Bernstein new book: Rational Expectations

[traineeinvestor]

I haven't read this book yet, but in other articles Bernstein argues that short term bonds should follow inflation and TIPs would obviously do so as well. I suppose one can get inflation adjusted annuities. Bernstein is US centric so maybe this (short bonds tracking inflation) doesn't happen where you are?

That may well be true - inflation is around 4% out here and the only bonds I can get which come close to at least matching that either involve (IMHO) material credit risk or an FX risk. If I want to match or beat inflation, I have to take some risks.

The local ibonds are okay if you get them on IPO but you can't get enough to be meaningful. As for what the banks sell as annuities out here in HK - they are belong in the same level of financial hell as insurance linked investments scams (basically not really annuities at all). I could buy overseas but (i) that adds an FX risk (ii) there is often a 30% withholding tax taken out of payments and (iii) the fees go up by a lot.

 

[clifp]

Assuming people were paying him to manage their money, I would assume his responsibilities included providing historical market perspective and setting expectations. Basically talking them off the ledge in 2008-09. Someone as intelligent and well-regarded as Bernstein couldn't convince his clients to stay in the market through the crash and subsequent +200% bull market? That doesn't sound right.

One thing that isn't quite adding up for me is that book is written for investing adults. A term which describes this forum about as well as anything. So if the majority of us managed to stay the course, maintain our AA, and most of all not panic and sell at the bottom, why do we need to do something different for the next crisis?

 

[tulak]

One thing that isn't quite adding up for me is that book is written for investing adults. A term which describes this forum about as well as anything. So if the majority of us managed to stay the course, maintain our AA, and most of all not panic and sell at the bottom, why do we need to do something different for the next crisis?

I think too much is being made of Bernstein's new recommendations. I haven't finished the book yet, but he clearly identifies three group of investors in the beginning. Most people on this forum fall into the 3rd category: "Those that have a coherent strategy and can stick to it."

Most of his clients probably fall into his group two. That's why he has a different recommendation for them. I think it's insightful for him to group investors into different categories, but we all have different risk tolerances and even being in group three can be uncomfortable. Just look back at the forum posts in 2008. And historically speaking, it could have been much worse and if it was, would all of us have stayed the course?

Otherwise, the book - so far - has had some good insights. It's not drastically different than his earlier writings, but there's enough new information to make it a worthwhile read. But I always appreciate an updated take on recent financial manifestations.

 

[daylatedollarshort]

I found some more on this topic on the Boglehead forum including some posts from Bill Bernstein in this thread:

Bogleheads View topic - Liability Matching Portfoloio

"I'd be careful about saying that three-fund wins sometimes, and LMP/RP wins sometimes, so it's a wash.

The key thing is the consequences of losing. When you "lose" with an LMP, you've got a few less luxuries or bequests. When you lose with the 3-fund in retirement, the consequences are much more dire.

Bill"

They've added some info to their wiki on a liability matching strategy as an alternative to the mutual fund approach, for those that are interested. The links to the wiki pages are in the above thread.

 

[gayl]

Bogleheads View topic - Liability Matching Portfoloio

"I'd be careful about saying that three-fund wins sometimes, and LMP/RP wins sometimes, so it's a wash.

Some people just like complexity ... sort of a 'game' to see if you can beat the indexes


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[brewer12345]

I wish I knew what percentage of investors 'stayed the course' vs those who panicked? I gather Bernstein was surprised at how small a group the former was, especially among his own client/investor 'discilples.'

I think you only need look at market history to get a good idea. If the heavy majority of [-]idiots with their lunch money in the market[/-] investors were not selling, the market would not have gone down like a two dollar hooker in 2008-2009.

As for Bernstein, I think his change of tune is for two reasons. First, he saw hordes of people who should have known better sell near the bottom. Second, with his new drumbeat he really stands out from the crowd. The latter is important if you are trying to run a business where everyone sounds the same.

 

[CaliforniaMan]

I think too much is being made of Bernstein's new recommendations. I haven't finished the book yet, but he clearly identifies three group of investors in the beginning. Most people on this forum fall into the 3rd category: "Those that have a coherent strategy and can stick to it."

