Thoughts on asset allocation

[Bimmerbill]

Anyone else read this:

Economist Zvi Bodie debunks standard investment advice - Sep. 16, 2009

"But mention this to Boston University School of Management professor Zvi Bodie, author of "Worry-Free Investing," and you'll get a stern reminder of how equities often betray investors. And you'll get an earful about how millions of us are taking too much risk with our nest eggs."

He is essentially saying to invest in all safe assets, like TIPS. And to increase savings rates to make retirement possible in these safe assets.

Seems like its kind of making sense to me. I've all equities, but have my small military pension that kicks in at age 60, and working on fed gov't pension.

 

[ERD50]

From the article:

Q: So you'd tell an investor to have 100% of his retirement money in TIPS?

Yes. In fact, I have 100% of my own retirement money in TIPS. I do have a small account of nonretirement funds in which I invest in bonds, options, and stocks.

Q: Currently, long-term TIPS earn just 2% after inflation. How is anyone going to be able to retire on so little growth?

From what I've seen, if you are willing to keep your withdraws to 2%, your AA won't make any difference over the 30 years (or less) that he is talking about. Heck, at 2% I don't even need (edit) *any* real growth for 30 years. I'd have 40% of my portfolio left even with 0% real growth.

-ERD50

 

[IndependentlyPoor]

And as it turns out, anytime there's been significant inflation, equities have been a terrible investment. Just look at the 1970s.

The 1970s were awful for stocks. Inflation went sky-high and stocks went sideways... for more than a decade.

Here is the S&P and inflation. S&P on the left scale, inflation on the right. Sorry about the lack of colors: spreadsheet burp.

Here is the S&P, inflation adjusted for constant dollars. The market cratered in real terms and stayed down until inflation was under control.

Here is real 20 years returns. Eventually the market recovered in real terms, but could you wait 15 years?

All data from:
http://www.econ.yale.edu/~shiller/data.htm
I'll post the speadsheet if anybody is interested.

 

[quietman]

I guess it's an interesting enough point of view, and strange enough to get him publicity. I think he misrepresents the "risk" of equity investing. Sure, stocks could be down 37% in a year, but in a diversified portfolio I have some intelligent control over what I do about it. I don't have to sell a bunch of them if I also have some other investments less affected. I can maintain a cash cushion to make me less vulnerable to random fluctuations. I can rebalance and capture some favorable fluctuations.

If anything having ALL my assets in any one thing is more risk of black swans. Of course I have no specific example (that's what makes them unexpected risks!) but suppose TIPS turn out to be vulnerable to some specific issue that isn't currently apparent. Inflation zooms up in some way that the TIPS formula misses, or politicians change the rules for TIPS and tax them horribly, or some other new instrument is invented and investors abandon TIPS and hugely depress their prices, or government default, whatever). Putting all the eggs in one basket is inherently risky - no matter how safe you think that basket is.

I can envision some kinds of annuity investment that give me guaranteed rates of return and COLA indexing. I still wouldn't put ALL my assets into it and I would expect that he wouldn't either. But somehow when wrapped in a "government" program as TIPS he's okay with it.

 

[CCdaCE]

It all comes back to need, ability and willingness to take a risk.

To me, this is comparing a black swan event to stuffing money in a mattress. "Well, because earthquakes happen in Calif., I'm never going to Calif." Doesn't make sense to be THAT risk averse, to me, but YMMV. The alternative is saving more and/or working longer. Pfft. Who wants that.

CC's wager: (A slight twist of Pascal's wager.) Contribute to a diversified, rebalanced, properly allocated portfolio in the hope that real return exists and I either have to work for a shorter time frame or contribute less. If real return doesn't exist, the hope is that my principle will at least still be in tact.

Zvi is saying that's too much hope, and it'd be safer to stick it in the mattress/TIPS/"safe" assets/etc.

-CC

 

[IndependentlyPoor]

Quietman, I agree that one should be somewhat wary of TIPS. Governments can change the rules and break their promises.

