Why Asset Allocation May Not Matter

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gbronc
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Why Asset Allocation May Not Matter

Post by gbronc » Mon Apr 09, 2012 10:58 pm

Would be interested in hearing feedback on this:
http://crr.bc.edu/wp-content/uploads/20 ... 012-13.pdf

Goes against everything I've read and believed for years.

Conclusion:
"Given the relative unimportance of asset allocations, financial advisers will be of greater
help to their clients if they focus on a broad array of tools – including working longer,
controlling spending, and taking out a reverse mortgage"

stlutz
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Re: Why Asset Allocation May Not Matter

Post by stlutz » Mon Apr 09, 2012 11:17 pm

Interesting article--thanks for sharing.

Goes against everything I've read and believed for years.


One thing the article is built around is the fact that most people retire without significant financial assets. If you're a multi-millionarie, asset allocation matters a lot more than the typical person they mention who retires with $100K in their 401K.

Reminds me a little bit of one recommendation from Jim Otar's Retirement Myth book--that people who are just starting out with saving for retirement should put 100% into low-risk investments. When your nest egg is small, losses take a bigger emotional toll than when you have more money. And, when do you don't have a lot, how much you save matters far more than your investment return. Once you've accumulated some dollars, then start to allocate into stocks.

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Re: Why Asset Allocation May Not Matter

Post by kwyjibo » Mon Apr 09, 2012 11:46 pm

The most important thing for investing might be asset allocation but the most important thing for retirement is still saving more and spending less.

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Re: Why Asset Allocation May Not Matter

Post by joe8d » Tue Apr 10, 2012 12:13 am

Reminds me a little bit of one recommendation from Jim Otar Retirement Myth book--that people who are just starting out with saving for retirement should put 100% into low-risk investments. When your nest egg is small, losses take a bigger emotional toll than when you have more money. And, when do you don't have a lot, how much you save matters far more than your investment return. Once you've accumulated some dollars, then start to allocate into stocks.stultz


Actually that what I did. I was pre IRA/ 401k and my money went into a 5.75 % savings bank account and savings bonds. Later,when interest rates were raising, it was a MMF, CDs and T-bills.I was almost 40 before I bought my first stock MF and then continued on in that direction with new money always having that initial safe cushion behind me.
All the Best, | Joe

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Re: Why Asset Allocation May Not Matter

Post by CaliJim » Tue Apr 10, 2012 12:31 am

"Rule #1: Your career provides your wealth"
Harry Brown

Living below your means helps too.

However - the primary determinant of investment outcomes, over the long term, is asset allocation.
-calijim- | | For more info, click this

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Re: Why Asset Allocation May Not Matter

Post by nisiprius » Tue Apr 10, 2012 5:32 am

First reaction: I've seen Alicia H. Munnell's name and the Center for Retirement Research at Boston College and I believe them to be straight shooters. High credibility. Now to read what they say! I think myself that savings and spending are hugely important, and that, yeah, it does matter in terms of outcome whether stocks/bonds are 100%/0%, 75%/25%, 50%/50%, 25%/75%, 0%/100%--not sure any differences smaller than that matter much--but they only matter if you happen to be doing your retirement savings during a time when stocks are doing well. If you are unlucky--not extremely unlucky, just unlucky with in the range of prudent planning contingencies--outcomes are surprisingly independent of stock/bond allocation. So, for planning purposes, it may not matter much.

OK, what do they say?

Yeah. They seem to be looking here at a sort of public policy question. It's not whether asset allocation matters to you or me with our particular financial situation, but what things should be concentrated on in educating or advising the public at large. And yeah, it's all about savings size and portfolio composition relative to other "levers." A rather key assumption is:
Household financial wealth invested in stocks, bonds, and short-term deposits is assumed to earn returns of 6.5, 3.0 and 1.0 percent, respectively, from the date of the interview until retirement. These rates approximate the long-run average rates of return on each of the three asset classes. Importantly, these assumptions are used throughout for projecting asset returns rather than incorporating any actual fluctuations. The objective is to assess whether households are on track to meet their replacement rate targets, not whether they actually succeeded in meeting them.
In one sense I applaud this, since the "propaganda" from many quarters is that the magic of high equity allocations will allow you to easily and painlessly secure a comfortable retirement with a low savings rate.

