Deep Risk by William Bernstein

[Gatordoc50]

For what is it worth, here is a list of the top 10 assets owned by millionaire households ($2M+) in the U.S. based on estate tax data, 2007 - 2009. Publicly traded stocks are 12.9%:

The Top Ten Assets Owned by Millionaires

Interesting. I wonder what the 11% in retirement assets represents. If those are also invested in the market then about 25% of assets are invested in stocks/bonds. That's about where I am.

 

[MooreBonds]

The Top Ten Assets Owned by Millionaires

Just as it is with people of lesser means, just because someone is a millionaire, it doesn't mean that they're automatically good with investments or money management. Some of them may be millionaires in spite of some of the assets they own.

 

[Gatordoc50]

Just as it is with people of lesser means, just because someone is a millionaire, it doesn't mean that they're automatically good with investments or money management. Some of them may be millionaires in spite of some of the assets they own.

They may not fare any better or worse than the average investor in terms of returns but it appears they are more diversified. I've often opined that having all your assets in stocks/bonds is poor diversification.

 

[Lsbcal]

I did a second pass on the booklet, reflecting on the statements that struck me the most, this all seems very sensible (as expected from Dr Bernstein), but... there is one part I don't quite get. Why does the author keep suggesting some precious metals (e.g. gold) in the portfolio?
...

I have not finished the book but from past Bernstein books he likes to take on some slivers of PME and other diversification assets. He used to call himself sort of an asset allocation junky ... or words to that effect. I don't think he recommends much of this stuff.

 

[Lsbcal]

In recent times Bernstein has suggested that fixed income be very short term (duration = months not years). I have not finished this book but I'll be curious to see if his writings support this current FI view.

 

[clifp]

I love Berstein's investing for adults series.
I took his criticism about the Permanent Portfolio were far more directed at the advocates of it than at Harry Browne or the concept itself. I also agree with Berstein that probabilities of the potential disasters are dramatically different. So the 25% AA to each component doesn't make a lot of sense.

The key take away for me is the time to buy bonds is after inflation occurs and fears of additional inflation is at their highest. that at least gives me a target to look for when timing my bond purchases.

I was very happy to see he provide some hard data on the illusion of safety on sovereign debt. Something I've been harping on for a few years.
I agree that the US is relatively immune to military devastation, but we aren't immune to the other risks especially inflation.

The psychological difference between having a 50/50 portfolio and 75/25 back in 1929 was pretty interesting. Berstein's point was that 75/25 retiree would have had hard time committing his funds in in 1932 when market was at his bottom.

I had the same experience back in Jan 2009 when I committed the last of my cash reserves. It was the only oh **** moment of my retirement when I realized that I was not only out of cash, but if the market went further I need to come up with another 200K to pay off my long term put that I wrote.. After that I ended up sticking ~100K in a CD ladder where I won't be tempted to buy cheap stocks.

 

[brewer12345]

Interesting. I wonder what the 11% in retirement assets represents. If those are also invested in the market then about 25% of assets are invested in stocks/bonds. That's about where I am.

So what else do you own? Real estate?

 

[daylatedollarshort]

I don't have any idea what kind of portfolio will do best going forward. I just think authors that change their opinions on the best way to invest over the next 40 years based on what has happened over the last 4 or 5 years, probably don't have any more of a clue than I do. They are just going along with recency bias.

I don't think studying existing millionaires provides all the answers on the best asset allocation for the future, but it does provide some food for thought and another data point to consider.

I have found it interesting that in the Thomas Stanley research I've seen, most millionaires don't have a huge percent of assets invested in stock mutual funds -

"The problem with mutual funds is that every year they've got to declare a dividend, and you're going to pay tax on that. The wisest investors, and the majority of the millionaires we've interviewed, are people who own stocks directly and don't trade much. They're not taking capital gains. They're not taking dividends. They're building a portfolio. Other unrealized income might come from a business. You might have a factory or a company that's growing, and you're putting money back into it. You're not taking it as income, and the business becomes more and more valuable. Or someone owns scrap metal. The more scrap metal he has, the more wealth he has."

