Why not 100% stocks all the way?

[Leonardo]

Hello everyone,

I've been reading lately a lot about portfolios, "time diversification" and asset allocation. According to books like "Stocks for the long run", the efficient frontier for periods of 20 years or so are very different than the "normal" graphs that I normally see. In fact, in 20 years, 100% stocks have an expected return of almost 7% while the SD is +-3%. In the minimum risk portfolio the return is a little above 5% for a SD of +-2.5%. You sacrifice almost 2% of return to decrease only 0.5% of the SD! Does that make any sense?

I mean, after reading all those texts I can't find a reason NOT to invest 100% in the stock market IF:

- You want to go for the very long-term (15-40 years)
- You can sleep at night watching 50-70% drawdowns

I've been reading some articles (like this one) criticizing the book, but the arguments in my opinion are not valid, because:

1- I know that dealing with the very long term, although the volatility of the expected returns decreases, the range of where you may end increases, like if you invest 1k you can end between the big range of 7k-112k in 40 years. I don't know how this makes the idea less interesting, because even 7k is still a 5% return, but you have a far better probability to end with a substancially bigger amount.

2- The probabilities. They argue that there is a 10% chance of stocks returning less than bonds in 20 years, and that the shortfall of only 2% means 50% less in 20 years, etc. etc. But what about the whooping 90%, where you normally end with something like 5x than if you had invested 100% bonds? Where do you want to stay, in the 90% or in the 10%?

I mean, if in a 20 year time horizon stocks have a BIGGER expected return and LOWER volatility than bonds, why invest in bonds at all if you want to stay in the market for that long? Why invest 10 or 20% in bonds to decrease the volatility somewhat at a huge expected return cost (remember a small difference in 20 years becomes a huge one)?

I know that everything can be different in the future, in fact the 20y return of the S&P 500 is now lower than bonds (unlucky 10% I mentioned above), but I can't see a better strategy than having a 95% chance of having the best returns (more $$$ means lower % of withdrawal, which is safer).

BTW, I'm a little confused of how to apply this "theory" with the withdrawals after retirement, because you neither stay fully invested (because you use 3% of your initial portfolio, for example), neither you sell everything at day 1.

 

[Notmuchlonger]

Ha! Damn took less time than I thought.

 

[walkinwood]

Sure! Why not? Do it with money you don't need for 20 years.

But if you are retiring, remember to remove the money you need to live for 20 years. Assuming, you start with $1M, invest the funds you need for the next 20 years into a TIP Ladder yielding 2.5%% REAL, you'll need to reserve $639,156 for your the ladder. That leaves your $360,844 to invest in your 100% stock portfolio.

That leaves you with a 36% stock, 64% bond portfolio.

Next year, you need to take what you'll need for your 21st year from your stock portfolio and buy a 20 yr TIP bond, and so on......

I haven't a clue what happens to portfolio survival if you follow the above method, but think of a scenario where 2008 is your first year.

 

[Leonardo]

Ha! Damn took less time than I thought.

Thanks for your insightful post, because of it I don't have any more doubts!

 

[Notmuchlonger]

Thanks for your insightful post, because of it I don't have any more doubts!

Well when things are really bad you don't get these kinds of posts. Maybe its a bullish signal for the market.

Yeah I think you got all the bases covered.

 

[FANOFJESUS]

I guess now would be a good time to start with the market down about 40%, but I would have trouble sleeping at night.

 

[free4now]

I personally have always been more aggressive than most; I was 100% in equities most of my working career, and even used a very small amount of margin for a while. That worked out well enough for me, but I accepted the risk of losing big.

The key is to do lots of soul searching about just what your risk tolerance is; it is perfectly reasonable in my mind for someone working who doesn't NEED to retire on a particular day to go 100%.

I loaded up on bonds when I retired and I'm very happy about that. Being 100% in the stock market while retired is insane in my mind. The only people that makes sense for are the truly rich, like 10 million plus. And if you have that much money why bother with the stock market at all; you can get your needs met with much safer options like bonds or even an annuity.

 

[Bimmerbill]

I'm still about 80% equities. But I have two gov't COLAd pensions to anchor my plans. Still 14+ years from retirement, 20 from age 62 social security.

 

[CyclingInvestor]

I am 50, retired 2.6 years now, and still (virtually) 100% equities, as I have been most of my adult life. I only own individual stocks, no finds/ETFs. They are virtually all in IRAs, where they generate enough dividends to cover the 72t withdrawals that I live on (no pension). These withdrawals approximately match my old take-home pay - actually a bit higher now, since my health insurance is less than my now paid-off mortgage was. I generally have about 2-4% in cash depending on where I am in the 72t transfer cycle.

