Burton Malkiel: 60/40 is dead

[Midpack]

(Bold added). I think it is generally a mistake to use "risk" and "volatility" interchangeable (I do it too, and I know it is accepted shorthand in the "biz"). Stocks do have higher volatility, but if we are worried about staying ahead of inflation over the long haul and producing enough return to retire starting with a "pot" less than 50x annual spending, then a broad portfolio of stocks has less risk (of the the we should care about) than a portfolio of 80% bonds.

Fair point. Though "less risk" does take on a significantly different meaning/probability of success once distribution/withdrawal begins (presumably of greater interest here) versus the accumulation phase. But I'm not disputing the distinction you make - thanks.

 

[galeno]

Total Expense Ratio (TER) = Expense Ratio (ER) + Tax Ratio (TR). Our TER = 0.34% +0.42% = 0.76%.

For FI we use 2 offshore intermediate bond funds and USA FDIC insured CDs.

I'm very similar. 60/40, age 58, WR ~3.3%. I'm planning to live to 100.
What is TER? ER? My weighted average ER is ~20bps.

On the bond side, I'm transitioning to CDs (in process of buying PenFed 2% 3 year) and target maturity bond funds from BND to reduce/mitigate interest rate risk.

 

[braumeister]

Going forward economists have the benefit of hindsight as to what caused the inflation of the past so we might not see those crazy numbers again.

You're probably right, but I'm much more afraid of inflation than of volatility.
I live with the memory of my grandfather, who retired just before inflation went nuts.

The graph below shows inflation since 1950. The double arrow shows the span of my grandfather's retirement years. When he quit working, he was very comfortable financially, but he went broke long before the end of his life.

Frankly, the spectre of inflation terrifies me, and as a result I'm well able to stand a considerably higher equity allocation than most.

 

[daylatedollarshort]

Frankly, the spectre of inflation terrifies me, and as a result I'm well able to stand a considerably higher equity allocation than most.

Zvi Bodie recommends TIPS, I bonds and inflation indexed annuities for inflation protection.

This article builds the case that there is a body of research that stocks actually have not done particularly well in past periods of high inflation -

Investing Error: Don't Use Stocks as an Inflation Hedge - DailyFinance

Here is another article on the subject -

"By 1979, an investor who bought stocks in 1964, when the market seemed to be a sure moneymaker, had lost money after adjusting for inflation, even after including dividend income. "

http://www.nytimes.com/2012/01/07/b...cal-cycle-bodes-ill-for-the-markets.html?_r=0

My grandfather retired through the high inflation years, lived to an outlier old age, and was always financially secure. I think it is real returns that count more than inflation, unless you are living off a fixed income, non COLA pension.

 

[foxfirev5]

It seems to me that a lot of people are again deciding that they can handle an increase in risk. The last couple of downturns were relatively brief and had substantial recoveries. There are no guarantees the next one will recover quickly. Also, the arguement could be made that the market is way ahead of the recovery when looking at the employment picture.
In any event I'm sticking to my plan. 45/35/20 w/5 yrs expenses in cash and avg duration of bond funds <4.

 

[audreyh1]

With the last CPI (Oct CPI-U), year-over-year inflation was 1%.

This is the lowest inflation level since 2009, and prior to 2009 you have to go back to 1965 to find a period with y-o-y inflation below 1%*.

I just have this feeling that inflation may stick around this 1% level for a while.

If so, bond returns aren't threatened by inflation.

They might be hurt a bit by the end of tapering or QE. Although we already took some of that bitter medicine this year. And equities will be hurt as well. REITs were clobbered this year due to the "end-of-taper" threat.

The longer we go, the less inflation pressures I see.

*Historical Inflation Rate | InflationData.com

 

[NW-Bound]

Zvi Bodie recommends TIPS, I bonds and inflation indexed annuities for inflation protection.

This article builds the case that there is a body of research that stocks actually have not done particularly well in past periods of high inflation -

Investing Error: Don't Use Stocks as an Inflation Hedge - DailyFinance

But, but, but the same article says that while stocks were bad during high inflation years, bonds were worse.

"In an article in the 2012 Credit Suisse Global Investment Returns Yearbook, they found that during periods of "marked" inflation, equities easily outperform bonds, probably the worst investment to own during inflationary episodes. Yet equities gave a real return of -12% during those periods, while bonds lost 23.2%. Double ouch."
​

However, that only applies to really high-inflationary periods of greater than 5%, of which Siegel had the following to say.

"Although stocks do well when annual inflation is in the range of 2% to 5%, their performance begins to falter when inflation exceeds 5%."

Why? Because "companies can't always pass along increased costs, especially in the case of an important raw material, such as oil. As a result, many companies will see their profits squeezed," he wrote.

