There was a place to hide in the perfect storm...

[NormR]

There's nothing wrong with your illustration. I was simply attaching some context to Norm's warning re: greater downside with more frequent data.

It also highlighted the danger of looking at your portfolio too frequently.

[George$]

...
If you are in the accumulation stage and can stomach the volatility and replace the lost capital from current earnings, then it's not surprising that you have no regrets. I submit though that as you near retirement or are in retirement, you're playing with fire if you don't have a fixed income component in some form. A DB pension, which is effectively fixed income, that covers most of your living expenses would allow you to have a far greater equity component. Risk taking should give way to risk reduction and elimination as you age.
...

Well said. I agree totally.
I am simply dumbfounded when I hear of stories from those at or near retirement - that they had all their retirement eggs in the equity basket - and no DB safety-net. Almost like totally counting on a lottery ticket for retirement income. (Apologies for a bit of hyperbole? )

[yielder]

I was looking for the equivalent of the -15.21% drop for a 25/75 portfolio. When it wasn't in the numbers you provided, I re-ran the numbers for myself. Now I don't know what the -15.21% tech bust number is.



These numbers illustrate what you would expect to happen: bonds dampen the impact of equity swings. While the ups are not as far up neither are the downs as far down.

I am simply dumbfounded when I hear of stories from those at or near retirement - that they had all their retirement eggs in the equity basket - and no DB safety-net.

I'm not. In fact, it's what I would expect to happen. Human nature is such that when market returns are good, there is no risk. As I said, sheep can smell a bear; we can't. Sheep knows what a bear means; we don't.

And the damage will continue. The future for investors burned by this experience won't be as good as it could be. A lot of people are not likely to go near equities again for a very long time. And they'll pay for that as well in continuous erosion of buying power as inflation eats into their GIC returns. 2% inflation annually over 20 years reduces your buying power by a total of +30%.

[DanH]

I was looking for the equivalent of the -15.21% drop for a 25/75 portfolio. When it wasn't in the numbers you provided, I re-ran the numbers for myself. Now I don't know what the -15.21% tech bust number is.

The -15.21% is simply the amount by which your PORTFOLIO #1 fell during the tech bust, based on monthly returns. See this post.

Then, in this post, I gave you the historical risk-return profile for the 75 stocks/25 bonds portfolio, which suffered a much worse loss than 15%.

Am I missing something or are we [s]talking[/s] posting past each other?

[northbeach]

Even for those who lost 'only' 10% of their portfolio plus 4% as SWR in 2008, the dollar loss is large enough to give those persons a pretty big scare. Also, 2007 was a negative or close to negative year for many.

So all may still be fine for only the most prudent, but what if 2009 turns down 30% from today's numbers?

[yielder]

There's nothing wrong with your illustration. I was simply attaching some context to Norm's warning re: greater downside with more frequent data.

It also highlighted the danger of looking at your portfolio too frequently.

Absolutely. You probably don't even want to look at it monthly or even use monthly data to calculate performance or variability unless you plan to rebalance monthly.

Am I missing something or are we [s]talking[/s] posting past each other?

Past each other. I missed the fact that you were using monthly numbers whereas I was using annual numbers. The difference though highlights the importance of looking at the right time measurement period. Using monthly stats is a bad idea unless you plan to rebalance monthly. Using monthly stats is a good idea if you are trying to get an idea of how rocky the ride might or might not be as you go along if you really must look at your portfolio on a [s]frequent[/s] monthly basis.

Even for those who lost 'only' 10% of their portfolio plus 4% as SWR in 2008, the dollar loss is large enough to give those persons a pretty big scare. Also, 2007 was a negative or close to negative year for many.

Recessions do occur. Look at 1981, 1990, and 2002. By mentioning SWR, I'm assuming that you are talking about someone in the withdrawal stage rather than accumulation stage. If that's the case, they shouldn't have a 50/50 portfolio. It's too risky unless they have a defined benefit pension that covers most of their expenses. Absent a DB component, they should be at 60/40 or higher depending on their age. Using the human capital approach, a 50/50 portfolio is appropriate for someone around 50, say 45-55, if they were planning to retire at 65. (If someone were planning to retire earlier, it wouldn't be appropriate.)

