Should we discourage the bond tent?

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BigJohn
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Re: Should we discourage the bond tent?

Post by BigJohn » Mon Dec 02, 2019 5:54 pm

David Jay wrote:
Mon Dec 02, 2019 11:44 am
ERN has done significant evaluation of rising equity glide paths here: https://earlyretirementnow.com/2017/09/ ... lidepaths/
Thanks for the link, I had not seen that article before. The last paragraph is a good summary of why I've chosen a rising equity glidepath.
Moreover, an equity glidepath is like an insurance policy. A hedge against a tail event! On average it will cost you money, but if and when you need it the most it will likely pay off. Exactly when the static stock/bond allocation paths had their worst sustainable safe withdrawal rates you get slightly better results but you also give up some of the upside if the equity market “decides” to rally some more right after your retirement. But that’s a good problem to have!

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watchnerd
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Re: Should we discourage the bond tent?

Post by watchnerd » Mon Dec 02, 2019 7:12 pm

I work in the high tech industry, which means:

--Good salary, bonuses, stock, and benefits while working, but no pension
--Aging out in the range of 55ish. My megacorp job has a "retirement age" (not mandatory) of 55, with a bunch of qualifying conditions, but it basically means your RSUs can keep vesting after you quit after age 55
--Long potential "early retirement" window, at least until 59.5 until I can withdraw from 401k without penalties. Even longer (62, 67, 70) to get social security.
--Long potential "pre-Medicare" health care window

I don't know if you call it a "bond tent" or not, but because of the sequence of returns risk, that means I feel like I need to have at least 5 years living expenses worth of risk free assets in taxable accounts by the time I'm 55. Luckily, with no debts and a paid off house, we're pretty close already.

As a result, my AA in my taxable accounts (i.e.the money I can get to without issue in the ages 55-59.5) has a higher bond/cash allocation than what we use in our 401k/IRA accounts.

Is this a psychology-driven decision?

Well, it sure helps me sleep at night and to maintain a higher equity allocation in my tax-deferred accounts that I know I won't be able to touch for longer periods of time (I'm 49 now).

It may not be a bond tent, but it might be a lean-to.
Last edited by watchnerd on Mon Dec 02, 2019 7:18 pm, edited 1 time in total.
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MP1968
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Re: Should we discourage the bond tent?

Post by MP1968 » Mon Dec 02, 2019 7:13 pm

scout1 wrote:
Mon Dec 02, 2019 12:30 am
MP1968 wrote:
Mon Dec 02, 2019 12:07 am
Wow, I know there's tons of savvy and smart people here but I don't understand why there's so much confusion and controversy about this topic.

Whether you call it a "bond tent" or a "rising equity glidepath" (who cares?), the concept is pretty darn simple. It's simply a mechanism to mitigate (not eliminate but mitigate) SOR risk. It does this by reducing equity exposure during the most critical years surrounding the start of retirement when SOR risk is the most potentially damaging and then reversing that process afterwards.

For those concerned about SOR risk, which in this high-CAPE environment I think should be pretty much everyone at or near retirement who doesn't have > 35x of their desired annual spending saved, why is this something to be "discouraged"?
Hi MP. It sure has generated much more discussion that I expected. Here’s my current perspective on the subject:

1) The bond tent/rising equity glide path reduces SOR risk by increasing longevity risk. I believe that tradeoff is being ignored by it’s proponents.

2) I believe that’s probably a bad tradeoff because I think that a rising equity glidepath is probably inferior to a decreasing equity glidepath with a more conservative stock/bond allocation for the same reasons people invest more conservatively when they are young.
Consider for instance a life-long "glidepath" (starting say at age 30 or so). As virtually every life-cycle fund does, the standard advice would be for a 30 yo investor to be much more heavily invested in equities (90+%) than a 65 yo one (~ 50-60%). I'm sure no one here would dispute that.

