90% / 10% too high?

[Midpack]

With all due respect, I'm done with this thread...

 

[REWahoo]

There seems to be some consensus among us in this forum about not getting too much debt, use tax deferral plans, SPIAs better than VAs, etc. But IMO the jury is still out regarding owning stocks and shares.

Your [-]perception of reality[/-] view of consensus on this forum regarding stock ownership differs considerably from mine.

 

[obgyn65]

My view of consensus regarding stock ownership was not related to this forum, but rather nationally where only half of the population owns stocks.

Your [-]perception of reality[/-] view of consensus on this forum regarding stock ownership differs considerably from mine.

 

[MichaelB]

My view of consensus regarding stock ownership was not related to this forum, but rather nationally where only half of the population owns stocks.

Just to clarify, you believe that half the population does not invest directly in equities, and they choose not to, as opposed to other reasons, such as not having enough assets to invest, or having pensions that do invest in equities, and that this represents a specific consensus view about equity ownership?

 

[ERD50]

I'm quite certain that far, far less than half the people who buy condos pay cash. Does that make it a bad idea, or somehow inappropriate to discuss the pros/cons, since so few people pay cash?

Popularity isn't always a good measure of what is optimal. Plenty of people pay high interest rates on credit card debt. If paying a rewards card in full each month is a minority position, so be it, but that doesn't justify doing the opposite, does it?

-ERD50

 

[MichaelB]

I looked over some Shiller data today. S&P 500 real returns, dividends, 10 year treasury rates and CPI, all monthly, beginning in 1900. I compared 10 and 20 year periods of S&P real price plus dividend vs 10 year treasury minus CPI. Over that period, of 1230 months (monthly 10 year periods), there have been 206 instances of negative total real return for S&P including dividends. There have been 439 instances of negative total real return for the 10 year treasury. (all before taxes). Looking at 20 year periods, there have been none for the S&P including dividends, there have been 152 occurrences of 20 year periods of negative real return for treasuries. Over the 1110 monthly 20 year periods, 1033 showed the S&P plus dividends had higher real returns compared with the 10 year treasury.

Over the past 110 years buying bonds has led to much worse outcomes than investing in stocks almost all of the time. Why is that? Value does not come from lending money; it is created from borrowing and applying it in competitive and creative ways. Has this come to an end? I think not. Does this mean the next 20 years will be good for stocks and not so good for fixed income? We don’t know, but probably. Why? Because people, and businesses, haven’t stopped finding ways to creatively use borrowed money to create value, for themselves and their investors.

My message to my children, and grandchildren, is simple. They can invest in growth around the world, own part of it, and enjoy the benefit of improving standard of living. If they don’t invest in it, though, they will find it difficult to enjoy the benefits later on because it may be unaffordable.

That’s why I recommend they keep a minimum of 70% of their portfolios in equities now, and consider lowering it to around 50% or so once they approach retirement. In no case less than 1/3.

 

[obgyn65]

The article I posted reads "In its annual Economy and Finance survey, conducted April 4-14, Gallup found that 52 percent of Americans said they (personally or jointly with a spouse) owned stock outright or as part of a mutual fund or self-directed retirement account. That’s not statistically different from the share last year (53 percent), but is down substantially from pre-recession levels." This percentage does not indicate the financial profiles, means, pensions, or personal circumstances of respondents.

Just to clarify, you believe that half the population does not invest directly in equities, and they choose not to, as opposed to other reasons, such as not having enough assets to invest, or having pensions that do invest in equities, and that this represents a specific consensus view about equity ownership?

 

[obgyn65]

Point taken. However, one of my questions above remains unanswered. Where would you be, Michael, without the federal and central banks interventions in 2008-2009 ? Would you say the same to your children and grandchildren about your approach if the Dow was still at 7,000 since 2009 and stayed there since then ? Would you go back to work ? Would you decrease your annual spending ? Would you buy an SPIA ? Would you ask for money from your kids ? I am happy for you that you have a family to fall back on to. Clearly this is not everyone's case. I have no family here, on my own. I have had no inheritance either. Condo value down since 2008. As you can see, it may be harder for me to take risks than it is for others in this forum.

