The Worst Retirement Investing Mistake

[audreyh1]

The provocative title of an event more provocative interview with Efficient Frontier guru William Bernstein. It seems that he had a lot of clients bail out of the bottom in 2008, and not get back in, and thus suffer "permanent portfolio damage". And now he preaches the philosophy of keeping 20 to 25 years expenses of retirement assets in ultra-safe investments - cash, TIPs, annuities, very short-term govt paper. And only when you have a larger nest egg should you put money in riskier assets including equities. These riskier assets then should be only be counted on as "icing on the cake" i.e. for "play money":

I wanted to deal with what happened in the 2008 financial crisis, which changed how people, myself included, think about risk. A lot of people had won the game before the crisis happened: They had pretty much saved enough for retirement, and they were continuing to take risk by investing in equities.

Afterward, many of them sold either at or near the bottom and never bought back into it. And those people have irretrievably damaged themselves. I began to understand this point 10 or 15 years ago, but now I'm convinced: When you've won the game, why keep playing it?

How risky stocks are to a given investor depends upon which part of the life cycle he or she is in. For a younger investor, stocks aren't as risky as they seem. For the middle-aged, they're pretty risky. And for a retired person, they can be nuclear-level toxic.

from The Worst Retirement Investing Mistake - Yahoo! Finance

This article came out a month ago, and I didn't get a chance to post about it here on this forum. I hadn't really seen a discussion either, other than Midpack's recent reference on a more general SWR discussion: http://www.early-retirement.org/for...factors-that-affect-it-63218.html#post1235810 Some of us did discuss it there today, but since it's so buried, I wanted to make sure it got more general attention.

I participated in a Morningstar discussion on the article (which is where I learned about it): The Worst Retirement Investing Mistake - Yahoo! Finance

Bernstein's new approach appears to fly in the face of needing equities to hedge inflation risk over the long term for portfolio survival.

 

[cute fuzzy bunny]

I'm not so sure of that. If you have 20-25 years of expenses in ultra safe investments...why would you need or want to take on a lot of equity exposure?

Not to mention, most of the 'ultra safe' options listed are unlikely to produce a significant positive return at this stage, so perhaps Bill oughta rethink that strategy.

Sounds like "If you're stupidly rich, don't take on a lot of risk you don't need, and if you take on the risk be prepared to ride through the downturns without flinching". Seems the error here is taking on more portfolio risk than you can handle, buying high and selling low.

Don't do that!

 

[REWahoo]

I thought the idea was to stick with your allocation, rebalance and ride out market [-]crashes[/-] fluctuations. Those of us who did that in 2008/9 may have some mental scars, but came through without serious financial damage.

Bernstein seems to assume everyone was guilty of bailing out at/near the bottom and not getting back in. Sounds like his mental scars are pretty bad...

 

[Chuckanut]

If one's financial plan is to buy at various higher price levels and then sell at a low point, I do think one should follow his advice.

 

[audreyh1]

I'm not so sure of that. If you have 20-25 years of expenses in ultra safe investments...why would you need or want to take on a lot of equity exposure?

Not to mention, most of the 'ultra safe' options listed are unlikely to produce a significant positive return at this stage, so perhaps Bill oughta rethink that strategy.

Sounds like "If you're stupidly rich, don't take on a lot of risk you don't need, and if you take on the risk be prepared to ride through the downturns without flinching". Seems the error here is taking on more portfolio risk than you can handle, buying high and selling low.

Don't do that!

Yep. Agreed - this is really about taking on too much portfolio risk. I wonder, would a person who had, say, 15 years covered in safer fixed income, panic and bail out of their equities? Maybe not.

Usually 25 years expenses [less other retirement income] in retirement assets is considered the minimum one should have to retire, so I don't agree with not needing to have equity exposure just because you've amassed that much. Usually 30 to 33x expenses is considered the minimum amount needed to avoid equity exposure yet still not lose spending power due to inflation.

