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Another perspective on a high-equity portfolio
Old 01-31-2006, 11:45 PM   #1
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Another perspective on a high-equity portfolio

(It's always nice to read a little confirmation bias, but I don't think there are many comments like this about high-bond portfolios.)

Roy Weitz posted these thoughts on his monthly FundAlarm Highlights & Commentary:

"This is the seventh year in a row that I don't show any bond funds in my portfolio and, from time to time, FundAlarm readers ask me why I've left such a gap......

In general, I feel that bond fund managers don't do a great job managing interest rate risk, which means that bond funds often suffer during periods of rising interest rates (like now).....

Bond funds also help cushion the bumps in a portfolio, which are typically caused by stock funds.....But if you can handle the bumpy ride that comes with owning an all-stock fund portfolio -- and I think I can -- then bond funds don't serve much purpose.....

Another reason for taking a pass on bond funds is suggested by Canadian finance professor Moshe Milevsky.....I can't say that I knew about Milevsky's work before I stopped owning bond funds, but what Milevsky says makes sense......Basically, Milevsky believes that each person's human capital -- which he defines as the present value of future earnings, net of income taxes and expenses -- should be viewed as an asset class, and considered in every personal portfolio allocation......

A person who has a relatively secure job (and I'm fortunate to be in that category, I think) can look forward to an assured income stream for a predetermined number of years, which is essentially the description of a high-quality bond.....In a sense, people with secure jobs are bonds, and if they add traditional bonds or bond funds to their portfolios they risk being too heavily invested in that category.....

On the other hand, people who work in volatile industries, like technology or finance, are more like growth stocks, and a generous helping of traditional bonds (or bond funds) could help dampen volatility and diversify their portfolios.....

Milevsky is still refining his concept of human capital by profession and asset category, to the point where he'll be able to describe a tenured university professor (for example) as "70% inflation-indexed bond, 30% nominal bond".....We're not sure that this level of precision will do much to help the average investor.....But Milevsky's big-picture insight is a good one, and relatively easy to understand: Each investor's employment situation should be considered as part of his or her portfolio design.

"Gauging whether a client is a stock or a bond," Rick Miller, InvestmentNews, February 7, 2005; an introductory article by Milevsky ("Is Your Client a Bond or a Stock?") can be found at http://www.ifid.ca/pdf_newsletters/NL_AE2003NOV.pdf"

(Edited to correct the last URL.)

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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 12:15 AM   #2
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Re: Another perspective on a high-equity portfolio

No doubt about this. Martin Whitman in The Aggressive Conservative Investor says that the financial position of the holder of a* security is as important as the financial position of the security he holds.

One more reason to be glad for your military background.

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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 09:29 AM   #3
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Re: Another perspective on a high-equity portfolio

What was that Peter Lynch said? "Bonds are for suckers?"...I think thats it...
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 11:07 AM   #4
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by Nords
(It's always nice to read a little confirmation bias...
Less Antman is another Bond Hater who has written pretty compelling arguments for bond-free portfolios. I hold ~15% in an AGG-like bond fund mostly because of an article Jon Clements wrote last June (I think...it's longer free-searchable) echoing Bernstein's sentiment that the first 15-20% doesn't reduce returns if you rebalance.

I recently saw a summary of an analysis that refutes that, but I'll take the chance that Jon & Bill are correct.

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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 12:55 PM   #5
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Re: Another perspective on a high-equity portfolio

Nords, The URL for the document did not open in my browser, does it work for you? I am interested in the bond Vs stock issue. I am almost bond free and I think this is OK becasue I will have a Govt COLAd pension, I have some diversification in stocks (TSP C, S, & I Funds) and some DRIP stocks, and I have a long enough investment window (I am 55). In my TSP I do have a large (35%) chunk of G Funds which are called a bond but really is more like cash, I think its the only bond I want.
So I am wondering how to construct a bond free or low bond diversified portfolio. I do not have much in after tax accounts except for the 6 DRIP stocks and cash in my credit union. Would holding equities in an after tax state might lean toward a VG tax managed fund or just buy & hold stocks?
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 05:13 PM   #6
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by yakers
Nords, The URL for the document did not open in my browser, does it work for you?
Sorry 'bout that, I had a "/" where a "." should be. It works now.
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 05:34 PM   #7
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Re: Another perspective on a high-equity portfolio