I looked over some Shiller data today. S&P 500 real returns, dividends, 10 year treasury rates and CPI, all monthly, beginning in 1900. I compared 10 and 20 year periods of S&P real price plus dividend vs 10 year treasury minus CPI. Over that period, of 1230 months (monthly 10 year periods), there have been 206 instances of negative total real return for S&P including dividends. There have been 439 instances of negative total real return for the 10 year treasury. (all before taxes). Looking at 20 year periods, there have been none for the S&P including dividends, there have been 152 occurrences of 20 year periods of negative real return for treasuries. Over the 1110 monthly 20 year periods, 1033 showed the S&P plus dividends had higher real returns compared with the 10 year treasury.

Over the past 110 years buying bonds has led to much worse outcomes than investing in stocks almost all of the time. Why is that? Value does not come from lending money; it is created from borrowing and applying it in competitive and creative ways. Has this come to an end? I think not. Does this mean the next 20 years will be good for stocks and not so good for fixed income? We don’t know, but probably. Why? Because people, and businesses, haven’t stopped finding ways to creatively use borrowed money to create value, for themselves and their investors.

My message to my children, and grandchildren, is simple. They can invest in growth around the world, own part of it, and enjoy the benefit of improving standard of living. If they don’t invest in it, though, they will find it difficult to enjoy the benefits later on because it may be unaffordable.

That’s why I recommend they keep a minimum of 70% of their portfolios in equities now, and consider lowering it to around 50% or so once they approach retirement. In no case less than 1/3.

 

[MichaelB]

How about we leave the kids and family aside, and lets do stay with facts, and data.

Since 1900 the US has suffered from the shocks of two world wars, a number of other wars, one great depression, numerous recessions, many terrible natural calamities. The cold war brought us close to another global conflict. Our current conflicts seem puny compared with the hardships and challenges we and others faced over the past century. Other countries have faced worse situations.

Over that entire period, and over rolling 10 and 20 year periods, savers have lost more value, more often, than investors, who have seen the real value of their investments grow over almost every period (US). The data is there for all to see in the Shiller numbers. When we think about risk we need to keep in mind what has happened over the past 120 years. Over long periods the risk of lost purchasing power is far greater than that of loss of capital.

You ask where we would be without the Fed intervention? If anything, and despite the whining one comes across in media, the US leadership, elected and appointed and across multiple administrations, has shown a remarkable ability to understand and assess the problems we faced and develop and implement appropriate policies. It does appear to me, however, thet many do not fully understand the economic challenge or policy response. If anything, Fed policy response should be seen as a positive attribute. Certainly, institutional investors around the world see it that way.

Oby, you ask what I would do if the Dow fell by half. Well, since I retired it has done so, twice. It may do so again. What to do? Rebalance, then move on. When the world stops growing and people no longer look to improve their lot in life, investors will suffer. Until then, markets fall and recover, but grow. There is no growth in fixed income.

This is not a discussion of equities, all or none. The question is how much? It should never be so much that it keeps you awake at night. In the accumulation phase, however, more is better. Even in the withdrawal phase, history has shown that less than 1/3 in equities is a losing strategy, and up to 1/2 contributes to portfolio growth with acceptable risk.

 

[ERD50]

Most of us who are looking to be conservative with our WR would consider it prudent to attempt to consider the 'black swan' scenarios (expect the unexpected?).

But why limit this view of a black swan visit to equities? A black swan could visit inflation and/or real returns of fixed income as well. One might even be inclined to think that the current low interest rates and high debt levels and future obligations of so many governments are a higher long-term risk to fixed income than to equities.

As has been posted time and time again, a balance of equities/fixed has historically provided the most safety for a retirement portfolio. And it also provides some diversification against future, unknown scenarios that might affect one asset class more than another. Just another form of the 'all your eggs in one basket' axiom.

Didn't the government also step in in the S&L crisis of the 80's, and the bank runs of the Depression? What would a lack of action have done to CDs and others tied to fixed income sources? It is not only equities that depend on a stable environment.