Most of his clients probably fall into his group two. That's why he has a different recommendation for them. I think it's insightful for him to group investors into different categories, but we all have different risk tolerances and even being in group three can be uncomfortable. Just look back at the forum posts in 2008. And historically speaking, it could have been much worse and if it was, would all of us have stayed the course?

Otherwise, the book - so far - has had some good insights. It's not drastically different than his earlier writings, but there's enough new information to make it a worthwhile read. But I always appreciate an updated take on recent financial manifestations.

Indeed it could have been much worse. During that time I remember thinking to myself, this is probably the best buying time in my lifetime, on the other hand, there are some very unpopular political decisions that had to be taken in Washington, and if we took the wrong ones, this could indeed have turned out very badly. Luckily we squeaked through. I didn't sell anything but I didn't buy either, partly because of my age, nearing retirement, and partly because I had been 100% equities, but mostly because I worried that there was so much popular pressure to immediately balance the budget (from all the panicked equity selling crowd I guess), that the politicians would succumb and send us rolling into a long depression.

In hindsight it did turn out to be one of the best buying opportunities ever. But we were lucky and dodged that bullet. Will we continue to be as lucky next time? Remember the majority is panicked and selling, and they are voting and panicking the politicians at the very time we need cool heads. That is the really unpredictable part.

 

[haha]

Good Luck Everyone

First we quit the prime way that people have of making themselves economically secure, a job or business or profession.

Then we read gurus in order to find out how to live on next to nothing, and to make a watertight living without any source of earned income.

We have essentially exchanged an occupation that tends to work, for one that is completely unproven and judging by the consternation caused by Señor B's about face not even satisfactory to the guru's who are promoting it.

No retired person in the generations before me had ever heard of a liability matching portfolio, unless he worked in a bank or insurance company, and they all survived well enough and many of the older one's well enough with no pension and before SS was created, though SS was welcome when it came along.

And it doesn't appear top me that Bernstein even understands what a liability matching portfolio is. A human individual cannot accurately lay out the liabilities he will face, and at least in the current environment he could not find instruments to match his liabilities even if god told him when they would occur and how much they would be.

Ha

 

[FedExCourier]

Finally,I have finished this book. Although all of his mathematical equations and graphs can give me a headache by trying to think through this stuff (I need a personal tutor for his examples) I think he is trying to communicate to all of us who went through the GFC. Many young investors are scared of risk because of the GFC and many seasoned investors bailed because of the cry about the world ending! Risk is the only way young investors can get to their liability managed portfolio amount unless they can save a tremendous percentage of their salary. It sounds like Bernstein couldn't hold back the stampede of his investors bailing out so he is wrote this book as another option for the masses that bail if the market has a downturn.
He has some thoughts and recommendations in the last chapter of his book for mutual funds. I will gladly pass this book around to some younger coworkers for investing ideas and adding more tools to hitting retirement goals.

 

[samclem]

As for Bernstein, I think his change of tune is for two reasons. First, he saw hordes of people who should have known better sell near the bottom. Second, with his new drumbeat he really stands out from the crowd. The latter is important if you are trying to run a business where everyone sounds the same.

And I think he had a practical issue to resolve: His previous (good) books put him clearly on record as favoring a lot of equities (for most investors), so how could he now recommend to many of his clients a much lower-volatility portfolio (esp for the ones he suspected would bail out). Answer: Write a book with the new formula.

He already had a model portfolio he called the Coward's Portfolio. What's this new one called? The "New-Portfolio-That-Is-So-Bland-It-Makes-The-Coward's-Portfolio-Look-Racy" ?

 

[MooreBonds]

I don't necessarily agree with Berstein's approach (and certainly wouldn't pursue it myself) but 100% in Firecalc from a mixed equity portfolio is not as sure a thing as say a 100% success rate from inflation adjusted bonds (for the time-frame planned).

I think another reason that Bernstein likes the 20-25 years of fixed income is that his clients have sold out at market bottoms. But I think the ER board is unusual in that most here have the knowledge and temperment to be the 1 in 1000 people who can successfully invest on their own.

So why are Bonds the panacea compared to stocks, for those without the intestinal fortitude to stay the course when the price drops 20%-40%?