In the article he mentions short-term Govt. bills, etc. keeping up with inflation. But I'm pretty sure that hasn't been shown to be true, and it's certainly not true right now, and unlikely to be true for a few years yet. Usually, 20% equity exposure is considered the minimum needed for 30 year portfolio survival. I suppose if you have 20 years in short-term bills, cash, etc., and 5 in equities, you match that 20% equity exposure.

 

[photoguy]

I think his advice makes more sense for folks retiring in mid-sixties where 25 years of expenses will cover their life expectancy (with a small amount of equities to make up for longevity risk). Maybe not so applicable to folks who will ER a decade or two earlier than normal.

 

[ejman]

I suppose Bernstein's approach would make sense if we have something worse than the Great Depression lasting for the next 25 years but for the bump of 2008? I suspect most people that rode it out and rebalanced with a sensible allocation are probably at a higher NW point now than then.

 

[audreyh1]

I thought the idea was to stick with your allocation, rebalance and ride out market [-]crashes[/-] fluctuations. Those of us who did that in 2008/9 may have some mental scars, but came through without serious financial damage.

Bernstein seems to assume everyone was guilty of bailing out at/near the bottom and not getting back in. Sounds like his mental scars are pretty bad...

I assume his "mental scars" reflect his clients "mental scars" magnified.

Yep, to me his advice is based on the assumption that MOST people will bail anyway, and I don't think that's true. Plenty of people didn't, their portfolios recovered - if not completely, they recovered a lot. Degree of recovery would depend on the annual withdrawal rate as well.

 

[audreyh1]

If one's financial plan is to buy at various higher price levels and then sell at a low point, I do think one should follow his advice.

Yep. Essentially that's who his plan is for. I think he ignores a large group of investors that don't have that problem.

 

[cute fuzzy bunny]

Yep. Agreed - this is really about taking on too much portfolio risk. I wonder, would a person who had, say, 15 years covered in safer fixed income, panic and bail out of their equities? Maybe not.

Most people are lousy investors. My dad lives in an elderly retirement community. Here's what almost everyone did: invest in a high equity portfolio while in their 70's and 80's, panic when the market dropped and sold all the equities at the bottom, then languished for a year or two and bought back in after it was back up, and had to increase the equity percentage to try to make back what they gave up, since they no longer have enough money to last the rest of their lives.

Its apparently very hard for people to perform to "buy low, sell high".

 

[cute fuzzy bunny]

I suppose Bernstein's approach would make sense if we have something worse than the Great Depression lasting for the next 25 years but for the bump of 2008? I suspect most people that rode it out and rebalanced with a sensible allocation are probably at a higher NW point now than then.

What may be occurring to Bernstein is that like all the pretty charts in his books, the US is now a declining mature market and we can't count on the emerging/developing nation returns we had from explosive growth in the 1900's.

Most of the data we kick around starts right after the civil war (a really optimistic starting point, since nothing had anywhere to go but up after that) and followed that with emerging market/developing nation economies. We're obviously not that anymore, so the reliable and fitting data seems to start in the 60's or 70's.

So perhaps Bernstein is just conflicted about the fact that equity returns won't be that great going forward, certainly not as good as most of the historical data would indicate.

 

[MichaelB]

Short term treasuries historically had positive real returns. TIPs had fantastic real returns for the first decade. These two factors [-]may be[/-] are influencing Bernstein's view. From the interview

Even though interest rates are terrible right now, if inflation recurs -- as I think it probably will -- short-term bonds are a fine place to be, as are individual Treasuries or certificates of deposit. Since they mature soon, you can replace them quickly with newer, higher-interest bonds.

He is giving advice based on a macro forecast. If he is wrong the consequences could be bad. And the part about annuities? Even worse advice if his macro view comes true. Has he gone over to the dark side? Wonder what the Bogleheads have to say.

 

[DFA]

Buying company stock.

 

[audreyh1]

I suppose Bernstein's approach would make sense if we have something worse than the Great Depression lasting for the next 25 years but for the bump of 2008? I suspect most people that rode it out and rebalanced with a sensible allocation are probably at a higher NW point now than then.