So all may still be fine for only the most prudent, but what if 2009 turns down 30% from today's numbers?

Before you get all antsy about down 30%, I think you have to look at the combination of bond and equity returns in a 50/50 portfolio that would lead to overall down 30% and think about what might cause them. Remember that it's unlikely that short rates are going up for the foreseeable future and that inflation isn't likely to be a problem until we get past the current deleveraging/asset deflation/economic contraction. Assume a 3% return on short term bonds. That means that down 30% would have equities down 57% next year from where we are now. If you think that's a possibility, best plan for it now.

[BRIAN5000]

Using the human capital approach, a 50/50 portfolio is appropriate for someone around 50, say 45-55, if they were planning to retire at 65. (If someone were planning to retire earlier, it wouldn't be appropriate.)

Now you tell me. I think my planning was a little suspect.

I think I was thinking if I retired at 52 I'd need a 50/50 to have income to 85.

[George$]

Zvi Bodie's take on safety
Point 1: Stocks are risky. Stocks are risky in the short run. Stocks are risky in the long run.
Point 2: The best and lowest risk investment going into retirement is TIPS (or RRBs in Canada)

[Arby]

George$, thanks for the link to the Zvi Brodie interviews. Another interview at the same link entitled "I love the stock market" is also worth a listen. Brodie talks about risk and the need to think about the consequences of worst possible results, rather than only focusing on average results.

[Taggart]

I'm not sure how valid it still is, since the paper was published in 1996 by York University finance professors Kwok Ho, Moshe Ayre Milevsky, and Chris Robinson.

Risk-adjusted Retirement

[yielder]

Using the human capital approach, a 50/50 portfolio is appropriate for someone around 50, say 45-55, if they were planning to retire at 65. (If someone were planning to retire earlier, it wouldn't be appropriate.)

Now you tell me. I think my planning was a little suspect.

I think I was thinking if I retired at 52 I'd need a 50/50 to have income to 85.

We did - 4 years ago.

[Shakespeare]

From the primer Table 2, from Bernstein's Four Pillars:

Code: Select all

Table 2.  Risk of Loss[a]
Maximum     Equity
Loss         Percentage
35%    80%
30%    70%
25%    60%
20%    50%
15%    40%
10%    30%
5%    20%
0%    10%

a. Bernstein, William, "The Four Pillars of Investing", p. 268.


My own maximum yoy loss of 20% has been reached twice, Nov. 20 and a week or so ago, and fits reasonably in this table (I started at 55:45 Equity:Bond). Peak-to-valley is somewhat greater than yoy, but I don't track that separately, although I track yoy on a rolling 12 month/11-month-plus-current day basis (corrected for withdrawals).

[BRIAN5000]

Using the human capital approach, a 50/50 portfolio is appropriate for someone around 50, say 45-55, if they were planning to retire at 65. (If someone were planning to retire earlier, it wouldn't be appropriate.)

Now you tell me. I think my planning was a little suspect.

I think I was thinking if I retired at 52 I'd need a 50/50 to have income to 85.

We did - 4 years ago.

I was only kidding thats why the LOL.

Write yourself an investment policy, using this template. Very conservative investors should probably have 75% of their portfolios in fixed income like GICs or bonds or preferred shares and 25% in equities. Very aggressive investors should have 20-25% in fixed income and the remainder in equities. If you're in the middle, a 50-50 or 60-40 mix is quite reasonable.

1) could someone attempt to fix the link to the IPS template
2) I choose the 50-50 as stated above
3) Read shakes primer ok with a 20 % downturn in equities, oh did he say portfolio, crap.
4) Now when things settle down, if and when, prepare for a future 50% downturn in equities after writing a new plan.

[Norbert Schlenker]

I started the thread because there have been comments here that there was no place to hide.

Hmmm. Sounds like something I said, because that's exactly how I felt in November.

I got nailed because I don't believe short bonds work for me. My wife and I are both 52, so we have a loooooong time horizon. Better than 80% of our portfolio is taxable so we have a strong preference for dividends. I'm not particularly good at ignoring volatility, so our asset mix is basically 50/50. To get that, I used (and still use) preferred shares but the shellacking late last year was very hard to take. Much of it has been reversed since, likely because a lot was tax loss selling, so I'm feeling more comfortable but by no means bullet proof.

