Balance is overrated

[CaliforniaMan]

I think there might be an explanation why people here see equity risk so differently, and why some are comfortable with large equity positions and others are not comfortable with any.

Equities clearly have a large and very visible amount of volatility relative to other investments. Also, I would venture to guess that most of us here are quite risk averse. We have all worked a long time in LBYM mode to acquire enough for FI, and don't want to risk loosing it all to have to spend our final days as a Walmart greeter .

But IMO there is a large difference between volatility and risk, risk being the possibility of a total or substantial loss, and volatility the statistically expected variation. Based on historical returns, while equity markets are extremely volatile, they are not especially risky investments unless you are forced (emotionally or economically) to sell out during a panic.

Now of course this applies only to the equity market (S&P500 for example), not individual securities. Individual securities can and often do go to zero, or if not zero, never recover. But there has been no point in our history, none, in which the equity market has not recovered.

So the point then becomes how long is long? That is why we diversify, so that there is some amount of fixed income holdings that will remove required selling into a panic and some equities to offset inflation. In all of the discussion here I don't see any way around the need to have a balanced portfolio. The need to balance for volatility with bonds and to try to hedge against the slow death of inflation with equities.

[Texas Proud]

Well, I will bring it back to the masses instead of Lawman...

His title is "Balance is overrated" and then goes on to say why HE does not think so... great for him if he does not want to invest in equities.... it is his money and he can invest any way he wished (which many people have told him)....

HOWEVER, the people who have received Nobel Prizes and many studies and evidence shows that he is just plain wrong in his statement... a balanced investment is very good... a 100% bond investment is not... just because you don't like the evidence does not mean it is not true... So your original statement is just plain false...

Lawman then talks about risk.... but then seems to just disregard the actual risks there are in owning bonds... again, seeming to cherry pick what he thinks is risky and what he thinks is not risky.... again, risk can be measured and yes, equities are riskier than bonds.... that is why they have a higher return.... CDs are less risky than bonds, which is why they have lower returns.... you chose to pick the risk of bonds but do not want to admit there is risk.... you chose not to pick the risk of any equities... and recent posts by you seem to confirm that you will never buy into them because they will never be cheap enough for you.... even if stocks dropped 50% in the next year, the drumbeat of doom and gloom will be there and you will not pull the trigger...


As I said, your money... do what you want with it, but do not think for a second that your original statement is true... you should have said "I am just so risk adverse with equities that I am willing to forgo a balanced portfolio and live with the results"....

[clifp]

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Originally Posted by daylatedollarshort Because of pensions, modest lifestyle and SS, Lawman has already stated in the first post he won't really be spending his portfolio money most years anyway, so he will still be saving money during retirement. So for people like him a TIPS ladder might suit his needs best. Personally I would never be comfortable having a bad sequence of returns early on and then spending 4% anyway, depleting our portfolio with fixed spending against variable and sometimes losing annual returns. I do see many posts here from people with stock / bond portfolios planning to live to X years and spending their last dime, so I do not think the issue of depleting the portfolio is necessarily unique to owning TIPS. When most people here use FIREcalc do they go to zero at a certain age or plan to leave more than when they started? I always got the impression many people were not planning to leave a lot left over even with a stock / bond portfolio anyway, but maybe that is an incorrect understanding of other poster's plans on my part.

There are fair number of forum members who are in Lawman's situation short of asteroid strike, massive pension failure or economic collapse, it is irrelevant where the put their money, gold, TIPs, CDs, mattress, Tesla stock, or on Red in Vegas, their lifestyles will be unaffected.

As I found in this thread I started Does anybody want to be rich when they get old? Loss aversion is much stronger than desire to be rich for a large segment of the forum members. But forums members are pretty financially savvy, I am sure most look at the average performance of a 60/40,70/30 portfolio and realized that if they restricting withdrawal to ~4% they'll generally die with a lot more than they have now. So while their plan may not to leave a lot, with average equity returns, a life long habits of frugality, their heirs maybe pleasantly surprised.

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Personally I would never be comfortable having a bad sequence of returns early on and then spending 4% anyway, depleting our portfolio with fixed spending against variable and sometimes losing annual returns.

I find this to be a bit of a straw man argument. I have yet to find a single retiree, who actually blindly withdraws 4% of their initial portfolio plus inflation. In practice in both the 2000-2002 bear market and in 2008-09, real retirees adapted and cut spending. At least all the ones who's post I read and were depending on investment income and not pensions.