-ERD50

 

[Animorph]

Point taken. However, one of my questions above remains unanswered. Where would you be, Michael, without the federal and central banks interventions in 2008-2009 ? Would you say the same to your children and grandchildren about your approach if the Dow was still at 7,000 since 2009 and stayed there since then ? Would you go back to work ? Would you decrease your annual spending ? Would you buy an SPIA ? Would you ask for money from your kids ? I am happy for you that you have a family to fall back on to. Clearly this is not everyone's case. I have no family here, on my own. I have had no inheritance either. Condo value down since 2008. As you can see, it may be harder for me to take risks than it is for others in this forum.

I don't think 2008 is a good pick for your argument.

In 2008 I was more worried about insurance companies and investment banks than stocks. That was what the government was propping up for the most part. Without that intervention, some SPIA guarantees might have been worthless. Though hopefully the government backstops would still back them up. I kept a little more cash on hand in a drawer just in case the banks froze up. I bought more stocks. Stocks will recover with the economy, defaulted bonds will never recover.

Even now, it's bond markets, even or especially government bonds. that look particularly risky to me. What if a country like Spain has to default? Heck, even the U.S. might end up delaying payments the next time congress has to raise the debt ceiling. We're still not out of the debt crisis yet. And that's not considering a possible interest rate rise, which I don't think will be too terrible if it is not too quick.

 

[Midpack]

Point taken. However, one of my questions above remains unanswered. Where would you be, Michael, without the federal and central banks interventions in 2008-2009 ? Would you say the same to your children and grandchildren about your approach if the Dow was still at 7,000 since 2009 and stayed there since then ? Would you go back to work ? Would you decrease your annual spending ? Would you buy an SPIA ? Would you ask for money from your kids ? I am happy for you that you have a family to fall back on to. Clearly this is not everyone's case. I have no family here, on my own. I have had no inheritance either. Condo value down since 2008. As you can see, it may be harder for me to take risks than it is for others in this forum.

for obgyn65
What do you think drives stock prices and therefore market indices? Your repeated use of the word "luck" to characterize stock markets suggests you only seem to recognize the less predictable emotional aspect that typically exaggerates market highs and lows, without recognizing the underlying fundamentals that correlate with stock prices/market indices over the long run. There's a reason the Dow has not remained at 7,000 since 2009, it's not just a matter of chance or luck...any more than it has been through every recession, depression, war or other past geopolitical or financial circumstance.

If you rely strictly on emotions and "what if's" to guide your investing decisions, you probably don't want to hold anything except cash. And you wouldn't be alone with your extremely low risk tolerance, but few people have been able to retire successfully for 30 years using such an approach, and current low interest rates/yields suggest that be all the more unlikely in the years ahead.

for other members
Per FIRECALC, a 30 year retirement with a $30K/yr inflation adjusted income at a 95% success rate has required a $751K portfolio with a 50/50 AA. Or $770K with a 33/67 AA.

With no equity, a 30 year retirement with a $30K/yr inflation adjusted income at a 95% success rate has required a $1064-$1285K portfolio of all fixed income AA - or as much as 40-70% more savings!

 

[photoguy]

for obgyn65
With no equity, a 30 year retirement with a $30K/yr inflation adjusted income at a 95% success rate has required a $1064-$1285K portfolio of all fixed income AA - or as much as 40-70% more savings!

What's amazing is that even a small amount of equities (20-30%) dramatically increases portfolio success rates. At 0% equities (4% WR) I think firecalc returns around 40% success whereas just adding 20% equities increases that to 70%.

The downside of having 20% equities in an extended bear market is small. Even with a 50% drop you still have the bulk of your portfolio (90%). It's almost a free lunch.

 

[obgyn65]

Thank you for your comments.

I agree that the US has suffered from many other calamities. I also agree that over long periods of time, the risk of lost purchasing power seems to be greater than the loss of capital - so far.

However, I disagree that the US leadership 'has shown a remarkable ability to understand and assess the problems we faced' late 2008 and 2009. In fact, there was a sense of a huge panic going on, the US Congress could not agree on what to do for a while, some leaders were calling for some automakers to go bankrupt, others were calling for AIG to be allowed to do the same. Since then, the entire financial system has been kept afloat only after massive liquidity injections globally while national debt levels keep rising - it's a scary world out there.

Had I been invested in shares in 2008-2009, I would have panicked and sold everything at a loss. Like many did. There is no indication that another intervention by governments and central banks will take place again next time the Dow goes south. Look again at the Nikkei over the last 20 years or so. I believe we are next - but hope to be wrong.