Do you realize what TIP funds or long-term treasury/corporate funds will do if you buy them now, and treasury rates rise up to 3%-4% real + inflation of 4%?

What will make that investor say "oh, it's a TIP ETF/mutual fund - I don't care if the NAV dropped 40% since it's a bond fund", versus substituting "stock" for "bond" in that sentence?

 

[daylatedollarshort]

Because you can hold TIPS to maturity and make 1% real or whatever you buy them at for the duration. He is not recommending mutual funds in general from what I have read except maybe short term bond funds that tend not to lose principal.

The advocates of this approach usually recommend ladders so you get a rolling average of interest rates for CDs or bonds, which usually run a percent or two above inflation. This is not a mutual fund type methodology. For a TIPS ladder you will not lose principal unless you sell prior to maturity.

 

[samclem]

(Quote form Bill Bernstein)
"The key thing is the consequences of losing. When you "lose" with an LMP, you've got a few less luxuries or bequests. When you lose with the 3-fund in retirement, the consequences are much more dire.

Bill"

Another way to "lose" with LMP is having to spend 5-10 more years in the cubicle. I think most folks would consider it a loss to die at your desk instead of having some years of free time.

 

[samclem]

For a TIPS ladder you will not lose principal unless you sell prior to maturity.

Those TIPS have a value, and it goes down just as surely whether the holder knows it or not. The adherents to this strategy could accomplish the same thing by buying TIPS ETFs/MFs, hold them for decades, and just not look at the statements.

 

[daylatedollarshort]

Another way to "lose" with LMP is having to spend 5-10 more years in the cubicle. I think most folks would consider it a loss to die at your desk instead of having some years of free time.

You have to decide what trade off point works for you. Many here can or have retired early and can still invest like this, so they are the ones who may benefit the most from this kind of methodology. Many here have other retirement income sources or high enough portfolios in relation to their spending to make this work and ER, too.

 

[daylatedollarshort]

Those TIPS have a value, and it goes down just as surely whether the holder knows it or not. The adherents to this strategy could accomplish the same thing by buying TIPS ETFs/MFs, hold them for decades, and just not look at the statements.

It is not the same. With ladders you hold the individual bonds to maturity and if you have planned it right you have some maturing each year for income. Bond funds never mature so you are never guaranteed of getting your principal back and the yield varies as pooled bonds are bought and sold. This is laid out in The Bond book by Annette Thau. There is a reason Bodie uses ladders and not TIPS funds. This methodology does not work with TIPS funds.

 

[gayl]

Because you can hold TIPS to maturity and make 1% real or whatever you buy them at for the duration. ... For a TIPS ladder you will not lose principal unless you sell prior to maturity.

You get the actual dollar back but not the 'real' dollar or the value of what a dollar will buy



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[MooreBonds]

It is not the same. With ladders you hold the individual bonds to maturity and if you have planned it right you have some maturing each year for income. Bond funds never mature so you are never guaranteed of getting your principal back and the yield varies as pooled bonds are bought and sold. This is laid out in The Bond book by Annette Thau. There is a reason Bodie uses ladders and not TIPS funds. This methodology does not work with TIPS funds.

....and between purchase and maturity, you're paying full-freight income taxes on the phantom income of inflation-adjusted principal increases, compared to tax-advantage capital gains or qualified dividends taxed at 0%-15%.

God-forbid the retiree is 'lucky' enough to get a decent 2% real return on those TIPs, because the tax bill could be a major budget item.

 

[daylatedollarshort]

....and between purchase and maturity, you're paying full-freight income taxes on the phantom income of inflation-adjusted principal increases, compared to tax-advantage capital gains or qualified dividends taxed at 0%-15%.

God-forbid the retiree is 'lucky' enough to get a decent 2% real return on those TIPs, because the tax bill could be a major budget item.

TIPS work best in retirement accounts. A liability matching portfolio strategy is not necessarily composed of 100% TIPS nor are TIPS usually recommended for taxable accounts. For your particular situation, they may not be a good choice at all. They might be a good choice for others. There are pros and cons to most asset classes.

