Why invest retirement funds in stocks?

By Felix Salmon
May 6, 2010
Eddy Elfenbein's response to Scott Adams, who thinks that a good simple retirement portfolio can be wholly made up of just two ETFs, one domestic and one emerging-market.

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I love Eddy Elfenbein’s response to Scott Adams, who thinks that a good simple retirement portfolio can be wholly made up of just two ETFs, one domestic and one emerging-market.

Elfenbein responds with a great question: why not just invest the whole thing in Treasury bonds? After all, I’m pretty sure that Scott Adams doesn’t have a great degree of certainty about the magnitude of the equity premium over the next decade or three, and the first priority when it comes to retirement funds is that you don’t lose them. Right now, with a eurozone crisis looming, it’s entirely conceivable that we could see a rerun of the stock-market panic we had in 2008 and a return to Dow 7,000 — or even lower, if the U.S. and European authorities find themselves without the fiscal and monetary ammunition that they had last time around. In any case, the point is that we’ve been there before and we can be there again, and if that’s a possibility that’s unacceptable to you, then you shouldn’t invest in a 100%-stocks strategy.

Of course, there are risks to government bonds as well, especially long-dated ones, as Jim Chanos loves to explain. But if Treasuries take a tumble, you need to be a very nimble investor indeed to outperform in some other asset class.

My feeling is that if you’ve got a nest egg which you want to keep safe for retirement, then investing it in the highest-yielding TIPS you can find is probably as good a strategy as any. You won’t get rich that way, but at least you’ll be protected against stock-market losses and against inflation. On the other hand, if you don’t have enough money for retirement and you need serious positive returns on your investment, then you’re going to have to start speculating. Either that or going out and earning more money.

Most people, I think, overestimate their risk appetite, and only realize when it’s too late that they really couldn’t afford to lose that money after all. Which is why right now in many ways is a better time to sell stocks for retirement and put the proceeds in something safe like TIPS, than it is to buy stocks for retirement. If you were sickened when the stock market was at its lows and promised yourself that you would be much more cautious in future, then now’s probably as good a time as any to take advantage of the big run-up that we’ve seen in stocks and rotate into something which allows you to sleep well at night. Unless you enjoy investing — and few of us do — I see no great reason to jump with both feet, Scott Adams style, into this increasingly unpredictable and senseless market.


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Problem is – where are those high-yielding TIPS? In the next couple of years you’re almost certain to have a negative real return on them, and thereafter is anybody’s guess. As high risk, me thinks, as splitting investment in some ETFs (as stocks perform not badly in a high-inflation environment), some high-quality variable rate bonds, real estate, and TIPS for insurance. And short term at least, cash also promises higher real returns than many other asset classes.

Posted by Abulili | Report as abusive

Agree the market is senseless and the past decade has shown poor returns.

Most investors like to look at the longer term picture. The downside to that is we are not going to have another post WWII bull market that lasts for decades – and thus, that longer term is deceptive.

To me the compromise is to still own stocks, but to protect those assets with options. Losses are limited. Alas, gains must also be limited – otherwise the cost of portfolio protection is immense.

If we assume a loner term upward bias – however small, doesn’t it make sense to participate when an investor can own protection against significant losses?


Posted by MarkWolfinger | Report as abusive

Boston College Center for Retirement Research has an issue brief out on this that supports your conclusion re TIPS for the “risk free” portion of the portfolio of most households. They have also put their money where there advice is. BC’s 401K default allocation places a high proportion in TIPS.

The Case for Investing in Bonds During Retirement. http://crr.bc.edu/briefs/the_case_for_in vesting_in_bonds_during_retirement.html

Posted by maynardGkeynes | Report as abusive

@Abulili, TIPS guarantee real returns > 0. The real returns on offer in the current market are punk, under 2% long term, but they’re not negative. How the quack can you have a negative real return on a government-guaranteed real return product? Answer: you can’t.

@MarkWolfinger, buying collars necessarily gives up the large, lumpy returns that stock investments tend to deliver. Having sold off your lumpy upside in return for protection from the lumpy downside, you might well end up underperforming even the spare 1.8% real returns that 30-year TIPS offer.

@maynardGkeynes, that study is for retired people, where I’d say a TIPS ladder to guarantee a life-expectancy’s worth of minimum income is indeed a no-brainer. The question here is for younger folks.

Me, I started buying equities and equity-like positions in late 2008 and scaling back in mid-2009. Valuation matters, but if reasonably valued in the long term equity positions should outperform TIPS. That said, there are periods (the tech bubble, when valuations were stretched and TIPS delivered 4% real returns springs to mind) when 100% TIPS makes sense even for those very far from retirement.

Posted by wcw | Report as abusive

@ACW Thanks. The BC study indeed focused on retired households. But really, most people have very little to invest until they are nearing retirement anyway (say, over age 50), so I’d say that TIPS are an answer for them too. FWIW, I saw Michal Lewis speak recently, and he is probably nearing 50, and he said he has all of his money in TIPS, FDIC savings banks and “a little bit with Warren Buffet” because he seems to have an edge.

Posted by maynardGkeynes | Report as abusive

Sorry wcw, your answer is not correct. TIPS only offer real returns if a) you bought at face value (hard to do if you buy in an overbought secondary market) and b) the government does not default over the life of the bond. Now, how likely is that?

Posted by Abulili | Report as abusive

“investing it in the highest-yielding TIPS you can find is probably as good a strategy as any”

What you really want to do is build a Treasury or TIPS ladder (as wcw notes). i.e. divide your nest egg to buy one year, two year, etc. out to however long you want to go and reinvest as bonds mature. This allows you to not be over-committed to a really bad choice of term/interest rate.

This is a very common conservative investment strategy.

Posted by csissoko | Report as abusive

@csissoko: laddering Treasuries might make sense, laddering TIPS less so. The main advantage of TIPS is that they allow you to go long duration without inflation risk. When you ladder, you lose this. Yes, you still bear the risk with long TIPS that real rates could rise, but that’s true of any bond. TIPS are a unique form of insurance, which should be mandatory for retirees, because inflation has ruined far more retirements than tight money (rising real rates) ever will.

Posted by maynardGkeynes | Report as abusive

@Abulili, you are a freaking idiot. One, the US is not 16th-century France and will not default over the life of these bonds. Two, face value has nothing to do with real returns; if there is inflation, TIPS will adjust up and deliver. Three, not that it matters much, but TIPS are available at auction from the Treasury for free so you can always buy in at face value.

There is a lone gotcha with TIPS, which I think in your addlepated way you were trying to note. If there is deflation during the period you hold your TIPS, “[t]he principal is adjusted downward, and your interest payments are less than they would be if inflation occurred or if the Consumer Price Index remained the same.” [Treasury FAQ] This is, of course, still a positive real return.

“[A]lmost certain to have a negative real return” still has me laughing at you. It is quite literally impossible to have a negative real return on TIPS unless the US defaults. Not improbable — impossible.

Posted by wcw | Report as abusive