[daylatedollarshort]

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Originally Posted by Texas Proud Lawman then talks about risk.... but then seems to just disregard the actual risks there are in owning bonds... again, seeming to cherry pick what he thinks is risky and what he thinks is not risky.... again, risk can be measured and yes, equities are riskier than bonds.... that is why they have a higher return.... CDs are less risky than bonds, which is why they have lower returns.... you chose to pick the risk of bonds but do not want to admit there is risk.... you chose not to pick the risk of any equities

I am curious what risks you would see in an individual TIPS and I bond portfolio with 0+ real returns, other than the risk that people with equities might make more money than you?

[youbet]

Given Lawman's personal situation which is:
1. He has pensions and future SS to live off of and
2. "Preservation of this capital is all that matters.." (quoted from OP)

I would see no problem going with a TIPs and I bond portfolio.

But I think for most of us, we'd like to be able to withdraw and spend from our FIRE portfolios and that "Preservation of this capital is 'NOT' all that matters..". Each to his own.

We should meet again in a decade or so and see how individual strategies are going.

Lawman, you should stop doubting and talking and questioning your strategy and get on with executing it.

[Texas Proud]

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Originally Posted by daylatedollarshort I am curious what risks you would see in an individual TIPS and I bond portfolio with 0+ real returns, other than the risk that people with equities might make more money than you?

In general or in this situation

In general, all bonds fluctuate with interest rates... unless you have enough TIPS to live on the small distribution (I do not know enough.... but if it is priced at 0, do you get anything paid to you), you are going to be selling them to pay expenses.... and maybe selling at a loss...


Another risk is that your individual inflation rate might be higher than CPI... so income does not keep up with your expenses..


If you are talking about a ladder of TIPS, then you have the risk of outliving your ladder... OR, you have to have a lot of money in order to retire to cover all possible years... that means you could have retired much sooner if you had some equity in your portfolio....


Just a few off the top of my head.... I am sure there are more out there that I cannot think of or do not know....

[daylatedollarshort]

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Originally Posted by Texas Proud In general or in this situation In general, all bonds fluctuate with interest rates... unless you have enough TIPS to live on the small distribution (I do not know enough.... but if it is priced at 0, do you get anything paid to you), you are going to be selling them to pay expenses.... and maybe selling at a loss...

I think the point of the ladder is to have some bonds, with principal guaranteed, mature every year.

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Another risk is that your individual inflation rate might be higher than CPI... so income does not keep up with your expenses..

True, but it could also be lower.

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If you are talking about a ladder of TIPS, then you have the risk of outliving your ladder...

I think outliving your money appears to be a common concern here, not just limited to those with TIPS.

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OR, you have to have a lot of money in order to retire to cover all possible years... that means you could have retired much sooner if you had some equity in your portfolio....

Maybe, but then there is the sequence of returns risk with equities that could wipe out half your life savings right after you retire.....

"A big portfolio drop at the end could possibly wipe out all of the portfolio gains from the first 25 years of one’s career. "

Wade Pfau's Retirement Researcher Blog: Lifetime Sequence of Returns Risk

I am not trying to convince you either way. I just like hearing other points of view for my own consideration. I am just surprised more people here are do not seem too concerned about the sequence of returns risk. I guess I am just very risk adverse compared to most of the posters here.

[lawman]

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Originally Posted by daylatedollarshort I think the point of the ladder is to have some bonds, with principal guaranteed, mature every year. True, but it could also be lower. I think outliving your money appears to be a common concern here, not just limited to those with TIPS. Maybe, but then there is the sequence of returns risk with equities that could wipe out half your life savings right after you retire..... "A big portfolio drop at the end could possibly wipe out all of the portfolio gains from the first 25 years of one’s career. " Wade Pfau's Retirement Researcher Blog: Lifetime Sequence of Returns Risk I am not trying to convince you either way. I just like hearing other points of view for my own consideration. I am just surprised more people here are do not seem too concerned about the sequence of returns risk. I guess I am just very risk adverse compared to most of the posters here.

This says it..

"It is the returns experienced at the end of the 30-year period which have the biggest impacts on the final wealth accumulation, as this is when a given percentage change in the portfolio value has the biggest impact on absolute wealth. Individuals are especially vulnerable to these returns as they approach their retirement date."

That's where I am now and I'm quite happy to pick up my chips, cash them in and go home..

[Texas Proud]

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Originally Posted by daylatedollarshort I think outliving your money appears to be a common concern here, not just limited to those with TIPS. Maybe, but then there is the sequence of returns risk with equities that could wipe out half your life savings right after you retire.....

I will respond to these since they are the important ones to me...