What about the no job, no pension early retiree?
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 05:54 PM   #8
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by . . . Yrs to Go
What about the no job, no pension early retiree?
I guess it depends on whether you want to beat inflation over the next six decades or just to avoid volatility over the next couple years.

And if you're willing to cut back spending or even get a -j-j-j-j-job during a prolonged bear market then a high-equity portfolio gives you even more flexibility.

Find your own comfort level on the risk/reward curve, but my parents-in-law have been extremely unhappy these last five-six years with their 100%-bond portfolio.
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 05:54 PM   #9
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Re: Another perspective on a high-equity portfolio

Nords,

Interesting idea. This is part of what everyone deferrs to as "well its an individual AA decision". Which is nice but what about a little help? How much risk should someone take? I do think a stable income or pension can allow a higher stock allocation. I am trying to figure out what asset classes I can have except for the G Fund to have diversification. I do not see the value of TIPS for a retiree with a COLAd pension either. Now I do have some ibonds but (I hope) they add some flexibility in being a source of cash after 1 yr and my income may go down (depends on how much my wife wants to work after she retires this June) when my son is in college in the next couple years and maybe they can be cashed tax free.
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 06:11 PM   #10
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by Nords
I guess it depends on whether you want to beat inflation over the next six decades or just to avoid volatility over the next couple years.

And if you're willing to cut back spending or even get a -j-j-j-j-job during a prolonged bear market then a high-equity portfolio gives you even more flexibility.

Find your own comfort level on the risk/reward curve, but my parents-in-law have been extremely unhappy these last five-six years with their 100%-bond portfolio.
I certainly wouldn't advocate a 100% bond portfolio. Nor would I rely on my ability to find a job that would pay a meaningful wage after being out of work for a decade - especially when considering the implications a prolonged bear equity market likely has on the labor market. I think I'm also less comfortable then many on this site with the notion that future market returns will be no worse then past market returns. It seems to me the past 100 years has been pretty extraordinary.

It's also easier to be aggressive when you have a pension to fall back on. When I retire, what I have at that moment is all I'm ever going to have. If my assumptions of historic equity market returns prove too optimistic I could be in deep trouble. It seems the middle path may be more prudent for some.
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 06:19 PM   #11
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by yakers
Nords,

Interesting idea. This is part of what everyone deferrs to as "well its an individual AA decision". Which is nice but what about a little help? How much risk should someone take? I do think a stable income or pension can allow a higher stock allocation. I am trying to figure out what asset classes I can have except for the G Fund to have diversification. I do not see the value of TIPS for a retiree with a COLAd pension either. Noow I do have some ibonds but (I hope) they add some flexibility in being a source of cash after 1 yr and my income may go down (depends on how much my wife wants to work after she retires this June) when my son is in comllege in the next couple years and maybe they can be cashed tax free.
Sorry about that, I wasn't trying to be flip.

The problem is that investing is more than just an intellectual exercise in asset allocation. *We could do the math on goals, expenses, retirement age, and so on to come up with a few portfolios that have stood the test of time. *That's just math and that's the easy part.

The difficult part is the emotional component of investor psychology. *Even with spouse's & my enhanced "volatility tolerance" our 95% stock allocation didn't look too smart when the portfolio was down 40% in Oct 2001. *The math says you need to come back up 67% just to return to parity. *Compared to looking down 40%, looking up 67% seems to be much more of an exercise in faith than in mathematics.