Excerpt from How The Millionaire Next Door Got That Way Save. Don't spend. When you do have to spend, be frugal. Then someday you, too, could be a millionaire. Really! - August 17, 1998

Maybe stock mutual funds will provide the best return going forward. I don't know. But I did find it interesting when I started reading the various Stanley books and found out most people who were millionaires didn't have a a big percent of their assets in stock mutual funds. In one of the Stanley books he had some thought along the lines of most millionaires like to control their money, and they can't control the stock market. And when they do own stocks it is often closely held or individual publicly traded stocks.

 

[samclem]

I don't think studying existing millionaires provides all the answers on the best asset allocation for the future, but it does provide some food for thought and another data point to consider.

I have found it interesting that in the Thomas Stanley research I've seen, most millionaires don't have a huge percent of assets invested in stock mutual funds -

Three problems I see:
1) If a person has a VERY big portfolio, they may choose to invest in individual stocks rather than MFs >even if they invest in the the identical securities< just to avoid the MF fees/expenses. That's unlikely to be the case for those with smaller portfolios: MFs and ETFs can be bought with less overhead than buying the stocks themselves unless the lots are very big.
2) There's not much reason to think "millionaires" make better investors, especially if that's not how they got their money.
3) Even if a person did make their millions by investing, that doesn't mean their methods are good ones. If 1000 people are each given $1000 to invest in stocks, the only ones who will have a million dollars in 10 years are those who made highly leveraged bets or those who invested in a highly concentrated way (in one or two speculative companies). 95 of 100 people who try that will go broke. But, if we surveyed the "millionaires" those are the techniques we'd see represented. Buying a broad index fund would likely have allowed an investor to "only" double his money in this time--but that's the better way for most people to accumulate (and keep) a retirement nest egg.
Thomas Stanley should interview the investors who got poor results, he might find that direct-stock ownership is the rage in that population, too.

 

[daylatedollarshort]

Three problems I see:
1) If a person has a VERY big portfolio, they may choose to invest in individual stocks rather than MFs >even if they invest in the the identical securities< just to avoid the MF fees/expenses. That's unlikely to be the case for those with smaller portfolios: MFs and ETFs can be bought with less overhead than buying the stocks themselves unless the lots are very big.
2) There's not much reason to think "millionaires" make better investors, especially if that's not how they got their money.
3) Even if a person did make their millions by investing, that doesn't mean their methods are good ones. If 1000 people are each given $1000 to invest in stocks, the only ones who will have a million dollars in 10 years are those who made highly leveraged bets or those who invested in a highly concentrated way (in one or two speculative companies). 95 of 100 people who try that will go broke. But, if we surveyed the "millionaires" those are the techniques we'd see represented. Buying a broad index fund would likely have allowed an investor to "only" double his money in this time--but that's the better way for most people to accumulate (and keep) a retirement nest egg.
Thomas Stanley should interview the investors who got poor results, he might find that direct-stock ownership is the rage in that population, too.

All good points to consider. However, I found it interesting to note the low percent of allocation to publicly traded stocks, and from the other article the lack of interest in mutual funds. Even if more loser investors were studied for comparison, it wouldn't increase the percent of stocks or stock mutual fund winners' asset allocations.

Certain posters here get picked on for not having much larger portfolio allocations to stock mutual funds, but it seems like from the Stanley data many wealthy people actually do not put most of their savings in stocks or stock mutual funds.

 

[clifp]

All good points to consider. However, I found it interesting to note the low percent of allocation to publicly traded stocks, and from the other article the lack of interest in mutual funds. Even if more loser investors were studied for comparison, it wouldn't increase the percent of stocks or stock mutual fund winners' asset allocations.

Certain posters here get picked on for not having much larger portfolio allocations to stock mutual funds, but it seems like from the Stanley data many wealthy people actually do not put most of their savings in stocks or stock mutual funds.

I'll point out the article is 15 years old 1998 and the data was almost certainly collected before the big tech boom (and subsequent bust).