Well...why? Simple, because a 30 yo isn't likely to be tapping into his/her investment savings anytime soon and a 65 yo is. The 30 yo also has way more time to ride out a bad market crash (adding to their investments along the way buying in at reduced prices). The 65 yo on the other hand has far less time and no new earned income to buy in with. This is basically SOR risk illustrated which hits the 65 yo far harder than the 30 yo (who is probably barely affected if he/she keeps working for several decades).

As far as #1 goes, yes the so-called "bond tent" acts as a modest insurance policy in that you forgo some potential positive returns if stocks do well in order to reduce potential losses if they don't. I don't know that anyone claims its some kind of "free lunch" which we all know doesn't exist in the real world. The point of it is to alleviate somewhat the pain you'd incur if you were unlucky enough to retire and start drawing on your investment savings in a time similar to say 1929 or 2000. For instance, it took the S&P 500 over 13 years to fully recover its 2000 peak after inflation and that is with all dividends reinvested, declining inflation, and zero withdrawals that entire time.

I honestly don't know what you were trying to say in #2 because people DON'T (or shouldn't) "invest more conservatively when they are young" as you stated. The whole point of this topic seems to be to "take some chips off the table" so to speak when you don't want to risk losing a bunch just as you're about to need them.

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Re: Should we discourage the bond tent?

Post by MP1968 » Mon Dec 02, 2019 7:28 pm

randomguy wrote:
Mon Dec 02, 2019 8:07 am
MP1968 wrote:
Mon Dec 02, 2019 12:07 am
Wow, I know there's tons of savvy and smart people here but I don't understand why there's so much confusion and controversy about this topic.

Whether you call it a "bond tent" or a "rising equity glidepath" (who cares?), the concept is pretty darn simple. It's simply a mechanism to mitigate (not eliminate but mitigate) SOR risk. It does this by reducing equity exposure during the most critical years surrounding the start of retirement when SOR risk is the most potentially damaging and then reversing that process afterwards.

For those concerned about SOR risk, which in this high-CAPE environment I think should be pretty much everyone at or near retirement who doesn't have > 35x of their desired annual spending saved, why is this something to be "discouraged"?

How effective have these bond tents or rising equity glide paths been? The SWR for that time period with no SOR is up around 6% for a 50/50 portfolio. The one with SOR risk is about 4%. What was the SWR with a bond tent or a rising equity glide path? 5%? Or at least 4.5% right? Or does it happen to be the same 4% you would have gotten by holding 50/50?:) Bond tends and rising equity glide paths reduce portfolio volatility. They don't do much to mitigate against SOR.
Seems to me that the SWRs you quoted illustrate the point. If someone is looking to have a typical 4% WR and feel confident about that, then a "bond tent/rising equity glidepath" approach would give them a buffer if things go bad just at the worst possible time (which is what SOR risk is). Without it, a 4% WR will probably survive but it may be just barely. If that's a concern for someone, then he/she might want to consider it.

Both Kitces and ERN discuss temporary equity nadirs of 40-60% so no one is advocating abandoning stocks altogether by any means. [BTW, Kitces used Monte Carlo sims in his models and ERN uses historical returns in his].

Yeah, if you want to maximize your WR and somehow don't care about potential portfolio failure, you should be 100% stock your whole life.

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Re: Should we discourage the bond tent?

Post by randomguy » Mon Dec 02, 2019 8:05 pm

David Jay wrote:
Mon Dec 02, 2019 11:44 am
randomguy wrote:
Mon Dec 02, 2019 8:07 am
How effective have these bond tents or rising equity glide paths been? The SWR for that time period with no SOR is up around 6% for a 50/50 portfolio. The one with SOR risk is about 4%. What was the SWR with a bond tent or a rising equity glide path? 5%? Or at least 4.5% right? Or does it happen to be the same 4% you would have gotten by holding 50/50?:) Bond tends and rising equity glide paths reduce portfolio volatility. They don't do much to mitigate against SOR.
ERN has done significant evaluation of rising equity glide paths here: https://earlyretirementnow.com/2017/09/ ... lidepaths/