The recent market gyrations have caused me no grief. The market value of my portfolio got hit just like everyone else, but earnings and dividends keep rising, which is what I actually care about. I do spend time tracking my watchlist of about 30 stocks, and trade between them when they get relatively under/over-valued, but I enjoy this.

 

[unclemick]

Billy and Aikasha? S&P 500?. They've been ER'd for a long time.

Greany? The founder of the Retire Early Homepage - although I'm not sure any more? I believe 100% stock was at least the horse he rode in on.

More than one way to skin a cat. But but but - ya need to watch yer TWD. .

Sometimes when I think myself smart - I Google up and reread William Bernstein's 15 Stock Diversification Myth.

And try to get/keep a grip - like Dirty Harry in - 'do ya feel lucky----- well do ya.'

Heh heh heh - low priced 'bargin periods' like now are real hard on the hormones. Football is coming. Hurry up and wait.

 

[Animorph]

I'm nominally 100% equities. In 2007, before I retired, I put about 3 years, including college expenses for one son, into cash, and added about 15% in gold and bearx hedges. You could pretty much see the recession coming by then, though certainly the depth of it was a surprise to me. I ended up putting most of the cash and hedges back in as equities dropped, ending up with 2 years of expenses in cash as of late 2008. I've been playing the peaks and dips with ETF's using HELOC borrowed money since the markets reached about 50% down (since I ran out of available cash by then).

The only thing I feel bad about when the market hits bottom is not having more cash to buy with, so my risk tolerance is compatible with 100% equities. Barring evidence of a new bear market in the future, I will try to take cash out when stocks are exceeding my retirement needs. Otherwise I'll just sell equities as needed without a specific cash allocation.

 

[CuppaJoe]

....

I mean, after reading all those texts I can't find a reason NOT to invest 100% in the stock market IF:

- You want to go for the very long-term (15-40 years)
- You can sleep at night watching 50-70% drawdowns


....

My 100% in equities, which I held for about 17 years before diversifying, is very very different from someone else's 100% equities, for instance, someone who owned a house during those same 17 years. Whatever equities I held then and hold from now on would fit your two criteria.

 

[Mill]

theres no rule that says the market has to go up...

 

[CuppaJoe]

theres no rule that says the market has to go up...

"There oughta be a law."

 

[kumquat]

I've been retired for almost 2 years. 85% equities/15%cash.

5 years+ expenses in cash.

40% of equities in a single stock.

Down 25% from the peak and up 40% since I retired. YMMV

 

[samclem]

I mean, after reading all those texts I can't find a reason NOT to invest 100% in the stock market IF:

- You want to go for the very long-term (15-40 years)
- You can sleep at night watching 50-70% drawdowns

I would add:
" - You are sure now and will remain sure that the next 40 years will not have a period significantly different from the historical pattern".

I added the italicized part because you need to imagine your emotions and second-guessing during a downturn if you are retired. If your stocks have gone down 70% in 3 years, will you really be confident that you aren't seeing something very different from what has happened before, that the problems aren't systemic rather than just a normal business cycle? How could you (or anyone) truly know for sure? Would you really want to sell your badly beaten down stocks to buy food--an eventual recovery of the share price won't help your portfolio recover if you've already sold the share. Would you be less likely to panic and sell your shares at a low price if you had some cash to let you pay your bills for a few years? These are some of the reasons people keep some cash and bonds in their portfolios. Despite what the pure numbers might say, when you take into account human nature and the real world in which we live, many people get better returns from a 80% stock portfolio than they would have gotten with 100% stocks.

 

[Nords]

Spouse and I each have a federal govt pension with a COLA. I have mine now, she'll get hers in 2022. So we keep our portfolio over 90% in equities, with two years' expenses in cash, and no bonds.

In fact, in 20 years, 100% stocks have an expected return of almost 7% while the SD is +-3%. In the minimum risk portfolio the return is a little above 5% for a SD of +-2.5%. You sacrifice almost 2% of return to decrease only 0.5% of the SD! Does that make any sense?

You have to believe that history will repeat itself. Mathematically there's no particular reason that the 21st century should be any better or worse than the 20th, let alone in America.

- You want to go for the very long-term (15-40 years)
- You can sleep at night watching 50-70% drawdowns

We've done that twice in one decade now! And lemme tell you, it's an emotional drag. We don't worry about becoming homeless or shopping for Friskies, but it seems like such a waste of a good charitable donation.

Today we're watching our portfolio recover and trying to pick a good point to start taking some off the table. I can't pretend that we've solved that conundrum either, but we're going to be a lot less willing to let things run to ridiculously high valuations.

1- I know that dealing with the very long term, although the volatility of the expected returns decreases, the range of where you may end increases, like if you invest 1k you can end between the big range of 7k-112k in 40 years. I don't know how this makes the idea less interesting, because even 7k is still a 5% return, but you have a far better probability to end with a substancially bigger amount.