But here is the kicker.

He's typically a male with a net worth of between $1 million and $5 million. He lives in a house valued at $278,000, which is not extravagant. He's self-employed or owns a business or is a partner in private business, maybe pest control or carpentry, plumbing, air conditioning, or contracting.

A relatively small number of forum members own or owned their own business. We do have a modest number of doctors and lawyer who had their own practice, but even some of those draw salaries. Unlike the typical "millionaire next door", forum members by an large were paid salaries. We LYBM, saved heavily and many of us invested (more successful than the average American), either in the market or in real estate.

 

[daylatedollarshort]

I'll point out the article is 15 years old 1998 and the data was almost certainly collected before the big tech boom (and subsequent bust).

The article may be older but the IRS estate data is from 2007 - 2009. You can do with the data what you want. I don't claim to have any answers or any crystal ball.

But when I read about millionaires wanting investments they can control and individuals not being able to control the stock market, and saw various versions of the assets millionaires do hold vs what places like Fidelity and popular financial writers suggest as normal / optimal, it personally gave me a lot of food for thought.

 

[Gatordoc50]

So what else do you own? Real estate?

Yes, mostly real estate. Some residential and some commercial and some land. Our plan is to live off our rental income and stock/bond portfolio and sell property when/if necessary. For business owners with income above IRA limits, any money invested in retirement accounts is accompanied by employer contributions to employee accounts. So it represents more of an employee benefit than an investment. I doubt that very many folk would invest in the market if it wasn't incentivized by the government. It's the tax treatment that makes it a viable investment. Stocks as a stand alone investment offer too much risk for too little return, IMO. Some like stocks over real estate due to their liquidity but as Bernstein points out, liquidity is a deep risk in the hands of most investors.

 

[nun]

A few things jump out- this advice is not just more of the same asset 60:40 or 50:50 stock:bond asset allocation, and save 25X spending before retirement. This is a lot more demanding. He says that if you are not working, you should have 15-20 x your (expenses-(SS and pensions)) in liquid and ultra safe investments like T-bills and short term liquid notes and CDs. Now remember that these investments are designed to guard against shallow risks, which are relatively short term, but will leave one heavily exposed to deep risks which tend to be longer term, but may actually come suddenly. He more of less suggests that retired people must design to deal with shallow risks, no matter what other risks may be left unguarded.

It seems that if this book is taken to heart, and if a secure retirement is something you want, run, don't walk to get a government job if you can. Otherwise save enough for your chosen SWR, but also save another 15 -20 x(expenses not covered by COLA annuities). So non-govt workers had better have very good jobs, or no life, or both, while they try to put together this huge amount of retirement funds.

The stock bond allocation and 4% SWR is a pretty recent dogma, surely. Before everyone in the US was funding retirement with defined contribution plans directly subject to the ups and downs of the economy people used annuities as the default. That's still the case in most other countries. To recommend 15 to 20 x (expenses - COLAed pensions) in cash and ultra safe fixed income is a big psychological shift.......and a good one IMHO. But it sounds like old news to me.

I plan to fund my entire spending from US and UK SS and a small company pension, so (expenses - COLAed pensions) = 0. When I was given the opportunity to pay into both US and UK SS I took it immediately as I figured it would be good to have the interest linked stable income sources. that was 27 years ago. So I've paid two sets of social security taxes for 27 years and I'll collect about $24k from the UK and the US at age 66. That $48k along with $20k rental income and $5k pension will cover my spending at age 66. Real estate equity and other retirement savings are a back stop.

 

[brewer12345]

Yes, mostly real estate. Some residential and some commercial and some land. Our plan is to live off our rental income and stock/bond portfolio and sell property when/if necessary. For business owners with income above IRA limits, any money invested in retirement accounts is accompanied by employer contributions to employee accounts. So it represents more of an employee benefit than an investment. I doubt that very many folk would invest in the market if it wasn't incentivized by the government. It's the tax treatment that makes it a viable investment. Stocks as a stand alone investment offer too much risk for too little return, IMO. Some like stocks over real estate due to their liquidity but as Bernstein points out, liquidity is a deep risk in the hands of most investors.

