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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-19-2004, 10:36 PM   #41
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Re: Safe Withdrawals of up to 6% per year? Part 1

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The "total market" is dominated by large cap growth stocks.
There's a reason for that. Large caps are large caps because that's the way "market experts" have allocated their capital. To overweight small caps is betting that you are smarter than the market -- it's really as simple as that.

I don't recall Bernstein ever discussing the Efficient Market Hypothesis, but it's pretty well accepted, and the whole slice and dice approach he espouses goes against EMH.

Not that there's anything wrong with that. I don't believe the market is all that smart either
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-20-2004, 05:25 PM   #42
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Re: Safe Withdrawals of up to 6% per year? Part 1

Wab, the "lumpers" and "splitters" have been
at odds on this since day 1. According to the
experts, most of the heavy lifting is done when
you decide on your stock/bond/cash allocation.
Over the long term, both approaches will have
close to the same compound annual return.

Over shorter durations, the "splitter" approach
avoids having most of your eggs in the large
cap growth sector, which can be out of favor
for several years at a time. Of course you miss
part of the big returns when large cap growth
is in the driver seat. On balance, equally
weighting the 4 corners plus REIT and International
just seems safer to me .......... and at age 70, my
horizon is a lot shorter than most of the great
unwashed who may read this.

Cheers,

Charlie
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-20-2004, 06:11 PM   #43
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Re: Safe Withdrawals of up to 6% per year? Part 1

Charlie, I'm not saying one camp is wrong and the other is right. * *I'm just trying to point out some fundamental philosophical underpinnings of the two approaches that most people miss.

Assuming "lumper" means somebody who buys the world market using cap-weighted indices that match the way the world allocates capital, then a lumper is simply following the market and betting that the net effect of all investors is to create an efficient market with the proper capital allocation. * *This is a very simple approach, and it doesn't require any rebalancing if you maintain a representitive sample of the market in your portfolio. * *It also leverages the efficiencies inherent in the world markets (including US, of course).

"Splitters" are betting that historical correlations between "asset classes" are what matter. * They disregard how the experts of the world have allocated their capital, and they pick a fairly arbitrary allocation based on voodoo and occassionally MVO tools.

Both groups are probably working under false assumptions, but I think the splitters have a tougher time justifying their allocations than the lumpers.

Consider this analogy (reductio ad absurdum):

A stock market only has two companies: GEE and LEM. * GEE is a $100,000,000 cap company (large cap), and LEM is a $100 cap lemonaide stand (small cap).

Two investors each have $1M to allocate. * The lumper will allocate $1 to the lemonaide stand, and $999K+ to GEE.

The splitter will invest $500K in each.

Which investor is more rational?
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-21-2004, 06:06 AM   #44
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Re: Safe Withdrawals of up to 6% per year? Part 1

Well, we all know that the "market" can go crazy
sometimes ....... take the late 90's for example.

"Splitters" mitigate that risk, somewhat, IMHO.

Cheers,

Charlie
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-21-2004, 07:11 AM   #45
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Re: Safe Withdrawals of up to 6% per year? Part 1

Heh,heh,heh

Also balanced index -to the extent they leave well enough alone and let the computers rebalance automatically in rising and falling markets.
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-21-2004, 10:25 AM   #46
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Re: Safe Withdrawals of up to 6% per year? Part 1

A question on the "world portfolio" though is how far do you follow the world division of investment dollars? It's not all in equities but is partially tied up in bonds, real estate, etc. Do you divide your portfolio totally as the market has?
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-21-2004, 11:05 AM   #47
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Re: Safe Withdrawals of up to 6% per year? Part 1

I don't think EMH can help you much with allocation across asset classes (and I don't consider the arbitrary lines drawn between small/mid/large/value/growth stocks to define distinct asset classes).

I'm not even sure data is available that would tell you how the world's investors allocate between stocks, bonds, real estate, metals, etc. Stocks are the only class that is held pretty much exclusively for investment. Metals and real estate are skewed by their utility value. And bonds are held for all sorts of weird reasons -- everything from governments trying to control the strength of their currency to giant mortgage companies hedging their loans.

I use bonds to dampen portfolio volatility and provide guaranteed income, so I tune my allocation to suit my needs (and volatility fears).

I use real assets to ensure that I'm always holding something that will continue to have fungibility in the face of just about any economic storm. So, I adjust my allocation based on my worst-case predictions for other assets.

I guess I take some solace in the lack of historical covariance among these assets too, but I don't really use that to help with allocation decisions.
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-21-2004, 11:46 AM   #48
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Re: Safe Withdrawals of up to 6% per year? Part 1

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A question on the "world portfolio" though is how far do you follow the world division of investment dollars? *It's not all in equities but is partially tied up in bonds, real estate, etc. *Do you divide your portfolio totally as the market has?
I like the idea Sharpe hits upon - you've got to start somewhere - and he proposes that it makes sense to start with a world portfolio as a basis. In other words, start with the concept of world cap-weighted portfolio and then start chipping away and making changes to fits one's needs. That makes sense to me. Why start with a cap-weighted world portfolio as a basis? Because any time I stray from the market as a whole I'm engaging in a zero sum game - for every winner there will be a loser relative to the entire market - I'm placing "bets". So every diversion should be made for a good reason. I'm still struggling with my own allocation. My total market approach has prevailed - but I may make a couple of side bets:

1. I'm sticking with my home bias because my risk tolerance just won't handle ~60% international.
2. I may tilt toward value stocks because I prefer the higher income, and I'm inclined to think value may provide a higher return going forward.
3. A dose of REITs makes sense to me.