At the linked page there is additionally a link to an SSRN paper by Pfau and Kitches with additional modeling of more typical 30 year retirements (ERN is focused on 60 year retirements). Here is the takeaway:

Across all time horizons and withdrawal rates, when examining the approach which provides the highest sustainable withdrawal rates given a prospective 10% failure rate, the results consistently show support for rising equity glidepath portfolios. Declining equity glidepaths do not necessarily help support retirement success, and even static allocations generally fare worse than more conservative starting allocations that rise in equity exposure throughout retirement. Generally, depending on the underlying assumptions, the optimal starting equity exposures are around 20% to 40% and they finish at around 40% to 80%.
I don't see either of those article talking about their 5% SWR.

This chart from Kitches paper sums it up
Image


Do you really think that the difference between 94.1% and 95.1% isn't with in the margin of error of the model?

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Re: Should we discourage the bond tent?

Post by randomguy » Mon Dec 02, 2019 8:25 pm

MP1968 wrote:
Mon Dec 02, 2019 7:28 pm


Seems to me that the SWRs you quoted illustrate the point. If someone is looking to have a typical 4% WR and feel confident about that, then a "bond tent/rising equity glidepath" approach would give them a buffer if things go bad just at the worst possible time (which is what SOR risk is). Without it, a 4% WR will probably survive but it may be just barely. If that's a concern for someone, then he/she might want to consider it.

Care to back up the statement that the bond tent will provide a buffer? It doesn't match any of the research I have seen or done. Seriously plot out how the 1966 retiree does either by holding 50/50 or by doing a rising equity glide path or by using a bond tent. There is no buffer. There is no higher SWR which would be there if sequence of returns had been mitigated.

You reduce the volatility by holding less stocks during the 70s market crashes (which is balanced by you not buying as much stock at depressed prices) but you don't end up generating higher returns over those first 15 years. It is the lack of returns not volatility that causes SOR issues.

These aren't horrible schemes that will cost you tons of money. But they don't do much either.

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willthrill81
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Re: Should we discourage the bond tent?

Post by willthrill81 » Mon Dec 02, 2019 9:32 pm

randomguy wrote:
Mon Dec 02, 2019 8:25 pm
You reduce the volatility by holding less stocks during the 70s market crashes (which is balanced by you not buying as much stock at depressed prices) but you don't end up generating higher returns over those first 15 years. It is the lack of returns not volatility that causes SOR issues.
Right. Kitces' own research has shown this. He found that the first 15 years of real returns of a 30 year withdrawal period were very strongly correlated (r = .91) with the period's SWR. Being bond heavy during those 15 years meant that a retiree was historically likely to avoid very negative real returns but at the expense of foregoing significant upside potential. It seems that the cost/benefit basically cancelled out, leaving the retiree no better with a 'bond tent' approach than with a fixed AA.
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MP1968
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Re: Should we discourage the bond tent?

Post by MP1968 » Mon Dec 02, 2019 10:40 pm

randomguy wrote:
Mon Dec 02, 2019 8:25 pm
MP1968 wrote:
Mon Dec 02, 2019 7:28 pm


Seems to me that the SWRs you quoted illustrate the point. If someone is looking to have a typical 4% WR and feel confident about that, then a "bond tent/rising equity glidepath" approach would give them a buffer if things go bad just at the worst possible time (which is what SOR risk is). Without it, a 4% WR will probably survive but it may be just barely. If that's a concern for someone, then he/she might want to consider it.

Care to back up the statement that the bond tent will provide a buffer? It doesn't match any of the research I have seen or done. Seriously plot out how the 1966 retiree does either by holding 50/50 or by doing a rising equity glide path or by using a bond tent. There is no buffer. There is no higher SWR which would be there if sequence of returns had been mitigated.