In another sense, I have to take exception to the idea that "working longer" is some kind of solution to the problem of retirement! Right, and you can retire comfortably on nothing at all by not retiring at all! Obviously personal situations differ, but retirement is usually somewhere in between a voluntary decision to lead a life of leisure and a forced decision due to physical inability to work and/or inability to find work suitable to one's abilities. "Working longer" has a host of problems, and frankly it makes me angry.

If getting work were a simple matter of wanting to work, a lot of people who aren't working, would be. Ask some people in their sixties laid off during 2008-2009 whether "working longer" is a solution for them; in their case, working until traditional retirement age is not an option. Among my circle of acquaintances, a fairly common story seems to be "I filed for Social Security at 62 because I'd been looking work for a year and hadn't even gotten a nibble."

And part of the original motivation for Social Security--explicit in the Townsend Plan to which it was a reaction, but implicit in Social Security as well--was to get older workers out of the workforce for the good of younger workers. A widespread cultural shift toward "working longer" (i.e. a partial abandonment of our traditional-since-1930 retirement aspirations) not only requires changes in attitude by employers, it also it setting up an arena for inter-generational conflict.
Last edited by nisiprius on Tue Apr 10, 2012 5:56 am, edited 3 times in total.
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Re: Why Asset Allocation May Not Matter

Post by The Wizard » Tue Apr 10, 2012 5:37 am

CaliJim wrote:However - the primary determinant of investment outcomes, over the long term, is asset allocation.

I think the amount saved per year is the primary determinant.
AA is probably #2...
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Re: Why Asset Allocation May Not Matter

Post by etarini » Tue Apr 10, 2012 5:50 am

Yes, Otar said it first...p. 52, Unveiling the Retirement Myth, as he looked at studies of the importance of asset allocation.

The “Importance” of Asset Allocation

“ Research has shown that asset allocation is the single largest contributor to a portfolio's success. It is much more important than security selection. In fact, one study concluded that asset allocation accounted for over 90% of the difference in a portfolio's investment return.”Different variations of this mantra appear in articles, sales brochures, and newsletters in the financial media. Each time I read it, I imagine myself at an auction: I can almost hear
the auctioneer shouting: “I have 90% for asset allocation, do I hear 100%!”



Lesson number 1: Save, save, save.
Lesson number 2: Don't lose what you've saved.

Eric
Last edited by etarini on Tue Apr 10, 2012 1:43 pm, edited 1 time in total.

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Re: Why Asset Allocation May Not Matter

Post by nisiprius » Tue Apr 10, 2012 5:52 am

Well, starting to save early is important, that's the big one I personally blew. (Long time in grad school!)
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Why Asset Allocation May Not Matter

Post by The Wizard » Tue Apr 10, 2012 6:10 am

nisiprius wrote:Well, starting to save early is important, that's the big one I personally blew. (Long time in grad school!)

OK, but extended grad school teaches one to be frugal by subsisting on rice & beans, etc.
So there's more than one way to nirvana.
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Re: Why Asset Allocation May Not Matter

Post by nisiprius » Tue Apr 10, 2012 6:22 am

The Wizard wrote:
nisiprius wrote:Well, starting to save early is important, that's the big one I personally blew. (Long time in grad school!)
OK, but extended grad school teaches one to be frugal by subsisting on rice & beans, etc.
So there's more than one way to nirvana.
Met my wife there, and she's worth her weight in gold. Well, figuratively, but the net present value of her future earnings counts... I still have a copy of a slim stapled "book" produced by someone using the self-publishing tools of the day, entitled The Impoverished Student's Book of Cookery, Drinkery, and Housekeepery that served me well during that era.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Why Asset Allocation May Not Matter

Post by Rodc » Tue Apr 10, 2012 6:59 am

The Wizard wrote:
nisiprius wrote:Well, starting to save early is important, that's the big one I personally blew. (Long time in grad school!)

OK, but extended grad school teaches one to be frugal by subsisting on rice & beans, etc.
So there's more than one way to nirvana.


Indeed.
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LH
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Re: Why Asset Allocation May Not Matter

Post by LH » Tue Apr 10, 2012 7:19 am

stlutz wrote:Interesting article--thanks for sharing.

Goes against everything I've read and believed for years.


One thing the article is built around is the fact that most people retire without significant financial assets. If you're a multi-millionarie, asset allocation matters a lot more than the typical person they mention who retires with $100K in their 401K.

Reminds me a little bit of one recommendation from Jim Otar's Retirement Myth book--that people who are just starting out with saving for retirement should put 100% into low-risk investments. When your nest egg is small, losses take a bigger emotional toll than when you have more money. And, when do you don't have a lot, how much you save matters far more than your investment return. Once you've accumulated some dollars, then start to allocate into stocks.