We're almost 13 years since the beginning of 2000, and we have weathered two of the worst bear markets in a long while. It does seem hard to imagine that we might still have to go through another 20 or 25 years of "lean times". Another 10? Maybe, although that seems to be stretching it.

I start to conclude that 20 years is some kind of "panic threshold" - i.e. he noticed that if a client had at least 20 years expenses in some cash/TIPs/safer bonds, etc., the client was much less likely to bail out of his equity assets and cause "permanent portfolio damage". I wonder if that's where the 20 years actually came from.

 

[audreyh1]

Most people are lousy investors. My dad lives in an elderly retirement community. Here's what almost everyone did: invest in a high equity portfolio while in their 70's and 80's, panic when the market dropped and sold all the equities at the bottom, then languished for a year or two and bought back in after it was back up, and had to increase the equity percentage to try to make back what they gave up, since they no longer have enough money to last the rest of their lives.

Its apparently very hard for people to perform to "buy low, sell high".

That's very interesting anecdotal evidence. Pretty shocking really, but if that's the reality for the bulk of Bernstein's clients, then I can understand why his philosophy has "evolved" this way.

 

[Midpack]

Sounds like "If you're stupidly rich, don't take on a lot of risk you don't need, and if you take on the risk be prepared to ride through the downturns without flinching". Seems the error here is taking on more portfolio risk than you can handle, buying high and selling low.

"EFA's (Efficient Frontier Advisors - Dr Bernstein's firm) services are designed for very high-net-worth individuals and institutions (minimum portfolio size $10 million) who want to implement an efficient, low-expense asset-class-based strategy." And I would swear their minimum investment used to be $25 million (would sort of confirm he had a lot of clients who locked in their losses during 2007-08)! I considered investing with EFA after reading The Four Pillars of Investing when it was first published, but found myself many millions short of his interest in our portfolio. My DIY approach is based on Four Pillars still...

So as much as I appreciate Dr Bernstein's thoughts on investing/retirement/etc. (and will always read him with interest) - I often wonder if he's talking to a wholely different audience than me (and presumably most here in terms of net worth), or at least from the perspective of advising the higher net worth crowd. If we had $10 or $25 million, I'd definitely take less risk too!!!

 

[nun]

All this hand wringing amazes me.......I've been saving for 30 years and only in the last 10 did I even noticed the advice of gurus and wikis. The advisers like Bernstein seem to change with however the economic wind is blowing. Rather than emphasizing "safe investments" for the retired person, I'd emphasize them for young people so they can build a guaranteed income foundation and once that is set up then go onto more speculative things.

I started out by building a foundation of cash and a TIAA annuity. At 23 years old I was very conservative. I factored in SS, UK state pension and eventually a small DB plan. Those will provide 100% of my income needs in retirement as I LBYM. Once I knew that I built a 50/50 portfolio of index equity and bond funds. I've rebalanced through the highs and lows......with a bit if a 2008 wobble, getting out at DOW 10.5k and getting back in at DOW 7k. I also made extra principal payments on my 2 family house so that I am now mortgage free and getting $1200/month rent from the ground floor apartment. Diversity and a low risk foundation is the way to go when planning for retirement income

 

[audreyh1]

I am also disturbed by the language "having won the game, get out". Yes, there is definitely a different game after retirement than while you are working and investing for retirement. So yes, recognize that you're in a completely different game now and change your asset allocation accordingly. And the AA might even deserve to be tweaked while you age. But the "get out entirely" part ignores long term portfolio survival issues IMO.

 

[Midpack]

I think his advice makes more sense for folks retiring in mid-sixties where 25 years of expenses will cover their life expectancy (with a small amount of equities to make up for longevity risk). Maybe not so applicable to folks who will ER a decade or two earlier than normal.

Important distinction IMO, too often left unsaid. Age 65 retirement seems to tacitly underpin an awful lot of comments (even here where ER is presumably the norm) and the reader may not realize same...

 

[MichaelB]

I think his advice makes more sense for folks retiring in mid-sixties where 25 years of expenses will cover their life expectancy (with a small amount of equities to make up for longevity risk). Maybe not so applicable to folks who will ER a decade or two earlier than normal.