I'm not trying to be flip here, either, but I'd recommend the library copy of "Four Pillars" for Bernstein's sample portfolios. *You may be perfectly happy with the default 80% stock/20% bond solution. *Or you may want to seek small-cap, value, & international equities instead of just the S&P500. *That might bust your stock allocation down to 60%. *And this is just a conversation about stocks & bonds, but imagine how complicated it can get when you add dividend-paying stocks, commodities, & REITs. *And venture capital. *And options. *Would anyone like an annuity with that?!?

Frank Armstrong does largely the same thing in his book, the Informed Investor, which is also a great read.

I can't tell you what you should do, but the simpler it is the more likely you are to stick with it. *For example at today's valuations you could skip the commodities & REITs, let alone the more exotic stuff, and not significantly hurt your returns. *(It might or might not affect your volatility, and it might or might not be significant. *I just don't know.) *We've put a third each of our portfolio with Buffett & Tweedy, Browne. *The rest is with a year's expenses in cash, a year's expenses in a CD, a small-cap value ETF, a DOW dividend ETF, and individual stocks. *My spouse's TSP is in the "S" fund but her Reserve income kept that allocation waaaaaay down in the grass. *

As we grow less inclined to play with the portfolio, it'll gravitate more toward dividend, international, & small-cap ETFs with low expenses & few trades. *Right now we're more interested in running around & exploring everything than we are in a simple portfolio.

The trick, like any kid in a candy store, is choosing which flavors we want to have. *They're probably all going to work and they're all certainly yummy.

Quote:
Originally Posted by . . . Yrs to Go
I certainly wouldn't advocate a 100% bond portfolio.
Yeah, I wouldn't either. Especially when the subject comes up blow-by-blow at every family gathering...

Quote:
Originally Posted by . . . Yrs to Go
Nor would I rely on my ability to find a job that would pay a meaningful wage after being out of work for a decade - especially when considering the implications a prolonged bear equity market likely has on the labor market.
I'm not so sure. If there's one thing I've learned about ER, it's that my creative juices have rebounded to see revenue opportunity everywhere. For example I have handyman skills that would have put me on the lowest rung of proficiency among my fellow submariners but which apparently make me the one-eyed man in the Valley of the Blind in my neighborhood.

ESRBob's not advocating a career, either, in his book-- more along the lines of Wal-Mart greeter or part-time at Home Depot. Those jobs are just intended to pay for a portion of your living expenses to get you through the bear market.

Quote:
Originally Posted by . . . Yrs to Go
I think I'm also less comfortable then many on this site with the notion that future market returns will be no worse then past market returns. It seems to me the past 100 years has been pretty extraordinary.
Let's see, two world wars, a huge depression and a prolonged stagflation, a Cold War, terrorism (both the nuclear threat and the conventional reality), several "other" unpopular wars (no disrespect intended), antibiotics, civil rights, an oil crisis, baby boomers, Wall Street greed, and the Internet gold rush. Yep, I sure hope the next century is comparatively quiet. I doubt it'll happen.

I think most of this board's starry-eyed optimists are looking at the Gordon Equation's 6-7% as reasonably achievable.

Quote:
Originally Posted by . . . Yrs to Go
It's also easier to be aggressive when you have a pension to fall back on. When I retire, what I have at that moment is all I'm ever going to have. If my assumptions of historic equity market returns prove too optimistic I could be in deep trouble. It seems the middle path may be more prudent for some.
Absolutely. If a pension's not part of your retirement then you either need more assets with less volatility-- or fewer assets with more volatility. But it doesn't work with fewer assets & less volatility, unless part-time employment is added.
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 07:32 PM   #12
 
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by Nords
I guess it depends on whether you want to beat inflation over the next six decades or just to avoid volatility over the next couple years.

And if you're willing to cut back spending or even get a -j-j-j-j-job during a prolonged bear market then a high-equity portfolio gives you even more flexibility.