I find the opposite.

When in had little money, if it went up and down it did not matter to me in accumulation stage. I was 100 percent stock. Now that my savings are bigger relative to what I am able to contribute, I am more conservative.

Aggressive early, more conservative later.

If you are conservative early on, you miss out on compounding opportunity.

2, 4, 8, 16

Save early enough,20s, early 30s, may be able to get a 16 multiplier on it...., if it's in stocks.

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Re: Why Asset Allocation May Not Matter

Post by Grt2bOutdoors » Tue Apr 10, 2012 7:42 am

LH wrote:
stlutz wrote:Interesting article--thanks for sharing.

Goes against everything I've read and believed for years.


One thing the article is built around is the fact that most people retire without significant financial assets. If you're a multi-millionarie, asset allocation matters a lot more than the typical person they mention who retires with $100K in their 401K.

Reminds me a little bit of one recommendation from Jim Otar's Retirement Myth book--that people who are just starting out with saving for retirement should put 100% into low-risk investments. When your nest egg is small, losses take a bigger emotional toll than when you have more money. And, when do you don't have a lot, how much you save matters far more than your investment return. Once you've accumulated some dollars, then start to allocate into stocks.


I find the opposite.

When in had little money, if it went up and down it did not matter to me in accumulation stage. I was 100 percent stock. Now that my savings are bigger relative to what I am able to contribute, I am more conservative.

Aggressive early, more conservative later.

If you are conservative early on, you miss out on compounding opportunity.

2, 4, 8, 16

Save early enough,20s, early 30s, may be able to get a 16 multiplier on it...., if it's in stocks.


That's wishful thinking and could be very costly indeed if it doesn't pan out. Let's take the 1990 - 2010 time period, during that period we had three stock busts, but the largest by far was in 2009. Now, I haven't done the math but have faithfully contributed to a retirement plan during that period which had a heavy stock allocation in broadly diversified index funds. I can tell you it most likely has not gone up more than 2x the value that I've contributed. I have about 25 more years to go, but I think I'll be lucky if I see in go up another 3x in that period remaining especially since it would be more prudent to shift away from risk rather than embrace it as time elapses.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Re: Why Asset Allocation May Not Matter

Post by Valuethinker » Tue Apr 10, 2012 7:52 am

nisiprius wrote:If getting work were a simple matter of wanting to work, a lot of people who aren't working, would be. Ask some people in their sixties laid off during 2008-2009 whether "working longer" is a solution for them; in their case, working until traditional retirement age is not an option. Among my circle of acquaintances, a fairly common story seems to be "I filed for Social Security at 62 because I'd been looking work for a year and hadn't even gotten a nibble."

And part of the original motivation for Social Security--explicit in the Townsend Plan to which it was a reaction, but implicit in Social Security as well--was to get older workers out of the workforce for the good of younger workers. A widespread cultural shift toward "working longer" (i.e. a partial abandonment of our traditional-since-1930 retirement aspirations) not only requires changes in attitude by employers, it also it setting up an arena for inter-generational conflict.


Nisiprius

'Therein lies the rub'.

In addition to your concerns, those in blue collar/ cleaning/ outdoor work *cannot* keep working into their mid 60s- not physically capable. In the old days maybe companies had inside jobs for you know, Nisiprius who used to work as a welder in the yard, now he does the front desk. But that's outsourced now.

Strong trade unions used to protect blue collar workers in that situation, but no longer in most private sector capacities-- and public sector is now outsourcing as well.

So absolutely. People, except very senior execs who often stay on into their late 60s (there are CEOs and Chairmen in their 70s), are usually out of large organizations (and small ones) by their early 60s. Fields (like universities) where this has been ruled illegal are having to significantly tighten performance standards. Old doc Valuethinker, did some good work in finance back in the 2000s, kids find him entertaining in class, but now? We need new young tenure track staff who understand the impact of neutrinos on modern finance. We have *got* to get our research rating up, it's a disaster to be ranked 56th with Podunk U at 55-- it's a school-wide mission to get to at least 54 this year.

There's just so much being done in post modern finance, discussing whether the meaning of finance is contextualized by the nature of the financial interaction in the meta human sphere. Doc Valuethinker? He's just not up to it.

(I had a friend in the accounting research sphere, and I am not kidding, they have gone all post modern-- he barely understands the jargon now).

