We've had this discussions like this in forum before and it seems to me that it always comes down to this, in a rough but useful way.
Let's use the phrase "range" to refer to fairly bad and good cases. Not the literal extremes but, let's say 10% and 90% percentiles. For example, when I was using it, the Fidelity Retirement Income Planner used the 10% percentile of stock market returns for projections.
Well, for stocks and bonds, the bottom end of the range is about the same, but the median and average are much higher for stocks, and the upper end is much much higher.
So us prudent/fraidycat/pessimistic types prefer to plan for the bottom end of the range, because we want to have enough even if the stock market does poorly. And that leads to the conclusion that you must save about the same amount no matter what your asset allocation is. You cannot safely take advantage of the higher expected return of stocks to justify slacking off on savings and making up for it with a more aggressive asset allocation.
In this case, we see that a) more stocks does not enable you to save less, and b) the spread of outcomes increases, not decreases with time.
The optimists observe, correctly, that the extra spread is upward from the same bottom, and object to calling this "risk" when the only uncertainty is by how much
stocks will beat bonds.
But a meaningful question is how people really act. Based on past historical statistics as always, if
high-stocks investors save just as much as low-stocks investors, then it would seem that they are getting the equivalent of free lottery tickets. Free, because it doesn't cost them any more
to invest in stocks. Lottery tickets, because there is no guarantee
that they will actually do better than they would have done in bonds.
The problem is that I doubt people act this way. I think high-stocks investors tend to count on
the higher historical averages
, making only partial allowance for it's just being an average, and base this on an incorrect
belief that the bounds on outcomes pull in and narrow for longer holding periods, so that it becomes safe to count on getting the average, rather than allowing for the wide range.
This impression could be the result of the wide publication of poisonous
charts like this one (Burton Malkiel, A Random Walk Down Wall Street
, 2015 edition.
This chart is poisonous in three ways. One is that because it is not inflation-corrected, it gives the impression that a fifteen-year holding period eliminated the risk of loss. One is that for unstated reasons, it throws out the worst periods for stocks in the US, and, guess what? all investments look good if you throw out the times when they looked bad. But, most serious of all, it's a chart of annualized average returns, CAGR. But if you hold an investment for 25 years, you don't get the CAGR, you get the CAGR compounded over 25 years. If you replace the chart with one that shows the results of compounding
, those narrowing bars explode right back out again.
It isn't productive to argue about "what is risk," etc. What is important is that:
- Increasing the length of the holding period does not pull in and narrow the spread. Hence, it does not improve the certainty or reliability of outcome.
- Assuming the same savings rate, increasing stock allocation widens the spread but it's all up from the bottom. The bottom stays put.
- Assuming the same savings rate, stocks give you "free lottery tickets" with a darn good chance at a jackpot, but you can't count on that jackpot and shouldn't plan for it.
- If you unwisely cut your savings rate in the belief that you can count on an average return, believing that long holding periods narrow the range and make stocks less uncertain, then you have changed the situation to one in which increasing stock stock allocation makes the range spread outward from the center. Your bidirectional risk has increased, down as well as up. The bidirectionality is not intrinsic to stocks, but is due to combination of stocks and the plans you have voluntarily chosen to follow. If the facts are that savers with high stock allocations customarily save enough for a comfortable retirement regardless of stock allocation, then, of course, I've set up a straw man.
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.