You reduce the volatility by holding less stocks during the 70s market crashes (which is balanced by you not buying as much stock at depressed prices) but you don't end up generating higher returns over those first 15 years. It is the lack of returns not volatility that causes SOR issues.

These aren't horrible schemes that will cost you tons of money. But they don't do much either.
Feel free to read both articles as I have (Kitces & ERN). In particular, ERN has analyzed it thoroughly using historical return data rather than Monte Carlo simulations as Kitces did. He also tends to focus on >30yr horizons as "early retirement" is his focus.

Regarding 1966, yeah you picked the ultimate straw man argument there. As has been pointed out many times, NOTHING could have saved that unluckiest of cohorts. The next ~ 15 years saw subpar GDP growth with rising inflation which resulted in terrible real returns for both stocks and bonds. Even the 4% rule failed. There was no safe harbor.

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watchnerd
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Re: Should we discourage the bond tent?

Post by watchnerd » Tue Dec 03, 2019 12:28 am

MP1968 wrote:
Mon Dec 02, 2019 10:40 pm
randomguy wrote:
Mon Dec 02, 2019 8:25 pm
MP1968 wrote:
Mon Dec 02, 2019 7:28 pm


Seems to me that the SWRs you quoted illustrate the point. If someone is looking to have a typical 4% WR and feel confident about that, then a "bond tent/rising equity glidepath" approach would give them a buffer if things go bad just at the worst possible time (which is what SOR risk is). Without it, a 4% WR will probably survive but it may be just barely. If that's a concern for someone, then he/she might want to consider it.

Care to back up the statement that the bond tent will provide a buffer? It doesn't match any of the research I have seen or done. Seriously plot out how the 1966 retiree does either by holding 50/50 or by doing a rising equity glide path or by using a bond tent. There is no buffer. There is no higher SWR which would be there if sequence of returns had been mitigated.

You reduce the volatility by holding less stocks during the 70s market crashes (which is balanced by you not buying as much stock at depressed prices) but you don't end up generating higher returns over those first 15 years. It is the lack of returns not volatility that causes SOR issues.

These aren't horrible schemes that will cost you tons of money. But they don't do much either.
Feel free to read both articles as I have (Kitces & ERN). In particular, ERN has analyzed it thoroughly using historical return data rather than Monte Carlo simulations as Kitces did. He also tends to focus on >30yr horizons as "early retirement" is his focus.

Regarding 1966, yeah you picked the ultimate straw man argument there. As has been pointed out many times, NOTHING could have saved that unluckiest of cohorts. The next ~ 15 years saw subpar GDP growth with rising inflation which resulted in terrible real returns for both stocks and bonds. Even the 4% rule failed. There was no safe harbor.
That's sobering....

Would 3% have worked? Or was inflation so bad it didn't matter?
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Re: Should we discourage the bond tent?

Post by randomguy » Tue Dec 03, 2019 1:25 am

watchnerd wrote:
Tue Dec 03, 2019 12:28 am


That's sobering....

Would 3% have worked? Or was inflation so bad it didn't matter?
Yes it is sobering. It is easy to come up with techniques that look good for minor downturns. But when SOR actually shows up, they do nothing. Blips like 2007-9 aren't things to lose sleep over. A decade long thing like 2000-9 is. But even that doesn't compare to a 15 year downturn.

3% definitely would have worked in the past . ~3.8% would have worked for the 1966 retiree. Something like 4.3% would have also worked if you held a diversified portfolio with international stocks and small value (both performed very well in the 70s).

To combat SOR, you either need to generate returns (adding diversified assets, market timing factor investing, gold... but none of that comes with any guarantees) or cut expenses. You can control cutting expenses but it is obviously a somewhat undesirable outcome.

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Re: Should we discourage the bond tent?

Post by watchnerd » Tue Dec 03, 2019 1:33 am

randomguy wrote:
Tue Dec 03, 2019 1:25 am
watchnerd wrote:
Tue Dec 03, 2019 12:28 am


That's sobering....