Siegel's conclusion: "Stocks are not good short-term hedges against rapidly increasing inflation, but bonds are worse."​

When inflation goes above 5%, perhaps the only safe things to hold will be gold and commodities. Until that happens, I will still be holding stocks. Now, what do I do with the cash that I have been holding in lieu of bonds? Long-term treasuries have been beaten down bad, but the yield is still too low to interest me though.

 

[NW-Bound]

With the last CPI (Oct CPI-U), year-over-year inflation was 1%.

This is the lowest inflation level since 2009, and prior to 2009 you have to go back to 1965 to find a period with y-o-y inflation below 1%*.

I just have this feeling that inflation may stick around this 1% level for a while.

Historical Inflation Rate | InflationData.com

But that could be due to the government shutdown. Only 3 months earlier, it was 2%. And in 2011, it went as high as 3.9% (inflation was 3.2% for all of 2011).

 

[audreyh1]

But that could be due to the government shutdown. Only 3 months earlier, it was 2%. And in 2011, it went as high as 3.9% (inflation was 3.2% for all of 2011).

I tend to believe it's more globally systemic than that.

Another perspective - Becoming Japan | News | News and Events | ECRI

 

[NW-Bound]

If we are to become like Japan, then there's no money in either bond or stock (Nikkei anyone?).

I don't know about y'all, but I would be calling people I knew to see if there's work for me.

 

[daylatedollarshort]

But, but, but the same article says that while stocks were bad during high inflation years, bonds were worse.

I think that is why Bodi recommends TIPS and I bonds for the required expenses part of a retiree's portfolio.

 

[Lsbcal]

...
Here's what malkiel now recommends.

the updated portfolio for an investor in his or her 50s would look like:

Cash: 5 percent
dividend growth stocks, emerging market bonds and tax-exempt bonds: 27.5 percent
reits: 12.5 percent
stocks: 55 percent​

Dividend growth stocks and REITS didn't provide ballast in the 2008-2009 decline. They are just not bond substitutes. I thought bonds are for safety and maybe a wee bit of real return. Inflation, just don't go out too far in bond maturities.

My guess is that intermediate bonds return near a zero real return the next 3 years or so. Spreads are reasonable so the market is paying one to take term risk. Then maybe after a few years we are nearer historical real rates. Just a guess.

Bond funds like PTTRX (or BOND etf) and DODIX (3 year duration) provide some foreign bond exposure and corporate bond exposure. Enough risk and one can always slide over to Treasuries in the event of an equity sell off.

 

[audreyh1]

REITs were killed this year. I think they are even more interest-rate-scare sensitive than bonds!

 

[Lsbcal]

REITs were killed this year. I think they are even more interest-rate-scare sensitive than bonds!

VGSIX (Vanguard REIT) was down -37% in 2008. Total Bond Market was up +5% in 2008.

 

[Running_Man]

But, but, but the same article says that while stocks were bad during high inflation years, bonds were worse.

"In an article in the 2012 Credit Suisse Global Investment Returns Yearbook, they found that during periods of "marked" inflation, equities easily outperform bonds, probably the worst investment to own during inflationary episodes. Yet equities gave a real return of -12% during those periods, while bonds lost 23.2%. Double ouch."
​

However, that only applies to really high-inflationary periods of greater than 5%, of which Siegel had the following to say.

"Although stocks do well when annual inflation is in the range of 2% to 5%, their performance begins to falter when inflation exceeds 5%."

Why? Because "companies can't always pass along increased costs, especially in the case of an important raw material, such as oil. As a result, many companies will see their profits squeezed," he wrote.

Siegel's conclusion: "Stocks are not good short-term hedges against rapidly increasing inflation, but bonds are worse."
​

When inflation goes above 5%, perhaps the only safe things to hold will be gold and commodities. Until that happens, I will still be holding stocks. Now, what do I do with the cash that I have been holding in lieu of bonds? Long-term treasuries have been beaten down bad, but the yield is still too low to interest me though.

As for inflation, I have computed this several times but there are very few times in the past 60 years where a ladder of 10 year treasury bonds did not outperform inflation. By the end of 1982 the ten year period from 1972 was the worst with an average loss to inflation of 1.75% per year. In real terms a 100,000 invested in a 10 year treasury ladder back then was worth $85,308.26 in 1972 dollars in 1982. But that is the very worst and in real terms that outperformed the S&P 500 during that time period in which that $100,000 would have been worth $81,036 in real terms. It was a devastating 10 years cutting the value of the dollar in more than half and set up these last 30 years for an enormous run in both stocks and bonds for investors. By 2002 the 10 year treasury ladder had returned an average of 5.46 over inflation for a 20 year period. In the last 10 years that premium has disappeared.

