Asset Allocation (equity/fix ratio) is probably the most important investing decision. According to Larry Swedroe (Your Complete Guide to a Successful & Secure Retirement – Chapter 3) an investor should consider the following different tests:
- The ability to take risk
- The willingness to take risk
- The need to take risk
I suggest reading this chapter (and the whole book)
I think investment choice is more important than asset allocation, just my opinion. You could say, "I'll do a safe 60/40" but then put the 60 in penny stocks or a single company, and the 40 in junk bonds, and do very, very badly. Allocation percent, investing choices, asset location are all primarily very important things.
Regarding the natural, built-in risk tolerance that each person has, I think this free tool is pretty good: https://pfp.missouri.edu/research/investment-risk-tolerance-assessment
It's anonymous, best of all. Does require some degree of knowledge (stocks vs bonds, etc) but not a lot.
It's also not tied to anyone trying to sell you anything, i.e. RISA profile and annuities. Those tools will too often say, subliminally "The answer is.....buy our product!" No thanks.
I got a 31 on the risk-o-meter. I find myself thinking on these types of assessment questions - it depends, which of course you can't ask. Some of these questions are more like how dumb is your decision as opposed to your risk tolerance. Making a bad decision is different then making a risky decision. Yes I am over thinking it ????, but it was fun.
Here is an "independent" assessment of the recent accuracy (2012 vs 2022) Capital Market Assumptions for assets and the rate of return.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4184885
The author's Linked-In page is here: https://www.linkedin.com/in/michaelsebastian/
He appears to have recently served as the CIO at NextCapital: https://www.nextcapital.com/sebastian-announcement.html
NextCapital was acquired by Goldman Sachs in August 2022: https://www.nextcapital.com/goldman-sachs-completes-acquisition-of-nextcapital-group.html
The author's key takeaways:
- De-emphasize CMAs in the asset allocation process, in favor of starting with the market portfolio and then adjusting based on any (mostly qualitative) strong views and your circumstances and objectives
- Focus on the unique characteristics of your fund relative to others, as much as on market expectations
- Be aware of how the CMAs you use compare with industry averages. Where they are different, give consideration to why.
- Use CMAs to assess a variety of economic and market regimes and stress test
- Be cognizant of time horizon; avoid setting policy frequently using long-term assumptions, which is demonstrably suboptimal
Learn to love the CMAs; reality is that fund overseers need something, and imperfect forecasts are the best we have
See also: https://www.linkedin.com/pulse/you-matching-your-investment-time-horizons-most-funds-mike-sebastian/
Good job @wallace471 finding this article. SSRN.com is a very good source for research papers!
Other tidbits from the article:
Stocks have outperformed bonds reliably over fairly long periods—85% of 10-year periods since the 1920s, only
falling short in the Great Depression, 1973-74, and the Global Financial Crisis. So, the relatively stable positive
risk premium the industry tends to envision could hold reasonably true over the next 10 years, if we avoid a
catastrophe.
But most periods may feature bigger oscillations in equity return premiums than industry CMAs are likely to
anticipate. And for decisions between other risky assets, such as U.S. vs. non-U.S. stocks, the
instability and cyclicality of actual return premiums means that your results will be highly
dependent on the coming economic regime, and a stable expected risk premium is unlikely to be a
good guide.
And:
CMAs: what are they good for?
None of the preceding is meant to denigrate the process of creating capital market assumptions, which are
demanded and used by institutional investors worldwide. As mentioned, firms bring enormous intellectual capital
and resources together to build, and convey to investors, highly sophisticated and reasonable views on a wide
variety of complex asset classes.
The problem is that predictions, especially about the future, are difficult. Some providers of CMAs have gamely
conducted reviews of the predictive power of their own assumptions, found results similar to what is presented
here for the industry composite, and reminded the reader that they are meant to describe a range of possible
outcomes, not just a point estimate.
That is true, but many institutional uses of CMAs are on potentially shaky ground if the return estimates
themselves aren’t a good guide to the future.
Is a recession coming in 2023-2024? Depends on your definition of recession. Two interesting articles on this question. Article 1 https://www.usatoday.com/story/money/2023/01/06/what-is-richcession-explainer-recession-2023/11001191002/ talks about a richcession:
Lahart argues that a richcession could be brewing because household wealth for those at the top didn't grow as much as it did for those at the bottom, percentage-wise, over the course of the pandemic.
