I know why I you refer to it as the "so-called" life-cycle finance approach. That is its name. By the way, what is the name of the mainstream approach, which must be a little tricky since there is no coherent theory for its basis? :wink:

I believe that a good many financial professionals are resistant to life-cycle finance for a very good reason that Upton Sinclair expressed many years ago.
It is difficult to get a man to understand something, when his salary depends upon his not understanding it!"


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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Mon Jan 02, 2012 3:34 pm

jenny345 wrote:
bob90245 wrote:BobK,

I acknowledge that Bodie and others prefer the so-called Life-cycle approach to investing. However, I don't see it gaining adherents in the mainstream. I'm sure investing experts like John Bogle, Larry Swedroe, Rick Ferri and William Bernstein have looked it this and many other approaches to investing. If Bogle, et al, found merit in the Life-cyle approach to investing, they would have altered their message by now.
Would they alter their message if it meant less commissions / management fees for them?
This is a valid point to discuss. This issue is also discussed in several books on the Boglehead reading list. What we're talking about is how an individual investor should go about hiring an investment advisor. They should look for an advisor who will be a fiduciary and place the client's interest above the advisor. If there are any conflicts of interest, the advisor should clearly disclose them. This is not a complete set of guidelines. But just the main ones that come to my mind.
Last edited by bob90245 on Mon Jan 02, 2012 3:43 pm, edited 1 time in total.
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Mon Jan 02, 2012 3:42 pm

bobcat2 wrote:Nor do I know why I you refer to it as the "so-called" life-cycle finance approach. That is its name. By the way, what is the name of the mainstream approach, which must be a little tricky since there is no coherent theory for its basis?
If you read books by Bogle, Ferri and Malkiel, they also use the term Life-cycle. Roughly, this is age-in-bonds. You also have mutual funds that have Life-cycle or Target date in the name. And these also follow a somewhat age-in-bonds glide path. That is why I refer to the other method you and Bodie like as "so-called". :D
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by umfundi » Mon Jan 02, 2012 3:43 pm

So I take it that Bodie is telling people not to invest in stocks before meeting one's minimum retirement goal. By contrast, the Boglehead approach doesn't make the distinction about "minimum retirement goal".
Or, "Don't invest in stocks if you cannot afford to lose (some of?) the money."I think Victoria said that.

This makes no logical sense. If you can afford to "lose" some money, it must be excess that you don't really need. So your goals must already be taken care of, right? Why risk the money at all?

I don't know what Bodie precisely means, but the idea you should take the minimum risk to meet a minimum goal is, in my opinion, very bad advice.

And, the idea that there can be absolutely no possibility of an intermediate downside is, I think, irresponsible.

The real danger with the advice in the OP (and perhaps with Bodie's advice) is that people might actually follow it.

What it does, and this is what really upsets me, is it exploits people's fears of a short term investment loss. The risk is not that the stock market may drop 30% tomorrow*. It is that 40 years from now you will be mired in relative poverty.

I've been running spreadsheets all afternoon. There is no way that anyone can succeed with a zero percent real return**. That dog won't hunt.

Keith

* Those that are funding their IRA's on this first trading day of the year will probably welcome such a price decline.
** Barring the inheritance from rich Aunt Lucy, the lottery, or other white swan events.
*** Keith's advice: Raise the goal, raise your savings, raise your risk above zero. The upside probability far outweighs the downside.
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by wbond » Mon Jan 02, 2012 3:46 pm

I apologize for being a bit off-topic here.

I have recently converted to a "Zvi's-100%-less-than-zero-if-taxed-at-all-expected-return-'investing'-plan."

Does anyone have an opinion on the best place to purchase a barrel with suspenders?

Interestingly, this place, does not appear to carry any.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bobcat2 » Mon Jan 02, 2012 4:09 pm

If you read books by Bogle, Ferri and Malkiel, they also use the term Life-cycle. Roughly, this is age-in-bonds.
I would say "age-bonds" as a life-cycle approach to investing is at best an extremely naive life-cycle theory of personal investing. This is nothing but a rule of thumb masquerading as a theory.

