Life Lessons about Investing and Risk

[chinaco]

I am at an age where retirement is an open discussion with certain co-workers I have known for years.

Several of them have been talking about it for a long time. ER to them will be at the earliest 62.

I noticed a couple of major mistakes some of these people made and I will share them... just in the hope that others learn from the errors.

1. Doing mental accounting and not checking out the facts. - Fortunately these people have pensions. Unfortunately they used the example calculation and were assuming it would be slightly more money. The same with certain benefits they were relying on... they cost more.
2. This is the biggest mistake. They stayed 100% in the stock market (no bonds). In certain cases had too much concentration in company stock which in one case has not recovered since the boom in the tech bubble (off significantly).

These two error have cause several to delay their retirement. I told them about holding bonds 10 years ago... and being too concentrated in a company's stock but they did not heed the warning.

The market cycle has disrupted their plans.

Still they are better off than most boomers because they do have pensions. But it does not cover their spending levels.


The odd part is while they have recognized mistake no. 1 (since they sharpened the planning pencil)... They still do not accept that bonds (fixed securities) make sense. They think the stock market will bail them out. Bonds are not considered. Even if the stock market repaired their portfolio... they would probably stay 100% equity... The reason it does not make sense.... the way they describe their situation... they want to lock-in their lifestyle (certainty of income as opposed to growing assets) , but yet they risk it...


I believe many people struggle with the transition from accumulation to decumulation. They think the market will fix their past mistakes... instead they are likely to repeat their past mistakes.

 

[traineeinvestor]

I'll treat this as a confessional and admit to having being blind and wrong about bonds - on a regular basis and having far less invested in them than I should. Fortunately, the other asset classes I invested in did fairly well and I got very lucky with some market timing so it has not done me any real harm....so far.

Unfortunately, I am finding it very hard to persuade myself to invest in bonds now with interest rates so low (sometimes below the yield on equities). I also have a problem in that the very low cost index funds like Vanguard are either not available to me or have a tax cost attached to them - individual bonds are probably a better option than a bond fund at this point.

I am still in the accumulation stage but do recognise that once I FIRE I should worry more about preserving the real value of my nest egg and reducing risk than about maximising returns.

 

[Pete]

I'm no bond expert, but it seems they also have a risk. Bonds are IOU's. I live in California and used to invest a lot in munis here for example. I started wondering, what if we all wanted our bond money back at once. I realized all that money has been spent. Calif. is like a person that has maxed out its credit card and is simply taxing us and paying the minimum payment (interest). Well, the tax base is drying up and the state has gone into deep debt, selling more bonds to pay the interest. Debt upon debt. Default is a real possibility, and there are no guarantees you'll get your money back. Like the wall street brokerages who were worth billions at night, and pennys the next morning. I would be very selective about who I give my money.

 

[NW Landlady]

OP - ITA, know a lot of Peeps who either can't retire because had a large % of savings in stocks, or have retired & now significantly reduced their annual budget because of stock poor performance.

But who can blame them? All their lives they have been told stocks perform 10% return consistently, historically...so Peeps relied on this. I'm not sure if this is driven by Greed or just Expectations promoted by Wall Street & the Like.

Pete -- while not sure, but OP may be referring to Bond Funds/Etfs, etc. you are absolutely correct, there is some risk if you buy individual Munis & research is necessary. I buy them only after research and guidelines. These are just my one personal rules & not to be construed as anything more.

1. It is my understanding that despite municipalities going under/bond default during the DEPRESSION, just about all of the GO bonds were paid in full after the DEPRESSION. GO bonds holders did not lose $$, just some time in getting it back on defaulted GO bonds.

2. I never buy them in CA, FL and other areas in really bad financial status (like Detroit).

3. Always check Bond rating -- including the "underlying rating" because many bond insurers are questionable. Rating should be AA or better in most cases.

4. Avoid bonds from small towns/jurisdictions. Look for good/strong population base with good per capita annual income levels (check wikipedia). Check the news/internet to make sure no current scandals/fraud/etc in local govt activities.