We continue to take these risks because the after-tax spread versus short term bonds is unbelievably high. (Yeah, yeah, I'm getting what I deserve. )

Not all bonds are in the same sort of pricing premium relative to equities as gov't bonds at this time. Long corporate bonds now yield 7.6% which provides the investor with a 400 basis point risk premium over long Canadas. By moving some of the equity exposure over to corporate bonds, you might be able to have your cake and eat it too.

That may be true now but I'm not so sure it would have felt any better than my own approach last year. Spreads blew out on corporates too. I doubt that ride was much more pleasant than the one I took.

[BRIAN5000]

Norbert you still out of the US totally, stocks and currency?

TWU Pension Plan Allocation

[yielder]

I don't believe short bonds work for me. My wife and I are both 52, so we have a loooooong time horizon. Better than 80% of our portfolio is taxable so we have a strong preference for dividends. I'm not particularly good at ignoring volatility, so our asset mix is basically 50/50. To get that, I used (and still use) preferred shares but the shellacking late last year was very hard to take. Much of it has been reversed since, likely because a lot was tax loss selling, so I'm feeling more comfortable but by no means bullet proof.

We continue to take these risks because the after-tax spread versus short term bonds is unbelievably high. (Yeah, yeah, I'm getting what I deserve. )

I would have looked at prefs if they'd been in the database. I suspect that they would have performed closer to long term bonds rather than short term bonds because of their longer duration. When you choose prefs, you're essentially making a tax-advantaged longer bond bet. When the inevitable jacking of interest rates comes in response to dealing with the inflationary consequences of the current ongoing stiumulus, I'm sure you'll be quick enough to time your way to safety. If you don't, 52 is [s]still[/s] nearly young enough to get a reasonably good job.

"Unbelievably high"? Don't we all know better than the market. Sometimes we get it right and sometimes we don't. 50% in prefs is a pretty hefty bet in a fairly illiquid asset class not to mention some of its equity characteristics.

WADR, I think you're reaching for return although that's not necessarily a bad thing if one has no choice such as leaving it too late to prepare financially for retirement. I know that doesn't apply to you but I want to qualify the reaching for return comment a bit.

[Norbert Schlenker]

Norbert you still out of the US totally, stocks and currency?

No, I started nibbling again. (I said so somewhere in the What Did You Buy thread.) I'm still not back to policy weight and I still won't keep my cash in USD but I'm back on the bus.

When you choose prefs, you're essentially making a tax-advantaged longer bond bet.

Agreed and I was willing to do that. The duration never bothered me and I was willing to take a 20% hit if rates rose 1%. Inflation was a concern but not an immediate one. What churned my stomach was that Canadian long rates declined, but credit spreads blew out, then tax loss selling went crazy, and I was looking at losses of 30-40% on some of my holdings.

At first I was in a terrible funk. How could I have been so incompetent? By December, I had calmed down but the market was so nuts that I spent a few weeks doing tax loss trades. I figured if I could swap, book the loss, pick up a few beeps in yield (pretty easy then because things were so ragged), and end up with a fancy credit rating and yielding 9% - tax advantaged - and well under any possible call price, it was a no lose proposition.

Now I have a different problem. I can't even do swaps any more to pick up yield. The gains from the Nov-Dec lows are huge: 20-30% is not unusual. I can't trade mispricings, say to pick up 0.1% in yield, because I would lose multiples of that to capital gains tax.

If you don't, 52 is [s]still[/s] nearly young enough to get a reasonably good job.

Hmmm. Planting potatoes in my future? My back already hurts.

[yielder]

I can't trade mispricings, say to pick up 0.1% in yield, because I would lose multiples of that to capital gains tax.

Think of it as a positive. If taleb is on the other side of the option trade, what are the chances that Mr. Hymas is on the other side of your pref trade? At worst, you'll save the bid/ask and the roundtrip commission.

If you don't, 52 is [s]still[/s] nearly young enough to get a reasonably good job.