But my bets will be relatively small. And I'm talking about stocks only - I look at bonds entirely differently for many of the reasons Wab mentions above. When it comes to bonds, I'll buy whatever I believe will provide a reasonably safe income stream, and a cash flow that fits my needs.
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-21-2004, 01:50 PM   #49
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Re: Safe Withdrawals of up to 6% per year? Part 1

Quote:
Consider this analogy (reductio ad absurdum):

A stock market only has two companies: GEE and LEM. * GEE is a $100,000,000 cap company (large cap), and LEM is a $100 cap lemonaide stand (small cap).

Two investors each have $1M to allocate. * The lumper will allocate $1 to the lemonaide stand, and $999K+ to GEE.

The splitter will invest $500K in each.

Which investor is more rational?
Wab,
Interesting thought experiment, but two points I'd add to counter (I am a splitter, btw).
a) you only work with real asset classes that have meaningful long term track records. (Your lemonade stand won't qualify!). Small Cap in most of these definitions, (e.g. DFA's) is the bottome 10 or 20% of NYSE stocks. These are what any one of us would recognize as massive, successful companies.

The other point is that Small Cap Value have trounced everything over the last 75 years -- people don't want to hold things that are undervalued (down on their luck?) or small, so these companies are underpriced, as an asset class. (They fix their problems and grow, which makes their prices go up eventually).

DFA's data book shows long term rates (1927-2002) at 14.2% vs 9.4% for Large Cap Growth over the same period, or 10.2 for the S&P 500.

Slicers get access to these less-correlated asset classes with less volatility of the SP500. (The less correlated asset classes being included tends to damp volatility - Modern Portfolio Theory).

We had a thread six months ago or so that talked about how the SP500 is actually a huge hype and is not the index that we want to follow -- it has huge concentration in its megacap stocks -- as I recall, 35% of the index was tied up in just 15 or so stocks, and the smallest 150 stocks made up a few percent of the index.

Not anyone's idea of diversification -- rather something that has been sold to us imho!

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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-21-2004, 03:41 PM   #50
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Re: Safe Withdrawals of up to 6% per year? Part 1

Bob, all I'm saying is that if you believe the markets are efficient, then investors have already considered all available information -- including the historical data you and I have seen -- and they have made their bets. The result is the market cap of each company in the stock market. Everybody is free to allocate anyway they want to, but overweighting in small/value is essentially a bet against market efficiency and an implicit statement that you're smarter than the market.

Now, what if I told you that over the last 75 years, companies whose names began with the letter "M" have outperformed the market as a whole and with less volatility to boot.

I've heard all of the rationalizations for why small/value (for a given arbitrary definition of the class) outperforms the market. But I'm not sure the predictive value of that historical data is any better than the "M" company data-mining, but who knows....
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Re: Safe Withdrawals of up to 6% per year? Part 1
Old 11-21-2004, 06:40 PM   #51
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Re: Safe Withdrawals of up to 6% per year? Part 1

Wab,
I take your point about market cap being "The Market" but the Splitter approach is looking for a way to dampen volatility (for a given return) or increase yield (for a given volatility) by being in minimally-correlated asset classes. *The theory is that a balanced blend of these assets will in fact be the optimum allocation.

Now to quibble with the cap-weighted 'Lumper's' premise a bit more: *We've moved our definition of "The Market" from a purely US-based stocks and bonds to an international one -- that is good. *But if we are really trying to own "All Assets in the proportion of their value" then we'd need to go a lot further than publicly traded stocks and bonds (although perhaps not all the way to the lemonade stand!).

In this way, we would pick up the vast amount of value in real esate, private companies, commodities, precious metals and so forth.

When we do this, we'd be well on our way to the Coffee-House or Bernstein "Gap" portfolios, though the equity proportions of those portfolios might still be overweighted to small and value.

So your point about overweighting Small and Value as being a bet that we are 'smarter than the market' is right on target -- at this point, I am going on the basis of the Portfolio Optimizer studies which show how these portfolios have behaved over time -- the virtues of their low correlations -- and that has given me the confidence to deviate from pure market weights. *The optimizer studies are based on the long run behaviors of the asset classes interacting in a portfolio, and that an asset class is not always represented by a common cap-weight index, nor is the final mix necessarily the cap-weight of the traded securities market.

I'm comfortable with it; it makes sense to me, but as you point out it is different from the Lumper's Efficient Market Theory approach of following the standard cap-weighted indexes. Thus this should serve as a warning label to any Splitters: *the implications need to be understood and accepted before one should become a 'splitter'. *

ESRBob
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