Find your own comfort level on the risk/reward curve, but my parents-in-law have been extremely unhappy these last five-six years with their 100%-bond portfolio.
Nords,

Didn't Bonds do pretty well the last 5 or 6 years, with the exception of the past year? I think they may have had double digit returns most of those years. No?
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 08:27 PM   #13
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by Nords
Let's see, two world wars, a huge depression and a prolonged stagflation, a Cold War, terrorism (both the nuclear threat and the conventional reality), several "other" unpopular wars (no disrespect intended), antibiotics, civil rights, an oil crisis, baby boomers, Wall Street greed, and the Internet gold rush.*
Yes, and after all the bumps in the road the US emerged as the world's lone superpower after a century of unprecedented economic advancement.* Certainly the next century need not be as rosy.

Quote:
I think most of this board's starry-eyed optimists are looking at the Gordon Equation's 6-7% as reasonably achievable.]I think most of this board's starry-eyed optimists are looking at the Gordon Equation's 6-7% as reasonably achievable.
I agree that 6-7% should be achievable.* I disagree that the conventional 4% withdrawal rate is backtested as "safe" against a market with those characteristics.


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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 09:27 PM   #14
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by Nords
Let's see, two world wars, a huge depression and a prolonged stagflation, a Cold War, terrorism (both the nuclear threat and the conventional reality), several "other" unpopular wars (no disrespect intended), antibiotics, civil rights, an oil crisis, baby boomers, Wall Street greed, and the Internet gold rush.
You forgot:

The black death, the red death, the green death, Godzilla, old people falling down stairs, and old people falling up stairs.
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 09:59 PM   #15
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Re: Another perspective on a high-equity portfolio

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Didn't Bonds do pretty well the last 5 or 6 years, with the exception of the past year?* I think they may have had double digit returns most of those years. No?
Sure they did. Buffett made millions off them in 2002-3, so technically our Berkshire Hathaway stock constituted a bond position. But what am I supposed to do with that bond performance data, accuse you of being a dirty market short-timer? Or point out that GM junk did even better?

I think the purpose of bonds in a portfolio is to (1) reduce volatility, (2) ensure that a known amount of money is available at a certain date for a financial obligation, (3) throw off a reliable stream of cash (e.g., from a ladder), and (4) diversify. There may be other purposes that I haven't mentioned; correct me if I'm missing something.

We don't care about any of those features. We care about inflation.

I think I can predict the next question. What about I bonds, which are indexed for inflation? Well, we don't want to match inflation. We want to exceed it, and not just by making "hedonic adjustments".

I'm halfway through "Triumph of the Optimists" (book report to follow) and it gives one a heckuva perspective. My biggest ER concern is inflation, not volatility. The only thing that reliably beat inflation over the last century, let alone the next six or seven decades that I may have to contend with, is equities. Not only that, but nothing beat inflation by a wider margin than small-cap & value equities.

Among Buffett, international, & the small-cap value ETF we hope we've addressed our inflation concerns. The DOW dividend ETF and the individual stocks are just testosterone poisoning that we might even grow out of someday. Or we might decide to become dividend investors.

I may be dead tomorrow and I may leave a lotta money unspent, but in a portfolio that has to last the rest of my life it seems more fiscally responsible to pretend that I'm gonna live to 120. With the size of our portfolio, our desired expenses, and the potential for a number of decades at 3-4% inflation, even I bonds aren't going to accomplish that goal.
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Re: Another perspective on a high-equity portfolio
Old 02-01-2006, 11:31 PM   #16
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Re: Another perspective on a high-equity portfolio

