Fear / Greed and AA

[enjoyinglife102]

The two points of view always expressed are one needs equities and inflation is the devil. There have been many discussions here though about how inflation that people actually experienced over long periods of time was much lower than the government's CPI. So I recommend trying to calculate your personal inflation rate because that's the only one that matters to you. How can anyone offer advice about the impact of inflation without knowing your personal rate? As far as equities, historical numbers (will they be repeated?) say you should own some to enhance your portfolio, but if you can't handle the inevitable fluctuations, then it's not a place to be. My parents never owned a stock, were very middle class with no big nest egg, had a very small pension, collected SS and lived happily into their mid 80's. Laddered CD's will keep you capturing current rates. I don't remember reading stories about how people were ruined, needed to go back to work and/or became desperate because they managed their money too conservatively during the Great Recession.

 

[brewer12345]

I don't remember reading stories about how people were ruined, needed to go back to work and/or became desperate because they managed their money too conservatively during the Great Recession.

Go look at the hapless 1966 retiree's experience instead. Or go look at someone who was 80% long bond starting in the late 60s. Not pretty.

As an ER/ESR at age 40, I am afeared of inflation enough that I decided I would keep my 30 year fixed rate mortgage in place as a hedge.

 

[daylatedollarshort]

I know many people here are Boglehead fans, personally I am more in the Zvi Bodie camp. I bought his Risk Less and Prosper book for my kids to read -

https://www.mint.com/blog/investing/risk-less-and-prosper-an-interview-with-zvi-bodie-022012/

He favors I bonds and TIPS for inflation protection with stocks okay for your fun money. Bill Bernstein seemed to move more towards this approach, at least for retirees, after the last stock market meltdown.

Here is another article on stocks, retirees and sequence of returns risk, and how to mitigate it with advice from various financial experts -

http://www.marketwatch.com/story/how-to-avoid-sequence-of-return-risk-2013-09-28?pagenumber=1

 

[BigNick]

One of the biggest blind spots that people have heading into (early) retirement is looking at risk of their portfolio versus overall risk to their total wealth and income stream. In the case of the OP, who I suspect may have saved hard for many years to acquire his current portfolio, this means accepting that a non-COLA pension (which we're all assuming is what he has) is a huge risk. Worse, it's a risk with a guaranteed downside: the only thing we don't know is how big that risk is. It's 25 years since we worried about non-housing inflation, and we forget how devastating it can be, but to summarise: it's worse than a bear market, because stocks bounce back, but money eaten by inflation is gone forever.

In our case, DW's salary and my pension are slightly more than we will be spending until she retires (probably about four years from now). Then we will draw down from the portfolio to complement our two pensions, which are both fully COLA'ed. But we also want to leave something substantial to our kids, so we are still thinking long-term: we want to protect this chunk of change for 30+ years, which means we ought to be even more into equities than we are (!).

 

[steelyman]

I bought his Risk Less and Prosper book for my kids to read -

Boy. My parents bought me stuff like bicycles and baseball bats/gloves.

 

[W2R]

As Clifp says, inflation is enemy #1 in retirement, one that slowly strangles your financial independence if you don't take measures to offset it.

Retiring at 60 is definitely early retirement and the odds are at least one of you will live to be 90+. If your pension isn't COLAd (few are) you'll need some way to help keep up with inflation - and that something is usually investing in stocks in some form, FIRECalc indicates at least 35% to 40%.

I view going all cash for the long term as the boiled frog approach to financial security. By the time you realize you're in hot water it will be too late.

+1000

REWahoo's posts always seem so sensible and down to earth. I couldn't agree more.

 

[daylatedollarshort]

Boy. My parents bought me stuff like bicycles and baseball bats/gloves.

When you were an adult?

 

[NW-Bound]

Well, if one is risk averse and puts money in CDs, it's not the end of the world, the way I look at it. It's not an irreversible process.

If inflation picks up, and to be fair it has not reared its ugly head so far, it will be gradual. As long as one recognizes the risk, he/she can still diversify out of "safe" money to equities. That is assuming that he/she does not jump into the market at the wrong time just to see it tanks. That's the tough thing about equities that some people cannot handle: the volatility.

