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What does reducing/eliminating 'uncertainty' cost?
Old 01-18-2013, 09:46 AM   #1
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What does reducing/eliminating 'uncertainty' cost?

While staying out of equities certainly reduces volatility/risk and that 'uncertainty' - at what cost? Some members choose to invest entirely in munis, CDs and other non-equity asset classes which is fine. But to tacitly suggest that's likely to provide the same or better results as a traditional equity/bond portfolio is 'unprecedented' in the US since 1871.

But let's say the US (or worse) is doomed and equities are just too risky. For those who take this approach, how about quantifying what it actually means in $ to build a portfolio that relies entirely on non-equity assets, so other members can fully evaluate that option?

I don't claim to know what the full costs are, but presumably folks who take that approach would have a better handle on it since they've chosen that path. With nothing better as a basis I used FIRECALC and solved for a 95% success rate over 30 years yields and using $1M as the baseline for a FIRECALC default 75% equity portfolio (and BTW, that's retiring at 65, not even early retirement). Again, the first line is simply to show the results for the presumed discredited 75%/25% portfolio of the past.

HoldingsNest Egg RequiredWR@95% success
75% equity / 25% bonds$1,000,0004%
100% bonds$1,410,0002.8%
50% US LT Treas / 50% LT Corp Bond$1,624,0002.45%

If either of these are in the ballpark, avoiding stocks means you'll have to work 40-60% longer or spend 40-60% less in retirement, or some combination. At current yields, much worse than historical averages, presumably it would be even more difficult.

I hope someone will come along and improve on my crude estimate regarding the cost of reducing/eliminating uncertainty.
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Old 01-18-2013, 09:50 AM   #2
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The best solution is to be doctor in a high paying field, have very small expenses and save like crazy. Then all CDs make perfect sense.
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Old 01-18-2013, 09:54 AM   #3
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Then all CDs make perfect sense.
Provided...

1. You have a boatload of CD's, maybe even a supertanker full.
2. The inflation gods smile upon you or you don't live very long.
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Old 01-18-2013, 10:13 AM   #4
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I've said it before, but rental income is a nice thing to have. Combine it with a 50/50 portfolio and you've got most bases covered. I currently get $15k a year from a rental and if I need capital I can always sell
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Old 01-18-2013, 01:37 PM   #5
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Midpack, you have a lot of time on your hands and are really into this stuff, don't/aren't you?
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Old 01-18-2013, 04:45 PM   #6
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I'm thinking with all the gloomy posts in other threads I might have to give up my own pessimism and reinvest all the cash I have raised (per investing plan). The big bull market is coming...
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Old 01-18-2013, 05:22 PM   #7
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While staying out of equities certainly reduces volatility/risk and that 'uncertainty' - at what cost?

I hope someone will come along and improve on my crude estimate regarding the cost of reducing/eliminating uncertainty.
I used to say the the best way to eliminate investment uncertainty was to buy a TIPS ladder. You don't need to worry about defaults, market prices, or inflation.

And, TIPS used to be issued with coupons around 2.5%. So, somebody planning on a 40 year retirement could withdraw an inflation adjusted 4% per year for all 40 years.

That means the "cost" of owning TIPs is borne by the heirs (if any), not by the retiree. It would be the difference between the potential portfolios of stocks/bonds vs. TIPS on the date of death.

Of course, coupons have dropped remarkably. Laddered TIPS would probably average 0.25% or similar today, so that brings the SWR down to 2.6% or so.

Worse, we've seen there's political risk with gov't bonds. Based on what I read, the possibility of default > 0. I never believed that was a possibility. [edit - removed comment on politicians]


Another approach is to buy a CPI-adjusted SPIA. In that case, the insurance company buys the TIPS for the retirees, but takes away the longevity risk, so the payout should be higher than they would get with a TIPS ladder. At one time, people could have hit a 4% return on the entire portfolio by only spending 85% or so of the portfolio, leaving the 15% to accumulate. The "cost" again would be borne by the heirs.

But, again, the low current coupon rates may have driven CPI-adjusted SPIAs out of the market.
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Old 01-18-2013, 05:39 PM   #8
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My philosophy has been to stay aggressive until I am too old to work anymore. It my egg get's large enough or my body get's too old, that would be the time to start moving away from stocks. Most importantly, don't get scared out of the market when it tanks. Instead take some profits at the top.
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Old 01-18-2013, 05:39 PM   #9
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Originally Posted by Midpack View Post
HoldingsNest Egg RequiredWR@95% success
75% equity / 25% bonds$1,000,0004%
100% bonds$1,410,0002.8%
50% US LT Treas / 50% LT Corp Bond$1,624,0002.45%

If either of these are in the ballpark, avoiding stocks means you'll have to work 40-60% longer or spend 40-60% less in retirement, or some combination. At current yields, much worse than historical averages, presumably it would be even more difficult.

I hope someone will come along and improve on my crude estimate regarding the cost of reducing/eliminating uncertainty.
I've made the same point numerous times, using FIRECALC results, in reply to people who say they consider stocks too 'risky' for their retirement portfolio. I don't know of any better way to express it either.

Some of them understand, and are fine with having to have a bigger portfolio or lower spending, so that's fine if that's the path they choose. Well, it's fine either way, it's their choice, I just think it should be an informed one. But then, with a larger portfolio, the volatility of stocks isn't a big deal either. As has been said before, more money is always better .