Hmmm. Planting potatoes in my future? My back already hurts.

It's always good to have a basic, barterable skill.

[adrian2]

The gains from the Nov-Dec lows are huge: 20-30% is not unusual. I can't trade mispricings, say to pick up 0.1% in yield, because I would lose multiples of that to capital gains tax.

What's that, capital gains tax? Habla Espanol?

After all the tax loss harvesting you did, still worried about paying CG? Lucky you!

[couponstrip]

If you are in the accumulation stage and can stomach the volatility and replace the lost capital from current earnings, then it's not surprising that you have no regrets. I submit though that as you near retirement or are in retirement, you're playing with fire if you don't have a fixed income component in some form. A DB pension, which is effectively fixed income, that covers most of your living expenses would allow you to have a far greater equity component. Risk taking should give way to risk reduction and elimination as you age.

These comments reminded me of a passage from one of the more interesting books I have read in the past three years called Against the Gods: The Remarkable Story of Risk by Peter Bernstein. While not a personal finance book, the interesting tour through history's scholars who addressed risk is fascinating, and occasonially draws examples and parallels to capital markets. In the middle of the book, Bernstein is discussing the normal distribution and its use in risk management. He indicates that there "is impressive evidence that stock market returns are normally distributed". He discusses monthly returns in the S&P500 over 840 months from 1926-1995 (it's a bit of an older book, first published in 1996). The mean monthly change in value of the stock market was 0.6%. Corrected for this "upward bias", the market returns quite remarkably organize themselves in the normal distribution.

Looking at the uncorrected data, the "superswings" of -11% or +12.2% monthly returns (defined by monthly movements greater than 2 standard deviations from the mean) occurred with greater frequency than the normal distribution would define, creating "untidy bulges" at the far left and right sides of the curve. Moreover, of the 33 superswings, "21 of them were on the downside; chance would put that number at 16 or 17. A market with a built-in long-term upward trend should have even fewer disasters than 16 or 17 over 816 months." Bernstein goes on to conclude:

"At the extremes, the market is not a random walk. At the extremes, the market is more likely to destroy fortunes than to create them. The stock market is a risky place."

I believe this may be what Shakespeare is referring to when he talks about "left tail risk". It is even more alarming when you consider that several of these down months can/tend to occur in succession. This passage continues to stick with me two years after reading the book as something to respect when my spouse and I approach the red zone (10-15 years before retirement), and most definitely something to respect once we are retired.

BTW, that was/is a great exchange between yielder and Norbert above which I hope not to interrupt. I suspect that you two are quite capable of sharing personal stories and debating strategy in private (and may do so), so I wanted to express my appreciation that you elected to do it publicly. I learn a lot from your discussions and debates.

[Shakespeare]

I believe this may be what Shakespeare is referring to when he talks about "left tail risk"

Exactly. If you plot the returns on a graph and compare them to a "normal", or Gaussian, curve, you will find that the left side in particular is a poor fit at the edges, as it is both higher (greater probability of loss) and longer (greater magnitude of loss) then the standard error function predicts. This type of distribution is a major trap for the unwary.

[deaddog]

Hmmm. Planting potatoes in my future? My back already hurts.

Maybe you should take up trading. 20 to 30 % gaiins even after CG tax is better than planting potatos and easier on the back.

[Norbert Schlenker]

After all the tax loss harvesting you did, still worried about paying CG? Lucky you!

I needed the losses (and then some) to cover this mistake. (In hindsight, not a terrible mistake, as I would have ridden POT all the way down to where it is now.) I have no way to shelter the gains since the preferred swaps.

Maybe you should take up trading. 20 to 30 % gaiins even after CG tax is better than planting potatos

1) I'm crap at trading.
2) The gains I can't realize approximately offset last year's losses on what I swapped out, so I'm not really ahead.

[adrian2]

I needed the losses (and then some) to cover this mistake. (In hindsight, not a terrible mistake, as I would have ridden POT all the way down to where it is now.)

You can count your blessings - on the date of your "mistake" it was around $200; now it's less than half that; the tax due next April would have been 0.5 x MTR x ($200 - ACB per share) x number of shares, your +3 good karma has saved you much more .