Wealth on the bottom grew as a result of stimulus checks and other government stimulus money as well as wage increases to try to keep up with inflation and attract workers in a historically-tight labor market. Wealth at the top, meanwhile, is stagnating because paychecks aren't rising and the stock market's decline over the past year is hitting the wealthier especially hard.
Lahart also points out that many of the layoffs that have made headlines are concentrated in tech, where workers often make six figures. For instance, the median worker at Meta earned close to $300,000 in 2021.
Working-class Americans, however, are in demand, albeit at much lower wages. That's part of the reason why 223,000 new jobs were added last month, bringing the unemployment rate to historic lows.
This isn't to say that a recession wouldn't be painful for low-income Americans. Inevitably, if there's a recession, they're likely to be impacted by layoffs as well. For many that will mean losing their health insurance, dipping into retirement savings to stay afloat and having to turn to friends and family for help.
So whether it's a recession or a richcession, it's worth taking the time now to prepare.
Article 2 includes a discuss about a "rolling recession" https://abcnews.go.com/US/wireStory/richcession-rolling-recession-recession-100434723
When different sectors of the economy take their turns contracting, with some declining while others keep expanding, it’s sometimes called a “rolling recession.” The economy as a whole manages to avoid a full-fledged recession.
The housing industry was the first to suffer a tailspin after the Fed began sending interest rates sharply higher 15 months ago. As mortgage rates nearly doubled, home sales plunged. They're now 20% lower than they were a year ago. Manufacturing soon followed. And while it hasn’t fared as badly as housing, factory production is down 0.3% from a year earlier.
And this spring, the technology industry suffered a slump, too. In the aftermath of the pandemic, Americans were spending less time online and instead resumed shopping at physical stores and going to restaurants more frequently. That trend forced sharp job cuts among tech companies such as Facebook’s parent Meta, video conferencing provider Zoom and Google.
At the same time, consumers ramped up their spending on travel and at entertainment venues, buoying the economy's vast service sector and offsetting the difficulties in other sectors. Economists say they expect such spending to slow later this year as the savings that many households had amassed during the pandemic continue to shrink.
Yet by then, housing may have rebounded enough to pick up the baton and drive economic growth. There are already signs that the industry is starting to recover: Sales of new homes jumped 12% from April to May despite high mortgage rates and home prices far above pre-pandemic levels.
And other sectors should continue to expand, providing a foundation for overall growth. Krishna Guha, an analyst at Evercore ISI, notes that some areas of the economy — from education to government to health care — are not so sensitive to higher interest rates, which is why they are still hiring and probably will keep doing so.
If the U.S. economy achieves a soft landing, Guha said, “we think these rolling sectoral recessions will be a big part of the story."
I like the rolling recession idea. I think the two articles show the resiliency of the US economy because of its great size and diversity, things other countries may not have. I bet you saw that coming from Pizza Man, the rogue ???? .
I believe the heresy of chasing performance on a quarterly basis, so in my most aggressive account I will weight any asset class as high as 45% in a quarter, including international growth, international value, and EM (along with standard US sectors).
This is only a small percentage of overall portfolio, so total exposure to EM is never close to 45%.
Latest (6/30/23) GMO 7-yr Real Return Predictions are out. Attached is a record of the prediction evolution.
See: https://www.gmo.com/americas/research-library/
Here is the Seven Great Challenges to Retirement Plans by Larry Swedroe:
https://www.advisorperspectives.com/articles/2023/08/07/insurance-stock-allocation-challenges-retirement-swedore?hsid=28216572&utm_campaign=AP Newsletters&utm_medium=email&_hsmi=269348208&_hsenc=p2ANqtz-_86N8LoHw0qid6eZYtcRfQaPp2Q7-t5SeK3E3DTS4WoGLqIm4XAgAs_BYRZbD0PyIk4Y_NtRZAA-jL5AJ8etbXebEGCA&utm_content=269348208&utm_source=hs_email
- Historically high equity valuations
- Historically low bond yields
- Increasing longevity
- Lower growth in corporate profits
- Lower GDP growth due to rising debt
- The risks of long-term care
- Failure to fully fund Social Security/Medicare/Medicaid
@hecht790 I requested the book by Larry Swedroe that you recommended from my local Library, was put on a wait list for 6 weeks, then informed me they no longer have the book ????.