5. Primarily purchase GO bonds or Revenue Bonds for Critical services like Sewer & water. Never buy Revenue Bonds for special projects.

6. Monitor Bond Ratings on Bonds you Hold. Most Brokers have systems that keep you advised of changes in Ratings.

Right now I am getting 4.5% apprx on the AAA munis, but since this is Tax Free Income, it equates to over 6% return if it was a taxable income in my case.

 

[Nords]

Maybe this could be broadened as:
2. Lack of diversification.
3. Insufficient savings?

100% equities has been bad for the last decade if that's interpreted to mean "100% S&P500", but other portions of the equities markets have done better.

I can understand why they wouldn't care for bonds either, but perhaps they could have stayed with TIPS or I bonds. That still doesn't excuse them from looking at real estate (rentals or REITs) and other classes of equities.

I think anyone receiving a pension has to look at it as a bond-related asset. It may be the equivalent of TIPS, Treasuries, munis, or commercial junk-- but it's a stream of cash largely based on a bond portfolio.

 

[jazz4cash]

I am in a very similar position to OP's co-workers, but hopefully I have avoided making critical mistakes.

It seems that nowdays I see many folks that describe thier asset allocation in terms of stocks and bonds only with no reference to cash. I usually think in terms of stocks/bonds/cash even if the cash allocation is tiny or even zero. I am currently reducing equity allocation a minimum of 2%/year, but with interest rates so low, it forces me to consider bond alternatives like higher yielding equities or CD's and I've done some of each.

My other technique is to knock 15-20% off the retirement income estimates I receive which is a crude method, but I'm too far off to get very precise anyway.

 

[Meadbh]

Chinaco, your colleagues may not be all that much out to lunch. As previously mentioned, their pensions can be considered as their bond allocation. I suggest they read Milevsky's book "Are you a stock or a bond?".

Welcome to the Individual Finance and Insurance Decisions Centre online...

 

[FIREd]

I think many people take great risks with their money later in life because they realize they didn't save enough in the first place to enjoy the kind of retirement they envision.

My in-laws are a great example of that. In their 50's, they realized they didn't have enough. So they started speculating aggressively with their retirement money, looking for that ever-elusive silver bullet that would solve all their problems. It actually made the situation worse.

At age 65, MIL had close to 100% of her meager savings in international stocks. She had doubled her money in 4 years, which was a great achievement, but she expected the party to go on forever. In 2007, I convinced her to divest some of her investments into bonds. She reluctantly did so. She described herself as a "conservative" investor: she wanted her money to grow as much as possible, yet she was allergic to any loss of principal (she didn't have much saved for retirement and couldn't afford to lose any of it). Her pre-2007 portfolio did not reflect her risk profile at all. I don't think she understood that risk is a double-edged sword. She focused too much on return on her money and not enough on return of her money.

But I think it's easy to become complacent after a few boom years like 2003-2007. I know I am not immune to that.

 

[Onward]

a lot of Peeps who either can't retire because had a large % of savings in stocks, or have retired & now significantly reduced their annual budget because of stock poor performance.

The vast majority of "broken retirement dreams," among people I know, are due to crashed real estate, not to stocks.

 

[ksr]

I'll add to this that a lot of people who are nearing retirement age are oblivious to the concept of safe withdrawal rates, too. A friend of mine who is a very bright, astute person suggested to me recently that if she had enough assets so she could live on the (presumed) 10% return each year, she'd be set. I reminded her that not only can you not count on such an aggressive average return, but you can't spend it all. I mentioned the 4% SWR that we often read about, and the concerns for inflation. She was pretty receptive to what I was saying, but it seemed like the first time she'd heard any of this.

 

[yakers]

There may be a bad stretch for bonds going forward. DW has bonds in he VG Wellesley & Star funds and we are not changing anything there but I have reduced my total bond fund holding in favor of a stable value fund (TSP G Fund). Diversification is important even though things seem to have gone down together in the last downturn, but I would not want to be the advisor telling people to dump equities for bonds right now.