I may increase my share allocation to 5% in the next couple of weeks though, or buy some additional deferred annuities, which is still very cautious.

How about we leave the kids and family aside, and lets do stay with facts, and data.

Since 1900 the US has suffered from the shocks of two world wars, a number of other wars, one great depression, numerous recessions, many terrible natural calamities. The cold war brought us close to another global conflict. Our current conflicts seem puny compared with the hardships and challenges we and others faced over the past century. Other countries have faced worse situations.

Over that entire period, and over rolling 10 and 20 year periods, savers have lost more value, more often, than investors, who have seen the real value of their investments grow over almost every period (US). The data is there for all to see in the Shiller numbers. When we think about risk we need to keep in mind what has happened over the past 120 years. Over long periods the risk of lost purchasing power is far greater than that of loss of capital.

You ask where we would be without the Fed intervention? If anything, and despite the whining one comes across in media, the US leadership, elected and appointed and across multiple administrations, has shown a remarkable ability to understand and assess the problems we faced and develop and implement appropriate policies. It does appear to me, however, thet many do not fully understand the economic challenge or policy response. If anything, Fed policy response should be seen as a positive attribute. Certainly, institutional investors around the world see it that way.

Oby, you ask what I would do if the Dow fell by half. Well, since I retired it has done so, twice. It may do so again. What to do? Rebalance, then move on. When the world stops growing and people no longer look to improve their lot in life, investors will suffer. Until then, markets fall and recover, but grow. There is no growth in fixed income.

This is not a discussion of equities, all or none. The question is how much? It should never be so much that it keeps you awake at night. In the accumulation phase, however, more is better. Even in the withdrawal phase, history has shown that less than 1/3 in equities is a losing strategy, and up to 1/2 contributes to portfolio growth with acceptable risk.

 

[obgyn65]

Points well taken, thank you.

I don't think 2008 is a good pick for your argument.

In 2008 I was more worried about insurance companies and investment banks than stocks. That was what the government was propping up for the most part. Without that intervention, some SPIA guarantees might have been worthless. Though hopefully the government backstops would still back them up. I kept a little more cash on hand in a drawer just in case the banks froze up. I bought more stocks. Stocks will recover with the economy, defaulted bonds will never recover.

Even now, it's bond markets, even or especially government bonds. that look particularly risky to me. What if a country like Spain has to default? Heck, even the U.S. might end up delaying payments the next time congress has to raise the debt ceiling. We're still not out of the debt crisis yet. And that's not considering a possible interest rate rise, which I don't think will be too terrible if it is not too quick.

 

[obgyn65]

To answer your question, I believe greed and fear drive stock prices. However, since 2008, the entire game has been made more complex, more biased, more open to manipulation simply because of the many governmental and public interventions around the globe. This has never happened before as far as I know.

Not many people assumed that central banks and governments would intervene in 2008. Although I sensed that the Dow was overvalued in early 2008, I expected it to crash - say down to 8,000 - and stay at that new level for a long time. I did not believe that governments around the globe would intervene the way they did and 'save' the system - at great expense IMO.

That is my view only. I am not an economist or a financial expert. But it seems to me that the 'blind faith' that the Dow will always outpace other types of more cautious fixed income investments is wrong in the long term, even if many generations have been able to retire by taking some risks.

To the OP : thank you for starting a thread on asset allocation. This has given me an opportunity to express myself at length for the first time since I joined this FIRE website about some of the reasons behind my choice of AA. I hope I did not highjack your thread too much. Apologies if it looks that way.

for obgyn65
What do you think drives stock prices and therefore market indices? Your repeated use of the word "luck" to characterize stock markets suggests you only seem to recognize the less predictable emotional aspect that typically exaggerates market highs and lows, without recognizing the underlying fundamentals that correlate with stock prices/market indices over the long run. There's a reason the Dow has not remained at 7,000 since 2009, it's not just a matter of chance or luck...any more than it has been through every recession, depression, war or other past geopolitical or financial circumstance.

If you rely strictly on emotions and "what if's" to guide your investing decisions, you probably don't want to hold anything except cash. And you wouldn't be alone with your extremely low risk tolerance, but few people have been able to retire successfully for 30 years using such an approach, and current low interest rates/yields suggest that be all the more unlikely in the years ahead.
!