Seems to me that real estate is heavily driven by favorable tax treatment as well.

Different strokes. I think the liquidity driven risk is way overblown, but de gustibus non disputandam.

 

[trirod]

For what is it worth, here is a list of the top 10 assets owned by millionaire households ($2M+) in the U.S. based on estate tax data, 2007 - 2009. Publicly traded stocks are 12.9%:

The Top Ten Assets Owned by Millionaires

I wouldn't read too much into that list - it's an average, not representative of any one individual. I would say the most common way to get wealthy in the US is to own a business. For most of these business owners, the vast majority of their wealth is tied up in their business (i.e closely held stock). So there will be a large subset of these "millionaires" who are not investing in the stock marketat all because they don't have any liquid funds to do so, and they also believe (right or wrong) they should get a better return on investing in their own business instead of in Apple or GE.

Also, wealthy people tend to buy individual stocks over mutual funds because they have a broker investing for them and the broker will convince them that they are better off paying a 1% or more assets under management fee for an actively managed portfolio vs. the 0.1% or so from a Vanguard Index Fund. Even though most of these managed portfolios end up looking a lot like the total stock market, but with a lot more fees and taxes due to the broker's constant churning of the investments.

A lot of the "real estate investment" property likely consists of vacation homes - not really an income generating investment.

 

[Gatordoc50]

Seems to me that real estate is heavily driven by favorable tax treatment as well.

Different strokes. I think the liquidity driven risk is way overblown, but de gustibus non disputandam.

+1 on tax favored treatment of real estate. The difference is that you can get the tax favored treatment regardless of income with real estate. I think that is also why you see the wealthy invested in insurance products. Tax deferral and asset protection. So maybe the portfolios of millionaires are not a function of diversification as I initially mused but rather a way to maximize tax efficiency and wealth preservation. I didn't invest in real estate because of my fear of stocks but I am hesitant to sell all of it now and invest in stocks due to fear.

 

[siamond]

I have not finished the book but from past Bernstein books he likes to take on some slivers of PME and other diversification assets. He used to call himself sort of an asset allocation junky ... or words to that effect. I don't think he recommends much of this stuff.

Yes, this is indeed a continuation of his past recommendations, albeit made in a mild manner.

I just don't quite understand the reasoning, notably in a deep risk context. He does state himself that gold isn't such a good hedge against inflation somewhere in the booklet. He show some numbers illustrating why (counter-intuitively) it might help against sustained deflation, but again, not terribly convincingly. And finally, if gold is 5% of your portfolio, I find hard to believe this would help very much in a sustained, decade-long, Japan-like scenario.

So I was a bit surprised that he kept such recommendation as part of the summary at the end. Maybe he's just being balanced, and saying 'yeah, you should consider it... but think twice about it!'.

On my side, I kept gold as one possible diversifier at some point in time in my investment plan, but... I'm on the fence, can't seem to convince myself to actually do so, and this booklet didn't convince me either. Rick Ferri's point that gold does NOT really appreciate on the long run, hence is a poor investment by nature, keeps resonating in my ears...

 

[daylatedollarshort]

Also, wealthy people tend to buy individual stocks over mutual funds because they have a broker investing for them and the broker will convince them that they are better off paying a 1% or more assets under management fee for an actively managed portfolio vs. the 0.1% or so from a Vanguard Index Fund.

That is pretty much the opposite of what is in the Stanley books. He says most MNDs ignore or at least discount the advice of stock brokers, and view them more as salesmen than investment advisers.

the vast majority of their wealth is tied up in their business (i.e closely held stock).

If that is true, it is not showing up in the top ten assets list averages. The averages show a broad range of diversification, and 14.5 percent in closely held stock.

A lot of the "real estate investment" property likely consists of vacation homes - not really an income generating investment.