If you join the partnership of a major professional firm like KPMG your contract, AFAIK: 1. requires you to contribute a mandated percentage to the pension scheme (in the case I am familiar with, it was 15% pa) 2. sets your departure date from the partnership (I think, 60th birthday, but I don't know).

That's how professional services firms are dealing with age discrimination legislation.

We live longer but our effective working lives have not necessarily increased. Government is speaking out of both sides of its mouth on this one.

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Re: Why Asset Allocation May Not Matter

Post by Valuethinker » Tue Apr 10, 2012 7:58 am

stlutz wrote:Interesting article--thanks for sharing.


Reminds me a little bit of one recommendation from Jim Otar's Retirement Myth book--that people who are just starting out with saving for retirement should put 100% into low-risk investments. When your nest egg is small, losses take a bigger emotional toll than when you have more money. And, when do you don't have a lot, how much you save matters far more than your investment return. Once you've accumulated some dollars, then start to allocate into stocks.


that might be psychologically true.

But in terms of getting there, you do need to take risk. You live a long time after age 65 (if you are lucky).

By investing in stocks in the 60s and 70s many of my relatives took real pain, but made it back in the 80s and 90s. Had they been entirely invested in UK goverment gilts (bonds) they would have been wiped out by the 20% pa inflation we experienced in the 70s. Also stocks allow you to defer capital gains taxes.

Nowadays we also have inflation linked alternatives which did not exist then: in the USA ibonds and TIPS. Current yields are so low, though, that I doubt many can save enough to provide for retirement on yields which approximate zero.

There are 'stretch' tactics. Annuitization (SPIA) is the first and foremost, and one that Americans generally underutilize (in Canada and UK you are forced to annuitize).

By contrast ERs are so much higher for us that it eats away retirement savings. US SS is also relatively more generous (much more so than the UK equivalent).

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Re: Why Asset Allocation May Not Matter

Post by Valuethinker » Tue Apr 10, 2012 7:59 am

GRT2BOUTDOORS wrote:That's wishful thinking and could be very costly indeed if it doesn't pan out. Let's take the 1990 - 2010 time period, during that period we had three stock busts, but the largest by far was in 2009. Now, I haven't done the math but have faithfully contributed to a retirement plan during that period which had a heavy stock allocation in broadly diversified index funds. I can tell you it most likely has not gone up more than 2x the value that I've contributed. I have about 25 more years to go, but I think I'll be lucky if I see in go up another 3x in that period remaining especially since it would be more prudent to shift away from risk rather than embrace it as time elapses.


My mental rule of thumb is if you've got 20 years to go, then equities should be OK (outperform fixed income).

10 or less, not.

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Re: Why Asset Allocation May Not Matter

Post by patrick » Tue Apr 10, 2012 8:04 am

The article's own data seems to go against the idea of asset allocation not mattering. For instance, down in table 4, the required savings rate (starting at age 35 and retiring at 70) is seen to vary between 7 percent and 16 percent depending on the rate of return. I don't think that a more than factor of 2 change in required savings is something that doesn't matter!

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Re: Why Asset Allocation May Not Matter

Post by Valuethinker » Tue Apr 10, 2012 8:52 am

patrick wrote:The article's own data seems to go against the idea of asset allocation not mattering. For instance, down in table 4, the required savings rate (starting at age 35 and retiring at 70) is seen to vary between 7 percent and 16 percent depending on the rate of return. I don't think that a more than factor of 2 change in required savings is something that doesn't matter!


Perhaps unjustified, but my rule of thumb is that over a 35 year career you need to be contributing (employer + employee) 15% of gross from the get go.

Asset allocation probably does matter, but 60-40 stocks to bonds as a baseline. With rebalancing. Maybe 80-20 in the earlier years. Amounts are so small in the first 5 or so years that 100% equities is justified.

You 'dial back' equity exposure after age 50, say. Never lower than 20%.

You annuitize most, or all, of your money upon retirement.

Whether I could prove this, other than an article about UK investors that appeared in the Financial Times about 15 years ago, I don't know.

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Re: Why Asset Allocation May Not Matter

Post by Random Musings » Tue Apr 10, 2012 10:35 am

IMHO, the paper will not apply for the majority of people on this board since savings outside SS, pensions and the like will have far more of an impact.

Hence, will the target audience ever read this paper? The answer is "No".