 

[traineeinvestor]

I'll add to this that a lot of people who are nearing retirement age are oblivious to the concept of safe withdrawal rates, too.

+1

When I started planning for my early retirement a few years ago, I was not familiar with the concept of SWRs. It's only when I started asking how much I need to ensure that I won't outlive my money and will not have to downgrade my desired standard of living that I started educating myself on this issue (and a few others).

 

[kumquat]

While I hold [-]a few [/-] very few bonds, I wouldn't recommend them to anyone today. The "bond" portion of my holdings are in "cash" or "near cash".

Stocks have their risks. We all know what they are.

Bonds also have their risks. We all know that rising interest rates or inflation greater than the bond's interest rate will devastate a bond portfolio. Hopefully, most of us know that:
1) interest rates are near zero (at least the lowest since the 'great depression')
2) government debt (and possibly the printing presses) may promote inflation in the years to come.

If you have an appropriate (to you) allocation of bonds, a small increase due to re balancing probably won't hurt you. If you are near 100% stocks, I'd question moving into a significant bond holding while cash is an option.

 

[Nords]

If you are near 100% stocks, I'd question moving into a significant bond holding while cash is an option.

I've been waiting for years for Bernstein to do his efficient-frontier analysis of portfolios consisting of varying degrees of equities/cash.

I guess TIPS and I bonds have made that a moot analysis.

 

[kumquat]

I think, in this case, I'm being a DMT. YMMV.

WADR, what's an "I bond"?

 

[chinaco]

Maybe this could be broadened as:
2. Lack of diversification.
3. Insufficient savings?


...

This is it .... and rebalancing. Even people just invested in the S&P 500 and a Bond index made money of they rebalanced.

A plain middling 60/40 balanced fund would have done OK.

In the case of these people, they saved diligently... but their portfolios were cut in half.


I have made many investment mistakes myself in spite of knowing better... usually by getting greedy and letting stock investments ride too long before rebalancing or buying into a run up late in the bull cycle.

I feel sorry for these people... their plans were derailed.

But one cannot pick up any source of information about investing for retirement (and I mean any!) and not read about a diversified portfolio of stocks and bonds that lightens up on the stocks as they age and approach retirement.

The only thing I can figure is they thought they would beat the stock market somehow.... but, ironically, the only way to beat the stock market is to pull money out of it....

IMO - The basic system of using a diversified portfolio of stocks and bonds rebalanced based on triggers or time is the best approach for most small investors. It is more likely to result in gains over time and help preserve capital (somewhat) in bad times.

 

[chris2008]

My most valuable lesson I have learned during my training in a bank more than 30 years ago.
It was the gold boom of 1977 to 1979. Colleagues and myself were young, had saved a bit saw the price rising from day to day, could buy with almost 0 commission.
So finally I thought why not? and invested a nice part of what I had saved for university, to start in autumn 1979.
I bought Kruger Rand, at that time still without VAT.
While I did not care too much for the actual prices in the next months some day the lady from the gold sales counter asked me if I had noticed my nice profit.
Indeed the price had boomed.
From that day on I could hardly sleep. Should I hold or sell? Now or later? What if...I knew I would need the money for university within some months....
Finally after 2 weeks I decided to sell all the coins.
It turned out that I almost hit the peak. So all went well.

But from that day on I knew about my limited risk tolerance and have learned that "You should not speculate with money you are sure to need for something else!"

Today DH and myself have defined a certain % of our savings to be in the stock market and another % to be in secured bonds or money market instruments.
We are rather conservative and know that all chances are attached to some risk.
I am aware that if my country or its major banks went bancrupt or the stock market got even more crazy than in the past one side would certainly have negative influence on the other. All instruments are connected in some ways.

But with our basic allocation scheme (and some other ones) so far we could sleep well at night even in the crazy markets of the last decade.