" 64% of the millionaires surveyed never owned a vacation home, beach bungalow or mountain cabin, not even a lean-to or a tree hut in the woods. "

From Stop Acting Rich -

http://www.thomasjstanley.com/blog-articles/164/Second_Homes..._Part_I.html

 

[samclem]

To recommend 15 to 20 x (expenses - COLAed pensions) in cash and ultra safe fixed income is a big psychological shift.......and a good one IMHO.

I think this "cash and ultra safe fixed income" recommendation is part of Bernstein's new thinking after seeing his clients dump their stocks in a panic in 2008-2009. I doubt it reflects his opinion of the best way (objectively) to preserve and grow a retirement portfolio that will support a 40 year retirement, but instead represents a response to the behavior of typical investors. If you're not this typical investor and won't sell your equities when they take a 50% loss, then I think you should feel free to disregard his recommendation.

 

[haha]

Meanwhile, back to something knowable, what Wm Bernstein says in this latest little book: Anyone notice what he gave as his reason for preferring a "value tilt" in his world investments? Firm level leverage. We ignore this kind of advice all the time, when we rush to pay off very low rate mortgages and school loans, and advise others to do the same.

Bernstein takes thinking farther than the usual retirement advice, but it doesn't really seem so special to me, other than he emphasizes that it is really a hard job to survive a long time without somebody else giving you money, whether that someone else be customers, taxpayers, a pension fund or paid employment.

But that has been said before, and it has not sold well.

Ha

 

[Animorph]

I have found it interesting that in the Thomas Stanley research I've seen, most millionaires don't have a huge percent of assets invested in stock mutual funds -

"The problem with mutual funds is that every year they've got to declare a dividend, and you're going to pay tax on that. The wisest investors, and the majority of the millionaires we've interviewed, are people who own stocks directly and don't trade much. They're not taking capital gains. They're not taking dividends. They're building a portfolio. Other unrealized income might come from a business. You might have a factory or a company that's growing, and you're putting money back into it. You're not taking it as income, and the business becomes more and more valuable. Or someone owns scrap metal. The more scrap metal he has, the more wealth he has."

Excerpt from How The Millionaire Next Door Got That Way Save. Don't spend. When you do have to spend, be frugal. Then someday you, too, could be a millionaire. Really! - August 17, 1998

That's pretty bogus about mutual funds. They don't have to declare a dividend, they only have to pass on what's left of collected dividends after taking out their expenses. That will be less than what the fund collects from their portfolio of stocks. I hadn't thought about it that way before, but those expenses are kind of paid pre-tax. The millionaires my choose only non-dividend paying stocks, but that has the same diversification problems as choosing all dividend stocks. You can find funds that don't trade much too, creating minimal capital gains. Index funds certainly have those characteristics.

 

[daylatedollarshort]

You can find funds that don't trade much too, creating minimal capital gains. Index funds certainly have those characteristics.

I don't have any individual stocks, but this is something I am thinking more about. With individual stocks there would be a more detailed level of control in taxable accounts to sell off individual losers each year and hang on to the winners.

 

[samclem]

With individual stocks there would be a more detailed level of control in taxable accounts to sell off individual losers each year and hang on to the winners.

That might be useful as a way to tailor taxable income (through tax loss harvesting, etc). It's probably not useful as a way to maximize pre-tax returns. Anybody really capable of accurately picking "winners and losers" in the equities market is wasting their talent if they are just working with their own personal portfolio--MFs, pension funds and others would pay tremendous bonuses to anyone who can do it reliably. Or, just use the talent to buy/sell futures: a handful of consecutive accurate highly-leveraged predictions can turn $1000 into a million dollars in short order. If it were easy, everyone would be doing it.

 

[clifp]

I don't have any individual stocks, but this is something I am thinking more about. With individual stocks there would be a more detailed level of control in taxable accounts to sell off individual losers each year and hang on to the winners.

Yes it definitely one of the benefits of owning individual stocks. It makes managing your income for tax purposes easier. I think the next bear market year, will also be the first year that I can qualify for subsidy under ACA.