Here is an excerpt from Kent Summers reviewing "Risk Less and Prosper" on the conventional approach to financial planning.
Besides challenging "what" to invest in, Bodie and Taqqu also challenge "how" to think about investing altogether. Most investment advice pitched by financial advisors is terribly naïve, even if supposedly based on "modern portfolio theory." In essence, most financial advisors construct investments based on a client's "risk tolerance" that is judged by asking them a series of hypothetical questions. Once created, this same portfolio is then applied across almost every potential goal of the client including, for example, a wedding next year, a house down payment, college, cars, vacations, and even retirement. This simpleton procedure is the basis of calculations by almost all popular software packages being used today by financial advisors. Instead, Bodie and Taqqu argue for a more real goal-based approach. Each goal should be matched with its own appropriate investment. Basic living expenses during retirement should be financed by low-risk investments...
BobK
Last edited by bobcat2 on Mon Jan 02, 2012 4:10 pm, edited 1 time in total.
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by Lbill » Mon Jan 02, 2012 4:10 pm

BobK - thanks for that link, very helpful. One thing that should be emphasized about the Lifecycle approach is the role of human capital in relationship to investing in equities. Human capital is a highly important "asset" when planning the allocation of one's financial assets. For example, someone whose human capital is more like TIPS than Stocks (e.g., relatively secure career, income not highly correlated to economic/financial factors, salary growth at least commensurate with inflation), has more discretion to invest in equities. By comparison, someone with low human capital (e.g., due to age, poor or uncertain career prospects) assumes a much larger risk by investing in equities; instead this person should be particularly interested in Bodie's safety-first approach.

As a side point: It's interesting that Bodie and Milevsky, both tenured professors who advocate the lifecycle view, seem to arrive at different personal retirement investing strategies. Milevsky has written that he takes account of his human capital as TIP-like, and invests his retirement accounts heavily in equities to diversify his total wealth (human capital + financial assets). In contrast, Bodie invests mostly in TIPS, even though his human capital is also TIPS-like. Age is perhaps one factor: Bodie is much closer to retirement than Milevsky and has less human capital based on future earnings. I think another is that Bodie seems to have a low "marginal utility of wealth." In addition, Bodie has stated elsewhere that he has a very high aversion to incurring investment losses.
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by yessiree83 » Mon Jan 02, 2012 4:12 pm

getRichSlower wrote:How do the people who suggest that 0% or below real returns are impossible explain Japan? Isn't someone who retired in 1990 in Japan still with a -50% cumulative real return on domestic equities since 1990? Since people are taking withdrawals over time, their realized returns are even worse than the -50% return.
The only reason it was possible to drive Japanese stocks to permanent losses was because the owners of Japanese stocks had the option of selling those stocks and replacing them with stocks from other countries (America, China, Europe, etc), but the owners of global stocks have no such option because there's nowhere else for them to put their money. Now of course the entire world could suddenly decide to replace stocks with bonds en masse, but that would entail a much more unlikely and profound economic transformation (for example, why wouldn't at least some of those companies continue to attract investors with dividends?) than simply replacing Japanese stocks with European stocks...it's possible, but I don't know how one might adjust a portfolio to prepare for such a scenario since it seems somewhat akin to global communism (which would presumably be bad for all private ownership whether it be of stocks, bonds, or otherwise).

I hope everyone who retired in Japan in 1990 was smart enough to diversify internationally.

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bobcat2 » Mon Jan 02, 2012 4:38 pm

Hi Lbill,

You wrote.
As a side point: It's interesting that Bodie and Milevsky, both tenured professors who advocate the lifecycle view, seem to arrive at different personal retirement investing strategies.
The strategy is the same but one is risk adverse and the other is a relative risk taker. Remember though that Milevsky has a very secure job, SS, and probably a handsome db pension. So he is not taking as much risk as it might first appear.

While the approach focuses on risk management it is not necessarily true that all portfolios using this approach will be very low risk. Two people with similar income and similar assets, such as ZB and MM, might decide on quite different minimum retirement income levels. One might decide that SS meets his minimum retirement income target, while the other might decide that 90% of his retirement income should come from safe assets. It's not that one is right and the other is wrong, they simply have different opinions about how much risk to take. However, both are approaching the problem the same way.

They are some things they will have in common though compared to conventional financial planning. Their goals will likely be more central to the financial planning process and they will consider hedging and insuring strategies to manage risk in addition to diversification strategies and precautionary savings. Also, as you note, human capital will play an important role in their planning. In conventional financial planning OTOH human capital at best plays a small secondary role. In some cases no more than a buzz word added to the conversation, but not acted upon in any significant way. :D

BobK
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bob90245 » Mon Jan 02, 2012 4:43 pm

bobcat2 wrote:
If you read books by Bogle, Ferri and Malkiel, they also use the term Life-cycle. Roughly, this is age-in-bonds.
I would say "age-bonds" as a life-cycle approach to investing is at best an extremely naive life-cycle theory of personal investing. This is nothing but a rule of thumb masquerading as a theory.
I agree the age-in-bonds approach to investing is a rule of thumb. No one has thought to elevate it to a "theory". :D It is most often just a starting point and best tailored to the investor's individual circumstances. Or as Larry might say, his unique ability, need and willingness to take stock market risk.