 

[brewer12345]

I will toss out three items, once of which I have fully licked, another I am part of the way there, and a third I am still struggling with:

- excess concern about tax implications: there are a lot of investors who spent more time worrying about avoiding cap gains taxes than making a return. After I lost a couple of small sums waiting for ST gains to go LT, I now sell when it is time to sell, taxes be damned.

- risk tolerance shifts over time: I went into the recent downturn investing as if I was still 26, not a decade older with kids, a mortgage and a volatile employer. It all worked out in the end due to my belt and suspenders approach to emergency cash and some luck, but I have had to become more disciplined and push back on my gunslinging impulses on a regular basis. This is still a work in progress ("hello, my name is brewer and I am a riskaholic"), but I am getting there.

- excess concentrations: I think this is a common bad habit of stockpickers. I have developed two outsized positions due to appreciation of stuff I bought at the bottom. I cannot quite bring myself to sell off just yet, but I know this is a problem and I will be addressing it in the medium term.

 

[kyounge1956]

I think, in this case, I'm being a DMT. YMMV.

WADR, what's an "I bond"?

It's a U.S. Savings Bond, Series I, which has an inflation-adjustment feature.

 

[Nords]

It's a U.S. Savings Bond, Series I, which has an inflation-adjustment feature.

I think Kumquat's question was actually a cynical sarcastic commentary (rightfully so) on the fact that I bonds are sold in limited quantities and are no longer offering the high base rates of a decade ago...

We held a few in our kid's college fund as education bonds, but they'll be phased out in another semester or two.

 

[dbr]

Have people noticed that if you look at FireCalc a 100% stock allocation at a reasonable withdrawal rate of around and under 4% is "safe"? The analysis shows that an investor who does not panic and sell stocks after a crash can certainly survive a retirement at 100% equities even with crashes along the path.

An investor who is 100% bonds cannot survive a retiremement at 4% WR with high likelihood of success. TIPS allocations and annuitization can change that equation.

Just asking.

 

[REWahoo]

Have people noticed that if you look at FireCalc a 100% stock allocation at a reasonable withdrawal rate of around and under 4% is "safe"? The analysis shows that an investor who does not panic and sell stocks after a crash can certainly survive a retirement at 100% equities even with crashes along the path.

An investor who is 100% bonds cannot survive a retiremement at 4% WR with high likelihood of success. TIPS allocations and annuitization can change that equation.

Just asking.

Yep, that's historically true. The future may or may not be different.

But even so, it's that "does not panic" thing that will get ya.

 

[Meadbh]

It's a U.S. Savings Bond, Series I, which has an inflation-adjustment feature.

Note to kumquat: Canadian equivalent = Real Return Bond (RRB).

Real Return Bonds

 

[haha]

The analysis shows that an investor who does not panic and sell stocks after a crash can certainly survive a retirement at 100% equities even with crashes along the path.

I can walk along a girder placed on the ground. Would I be able to walk along a girder 500 feet up in the air? One more area where theory often diverges from reality.

Ha

 

[chinaco]

Have people noticed that if you look at FireCalc a 100% stock allocation at a reasonable withdrawal rate of around and under 4% is "safe"? The analysis shows that an investor who does not panic and sell stocks after a crash can certainly survive a retirement at 100% equities even with crashes along the path.

An investor who is 100% bonds cannot survive a retiremement at 4% WR with high likelihood of success. TIPS allocations and annuitization can change that equation.

Just asking.

You said it... analysis, but there is a level of uncertainty.

Survive vs increasing the probability of maintaining a certain lifestyle.

Besides... the post was not suggesting 100% fixed.

I don't think anyone is counting the US stock market out in this thread... it is about managing risk. Why manage the risk? Because the impact to one's lifestyle could be significant.

Why do we FIRE oriented investors invest in securities?? To look at a statement and count our money, or to marvel at how much it grown? And conversely shriek in horror when the valuation is halfed?

I don't think so... I believe most FIRE oriented investors have a goal to build wealth and eventually use it to maintain a lifestyle with some level of confidence.


The mechanics of rebalancing between stocks into bonds and back again between bull and bear markets helps to achieve that during accumulation and decumulation.