Answer to John Galt's Question - Why own Stocks ?

nm

[sgeeeee]

While I believe the conclusion, I'll bet I don't agree completely with the definition of "risk" or the calculation used in the graph.

Risk comes in many forms. Some may be approximated by quantitative metrics while others may not. And any quantitative metric for risk must be based entireley on historical results. Then there's the problem of translating this standard deviation risk value into the feelings you get when your portfolio value drops. How is 10% standard deviation going to feel compared to 14% standard deviation over the next 10 years?

[BigMoneyJim]

Before I start, I'll say I challenge numbers and methods to understand them better, not to attack them or to necessarily invalidate them. Additionally, until a week or two ago I was over 95% in stock index funds for long term investing. Now I'm about 80/20 stock index funds & bond "total market index" and slowly considering whether I want to go to 70/30 or 60/40 in the near future even with 15-30 years until expected withdrawals begin and up to 30-45 years span of withdrawals.

First, I agree with salaryguru's objection about presenting standard deviation as risk. At first glance it seemed the only reasonable measure for risk, but if historically annualized stock returns dropped 22% one year then bounced up 22% the next, for example, that doesn't necessairly indicate more long-term risk if you're withdrawing a single-digit portion of your portfolio. I'm way too lazy today to look up historical statistics right now, but I seem to recall any dramatic one-year drop in stocks was generally quickly followed by a bounce in the other direction.

Second, I am a bit tickled about the 8% 100% stock returns given that I've read many times here that Bernstein expects closer to 3% returns over the next 30 years. I don't see how you can say that stock returns will be much less in the future while confidently applying historical deviation or "risk". Intuitively stocks will still be more volatile than bonds, but if one believes that stock returns will be much lower for a 30-year span then how would he also apply anything but a similarly-performing subset of historical statistics to that span? (Disclaimer: He isn't claiming both at the same time as far as I know, but both bits of information come from the same guy, and I find that curious.)

Third, it's been over 10 years since my statistics class, but I still have the textbook. I recall the standard deviation being somewhat of an average of deviations from the mean, and if that's the case then 20-22% sounds incredibly high for 100% stocks. (I am assuming by "stocks" he's using the total market index index.) I am opening my textbook to the definition of standard deviation, and there are too many greek letters for me to choose verifying my suspicion over getting myself a glass of wine, so my rusty half-informed speculation stands until someone more recently acquainted with statistics corrects or verifies my objection.

Oops, something just slipped loose in my brain, and I haven't started drinking wine yet. With the squares and square roots and a recollection of somewhat parabolic population bell curves, I recall the standard deviation helps shape the curve with respect to the mean; 20-22% still sounds high to me.

[cute fuzzy bunny]

We've had a number of big drops that took a while to recover from. We just had one that stuck for 3 years before the bounce back.

Here's the deal! If you can average , oh say 6%
on your "forever" money without worry about default,
would you take that or gamble on stocks??
Is it really that simple or am I missing something?

John Galt

And another thing Cut-throat, I thought you were
fishing. What are you doing reading financial
books?? My day? Slept late, ran some errands and then fished
until cocktail hour. Life is good!

John Galt

John,

I was fishing.

But then there was the 4 hour plane ride each way and the 1/2 hour read before bedtime each night.

I may be unusual that I am enjoying financial reading lately. But since I don't have a job, it's more enjoyable now.

I read every fishing book I could get my hands on 15 years ago when I was working and not able to fish as much. Now the tables are turned a bit!

Here's the deal! If you can average , oh say 6%
on your "forever" money without worry about default,
would you take that or gamble on stocks??

If you were talking about a 6% real return over inflation, with less risk than stocks - I'd be in. Of course we know that no such investment exists.

If you are talking about a 6% return before inflation of 8%, I would not be interested in losing 2% of my money.

And no, it's really not that simple.

Well, if we have 8% inflation, all bets are off.
I suppose I would have to hope my real estate bailed me out, or maybe I would get lucky and expire before my money was gone. On the other hand, maybe I am old enough now to survive with a minus 2% until my demise

John Galt

[renferme]

John Galt,
ok, where do you get 6% ? can you be a little bit specific ?
Ray

[cute fuzzy bunny]

My dad's still carrying some old bonds that pay 6+%.

[charlie]

bennevis,

A joint immediate life annuity, both 60 years old,
pays about 6% right now. Don't get me wrong,
I am not advocating this strategy for all your
portfolio, but some may find it attractive for part.

Of course inflation eats away and no estate is
left. It is possible to buy annuities with a fixed
percentage rise, but the return is less than 6%.
I believe Vanguard has such an immediate annuity,
but I have not checked into it yet.

As an academic exercise it might be fun to use
FIREcalc to determine the best annuity/stock
balance.

Cheers,

Charlie

[sgeeeee]

A TIAA-CREF article that might address your question about annuity/stock allocation. Go to:

www.tiaa-crefinstitute.org

click on "Pensions and Retirement"

click on "Published Articles"

The article is titled:
Making Retirement Income Last a Lifetime
John Ameriks, TIAA-CREF Institute, Robert Veres, Inside Information and Mark J. Warshawsky
December 2001

The article is about annuities as a component of a retirement portfolio and how it affects portfolio longevity risk, the authors use a Monte Carlo simulator that they attempt to calibrate with a historical simulator. They publish a number of detailed tables with the results from both simulators.