There is however a vast difference in risk of bonds on whether one holds a continously long position without reinvestment such as the ETF TLT and a recurring percentage of the portfolio coming due and being reinvested at current rates.

As for Burton, I do not see the logic behind stating that the govenment interfering with the bond market makes stocks better. It could easily be argued that goverment purchases have pushed money into stocks that otherwise would have been invested in bonds (had they been issued into the free market, rates would rise to the level needed to sell) and so the overinvestment is in stocks not bonds, as in reality the bonds were never issued and instead furthered economic activity that is increasing the earnings of companies leading to greater stock prices, and when the bonds are issued corporate earnings growth will stall. What the unwinding of this will do I have not the slightest idea, however to state dividend and foreign bonds are safer to a US citizen than 10 year goverment treasuries, particulary if held in a ladder, I do not believe to be true.

 

[aim-high]

It's interesting reading this discussion in light of the questions I posted regarding setting up my asset allocation.

If I can swing it, I'll definitely be laying the foundation for a liability matching portfolio in TIPS, I-Bonds, and so forth.

 

[Marc]

I found the interview with Malkiel very thought provoking. As I am 56 with basically a 70/30 split very overweighed in small caps, I know I have to do something. His inclusion of REITS in the portfolio he recommended led me to research my FIDO options. I am thinking of moving my entire position in FCPGX (4% of my portfolio) to either FRSVX or FRIFX or both. I have never invested in REITs or real estate stocks. The first of the two seems to be purely REITs with low income while the latter has a very high income component.

These funds are in an IRA. I am looking to reduce equity position without increasing my bond position too much right now; do these two funds make sense? Any preference for one or the other (not retiring for a few years yet)?

thanks,

Marc

 

[daylatedollarshort]

I found the interview with Malkiel very thought provoking. As I am 56 with basically a 70/30 split very overweighed in small caps, I know I have to do something.

Have you also followed the Bernstein interview / ebook -

The worst retirement investing mistake - Sep. 4, 2012

 

[Lsbcal]

Have you also followed the Bernstein interview / ebook -

The worst retirement investing mistake - Sep. 4, 2012

Good link, thanks. Here is what I like:

By owning stocks you do mitigate inflation risk, but of course, you're exposing yourself to equity risk to do it. It's sort of like all these people who are now buying dividend-yielding stocks because Treasury bonds don't have any yield; they're exchanging a riskless asset for a risky asset.

But there's another asset class that people really don't think about when they think about inflation protection, which is short, high-quality bonds with a maturity of less than three years. If we ever do get an inflationary shock, investors will demand a high real short-term rate of return. It's what happened during the late '70s and early '80s.

Even though interest rates are terrible right now, if inflation recurs -- as I think it probably will -- short-term bonds are a fine place to be, as are individual Treasuries or certificates of deposit. Since they mature soon, you can replace them quickly with newer, higher-interest bonds.
Interest rates usually more than keep up with inflation. It's true that real yields right now are historically low, but as a student of financial history I have to believe that's not going to last forever.

And this:

Getting close to hitting your number is usually going to happen during a bull market, so the psychology of doing this right is tricky. It's hard to cut back on risk and accept lower returns when your neighbors are getting rich.

 

[seraphim]

I'm just thankful to have SV accounts. Most of my fixed assets can sit there a while.

 

[tinlizzy]

How about the floating rate notes the treasury is releasing in Jan? They are pegged to the 13 wk treasury bill instead of LIBOR.

What kind of returns might these get?
http://www.treasurydirect.gov/instit/statreg/auctreg/FRNTermSheet.pdf

 

[daylatedollarshort]

Good link, thanks. Here is what I like:And this:

As far as the neighbors getting rich, try this if you want a more conservative portfolio but are worried about keeping up with the Joneses, try this -

Global Rich List

It is shows where you stand in terms of wealth or income compared to the rest of the world. (Just for grins try typing in just your SS benefits alone and see where you end up.)

On the OECD Better Life income index, two higher end U.S. Social Security incomes alone rank pretty favorably compared to most other household incomes in the OECD -

OECD Better Life Index

 

[Dwhit]

That list is totally awesome! It makes you realize how good we have it as we head in to Thanksgiving. Much to give thanks for!

 

[Ed_The_Gypsy]

Anything you can do will be wrong. It is time to panic. Again.

Time to buy Venezuelan bonds. From me.

 

[galeno]

Regarding the Bernstein article, we plan to be retired for 39 more years. I feel very comfortable holding good quality intermediate term bonds (3-7 year duration).

When their NAV drops due to rising rates we will simply buy more bonds at a higher yield.