If you are living off of TIPs... and do a ladder... (and I might be wrong on this)... but are you not SURE of running out of money IOW, you have your bond mature and use that money to live... next year you do the same... when your last bond pays up, you are done.... to me that is a bigger risk I am not willing to take...


Yes, the sequence of returns is a risk.... but history seems to show that the risk is a lot smaller than most people make it out to be.... so far in my life I have been through 3 major downturns, with the 2008/09 being considered the second worst in recent history.... my portfolio is doing just fine... now, I am not retired yet, but the results of these 3 major downturns seem to show that stocks have some big time short term risks, but not long term risks.... as long as you account for those short terms, the long term should take care of itself....

[brewer12345]

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Originally Posted by Texas Proud I will respond to these since they are the important ones to me... If you are living off of TIPs... and do a ladder... (and I might be wrong on this)... but are you not SURE of running out of money IOW, you have your bond mature and use that money to live... next year you do the same... when your last bond pays up, you are done.... to me that is a bigger risk I am not willing to take... Yes, the sequence of returns is a risk.... but history seems to show that the risk is a lot smaller than most people make it out to be.... so far in my life I have been through 3 major downturns, with the 2008/09 being considered the second worst in recent history.... my portfolio is doing just fine... now, I am not retired yet, but the results of these 3 major downturns seem to show that stocks have some big time short term risks, but not long term risks.... as long as you account for those short terms, the long term should take care of itself....

To put it another way, if you elect a TIPS ladder you know for sure you will run out of money at a certain date. Either you have contingency plans for great longevity, or you have the <caliber of your choice> solution.

I think that sequence of returns is a risk which can be hedged in a variety of ways, many of which are fairly obvious. When I feel like sitting down and writing in a structured manner, I will spew at length on the subject.

[daylatedollarshort]

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Originally Posted by Texas Proud I will respond to these since they are the important ones to me... If you are living off of TIPs... and do a ladder... (and I might be wrong on this)... but are you not SURE of running out of money IOW, you have your bond mature and use that money to live... next year you do the same... when your last bond pays up, you are done.... to me that is a bigger risk I am not willing to take... Yes, the sequence of returns is a risk.... but history seems to show that the risk is a lot smaller than most people make it out to be.... so far in my life I have been through 3 major downturns, with the 2008/09 being considered the second worst in recent history.... my portfolio is doing just fine... now, I am not retired yet, but the results of these 3 major downturns seem to show that stocks have some big time short term risks, but not long term risks.... as long as you account for those short terms, the long term should take care of itself....

For the most part we would probably buy new TIPS as the oldest mature so we'd get a rolling average of rates. We have pensions, two SS checks (future), we each have hobby jobs and a relatively modest lifestyle so we still plan to save money in retirement, and will try not to spend down the portfolio. If all goes according to my spreadsheet and Fidelity's RIP we should have a larger portfolio in inflation adjusted dollars when we are 100 than we do now. For us, I just don't see the need to take any risks with equities but maybe I am missing something.

[photoguy]

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Originally Posted by CaliforniaMan Based on historical returns, while equity markets are extremely volatile, they are not especially risky investments unless you are forced (emotionally or economically) to sell out during a panic.

Are you looking at only US historical returns? Although I have a high equity position, I don't agree that equities are "not especially risky investments" even if you exclude panic selling. There could be a long period of decline or even complete market failures.

[Texas Proud]

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Originally Posted by daylatedollarshort For the most part we would probably buy new TIPS as the oldest mature so we'd get a rolling average of rates. We have pensions, two SS checks (future), we each have hobby jobs and a relatively modest lifestyle so we still plan to save money in retirement, and will try not to spend down the portfolio. If all goes according to my spreadsheet and Fidelity's RIP we should have a larger portfolio in inflation adjusted dollars when we are 100 than we do now. For us, I just don't see the need to take any risks with equities but maybe I am missing something.

Do you have any kids or relatives you might want to leave money


If you have already covered your expenses (which both my mom and sister have done) with pension and SS.... savings are irrelevant... therefore you can take more chances with them... if the market does what it does most of the time, you leave a much bigger chunk of money to whomever.... if it does not, who cares


My sister is in her 70s and is saving money.... she is also spending money with many trips, a new car, etc. etc.... she has most of her savings in equities since her 'bonds' are her pension and SS.... they are worth many times what she has in equities.... if you do a PV on them, she is probably 20% equities even though 80% of her savings (or more) are in equities...

