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Old 11-26-2013, 01:44 PM   #21
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As indebted as I am to Malkiel as one of the chief enablers of my FIRE, the portfolio he recommends is ... much to hairy for me.

He's replaced the ballast in a portfolio with more stocks and emerging-market debt. No thanks.

The outlook for U.S bonds may be questionable, but, historically, a fierce bear market in bonds is a single-digit annual loss.

Compare that to stocks and EM debt?
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Old 11-26-2013, 02:07 PM   #22
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Malkiel (and everybody else including yours truly) is basically telling investors that the 30 year bond party is over and to push your equity risk tolerance to the max.

I like to follow two rules of thumb regarding asset allocation. In a normal market, where good quality intermediate bonds can deliver a 2% real return, we are "moderate" investors.

Rule 1: A conservative investor should have his age in fixed income. Moderate investor age-10. Aggressive investor age -20. Since all good quality short to intermediate fixed income is so expensive, I allow our port to go from moderate to aggressive.

Rule 2: Fixed income allocation = annual SWR X 10. E.g. SWR = 3% FI = 30% etc.

Our port: 65% equities + 35% FI. Age = 56. Gross AWR = 3.50%. TER = 0.76%. Term = 39 years.
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Old 11-26-2013, 02:20 PM   #23
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Malkiel (and everybody else including yours truly) is basically telling investors that the 30 year bond party is over and to push your equity risk tolerance to the max.

I like to follow two rules of thumb regarding asset allocation. In a normal market, where good quality intermediate bonds can deliver a 2% real return, we are "moderate" investors.

Rule 1: A conservative investor should have his age in fixed income. Moderate investor age-10. Aggressive investor age -20. Since all good quality short to intermediate fixed income is so expensive, I allow our port to go from moderate to aggressive.

Rule 2: Fixed income allocation = annual SWR X 10. E.g. SWR = 3% FI = 3% ext.

Our port: 65% equities + 35% FI. Age = 56. Gross AWR = 3.50%. TER = 0.76%. Term = 39 years.
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.
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Old 11-26-2013, 02:24 PM   #24
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Of course higher stock allocation (historically) provides a greater return, but risk increases as well...would be nice for folks recommending bond fund alternatives acknowledge risk too.

Though bond funds seem unlikely to provide a real return in the mid/long term ahead of us, stocks are still subject to more volatility - even high quality dividend growth stocks.
(Bold added). I think it is generally a mistake to use "risk" and "volatility" interchangeably (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 we kind should care about) than a portfolio of 80% bonds.
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Old 11-26-2013, 02:29 PM   #25
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(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.
That's the thing. Cash has "risk" too -- the risk of inflation and after-tax returns not keeping up with inflation (let alone growing).

Volatility breeds risk, but not all risks create volatility.
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Old 11-26-2013, 02:57 PM   #26
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(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.
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Old 11-26-2013, 02:57 PM   #27
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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.

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Originally Posted by pb4uski View Post
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.
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Old 11-26-2013, 02:58 PM   #28
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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.
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Old 11-26-2013, 03:28 PM   #29
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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/bu...kets.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.
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Old 11-26-2013, 03:56 PM   #30
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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.
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Old 11-26-2013, 04:15 PM   #31
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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
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Old 11-26-2013, 04:19 PM   #32
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Originally Posted by daylatedollarshort View Post
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.
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Old 11-26-2013, 04:25 PM   #33
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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).
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Old 11-26-2013, 04:33 PM   #34
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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
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Old 11-26-2013, 04:47 PM   #35
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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.
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Old 11-26-2013, 05:03 PM   #36
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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.
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Old 11-26-2013, 05:13 PM   #37
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...
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.
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Old 11-26-2013, 05:22 PM   #38
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REITs were killed this year. I think they are even more interest-rate-scare sensitive than bonds!
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Old 11-26-2013, 05:35 PM   #39
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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.
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Old 11-26-2013, 05:57 PM   #40
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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.
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