 

[daylatedollarshort]

You get the actual dollar back but not the 'real' dollar or the value of what a dollar will buy



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Unlike nominal treasury bonds, the principal in TIPS is adjusted for inflation:

https://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_faq.htm#calculate

I don't know what you mean by not getting the "real" dollar back.

 

[FIREd]

TIPS work best in retirement accounts. A liability matching portfolio strategy is not necessarily composed of 100% TIPS nor are TIPS usually recommended for taxable accounts. For your particular situation, they may not be a good choice at all. No one is forcing you to buy any.

IIRC, Bernstein recommends munis, CDs, and short term treasuries in taxable accounts.

 

[samclem]

And it doesn't appear top me that Bernstein even understands what a liability matching portfolio is. A human individual cannot accurately lay out the liabilities he will face, and at least in the current environment he could not find instruments to match his liabilities even if god told him when they would occur and how much they would be.

Yes. But "Liability Matching Portfolio" sounds very comforting.

 

[daylatedollarshort]

A human individual cannot accurately lay out the liabilities he will face, and at least in the current environment he could not find instruments to match his liabilities even if god told him when they would occur and how much they would be.

Ha

If a retiree household has expenses covered from SS and COLA pensions, that works for a LMP. I think there are a number of posters here who do that now, without even adding in other inflation adjusted income streams.

The concept has its pro and cons, but so does the 3 fund mutual fund approach:

Matching strategy - Bogleheads

 

[haha]

If a retiree household has expenses covered from SS and COLA pensions, that works for a LMP. I think there are a number of posters here who do that now, without even adding in other inflation adjusted income streams.

The concept has its pro and cons, but so does the 3 fund mutual fund approach:

Matching strategy - Bogleheads

If retirees have those two pension sources, they have no problem. Do you have these? Me neither, though I have SS begun at 70. Still, that leaves a long haul between a truly early retirement and age 70, or whenever one takes SS.

It's those of us who are not protected by these flows that need to plan for this. Cullen Roche has an interesting book Pragmatic Capitalism, that makes the obvious but frequently ignored point that life happens at odd and unpredictable times.

Currently, without the questionable prospective returns of equity investments, what are we looking at? Perhaps real returns of 1%. And unless these are from TIPS or Ibonds, there is risk in these projections of real return, unless we use very short durations in which case the real returns are mostly negative. OK, say we are willing to work like crazy and live like no monk would likely live these days, and we and our equally monkish spouses are ready to retire at age 50 with $5million. Wohoo, easy street. But wait, 1% of $5million is $50,000. Well that is about 1/2 or what a King County Metro Driver pulls down, so as long as we are able to find our material needs at Goodwill, we're golden. Oh there is a spouse? Well $25,000 per cap isn't bad, after all we are only penta-millionaires. Shoulda saved more I guess.

One could treat the $5mil like a pot to be drawn down and spend more. That's the idea behind the annuity recs. But our guru fails to mention that it is impossible or nearly so to purchase a quality, indexed annuity.

I would rather throw my future into a mixed portfolio, which seems to be what he is currently fleeing.

Ha

 

[daylatedollarshort]

If retirees have those two pension sources, they have no problem. Do you have these? Me neither, though I have SS begun at 70. Still, that leaves a long haul between a truly early retirement and age 70, or whenever one takes SS.

We are able to use the LPM approach or else I wouldn't take so much abuse here for even bringing it up. I wish I'd heard more about it years ago.

This portfolio may not work for every poster here. It may not work for most posters here. But for some it might work much better than the 3 fund approach because it avoids this possibility:

"This is sequence of returns risk! People are more vulnerable to the returns experienced when their portfolios are larger because a given percentage change has a bigger impact on absolute wealth. 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: You Can't Control When You're Born... Revisiting Sequence of Returns Risk

Check out the maximum SS benefits and compare that to the Consumer Expenditure Survey:

https://faq.ssa.gov/ics/support/KBA...62+48+47+32+31+26+12+11+8+7+6+5+4&docID=13009

Households at the higher end might be able to live off SS alone. To ER they would only need to cover the years prior to SS benefits. Then pensions, safe assets returns, rental income, royalties, home equity might all add to the mix.