Felix TV: Time to chill out

By Felix Salmon
August 5, 2011

Jason Varone was not impressed by this video. “I guess you don’t know anyone trying to retire?” he tweeted in response.

Actually, I do. But retirement isn’t — or shouldn’t be, in any case — a day on which you suddenly liquidate your entire stock portfolio and go from risky stocks to safe cash. As we get older and more risk-averse, we should hold fewer risky stocks and more safer bonds. (Although the idea that bonds are particularly safe is something you might want to reconsider, these days.) Retirement is the point at which you stop putting money into your retirement account — and therefore the point at which you stop buying more stocks. But not-buying isn’t the same as selling.

What’s the optimal asset allocation for someone who’s retiring right now? The answer there depends on a huge number of variables — whether you own your own home, what kind of a mortgage you have, what your monthly expenditures are, what kind of Social Security income you have, etc etc etc. But one thing I can say: the amount of stocks you have the day before you retire shouldn’t be vastly different from the amount of stocks you have the day after you retire.

Yes, there’s always a small number of people who are genuinely hurt by a big stock-market sell-off — people who for some reason have to sell now and who would in hindsight have been much better off selling a few weeks ago. But I don’t see a lot of forced selling in the market right now, and I don’t think there are all that many people in that position: while unemployment is still at very high levels, the amount of new unemployment — people being laid off, and forced to live on their savings — is quite low, and the economy is gaining jobs, not losing them.

As for the rest of us — the employed majority — we should just continue to dutifully put aside a chunk of money every paycheck, and invest it in the broad stock market. Sometimes our retirement account will go up, and other times it will go down. But over the long term, simply putting money in every month is the most important thing of all — that and not panicking when the market gets volatile.

15 comments

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The retirement problem isn’t whether you buy or sell yesterday or tomorrow. The problem is that the stock market has essentially treaded water for the last 10 years. I’ve heard a figure of one percent per anum over that period, and that includes dividends. Even if you have set aside a sufficient part of your income for much of your working life, it’s difficult to retire on those returns.

Posted by Curmudgeon | Report as abusive

Aren’t you conflating two incompatible concepts. There is no time diversification of risk. There is diversification across asset classes. Don’t invest any more in stocks than you can afford to lose at anytime.

Advice to “hold stocks for the long term” is pretty meeaningless. There have been long stretches of time when stocks have gone virtually nowhere and, actually lost value when inflation is considered. Look at the S&P from 1966 to 1982 – 16 years.

Posted by lynnlee007 | Report as abusive

“What’s the optimal asset allocation for someone who’s retiring right now?”

Difficult question… You might as well burn your savings for heat as put them in long-term bonds right now. Even if nobody ever defaults on anything, the promised returns are abysmal. Twenty year TIPS have a coupon under 1%, and the real return on conventional Treasuries might be even lower.

On the other hand, there is still a huge amount of trash baked into the stock indexes. If you buy an index fund right now, you are consigning a third of that money to stagnation, another third to mediocrity, and you’re hoping that the modest returns on the final third will keep the whole above water.

Lower your expectations. If you look for companies with a steady and predictable 4% real return (perhaps a 3% dividend and 1% real growth), you will find a few dozen candidates. Pick a dozen of those that you are most comfortable with and you will hit that 4% real return with ease.

I’ve averaged 8% returns on my retirement portfolio since January 2007 using this strategy, and while that was with near-ideal market conditions (the market crash in 2009 produced many dozens of high-quality companies guaranteeing my target 4% return), I see no reason why it shouldn’t continue to be successful.

So 80% high-quality equities, 20% cash/CDs/bonds with maturities of 1-7 years. Withdraw the dividends on the equities (3% of 80% is 2.4% of the portfolio) and a portion of the cash for a 4% total draw rate. Replenish the cash as stock market valuations permit, but with a 20% cushion there is never a need to sell in the middle of a crash.

Posted by TFF | Report as abusive

@TFF, you are speaking as one of the few non-financial professionals who are willing and able to spend a significant amount of time understanding finance and managing your portfolio. I, on the other hand, find it boring, tedious, and time-consuming, and have learned just enough to understand the terminology and hopefully make semi-intelligent choices. But I outsource the actual allocation to index and retirement-year funds. And they have generally (pardon the expression) sucked for the last decade.

I don’t know if you’re trying to turn everyone into someone like you, but it’s not going to happen. That’s why we have professionals, right? You can make the case that investing is too important to leave to the professionals, but saying that still won’t make me pay attention long enough to actively manage my own portfolio. Life is just too short for that kind of tedium.

Posted by Curmudgeon | Report as abusive

I like John Bogle’s books, index funds, my age in bonds, and all that … but I recognize that a bad decade can play hob with even that defensive plan.

The problem with this correction is that it comes in a bad decade, and that is something retirees should fear.

Posted by jpersonna | Report as abusive

Actually, my goal was always my age in bonds, but I’m light stocks because I also kind of trust Shiller’s PE10. That cuts me out of Bogle circles a bit.