From the interview, it seems he is all for stocks until one reaches retirement.

Okay, so stocks are risky at retirement. What about when I'm young?
For the average person, you'll want a very high stock allocation. Let's imagine you start working at age 25, and let's say for the sake of argument you have 35 years worth of human capital -- that is, 35 years of salary left in you. That's an asset that you own. What you've saved in one year for retirement is still minuscule compared to that 34 years of earning and saving that you have left.

 

[Midpack]

I thought the idea was to stick with your allocation, rebalance and ride out market [-]crashes[/-] fluctuations. Those of us who did that in 2008/9 may have some mental scars, but came through without serious financial damage.

Bernstein seems to assume everyone was guilty of bailing out at/near the bottom and not getting back in. Sounds like his mental scars are pretty bad...

We stayed in throughout the meltdown and even rebalanced a little behind the curve. Ironically, the discipline to hold on for me comes largely from not wanting to pay income taxes, and less due to pure investing discipline. Same thing I did throughout the 2000 dot.com bust, I rode it out mostly to avoid income taxes. Whatever works?

 

[audreyh1]

"EFA's (Efficient Frontier Advisors - Dr Bernstein's firm) services are designed for very high-net-worth individuals and institutions (minimum portfolio size $10 million) who want to implement an efficient, low-expense asset-class-based strategy." And I would swear their minimum investment used to be $25 million (would sort of confirm he had a lot of clients who locked in their losses during 2007-08)! I considered investing with EFA after reading The Four Pillars of Investing when it was first published, but found myself many millions short of his interest in our portfolio.

So as much as I appreciate Dr Bernstein's thoughts on investing/retirement/etc. (and will always read him with interest) - I often wonder if he's talking to a wholely different audience than me (and presumably most here in terms of net worth), or at least from the perspective of advising the higher net worth crowd. If we had $10 or $25 million, I'd definitely take less risk too!!!

You've probably hit the nail on the head. "You're super rich, stupid, don't take any more risk." Those folks have truly won the game.

But then why isn't he saying - make sure you have 30 to 33 years in annual expenses, and then you don't have to own equities at all? Surely these folks have way more that 20 to 25 years expenses in assets. And if they don't (due to lavish expenses), they probably have a room to "tighten their belt" and still life a pretty lavish lifestyle. It's a bit hard to fathom these folks dealing with such serious portfolio damage that they are doomed to eating dog food.

In the interview he's clearly addressing the "common man" because he's talking to the guy/gal who "can't afford to retire yet" and needs to keep working and investing. It's hard to imagine telling someone with $25M under management that they can't afford to retire yet.

So perhaps the error is that he is extrapolating from his rich client base to the everyday person with a much more meager nest.

 

[Midpack]

I am also disturbed by the language "having won the game, get out". Yes, there is definitely a different game after retirement than while you are working and investing for retirement. So yes, recognize that you're in a completely different game now and change your asset allocation accordingly. And the AA might even deserve to be tweaked while you age. But the "get out entirely" part ignores long term portfolio survival issues IMO.

Coupled with "20 to 25 years worth of retirement assets" in ultra safe investments - I agree with you. If I had 100 years worth of retirement assets (or some unobtainable number), I might indeed "get out." But we have to continue to play the game, but at increasing lower exposure as we age.

 

[Midpack]

So perhaps the error is that he is extrapolating from his rich client base to the everyday person with a much more meager nest.

That's my guess, though you've stated it way more concisely than I did. He literally hasn't talked investing to anyone with less than $10 million for at least a decade. I am sure that would change my perspective...

 

[audreyh1]

Short term treasuries historically had positive real returns. TIPs had fantastic real returns for the first decade. These two factors [-]may be[/-] are influencing Bernstein's view.

I don't remember the average positive real returns for short-term treasuries or T-bills, but if they keep up with inflation, that would give you 20 or 25 years of inflation-adjusted withdrawals [depending on how much you started with], and then you will have spent down your portfolio. Most plans try to make a portfolio last at least 30 years, which is why they add an asset class that beats inflation pretty well over a long period of time.