Would 3% have worked? Or was inflation so bad it didn't matter?
Yes it is sobering. It is easy to come up with techniques that look good for minor downturns. But when SOR actually shows up, they do nothing. Blips like 2007-9 aren't things to lose sleep over. A decade long thing like 2000-9 is. But even that doesn't compare to a 15 year downturn.

3% definitely would have worked in the past . ~3.8% would have worked for the 1966 retiree. Something like 4.3% would have also worked if you held a diversified portfolio with international stocks and small value (both performed very well in the 70s).

To combat SOR, you either need to generate returns (adding diversified assets, market timing factor investing, gold... but none of that comes with any guarantees) or cut expenses. You can control cutting expenses but it is obviously a somewhat undesirable outcome.
Now I feel better that I keep 50% stock in international (which seems on the more radical end compared to most US investors).
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Re: Should we discourage the bond tent?

Post by randomguy » Tue Dec 03, 2019 1:46 am

MP1968 wrote:
Mon Dec 02, 2019 10:40 pm

Feel free to read both articles as I have (Kitces & ERN). In particular, ERN has analyzed it thoroughly using historical return data rather than Monte Carlo simulations as Kitces did. He also tends to focus on >30yr horizons as "early retirement" is his focus.

Regarding 1966, yeah you picked the ultimate straw man argument there. As has been pointed out many times, NOTHING could have saved that unluckiest of cohorts. The next ~ 15 years saw subpar GDP growth with rising inflation which resulted in terrible real returns for both stocks and bonds. Even the 4% rule failed. There was no safe harbor.
I read them years ago. Hence my ability to post that chart from Kitches which shows how little difference rising glide paths make. I am just pointing out that your assertion that bond tents provide a buffer is a fantasy. In bad times, the bond tent performed about the same as the fixed AA. And yes we focus on the 1966-1969 period because it and 1929 are pretty much the only poor retirement cases in post 1920 US history. It is easy to come up with schemes that deal with say a bad 5-7 year stretch. But those stretched just don't matter because they are so much better than the 15 year stretches that set the SWR down at 4%.

The only tool we you have to deal with SOR that you can control is cutting spending. There are bunches of papers that talk about how much and when to cut and you can pick which scheme appeals to you the most. It is far from a great solution.

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Re: Should we discourage the bond tent?

Post by AlohaJoe » Tue Dec 03, 2019 3:56 am

randomguy wrote:
Mon Dec 02, 2019 8:05 pm
Do you really think that the difference between 94.1% and 95.1% isn't with in the margin of error of the model?
I agree with you that SWRs don't show a significant difference -- quite possibly within the margin of error of the model. There are other metrics, though, that shed more light.

For instance, we can compare Certainty Equivalent Withdrawals under a variable withdrawal strategy:

Image

Numbers bigger than $0 means a bond tent "wins" for that retirement cohort. Numbers lower than $0 means a bond tent "loses" for that retirement cohort. It is immediately clear that bond tents usually lose. That's not necessarily a bad thing. After all, we're usually okay forgoing some upside to reduce the downside in the worst cases. So how do bond tents fare in the worst cases?

They do better in 1906-7, 1928-1931, 1965-1970. On the surface that's kinda exactly what we want. But "winning" doesn't mean it was significant. Here's the annual withdrawals for 1966 and 1969:

Image
Image

We're usually talking about 1-2% more income, just a few hundred dollars a year. It seems unlikely to make or break a retirement.

Overall, tents win 17% of the time and lose 83% of the time. When they win, the median gain is only $691 a year (from a $1,000,000 portfolio). When they lose, the median loss is $3,268 a year.

The only time that bond tents ever amount to anything was 1929, where they resulted in +12% more income. That's definitely something you'd notice.

Image

If you don't like CEW and variable withdrawals, you can also use a coverage ratio with constant dollar withdrawals but the result is basically the same

Image

So really bond tents don't protect against "sequence of returns" the way you might naively expect it. That's because the way most people talk about sequence of returns is vague. There are all kinds of bad sequences and bond tents only protect against one kind: sudden, large stock crashes.