But the PE10 kind of ties to my idea of good and bad decades.

Posted by jpersonna | Report as abusive

Curmudgeon, there are always choices in life, and I wouldn’t presume to make yours for you. I have never pretended that my way is the only way. It is simply the approach that works best for me, and one that some people may wish to consider.

You noted that you’ve seen zero returns from index funds over the last decade. I expect you will continue to see mediocre returns from index funds over the next decade. If you have enough savings to retire comfortably on that, then go right ahead!

But I don’t see any alternative for small-time investors that promises respectable returns over the next decade WITHOUT personal effort. Do you?

Posted by TFF | Report as abusive

Felix…

I’ve read at least 1,000 of your generally execelent posts… but this is by far the best. I espically like the following quote:

“one thing I can say: the amount of stocks you have the day before you retire shouldn’t be vastly different from the amount of stocks you have the day after you retire.”

-Pure gold!

You keep up the great work and I’ll keep telling everyone I know to add your blog to their regular reading. Have a great weekend!

Posted by y2kurtus | Report as abusive

Just a thought reguarding asset allocation. If you are a home owner in the northern U.S. with a 25 mile commute to and from work and an average size house how much money do you spend on oil every year?

My family spends about $6,000 which is probably about double the U.S. average. Because I love where I live and love where I work and the two places are 30 miles apart I’m a bit locked into that fuel spending unless I buy a prius (which is on my short list) or put in a solar thermal heating system (which would require cutting down lots of trees I like to look at.)

So what happens to me if energy prices double… then I’ve got to cut $4,000ish out of my discrecionary spending / savings budget… and even that assumes I cut back usage to the bone. That hurts and I’ll estimate that about 50 million Americans are in the same boat. My insurance is that I’ve got roughly 35% of my net worth in energy stocks. If rising prices crush my spending power at least that part of my portfolio doubles and on net I’m breaking even.

My boss who has tripple my expierience in the industry, who has pleanty to retire today but works by choice, thinks 35% in one highly volitile sector is to risky for clients. For my personal account though the risk of rapidly rising energy prices makes me think I can’t afford NOT to over allocate to that sector.

Like it or not the safest retirement decision you can make is to find work you enjoy and dealy retirement until it is forced upon you or until you have TWICE what you think you will need squirled away. Thats a tough pill to swallow but it beats eating cat food my friends.

Posted by y2kurtus | Report as abusive

Interesting point, y2kurtus. Matching portfolio to lifestyle makes a lot of sense (and is one reason to weight domestic stocks more heavily than foreign stocks).

Posted by TFF | Report as abusive

Curmudgeon, then expect to be ripped off if you can’t be bothered to learn anything about a major investment decision. Would you have sympathy for someone who bought a house sight unseen after telling the estate agent that he wants somewhere big and cheap?

Posted by Danny_Black | Report as abusive

The real problem is that the Boomers are starting to retire. They’ve been in their “gradual accumulate” phase for 30+ years, and the market has priced their demand in. As they shift to their “gradual liquidate” phase (when they try to live off their savings), it’s going to fundamentally change the supply and demand curves for pretty much all investment assets. This change could easily take the Dow south of 5,000 and keep it there for a decade or two; the Boomers’ overall market power is just that strong.

Posted by JayCM | Report as abusive

“This change could easily take the Dow south of 5,000 and keep it there for a decade or two; the Boomers’ overall market power is just that strong.”

That makes no sense whatsoever!

The Dow at 10,000 would represent a P/E around 12, i.e. an investment return of 8% even without growth. For the Dow to stay at that level for “a decade or two” would require massive wealth destruction — essentially burning the earnings for 20 years. I suspect you of pulling numbers out of of a hat?

At a sufficiently low P/E, earnings absolutely matter. A company with a P/E of 10 and zero growth can self-capitalize in a decade, eating its tail like the legendary Ouroboros!

It is very reasonable to expect P/E ratios to fall to historically low levels (from their present historically high levels) and to remain there for a decade or two as Boomers retire. It is very reasonable to expect global growth to slow as all of the major world economies age. But even without growth, the earnings ability of the multinationals will kick out a steady 6% annual “coupon” on their stock price. As P/E ratios fall, that coupon will rise.

Based on these assumptions, a Dow of 10,000 would be reasonable this year (anything lower would be a tremendous buying opportunity), and a Dow of 20,000 should be anticipated in roughly 10-15 years after that based on the ability of these companies to self-capitalize.

That’s not a great investment return, especially if inflation picks up, but it is a far cry from what Jay suggests.

Posted by TFF | Report as abusive

TFF,

You have a lot more faith in companies’ reported earnings than I do.

Posted by JayCM | Report as abusive

“You have a lot more faith in companies’ reported earnings than I do.”

Depends on the company, JayCM, but I suppose I do…

Posted by TFF | Report as abusive