Another good article by Larry Swedroe: The Underlying Difficulty in Forecasting Equity Returns
Because we must develop financial plans without the benefit of a clear crystal ball, we should use the best tools available. But when using these tools, the evidence demonstrates that we should have a healthy skepticism as to the accuracy of forecasts. We must be careful not to treat outcomes from models in a “deterministic” fashion. Instead, we should treat them only as the mean of a very wide potential dispersion of possible outcomes. As an example, I’m not aware of anyone who in 1990 predicted that through 2022, Japanese large-cap stocks would produce a return of just 0.2% per annum over the 33-year period.
Your comprehensive investment plan should include options you will exercise if the equity-risk premium turns out to be less than expected. You need to list actions you will take to prevent your plan from failing to meet its primary objective – that your assets outlive you.
https://www.advisorperspectives.com/articles/2023/07/31/stock-allocation-forecasting-equity-larry-swedroe?hsid=28216572&utm_campaign=AP Newsletters&utm_medium=email&_hsmi=269056412&_hsenc=p2ANqtz--9ubMPB1a2yh09lttMfJ5CBsg9A6JjpdU2QbkXcpa_gHk9_aRyHJu_FcWgC9EXjiWZWKbniTNFE63HTHYYMoJ2r48Inw&utm_content=269056412&utm_source=hs_email
@pizzaman Towards the very end of this article it says "The earnings yield on the Shiller CAPE 10 had risen from 3.1% to 4% by the end of March, raising the expected real U.S. equity return by 0.9%. However, the sharp fall in Treasury bond yields lowered the yields on the five- and 20-year Treasury bonds to 0.4% and 1.0%, respectively." Am I interpreting it correctly that Swedroe is indicating a 4% real ROR on equities? If so, that seems close to Bernsteins 4.5%
@nc-cpl Yes that's how I read it too. I've been playing around with 4.0%, 4.5% and 5.0% real ROR for my input into PRC. I think I will use 4.5% going forward. I don't understand his 5 and 20 year T-bond numbers though. Are not they around 4.4%?
He is referring to March 2020 during the COVID crisis not 2023 if I read it correctly.
My takeaways are:
1. Yes, future expected (mean) market returns have a lot of uncertainty. That is his point about starting conditions matter. Today equity valuations are high so maybe we should not use historical averages that have many cases that do not start at the current high valuations. Running monte Carlo simulations using appropriate standard deviation values helps us understand the possible outcomes.
2. We should update our expected returns as market conditions change. It is likely our portfolio has also changed in value when this occurs.
3. Have a plan B. I have incorporated my plan B into my plan A by annuitizing our pensions rather than taking them in a lump sum. This creates a secure enough income to almost eliminate the reliance on market returns to support my spending. One could consider buying secure income as well. You could also cut back on your spending, but do you really want to do that while you are in early retirement? You could use a bucket approach but that still relies on market returns to fill the early buckets. What other plan B's are there?
4. For all the reasons he states, we should not use historical average returns to be our base case for our expected future returns.
5. Not in the article, but maybe AI will bail us out!
5. Not in the article, but maybe AI will bail us out!
"I'm sorry, Dave, but I can't do that..." HAL, 2001
In addition to running Monte Carlo simulations I think you can still use historical data by picking dates that had high CAPE 10 ratios and plug them into PRC Historical Sequence Analysis on the Run Analysis page. For example you could use these starting dates:
Date CAPE RATIO
Aug 1929 32.56
Jan 1937 22.24
Oct 1965 23.93
Sept 1999 40.55
I like using Oct 1965, not only is the CAPE high but inflation starts to take off.
Sept 1999 is also interesting. On 9/20/1999 the S&P 500 was at 1,277. Today its at 4,369. Patience pays off.
Another way to reduce rick is to buy 20 year Treasure bonds which are now at 4.55%. They pay out semi-annually, and you can sell them in the future if you need the money before 20 years, and if rates are lower then, very likely, you won't have a problem selling them, win-win. @hines202 what do you think of that idea??