 

[NW-Bound]

Back in 1999 at age 39, cocky me wouldn't have traded a million dollars for $40,000 COLA pension from a credit worthy organization. 15 years later, despite a much lower life expectancy, I'd do it in a heart beat.

Well, there may come a time when we again will want something higher than a 4% COLA annuity. Yeah, dream on as some people will say.

As I have children and want to leave them something, I am OK with the present 3.5%WR, with COLA I certainly hope. I am willing to give up that 0.5%WR to give my children a chance to ER too, in case they run into trouble with their career later in life.

 

[daylatedollarshort]

Well, if one is risk averse and puts money in CDs, it's not the end of the world, the way I look at it. It's not an irreversible process.

If inflation picks up, and to be fair it has not reared its ugly head so far, it will be gradual. As long as one recognizes the risk, he/she can still diversify out of "safe" money to equities. That is assuming that he/she does not jump into the market at the wrong time just to see it tanks. That's the tough thing about equities that some people cannot handle: the volatility.

Maybe I am missing something, but isn't it that inflation itself is not so much a problem as negative real return rates? With fixed income ladders and short term bond funds isn't inflation really only an issue when prolonged real interest rates are lagging the inflation rate?

And aren't TIPS and I bonds more of a sure inflation hedge than stocks? It seems like from what I have read and some of the links I posted that there have been extended periods in the past where stocks did not keep up with inflation, and they may or may not do so in the future.

I get if you want to play the odds that a higher equity position will most likely lead to a higher rate of return long term, potentially a much higher rate of return, but I think for just a pure inflation hedge wouldn't that be more investments like delaying SS (since it has a COLA), obtaining a fixed rate mortgage when rates are low, inflation indexed annuities, TIPS and I bonds?

 

[W2R]

For the OP: here is an excellent list of books on these topics.

Investment Books

 

[ERD50]

... It seems like from what I have read and some of the links I posted that there have been extended periods in the past where stocks did not keep up with inflation, and they may or may not do so in the future. ....

This may be the case, but I think it may not be the point.

I'm mostly just guessing here, but I think the advantages of stocks over a 30-40 year period is that the average higher gains will carry you through a period of high inflation. Those gains may not necessarily occur at the same time as the high inflation hits, but if they occur before and/or after, it helps you overall.

Regardless the reasons, FIRECalc clearly shows that a low stock exposure has been very risky over a 30-40 year time frame.

-ERD50

 

[NW-Bound]

As I am not obscenely wealthy, I would like to get some gains more than just keeping up with inflation. Historically, a balanced portfolio will carry 4% withdrawal rate through 30 years. Throw in some SS, and one should be safe. I have dialed back the WR to 3.5% to be even safer.

If I were to put my money into something that will barely keep up with inflation, my 3.5% WR would only last me 100/3.5 = 28.6 years. While I may not live beyond that, my wife may. SS alone might be all that she needs, but having nothing else would not let her feel safe. And then, I want to leave something to my children.

I guess if one is really risk averse to stocks, he/she can justify CDs and annuities. As for me, I prefer to have diversification (never 100% in any single thing), and frankly I am quite comfortable holding some equities and do not perceive them as risky compared to anything else. The value of my homes or the price of gold have been going up/down as much or more.

 

[obgyn65]

Unfortunately my financial modeling skills are not great, but wouldn't a retiree spending 1.75% above his/her SWR be more at risk of depleting his/her assets over 30 years than another retiree who would spend a constant amount of money over 30 years (thus ignoring 1.75% rate of inflation)?

Happy to change my mind on this topic if presented with evidence.

+1000

REWahoo's posts always seem so sensible and down to earth. I couldn't agree more.

 

[harley]

Unfortunately my financial modeling skills are not great, but wouldn't a retiree spending 1.75% above his/her SWR be more at risk of depleting his/her assets over 30 years than another retiree who would spend a constant amount of money over 30 years (thus ignoring 1.75% rate of inflation)?

Happy to change my mind on this topic if presented with evidence.

I may be mistaking what you are saying. Do you mean that you start out spending, say, $40K/yr, and 30 years later you are still spending $40K/yr? If so, your financial quality of life will be devastated. Even at 1%/yr inflation, you would be living on less than 3/4 what you started with. And I don't think anybody is predicting ongoing 1% inflation. At a more standard 3% you would be living on the equivalent of $16.5K per year. That's below the poverty level.