 

[ERD50]

If fear and greed drive stock values, what drives fixed income values?

Isn't the government currently manipulating interest rates, and affecting fixed income values (ask any senior who depends on CDs for income)?

I fail to see how any one asset class is immune from these factors.

-ERD50

 

[Midpack]

To answer your question, I believe greed and fear drive stock prices.

Stock prices are not driven by fear and greed alone, so you're aware of the short(er) term emotional factors but completely unaware of the underlying fundamental values in stock pricing. The S&P 500 has not gone up 6,800% in the past 60 years on fear and greed alone - but your views explain why you're reluctant to invest in equities.

 

[skyline]

Not sure if this has been addressed in this thread already, but I've always thought that the %-based allocation of fixed income securities was flawed. For me, the purpose of bonds/cash is to ride out downturns in the equities market. So the amount of bonds/cash to maintain is equal to (annual expenses) x (# of years you think the majority of downturns last).

For example, if you feel that most market downturns recover in 5 years or less (allowing that some will last longer, but you're not planning on catastrophe), and your living expenses are $50K/yr, then your bond/cash allocation would be $250K.

Depending on your net worth, that may be 50/50, 75/25, 90/10, or 98/2 - just depends on how much you need to ride out what you think is a vast majority of market downturns...

 

[MichaelB]

To answer your question, I believe greed and fear drive stock prices.

Profits, specifically earnings per share, along with cash, are what drive stock prices. Here and around the world, in the past and still today. Fear and greed can affect those prices and cause deviations. So can any multitude of things. Prices, however, revert back to earnings and cash. As Benjamin Graham put it, in the short term the market is a voting machine, in the long term it is a weighing machine, and it weighs those two things.

That is my view only. I am not an economist or a financial expert. But it seems to me that the 'blind faith' that the Dow will always outpace other types of more cautious fixed income investments is wrong in the long term, even if many generations have been able to retire by taking some risks.

One doesn't need to be an expert to acknowledge there are legitimate financial underpinnings to asset pricing and investment markets much in the same way we don't all need to be trained medical professionals to understand that medicine is not voodoo and practitioners are not witch doctors.

No one here is saying "the Dow will always outpace other types of more cautious fixed income investments". In fact, most of the thread discussions on specific asset allocation carefully qualify recommendations only after looking at age, debt levels, retirement objectives, and other factors. The most common recommendations are for allocations to equity that are higher for younger people and decline over time, but still remain generally high (30% - 45%) even for conservative investors. This is not based on blind faith. It is the expectation that the US (and global) economy will continue to grow. How much, and how quickly it grows has a direct impact on the things that will affect stock prices, interest rates and real returns.

Even with economic growth, we cannot be sure what will happen with asset prices, so we hedge with diversification, and try to avoid all extreme outcomes. Critical to this, however is understanding both those extremes. One is loss of capital, the other loss of purchasing power. Avoiding one without the other is like avoiding obesity by not eating. It will work, but the end result may not be any better.

If we compare a portfolio of mostly fixed income with one mostly of equity, over time, the fixed income portfolio fails more frequently. Yet is it barely mentioned (in the media). I'm not sure why, but two reasons come to mind. One is the loss of purchasing power is slow and less easily perceived, especially over long periods, while the loss of equity is immediate and sharp. The second is the loss of purchasing power grows as people age, and, when it pushes the retired into poverty, society and the media turn a blind eye.

 

[obgyn65]

Thank you for this post, Micheal. Sorry for not replying sooner as I was traveling. I will come back to you when time permits.

Profits, specifically earnings per share, along with cash, are what drive stock prices. Here and around the world, in the past and still today. Fear and greed can affect those prices and cause deviations. So can any multitude of things. Prices, however, revert back to earnings and cash. As Benjamin Graham put it, in the short term the market is a voting machine, in the long term it is a weighing machine, and it weighs those two things.

One doesn't need to be an expert to acknowledge there are legitimate financial underpinnings to asset pricing and investment markets much in the same way we don't all need to be trained medical professionals to understand that medicine is not voodoo and practitioners are not witch doctors.