[daylatedollarshort]

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Originally Posted by Texas Proud Do you have any kids or relatives you might want to leave money If you have already covered your expenses (which both my mom and sister have done) with pension and SS.... savings are irrelevant... therefore you can take more chances with them... if the market does what it does most of the time, you leave a much bigger chunk of money to whomever.... if it does not, who cares

Since we are saving money in retirement, the kids should get an inheritance even with conservative investments. I see it as if we have enough from SS and pensions, why take chances with the rest? This way of thinking is actually described in the book Against the Gods with the theory of utility - the savings we have now means more to me than any increase, so the pain of losing it is worse than any joy from the gain of making more. I don't ever want to lose half my life savings. To each his own, but that would stress me out.

[CaliforniaMan]

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Originally Posted by photoguy Are you looking at only US historical returns? Although I have a high equity position, I don't agree that equities are "not especially risky investments" even if you exclude panic selling. There could be a long period of decline or even complete market failures.

Yes, I was looking only at US returns. Historically we have never had a "complete market failure" in the US. We have had a lot of bad things happen of course, among them two world wars, a cold war, panics, recessions, a great depression, but never a complete market failure. Thankfully we were never 1939 Poland.

I was looking only at historical data and believe that this is all that is possible since this is all we have from which we can derive statistical information. Other than that all we have are guesses and emotion. There is no way to protect from every imaginable possibility or to even anticipate them. So I don't consider "complete market failure" in my mix, especially since we have no idea what it might look like. Build an ark and invest in guns and gold I guess.

Of course "there could be a long period of decline", and there most likely will be which is why I mentioned "So the point then becomes how long is long? That is why we diversify..."

Simply, IMO we need to differentiate risk and volatility. Buying into a single stock may be risky but buying into the equity market in the US is volatile, sometimes extremely so, but given enough time it is not particularly more risky than other investments.

Burton Malkiel has a good chart of this in his Random Walk Guide to Investing.

For example, I would venture to guess that to a person in their 20's, it would be much more risky to be invested 100% in the bond market than 100% in the equity market. In the bond case the risk of loss is inflation, and the volatility of the equity market dramatically decreases with time.

For someone in their 80s, it would be much more risky to be invested 100% in equities than 100% in bonds, since they are much more likely in the fewer years remaining to them to turn the equity volatility into a loss, than experience a loss due to inflation.

I just mean that risk and volatility are different and very dependent on the time period.

[lawman]

"A final note – in my view, it is incorrect to believe that the 2008-2009 market plunge and financial crisis were caused by the housing bubble. The housing bubble was merely the expression of a very specific underlying dynamic. The true cause of that episode can be found earlier, in Federal Reserve policies that suppressed short-term interest rates following the 2000-2002 recession, and provoked a multi-year speculative “reach for yield” into mortgage securities. Wall Street was quite happy to supply the desired “product” to investors who – observing that the housing market had never experienced major losses – misinvested trillions of dollars of savings, chasing mortgage securities and financing a speculative bubble. Of course, the only way to generate enough “product” was to make mortgage loans of progressively lower quality to anyone with a pulse. To believe that the housing bubble caused the crash was is to ignore its origin in Federal Reserve policies that forced investors to reach for yield.

Tragically, the Federal Reserve has done the same thing again – starving investors of safe returns, and promoting a reach for yield into increasingly elevated and speculative assets."



Hussman Funds - Weekly Market Comment: It Is Informed Optimism To Wait For The Rain - March 10, 2014

[daylatedollarshort]

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Originally Posted by lawman "A final note – in my view, it is incorrect to believe that the 2008-2009 market plunge and financial crisis were caused by the housing bubble. The housing bubble was merely the expression of a very specific underlying dynamic. The true cause of that episode can be found earlier, in Federal Reserve policies that suppressed short-term interest rates following the 2000-2002 recession, and provoked a multi-year speculative “reach for yield” into mortgage securities. Wall Street was quite happy to supply the desired “product” to investors who – observing that the housing market had never experienced major losses – misinvested trillions of dollars of savings, chasing mortgage securities and financing a speculative bubble. Of course, the only way to generate enough “product” was to make mortgage loans of progressively lower quality to anyone with a pulse. To believe that the housing bubble caused the crash was is to ignore its origin in Federal Reserve policies that forced investors to reach for yield. Tragically, the Federal Reserve has done the same thing again – starving investors of safe returns, and promoting a reach for yield into increasingly elevated and speculative assets." Hussman Funds - Weekly Market Comment: It Is Informed Optimism To Wait For The Rain - March 10, 2014

I also wonder what 1 trillion dollars in nondischargeable student debt for the younger generation and not much in retirement savings for those nearing retirement going forward means for housing prices. I think this basically can't be good long term. We've have never had a younger generation with student loans repayments the size of house mortgage before or an older generation largely without pensions and savings.