But, as I said, I may have misinterpreted your example.

 

[ERD50]

... I view going all cash for the long term as the boiled frog approach to financial security. By the time you realize you're in hot water it will be too late.

That is the best description of this scenario I've ever heard! Well done!

-ERD50

 

[daylatedollarshort]

I view going all cash for the long term as the boiled frog approach to financial security. By the time you realize you're in hot water it will be too late.

With inflation running about 1.5% this past year, why would you invest in cash and lose money instead of choosing products like 3% 5 year Penfed CDs, long term TIPS, which have been yielding around ~1.5% over inflation this past year, I bonds or stable value funds?

The inflation rates and rates on all these products are published daily various places on the Internet, so it you could see which ones were keeping up with inflation and which ones were not.

Maybe I misunderstood how they work, but I thought TIPS and I bonds bought at 0 or a positive yield, always keep up with inflation, if the bonds are held to maturity? Why would someone go all cash instead and lose money to inflation? I have never heard of any investment expert recommending all cash.

 

[REWahoo]

With inflation running about 1.5% this past year, why would you invest in cash...

I wouldn't.

I have never heard of any investment expert recommending all cash.

Nor have I - at least not any "expert" I would give credibility.

I think you missed the point of my post, but that's a common problem on discussion boards.

 

[daylatedollarshort]

I wouldn't.

Nor have I - at least not any "expert" I would give credibility.

I think you missed the point of my post, but that's a common problem on discussion boards.

I meant the generic "you". Perhaps I should have said why would any one go all cash? Sorry I guess I did miss the point. I don't know why any one would go all cash when they could buy TIPS or I bonds or some other investment product yielding the inflation rate or more.

 

[Mulligan]

I meant the generic "you". Perhaps I should have said why would any one go all cash? Sorry I guess I did miss the point. I don't know why any one would go all cash when they could buy TIPS or I bonds or some other investment product yielding the inflation rate or more.

I think the definition of cash is sometimes different for some people. Many people consider IBonds and CDs as both part of cash.

 

[Mulligan]

I'm not a pension expert at all but this had me reaching for the latest annual reports from my private pension schemes and they all have less than 15% invested in equities, and are all over 90% funded. Consequently my AA these days is approaching 50% equities which is where I'd like to keep it going forward.

15%, wow, that is interesting. I didn't realize a fund would have such a small allocation. I just checked mine and it's a little over 50%. It also has a good chunk in hedged assets and private equity. I don't like the sound of those words, but then again I like the term I Bonds....

 

[steelyman]

I wouldn't.
.

Neither would I. I have a lot of money in a stable value fund but I don't consider that an "investment". Rather, it's a 2008-inspired "won't get fooled again" pile.

 

[Alan]

15%, wow, that is interesting. I didn't realize a fund would have such a small allocation. I just checked mine and it's a little over 50%. It also has a good chunk in hedged assets and private equity. I don't like the sound of those words, but then again I like the term I Bonds....

It looks like ~50% equities is close to the average for Fortune 1000 companies. Possibly a cultural difference between the UK and US? (I have 2 UK private company pensions)

2012 Asset Allocations in Fortune 1000 Pension Plans - Towers Watson

 

[brewer12345]

15%, wow, that is interesting. I didn't realize a fund would have such a small allocation. I just checked mine and it's a little over 50%. It also has a good chunk in hedged assets and private equity. I don't like the sound of those words, but then again I like the term I Bonds....

Evaluating counterparty exposures like this is inherently challenging. I think you want to look at a couple of things I think are more important than the pension fund's asset allocation. First and foremost, how well funded is the plan? I would check how things look more recently as the level of long term interest rates affect the measurement of how well funded pension plans are. If the plan is reasonably well funded, you probably don't have much to worry about. The second thing I would be looking at is the condition of the pension sponsor and their interest in keeping the plan funded. Is the sponsor in good shape financially? If they are, is the pension still open to current employees or has the sponsor closed the pension and looking to minimize its exposure to the ongoing liability? I would say only if the plan is materially underfunded and you are unlikely to get any help from the pension sponsor to make it up would it be worth delving into what the plan assets are invested in.

 

[Alan]

Thanks for that Brewer, very interesting.