No one here is saying "the Dow will always outpace other types of more cautious fixed income investments". In fact, most of the thread discussions on specific asset allocation carefully qualify recommendations only after looking at age, debt levels, retirement objectives, and other factors. The most common recommendations are for allocations to equity that are higher for younger people and decline over time, but still remain generally high (30% - 45%) even for conservative investors. This is not based on blind faith. It is the expectation that the US (and global) economy will continue to grow. How much, and how quickly it grows has a direct impact on the things that will affect stock prices, interest rates and real returns.

Even with economic growth, we cannot be sure what will happen with asset prices, so we hedge with diversification, and try to avoid all extreme outcomes. Critical to this, however is understanding both those extremes. One is loss of capital, the other loss of purchasing power. Avoiding one without the other is like avoiding obesity by not eating. It will work, but the end result may not be any better.

If we compare a portfolio of mostly fixed income with one mostly of equity, over time, the fixed income portfolio fails more frequently. Yet is it barely mentioned (in the media). I'm not sure why, but two reasons come to mind. One is the loss of purchasing power is slow and less easily perceived, especially over long periods, while the loss of equity is immediate and sharp. The second is the loss of purchasing power grows as people age, and, when it pushes the retired into poverty, society and the media turn a blind eye.

 

[obgyn65]

I have read your post several times over the last few days. I guess I am in the camp of those who prefer to live below their means and take the risk of losing purchasing power slowly over time rather than risking a sharp loss of equity.

I am encouraged by the fact that a couple of posts recently in other threads seem to indicate that other forum participants seem to be as conservative as I am.

If we compare a portfolio of mostly fixed income with one mostly of equity, over time, the fixed income portfolio fails more frequently. Yet is it barely mentioned (in the media). I'm not sure why, but two reasons come to mind. One is the loss of purchasing power is slow and less easily perceived, especially over long periods, while the loss of equity is immediate and sharp.

 

[photoguy]

I have read your post several times over the last few days. I guess I am in the camp of those who prefer to live below their means and take the risk of losing purchasing power slowly over time rather than risking a sharp loss of equity.

Do you believe others have misjudged the risk of equities? or is your choice of portfolio driven by behavioral introspection (e.g., you might be fearful and sell equities during a bear market)? I think I've seen comments leaning both ways in your postings.

To what other types of investors would you recommend your approach?

 

[obgyn65]

To answer your first question, there is no doubt that millions of people have taken too much risk financially and have been taking too much debt - just look at the number of bankruptcies and foreclosures overall since 2008. And just look at what happened to Lehman, Bear Stearns, Merryll Lynch etc.

Because of my grand parents' histories in Europe (financially ruined on both sides twice because of two wars) I tend to be very risk averse and hide my wealth. Also working in a very litigious environment makes me very cautious in general. I guess I also hate the idea of losing money. I already know I will cringe at the idea of taking even 1% of my capital after FIRE. If given the marshmallow test when I was a kid, I would never have eaten mine. I would have waited for the second marshmallow. And then a third one, fourth, etc.

To answer your third question, the key idea IMO is to live below your means "safely" from a financial standpoint, i.e. without taking too much risk, whatever that level of acceptable risk is to you in the medium and long term. At the moment, there seems to be some consensus around 3% SWR (used to be 4%) for about a 30-year retirement, which seems about right. This number can change when you factor in SS, pension, annuities etc. I would not recommend a very conservative approach for everyone, as some with a smaller nest egg and no pension for example will need to take more risks to make their FIRE plan work. However, some here like me seem to be able to FIRE while taking much less risk.

Good luck to us all.

Do you believe others have misjudged the risk of equities? or is your choice of portfolio driven by behavioral introspection (e.g., you might be fearful and sell equities during a bear market)? I think I've seen comments leaning both ways in your postings.

To what other types of investors would you recommend your approach?

 

[FIREd]

Because of my grand parents' histories in Europe (financially ruined on both sides twice because of two wars) I tend to be very risk averse.

I do get that. My European parents and grandparents are/were very risk averse. Their wealth is/was held in cash and real estate, with virtually zero exposure to stocks and that's how I learned how to invest my money too. So there is definitely a cultural dimension to this. Still, after spending a lot of time reading about investment theory, I have chosen to own some equities. I think that the long term benefits of a small equity allocation far outweigh the short term risks.