Investor psychology is very risk averse. It's no problem getting an unexpectedly high return, but it's a very big problem if one bladk swan takes away your retirement. As for that range of returns, take a look at the bottom side. Kotlikoff & Burns point out that the longer you're in the market, the more opportunity you're giving it to deliver a black swan. In other words, the longer you're in the market, the more certain you are to get hammered. CuteFuzzyBunny's famous analogy is running back & forth across a four-lane interstate highway with a paper bag over your head. Nothing bad happened the first couple times!

2- The probabilities. They argue that there is a 10% chance of stocks returning less than bonds in 20 years, and that the shortfall of only 2% means 50% less in 20 years, etc. etc. But what about the whooping 90%, where you normally end with something like 5x than if you had invested 100% bonds? Where do you want to stay, in the 90% or in the 10%?

The math underlying the probabilities makes a few assumptions that are necessary for the mathematical analysis to work, let alone to work correctly. For example, two assumptions are that returns are relatively symmetrical (when the fact is that they're skewed about the median) and that they display "log-normal" behavior about that bell-curve shape (the fact is that the data has fat tails). Hardly any book ever mentions those problems because they're so eager to dive into the subsequent "analysis", despite the fact that they might actually just be picking through garbage.

So again the question is not whether you want to be rich, but whether you can stand to be poor.

I mean, if in a 20 year time horizon stocks have a BIGGER expected return and LOWER volatility than bonds, why invest in bonds at all if you want to stay in the market for that long? Why invest 10 or 20% in bonds to decrease the volatility somewhat at a huge expected return cost (remember a small difference in 20 years becomes a huge one)?

Again we're hoping that past is prologue, and bond volatility is irrelevant if (like most bond investors) you're holding to maturity or invested in a widely diversified portfolio (bond fund).

What you see as a huge cost is perceived by risk-averse investors to be a cheap insurance premium. Giving up a few percent a year to a financial advisor who can't deliver market-beating returns is a waste. But giving up that same amount to avoid the really bad numbers is probably worth not working for the rest of your life.

I know that everything can be different in the future, in fact the 20y return of the S&P 500 is now lower than bonds (unlucky 10% I mentioned above), but I can't see a better strategy than having a 95% chance of having the best returns (more $$$ means lower % of withdrawal, which is safer).

Take a look at Milevsky's "Are You a Stock or a Bond?" book. He used to be dead-set against annuities because of their gimmicks & costs, but in this book he strongly advocates annuitizing against longevity and "black swan" events. Or take a look at Raddr's hapless Y2K investor, who's been slavishly following a 4% "safe" withdrawal rate through the subsequent runup & meltdown. (And IIRC, that portfolio is just 75% S&P500.) Or look at Greaney's series of articles on "real life returns" of various portfolio strategies.

So one "better" strategy would be to annuitize a portion of your portfolio to support a poverty-level retirement. Another option would be to invest in a more widely diversified equity portfolio of dividend-payers, internationals, small-cap, and value stocks. An even better strategy would be to add other (so far) non-correlated assets like REITs and commodities.

And best of all, perhaps you'd want to sit on 2-5 years' expenses in cash to ride out the downward volatility. No one has any trouble handling the upward volatility.

BTW, I'm a little confused of how to apply this "theory" with the withdrawals after retirement, because you neither stay fully invested (because you use 3% of your initial portfolio, for example), neither you sell everything at day 1.

Those plans keep running afoul of reality. The most recent innovation has been a variable withdrawal scheme like Bob Clyatt's 4%/95% plan in "Work Less, Live More"... and a willingness to seek part-time employment when necessary. Or take a look at Kotlikoff/Burns' ESPlanner consumption-smoothing software.

 

[brewer12345]

I typically have 90% or more in equities with relatively high concentrations in single issuers or sectors, but I am now closing in on 35% bonds. This is for an unusual reason, though. I actually drew down a chunk of money on my HELOC to fund the purchase of investment grade bonds trading at historically high spreads and which offer equity-like returns with much less risk. Once these appreciate or mature, I will go back to chasing return wherever I find it, be that stocks, bonds, derivatives, etc. But here is the important part: I know my risk tolerance and it is quite high. Yours may or may not match mine and figuring out exactly what your risk tolerance is can be difficult. It also changes over time and the changes can be slow enough that you suddenly wake up one morning to the realization that you are terrified of your portfolio. So high equities (or anything else) may suit you, but spend a lot of effort thinking about your risk tolerance before you conclude that this is the case.