[Jaded salami]

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Originally Posted by daylatedollarshort I also wonder what 1 trillion dollars in nondischargeable student debt for the younger generation and not much in retirement savings for those nearing retirement going forward means for housing prices. I think this basically can't be good long term. We've have never had a younger generation with student loans repayments the size of house mortgage before or an older generation largely without pensions and savings.

I think it means cat and dog food manufacturers are a good long-term play.

[photoguy]

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Originally Posted by CaliforniaMan Yes, I was looking only at US returns. Historically we have never had a "complete market failure" in the US. We have had a lot of bad things happen of course, among them two world wars, a cold war, panics, recessions, a great depression, but never a complete market failure. Thankfully we were never 1939 Poland. I was looking only at historical data and believe that this is all that is possible since this is all we have from which we can derive statistical information. Other than that all we have are guesses and emotion. There is no way to protect from every imaginable possibility or to even anticipate them. So I don't consider "complete market failure" in my mix, especially since we have no idea what it might look like. Build an ark and invest in guns and gold I guess.

While US returns have been fantastic for the past century or so, if you look at SWR internationally (i.e. see work by Pfau) there are many failures. The US didn't become one of those cases but could have been if history had been a little different (what would have happened if the debt ceiling wasn't raised?). I think the danger in generalizing just from US history and ignoring other countries is that we may be subjecting ourselves to survivorship bias.

Wade Pfau's Retirement Researcher Blog: The Shocking International Experience of the 4% Rule

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Originally Posted by CaliforniaMan Simply, IMO we need to differentiate risk and volatility. Buying into a single stock may be risky but buying into the equity market in the US is volatile, sometimes extremely so, but given enough time it is not particularly more risky than other investments.

I think it depends on what risk you are trying to counter. But if you are trying to match a known future real or nominal liability, equities are much more risky than real/nominal bonds. If I need 20k (real) in living expenses 30 years from now, TIPS or iBonds will get me there with near zero risk (US government would have to fail).

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For example, I would venture to guess that to a person in their 20's, it would be much more risky to be invested 100% in the bond market than 100% in the equity market.

This is different from saying that equities aren't risky over long periods of time.

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the volatility of the equity market dramatically decreases with time.

Can you clarify what you mean here? I don't think the volatility of equity returns is decreasing but I'm guessing you mean something else?

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I just mean that risk and volatility are different and very dependent on the time period.

Although volatility is often used as a proxy for risk, I agree that they are not the same for an ER investor.

[CaliforniaMan]

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Originally Posted by photoguy While US returns have been fantastic for the past century or so, if you look at SWR internationally (i.e. see work by Pfau) there are many failures. The US didn't become one of those cases but could have been if history had been a little different (what would have happened if the debt ceiling wasn't raised?). I think the danger in generalizing just from US history and ignoring other countries is that we may be subjecting ourselves to survivorship bias. Wade Pfau's Retirement Researcher Blog: The Shocking International Experience of the 4% Rule I think it depends on what risk you are trying to counter. But if you are trying to match a known future real or nominal liability, equities are much more risky than real/nominal bonds. If I need 20k (real) in living expenses 30 years from now, TIPS or iBonds will get me there with near zero risk (US government would have to fail). This is different from saying that equities aren't risky over long periods of time. Can you clarify what you mean here? I don't think the volatility of equity returns is decreasing but I'm guessing you mean something else? Although volatility is often used as a proxy for risk, I agree that they are not the same for an ER investor.

The attached plot illustrates the point about decreasing volatility with increasing time periods. I think it probably wasn't clear what I meant.

Historically volatility does decrease with longer time periods as would be expected from the Law of Large Numbers, where variance decreases toward the mean with increasing sample size. No real surprise here.

As for survivorship bias, I think that is the more interesting question, but I am not certain that it applies. There is a qualitative difference between the US and the other failed states in recent history, stability, rule of law, heterogeneity of society, support for the constitution, on and on.

Also, I don't take seriously the premise "what would have happened if the debt ceiling wasn't raised" that this would cause a total market collapse. We didn't even have a total market collapse tin the 1930s, even with the failure of banks and disastrous unemployment. It would have deepened the recession but in the end our system seems to be fairly self-righting. Don't forget every two years we get a chance to throw the ... out.

Again, this gets back to portfolio balance. Bonds of various types for stability and equities for long term growth. I don't really think I have anything creative to contribute to that discussion. Only what I observe from history. To me a balanced portfolio makes the most sense. How to do that balance is the question we all grapple with.