Nords, I didn't think you were being flip. I like the issue you raised and the article you referenced. I have read Four Pillars and liked it intellectually but wasn't wowed by it as most people seem to be. Maybe because I do not have a firm idea or plan for my investments. I did not fold or run from my mostly stock AA* in 2000, lost 40% in one fund and a bit more in the one tech fund (unfortunately my son's college fund, more time sensitive). But other funds Vanguard AA (VAAPX) did OK through that time as did some other holdings. And as I was in acquisition mode my overall funds have done well in the last 6 years. The problem now is I am older and not as happy with volitility as I was but I don't like bonds I really think inflation will hit hard sooner or later. I am really happy I have the TSP G fund, the only bond I can like. I feel the challenge, at least mentally-may not act on it, to figure out how diversified I can be without bonds. I look at the VG AA fund (VAAPX) and they are 100% stock & cash and I agree with them. So my somewhat simple plan is to buy total market (TSP C&S) a good bit of total international stock (TSP I) and dividend paying stocks in DRIP accounts. I hold about 35% of my TSP in the G fund and leave the VG AA to go to bonds when they see fit.
Will this work? How the hell do I know. But it is what I am comfortable with right now. And I find it very interesting to see how others have engaged with the issue.
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Re: Another perspective on a high-equity portfolio
Old 02-02-2006, 12:22 AM   #17
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Re: Another perspective on a high-equity portfolio

I realize that many of you don't like math and historical simulation results, but I'm retired and I don't really care.

Run FIRECalc with a 100% stock portfolio and 0 withdrawals. Then run it with a 50/50 portfolio (using commercial paper). Look at the detailed results and compare the two cases.

A diversified stock/bond portfolio beats the all stock portfolio only for short time periods. The longest time period where diversified beats stock is 19 years for the 1929 retiree.

For time periods greater than about 6 to 8 years, it is rare for diversified to beat all stock.
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Re: Another perspective on a high-equity portfolio
Old 02-02-2006, 12:54 AM   #18
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Re: Another perspective on a high-equity portfolio

Quote:
Originally Posted by Nords
I think the purpose of bonds in a portfolio is to (1) reduce volatility, (2) ensure that a known amount of money is available at a certain date for a financial obligation, (3) throw off a reliable stream of cash (e.g., from a ladder), and (4) diversify. There may be other purposes that I haven't mentioned; correct me if I'm missing something.
One might say you've covered this with (1) and (4), but I am holding bonds to help ensure portfolio survivability during withdrawal stage.

I have no pension, and don't expect much from social security.

Not long ago, I was a bond hater, and had a target of 0% cash+bonds, until something like a year ago. Now, target is 10%. My belief is that it reduces the risk of my portfolio falling so much in an extended bear that I need to return to work.

Depending on the circumstances of the bear market, I will be willing to spend down the entire cash/bond position, before selling equity which has become cheap.

Something I need to (eventually) read more on is deflation. I am considering defending against it, by holding short/intermediate treasuries for the 10% position, instead of TIPS. (At today's rates, I'd take the 6mo 4.6% treasury, but if curve changes enough, might go a little longer which would provide better deflation protection. I still haven't ruled out 5yr TIPS though. )
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Re: Another perspective on a high-equity portfolio
Old 02-02-2006, 12:57 AM   #19
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Re: Another perspective on a high-equity portfolio

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Originally Posted by ((^+^)) SG
Run FIRECalc with a 100% stock portfolio and 0 withdrawals. Then run it with a 50/50 portfolio (using commercial paper).
For someone still accumulating, I think 100% equity/high-risk asset classes can make excellent sense, provided an iron stomach and will. It's what I would do if I were making 0 withdrawals.
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Re: Another perspective on a high-equity portfolio
Old 02-02-2006, 06:14 AM   #20
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Re: Another perspective on a high-equity portfolio

Without repeating the ancient story(or trying to remember which newspaper 40ish years ago) - the Norwegian widow did just fine with 100% individual dividend paying stocks.

With some of my frivolous money - I still subscribe to Dick Young's Intelligence Report. Reading last night(Feb 06) - his current optimum number is 32 stocks. In the past he has been as low as 8 stocks. Diversification and relativily high yield are key. This is vs a vs the NYSE.

? Anyone seen any academic curves? They pop up from time to time.

Dividends are real money - not exactly a Yogi Berra quote - but I like to paraphrase.

The central difficulty remains - the low dividend yield of the stocks one might want to own today - at least for me.

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