 

[Steve O]

Firecalc says Im OK for 42 years at 99% success with 35% stocks and 3% draw so why take any unnecessary risk

That assumes 3.5% inflation, if inflation goes higher than that I might have problems

I wonder how TIPS will react to some real inflation

Im locked in my old company's 401K until July and Im 30% stocks right now waiting for another correction to buy more...

When I roll it all over to Vanguard I might go 40%, that's about all the risk I can take

Im still looking to marry a Sugar Momma, just in case

 

[ziggy29]

If you are VERY sure won't need the money for 25 years or more and you have a cast-iron constitution and can sleep soundly at night even if a jackhammer is operating 20 feet away, by all means go 100% into equities.

I believe recent events have convinced quite a few of us that our ability to withstand such stomach-churning volatility was not as great as we thought it was, say, two years ago.

 

[FUEGO]

Currently 100% equities during accumulation phase. May tone it down a bit as I approach the target portfolio goal sufficient for ER.

I have considered staying essentially 100% equities during ER (plus a year or so in cash for living expenses). But that is due to ER (hopefully) coming at a very early age (late 30's or 40-ish).

Now that I know what it feels like to experience a 50+% drop in my portfolio, I have reconsidered the 100% equities route but may still end up with something like 80-85% equities with the remainder being in cash/bonds/CD's sufficient to fund 5 years of living expenses. I will probably have a withdrawal rate that is tied to current portfolio value, and it may be less than 4%. The result is that the dividend yield from the equities component plus the interest yield from the fixed income component will be almost enough to pay my withdrawal rate in perpetuity without tapping the equities too much. In really bad markets (like now) the capital portion of the fixed income component can be consumed if dividends or interest drop too much.

 

[Hamlet]

I'm 36, and outside of an emergency fund, I am 100% equities.

This downturn has convinced me that I will want some bonds in my portfolio when I retire.

I've got quite awhile before that occurs, though, so I'm continuing with 100% equities.

My emergency fund has gotten larger though

 

[FUEGO]

Also consider that a paid off house can be viewed as a bond in a way. I know this may be contentious to some and to a certain degree is just semantics. But the imputed rent you receive from a paid off house is a certainty. It is a roof over your head. Some would say not having a mortgage just lowers your expenses, hence allowing a lower withdrawal rate (or smaller portfolio). Either way, one less fixed expense could help to allow 100% equities more easily since you won't be forced to pay a mortgage payment when the equities are doing particularly poorly.

I hope this doesn't revive the pay off the mortgage debate.

 

[ziggy29]

Also consider that a paid off house can be viewed as a bond in a way. I know this may be contentious to some and to a certain degree is just semantics. But the imputed rent you receive from a paid off house is a certainty. It is a roof over your head.

Agreed. I personally don't put my paid-off house anywhere in my AA, but I also recognize that the cash I have "allocated" in buying the house displaces what would otherwise be an outflow of about 7% of the home's value each year in renting it. In that sense it would be cash-flow equivalent to owning a bond in the amount of the home's value, getting a tax-free 7% on the bond's interest and using that income to rent the house.

Of course, there would be additional expenses above and beyond equivalent "rent" like taxes, insurance and maintenance. For me, these costs have been about 2.5% of the market value per year. So in a total cost of ownership sense, you lose 2.5% of the yield to these expenses so you could almost look at the house as equivalent to owning a tax-free bond yielding 4.5% after expenses. Again, I don't do it this way, but in some sense it we rented instead of bought, this would be the equivalent scenario in terms of cash flow if we rented.

I hope this doesn't revive the pay off the mortgage debate.

Ditto. I grow weary of the "payoff mortgage or invest" debate as well as the "rent or buy" debate.

 

[Leonardo]

Thanks everyone for your posts. So the conclusion that I came is that we should all go for equities in the very long term if we can handle the brutal market swings, because it has lower volatility and higher return in the end.

I'm really confused of how to apply this "principle" in my future early retirement. The "normal" asset allocation after retirement (60/40, etc.) is misleading because it uses the risk/return of stocks/bonds in a 1 year horizon, while you only use 3-4% of it in 1 year. However, I can't go 100% equities once I retire because for example in 5 years I will be using a part of my portfolio, and in 5 years the volatility of stocks are still pretty high.

I am convinced that buckets are nothing more than "mental accounting", but what if I use a different asset allocation for each year all the way to 15 years and after that 100% stocks? Than I would sum everthing and see the final asset allocation.

For example, in year 1 let's assume I will use 40k during that time. I would make a graph and would try to get the allocation with the most return per volatility. I assume it would be something like 40% stocks 60% bonds.

For year 2 I would use 41.2k (3% inflation) and look the historical expected returns and SD for 2 years. I would make a graph (already very different from the graph of year 1) and would try to get the allocation with the most return per volatility. Etc. Etc. Etc.

Is that reasonable? Am I speaking non-sense?