Some posters don't like the semantics - since traditionally 'risk' and volatility are used interchangeably in the finance world. But in the context of 'risk' to your retirement portfolio, I think the risk of running out of money is the meaningful one. A hypothetical 5% inflation adjusted WR on a 0% real return investment would provide a straight-line drop in 20 years - and a maximum 5% swing, but it sure is 'risky' if you anticipate a 35 year retirement!

Anyhow, a few people with credentials seem to agree with that distinction (some comments by W Buffett further down):

Risk is Not The Same as Volatility - Volatility risk

Quote:
Risk is Not The Same as Volatility By Michael Keppler

If you ask investors what risk they assume when buying stocks, they likely will respond, “Losing money.” Modern portfolio theorists do not, however, define risk as a likelihood of loss, but as volatility, which is determined using statistical measures of variance such as standard deviation and beta. While standard deviation is a measure of absolute volatility that shows how much an investment’s return varies from its average return over time, beta is a measure of relative volatility that indicates the price variance of an investment compared to the market as a whole. The higher the standard deviation or beta, the higher the risk, according to the theory. In a rising market, however, high volatility can boost the return potential of an investment. Volatility, in other words, is essentially a double-edged sword, and does not measure what an investor intuitively perceives as risk.

Suppose the price of a stock goes up 10 percent in one month, 5 percent the next, and 15 percent in the third month. The standard deviation would be five with a return of 32.8 percent. Compare this to a stock that declines 15 percent three months in a row. The standard deviation would be zero with a loss of 38.6 percent. An investor holding the falling stock might find solace knowing that the loss was incurred completely “risk-free.”
-ERD50
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Old 01-18-2013, 05:54 PM   #10
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Provided...
2. The inflation gods smile upon you or you don't live very long.
THIS!!!! If you are invested a large portion in bonds, you better pray that the Central Bank overlords don't evaporate your wealth through inflation (theft).
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Old 01-18-2013, 05:54 PM   #11
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Midpack,
I agree with your points and think it's important to raise the issue. But everyone can make their own choice. It is some comfort to remember that every CD investor is providing capital that companies will use to increase their profits, dividends, and share prices. So, CD investors help stock investors.
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Old 01-18-2013, 06:20 PM   #12
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Thank you for validating some of the reasoning I have been trying to explain in this forum for the last year or two. CDs do make sense in some specific situations.
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The best solution is to be doctor in a high paying field, have very small expenses and save like crazy. Then all CDs make perfect sense.
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Old 01-19-2013, 05:12 PM   #13
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I'm thinking with all the gloomy posts in other threads I might have to give up my own pessimism and reinvest all the cash I have raised (per investing plan). The big bull market is coming...
Just what I was thinking. Time to buy!
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Old 01-19-2013, 06:21 PM   #14
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I wouldn't want to be up at night worrying about my investments.

If I had 100% in equities, I wouldn't be able to sleep. Nor would I with 100% in cash.

I allocate to my sleeping point.
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Old 01-19-2013, 07:31 PM   #15
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My investments and rental income are to bridge the ER to age 66 gap and then to provide an insurance policy against the failure of both US and UK SS systems as my current plan is to have them cover my expenses post 66. In fact recent UK SS reform means that my UK state pension will be 35% higher than I had anticipated. I reduce the uncertainty of me being able to fund retirement by paying for as much as I can while I'm working, so pay off the mortgage, buy a new car, and get your dental work done before you retire.
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Old 01-19-2013, 09:15 PM   #16
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I wouldn't want to be up at night worrying about my investments.

If I had 100% in equities, I wouldn't be able to sleep. Nor would I with 100% in cash.
That's how I feel too...especially after the last crash.
Even the traders on CNBC are leary of the mkt now. A lot are warning to buy protection in case another correction comes.

I have 70% in total return, 20% in Stable Value and 10% in EM debt.
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Old 01-19-2013, 09:25 PM   #17
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Avoiding stocks means you'll have to work 40-60% longer or spend 40-60% less in retirement, or some combination. At current yields, much worse than historical averages, presumably it would be even more difficult.
Yep, that's pretty much how I've always looked at the issue, although I thought it took only about 33% more to go all (high quality) bonds - for 30 years. Hmmm, I guess that was back when TIPs were yielding more - not in our current era of "financial repression".
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Old 01-19-2013, 09:27 PM   #18
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That's how I feel too...especially after the last crash.
Even the traders on CNBC are leary of the mkt now. A lot are warning to buy protection in case another correction comes.
I always feel so much better when the financial talking heads are leary, worried, or downright depressed.
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Old 01-19-2013, 09:41 PM   #19
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We need a name for this paradox:

To live off of super "safe", i.e. low volatility assets, one needs a pretty big nest egg.

Yet, if one has a pretty big nest egg, then the higher volatility associated with riskier, higher return assets doesn't seem quite so scary.

If someone has a small nest egg, they may loath to take on "risk" and seek safety, even though it increases their chances of running out of money in the long run.

If someone has a large nest egg, they might feel like they can take on more risk, because they can "afford" to lose some and still be OK, even though they could actually get away with living off of lower volatility assets.

There may already be a name, but I have never heard it.
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Old 01-19-2013, 09:52 PM   #20
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