Will advisors handling clients with small AUM's (<100K) apply this information in practice? The answer is most likely "No", except for those who do it by sheer coincidence.

RM
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Re: Why Asset Allocation May Not Matter

Post by bob90245 » Tue Apr 10, 2012 12:30 pm

I haven't read the paper. But I can tell you what I know with playing with all sorts of spreadsheets containing historical data.

Yes, savings rate does matter. But only before the nest egg has grown to a certain amount, say, $200,000 or thereabouts. After that, the rate earned on those savings matter more.

As to whether asset allocation matters, this is very period-dependent. You can try this thought experiment. Sometimes stocks go for long stretches of above-average performance. Those are also called secular bull markets. Alternatively, sometimes stocks go for long stretches of below-average performance. Those are also call secular bear markets. And to maket the point without having to type a thousand words, refer to this chart and click to enlarge:

Image
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Why Asset Allocation May Not Matter

Post by nisiprius » Tue Apr 10, 2012 1:18 pm

I think people are missing an absolutely key point about this paper. It is not about the usual question of dispersion of outcomes for various asset classes. It is not about the chances that stocks will beat bonds over a 20-year period. Let me repeat:
Household financial wealth invested in stocks, bonds, and short-term deposits is assumed to earn returns of 6.5, 3.0 and 1.0 percent, respectively, from the date of the interview until retirement. These rates approximate the long-run average rates of return on each of the three asset classes. Importantly, these assumptions are used throughout for projecting asset returns rather than incorporating any actual fluctuations. The objective is to assess whether households are on track to meet their replacement rate targets, not whether they actually succeeded in meeting them.
It is about the real financial situations of real households, and they are saying that they assume that stocks, bonds, and short-term deposits are going to earn exactly 6.5%, 3%, and 1% real (a footnote does say it's real).

That is, they are assuming that 100% stocks would be guaranteed to earn 6.5% and 100% bonds would earn 3%.

And they say it basically doesn't matter, because in the total picture, the difference between earning 6.5% versus earning 3% turns out to have much less effect than other factors "Households have much more potent levers for achieving retirement security."

This is very different from e.g. my contention that asset allocation doesn't matter for planning, because prudent planning is pessimistic, and pessimistically stocks and bonds do about the same.
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Re: Why Asset Allocation May Not Matter

Post by ted123 » Tue Apr 10, 2012 1:36 pm

etarini wrote:Yes, Otar said it first...p. 52, Uneiling the Retirement Myth, as he looked at studies of the importnace of asset allocation.

The “Importance” of Asset Allocation

“ Research has shown that asset allocation is the single largest contributor to a portfolio's success. It is much more important than security selection. In fact, one study concluded that asset allocation accounted for over 90% of the difference in a portfolio's investment return.”Different variations of this mantra appear in articles, sales brochures, and newsletters in the financial media. Each time I read it, I imagine myself at an auction: I can almost hear
the auctioneer shouting: “I have 90% for asset allocation, do I hear 100%!”



Lesson number 1: Save, save, save.
Lesson number 2: Don't lose what you've saved.

Eric


I like Otar's book and think it contains a number of valuable insights, but I didn't particularly care for his discussion of asset allocation. IMO, he seemed to be arguing against a misuse of the asset allocation studies -- that advisors could somehow supercharge returns through savvy asset allocations is used as a sales tool -- without acknowledging the actual contribution of those studies -- that the difference in performance between fund managers is primarily explained by the asset classes they invest in, rather than their ability to select winners within the asset classes.

I can't say he's wrong about the way advisors use the studies, but he ends up basically denying value in diversifying among equity asset classes.

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Re: Why Asset Allocation May Not Matter

Post by Clearly_Irrational » Tue Apr 10, 2012 2:04 pm

nisiprius wrote:A widespread cultural shift toward "working longer" (i.e. a partial abandonment of our traditional-since-1930 retirement aspirations) not only requires changes in attitude by employers, it also it setting up an arena for inter-generational conflict.


I think that's inevitable at this point, even worse I think it's likely that over the next several decades the total number of jobs in the economy is going to decline significantly as robots and expert systems continue to become more capable. Extrapolating the results of Google's driverless car to the trucking industry alone would eliminate over a million and a half jobs. (Yes, I'm aware of the Luddite fallacy, but I truly believe this time is different)

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Re: Why Asset Allocation May Not Matter

Post by Clearly_Irrational » Tue Apr 10, 2012 2:10 pm

bob90245 wrote:Image


Awesome chart bob90245.

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