CCdeCE, I agree that it is easy to overdo it on risk aversion. However, I think it is worthwhile to keep in mind that the stock market can stink for long periods of time. Stagflation did happen, and might again. Some would say that stagflation is almost inevitable given the recent flood of money and debt. In the withdrawal stage [-]one must be[/-] I think it is a good idea to be prepared for such events, either with a tilt towards interest and dividend income or a significant cash cushion for the total return folks.

Me, I'm probably over conservative: 40/40/10/10 equities/bonds/TIPS/cash, but trying to figure out how to lower the cash allotment.

 

[Bimmerbill]

Kind of reminds me of what my parents did. All their retirement was in CDs.

I thought it was an interesting point of view and wondered if I should be more into bonds or "safer" assets.

 

[LOL!]

Bodie has this series of videos: Boston University School of Management in which he discusses his views.

All I can say is that he is a very rich professor that is still working in his 60s and will probably be still working into his 70s. When one has a lot of money, one thinks differently about investing and retirement assets.

TIPS are not going to make the average accumulator rich, so if you go Bodie's route, you will be slogging away until you become eligible for full-retirement benefits from the Social Security Administration.

 

[IndependentlyPoor]

Isn't it also true that TIPS produce an unreliable income stream? I have never purchased individual TIPS, so I have no data to go on there, but I did grab the VIPSX dividend data from Yahoo.

If you had purchased $1mil worth on TIPS in July of 2000 intending the dividends to fund your retirement, you would have had some hungry quarters. Here is the chart.

While the average annual return is a quite respectable 3.85%, the quarterly dividends are all over the map: an undesirable characteristic for a retirement income stream.

Maybe somebody who owns individual TIPS can comment.

I would be happy to post the speadsheet if anyone wants.

 

[W2R]

Isn't it also true that TIPS produce an unreliable income stream? I have never purchased individual TIPS, so I have no data to go on there, but I did grab the VIPSX dividend data from Yahoo.

If you had purchased $1mil worth on TIPS in July of 2000 intending the dividends to fund your retirement, you would have had some hungry quarters. Here is the chart.
View attachment 7368
While the average annual return is a quite respectable 4.4%, the quarterly dividends are all over the map: an undesirable characteristic for a retirement income stream.

Maybe somebody who owns individual TIPS can comment.

I would be happy to post the speadsheet if anyone wants.

I don't own TIPS but I don't see the problem. I would direct the income stream to my money market account. Every month I would remove an amount equal to the sum of the previous four quarters' yield, divided by 12. Who cares if the quarterly yield varies?

Well, unless the yearly standard deviation is high compared with the yearly average. Can't really tell from the chart.

 

[IndependentlyPoor]

Well, unless the yearly standard deviation is high compared with the yearly average. Can't really tell from the chart.

Good point.

The standard deviation is $8,132.08 or about 85% of the average.

Ouch.

 

[W2R]

Good point.

The standard deviation is $7,763.44 or about 71% of the average.

Ouch.

That would be for the quarterly yield, correct? I was asking about the standard deviation of the YEARLY yield. I would not be too concerned with getting a much higher yield each December, for example, as is the case with some mutual funds. I would deal with it as I suggested above. Come to think of it, that time series is awfully short to be getting a meaningful and stable idea of yearly variability for it so sorry, never mind! (oops) I guess you could plot a running mean with a window of four (quarters) to see how high and low a yearly mean would have gone during that time period.

 

[IndependentlyPoor]

Okey dokey,
I only have complete data for 2002 through 2009. The average annual income is $40,718.84. The std. dev. is $18.703.53 or about 46% of the average. Here is a chart of the annual dividends.

Still ouch.

In doing this I discovered that the data in my original post was incorrect. Things are worse than what I posted. I will correct it when I get a chance, but can't right now.

 

[Bimmerbill]

I think he mentions upping savings rates to 30%. I wonder how much I would have to save over the next 13-17 years to be able to swing it, without worrying about the wildly gyrating stock market.