This is easiest to see when we look at (real) portfolio values in the 1929 scenario (massive, sudden stock crash) versus the 1966 scenario (low returns over a long period of time)

Image
Image

It seems to me that a bond tent is mostly about giving up approximately 8-10% of your income in almost every scenario in order to do better in the event of an 70%+ stock crash in early retirement. Investing is all about tradeoffs, so I wouldn't call anyone crazy if they decided to make that tradeoff for themselves. But I'm less clear that is something that should be "recommended" as a "default" for people who don't know about they are trading off.

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Re: Should we discourage the bond tent?

Post by dbr » Tue Dec 03, 2019 9:34 am

AlohaJoe wrote:
Tue Dec 03, 2019 3:56 am

It seems to me that a bond tent is mostly about giving up approximately 8-10% of your income in almost every scenario in order to do better in the event of an 70%+ stock crash in early retirement. Investing is all about tradeoffs, so I wouldn't call anyone crazy if they decided to make that tradeoff for themselves. But I'm less clear that is something that should be "recommended" as a "default" for people who don't know about they are trading off.
I agree that "sequence of returns risk" has become a fad demon on the board without a lot of understanding about what is involved in the bigger picture.

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Re: Should we discourage the bond tent?

Post by randomguy » Tue Dec 03, 2019 4:30 pm

watchnerd wrote:
Tue Dec 03, 2019 1:33 am

Now I feel better that I keep 50% stock in international (which seems on the more radical end compared to most US investors).
That part that makes you lose sleep is that their is no law that says it will work next time. It just happened to line up in 1966 (and to some extent 2000-9). I know a lot of people think that some of the diversification benefits of international have shrunk over the last 30 years.

Pretty much the only thing guaranteed to help is cutting expenses. But that is a very painful choice to make and you will not even know if you needed to do it until like 20 years after you make the choice. It is easy know to look back and say the 2000 retiree didn't need to cut. But in 2002 or . March 2009, saying the same thing would have required a huge leap of faith.

One thing to remember is that your odds of hitting one of these horrible patches are low. Odds are someone in the next 30 years is going to get hit by some horrible SOR issue. Odds of you picking the exactly wrong time to retire though are pretty low. It is important to have a plan to deal with them but don't let fear dominate your life.

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Re: Should we discourage the bond tent?

Post by willthrill81 » Tue Dec 03, 2019 5:17 pm

AlohaJoe wrote:
Tue Dec 03, 2019 3:56 am
I agree with you that SWRs don't show a significant difference -- quite possibly within the margin of error of the model. There are other metrics, though, that shed more light.
Thanks for the work putting this together. It's very enlightening.
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Re: Should we discourage the bond tent?

Post by YRT70 » Wed Dec 04, 2019 9:05 am

Looks like the rising equity glide path (60->100%) can have some merit for people with a longer retirement. This is data and the conclusion from ERN for a 60 year retirement.

Image
Conclusion

Early retirees need the power of equity expected returns to make the nest egg last for many decades. Even more so than the traditional retiree at age 65! But that exposes us to Sequence of Return Risk. An equity glidepath can alleviate some of the negative effects of Sequence of Return Risk. But it shouldn’t come as a surprise that you will never completely eliminate the risk. For a given withdrawal rate, say 3.5%, we can only reduce the failure rate while leaving some residual risk. And likewise, the 4% rule would still not be safe for today’s early retirees even with an equity glidepath.

Moreover, an equity glidepath is like an insurance policy. A hedge against a tail event! On average it will cost you money, but if and when you need it the most it will likely pay off. Exactly when the static stock/bond allocation paths had their worst sustainable safe withdrawal rates you get slightly better results but you also give up some of the upside if the equity market “decides” to rally some more right after your retirement. But that’s a good problem to have!
https://earlyretirementnow.com/2017/09/ ... lidepaths/

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