Now it is nice that Bodie and others have come up with a neat Theory for Life-cycle investing. But just because it is a Theory, doesn't mean that it is any more special than other approaches. It still must face scrutiny whether the Theory merits usage outside the Ivory Tower and used by real investors like you and me. :D
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by umfundi » Mon Jan 02, 2012 4:59 pm

They are some things they will have in common though compared to conventional financial planning. Their goals will likely be more central to the financial planning process and they will consider hedging and insuring strategies to manage risk in addition to diversification strategies and precautionary savings. Also, as you note, human capital will play an important role in their planning. In conventional financial planning OTOH human capital at best plays a small secondary role. In some cases no more than a buzz word added to the conversation, but not acted upon in any significant way.
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by peter71 » Mon Jan 02, 2012 5:10 pm

dmcmahon wrote:
frose2 wrote:if you live in America and realistically want to retire, you must work for the government.
The truth of this statement has yet to fully penetrate the collective conciousness.
Brilliant. My multi-millionaire CFO uncle was just about to retire, but I'll let him know he'd better get a job as a government secretary first. :roll:

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bobcat2 » Mon Jan 02, 2012 5:13 pm

Hi Bob,

But an important point is that there isn't any other theory in this case. This theory, life-cycle finance, is the only theory we have for personal finance (all other theories in personal finance have been found seriously wanting). Life-cycle finance was first advanced in the mid 1950s and many refinements have been made, and continue to be made, to the theory and its application ever since then. The other approaches to personal finance and investing are essentially collections of rules of thumb, and these rules of thumb are often not consistent with one another.

Also we have more products being introduced over time that make the life-cycle approach more actionable. That would include real bonds, reverse mortgages, LTCi, and inflation-indexed life annuities. Furthermore we can expect these products to improve and become more widely available in the future. We can also expect more products amenable to the life-cycle approach to appear in the near future. For example, a new product consistent with the life-cycle approach, the Managed Defined Contribution 401k plan, was introduced by DFA last summer.

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

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by peter71 » Mon Jan 02, 2012 5:19 pm

Hi Bob,

What exactly are your qualifications to speak about what's mainstream in Economics? Are you currently an active (i.e., non-emeritus) faculty member at a major research university? (I'm a political scientist at a major research university and while I know dozens of economists I've never known one to have an opinion on or even an interest in Lifecycle Finance.)

Best,
Pete

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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by brick-house » Mon Jan 02, 2012 5:35 pm

Check out Larry Kotlikoff's website for his esplanner (economic security).

Larry Kotlikoff - Professor of Economics Boston University and President of Economic Security Planning, Inc.

http://www.esplanner.com/

Check out some research on Lifecycle planning

http://www.esplanner.com/learn/comparin ... l-planning
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by nisiprius » Mon Jan 02, 2012 5:36 pm

The idea of "human capital" makes my cranky. It has no practical value, because a) you do not own your job, which makes it different from every other investment asset we talk about, and b) you cannot get any reliable data on the mean, volatility, etc. of your human capital to plug into any planning you might be doing.

In a thought experiment, in principle we could put dollar values on human capital and imagine measuring correlation coefficients and so forth, but in real life you can't do it. It's all IF we had ham, we could have ham and eggs, IF we had some eggs. If we actually knew that our income had an 0.78 correlation to the MSCI U.S. IM Semiconductors & Semiconductor Equipment 25/50 Index, then, sure, we could short that sector or something.

In reality, it's just flattery. I suppose there are stage actors, construction workers, and seasonal agricultural laborers with 401(k)'s, but most investors are white-collar workers with what once would have been thought of as steady, secure jobs. Most investors have bond-like human capital and always have, so using the term "human capital" is not an insight that leads to anything in particular you should be doing differently from other investors.

Certainly it is not some breakthrough discovery that means that a senior financial analyst at United Technologies ought to be advised to use some utterly different investment strategy than would have been advisable two decades ago.

The biggest "human capital" fact is that people should not invest much in the stock of the company they work for. But that's nothing new. It's probably the most important "human capital" consideration (but it's routinely ignored, of course, because the companies people work for routinely give them conflicting advice). Beyond that, "human capital" is not "news you can use."

Show me a link to a page that gives the standard deviation of the salary history of financial analysts at United Technologies... or philosophy professors at Case Western Reserve... or quality control maangers at General Electric... and then I'll agree that human capital is a usable concept.
Last edited by nisiprius on Mon Jan 02, 2012 5:46 pm, edited 2 times in total.
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Re: Bodie: Plan your retirement portfolio for zero real retu

Post by bobcat2 » Mon Jan 02, 2012 5:41 pm

You really need to get around more Pete. :wink:

Best,
BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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