Joe Tomlinson: Is investing in stocks still as attractive for retirees?

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Fremdon Ferndock
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Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Fremdon Ferndock »

Interesting article on the possible effect of lower equity risk premium on equity investing during retirement by comparing 60/40 to a "base case" portfolio consisting of a 100% TIPs ladder.
Forecasts point to lower future investment returns and, more specifically, to a lower equity premium return for stocks over bonds. If indeed we will experience a lower equity premium, how much lower of a premium will make stock investing unattractive relative to bonds? I’ll develop an example based on a retirement scenario to help us think through this issue.
There is the risk, as shown by the 10th percentiles, that cash flow over retirement could come in below the base case. Related to this risk are instances where the annual cash flow falls short of the base case, and these get worse with the reduced equity premium assumption. Finally, with variable withdrawals, there is the prospect of disruption due to cash flow bouncing around from year to year.
https://www.advisorperspectives.com/art ... -in-stocks
"Risk is what’s left over when you think you’ve thought of everything." ~ Morgan Housel
Leesbro63
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Leesbro63 »

I don't understand the above post, and the link doesn't work. But I do understand the subject. I've been asking a sort of similar but different question: Is investing in fixed income still as attractive for retirees".

To the original poster: If not stocks, then what?
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Fremdon Ferndock
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Fremdon Ferndock »

Just checked the link and it works for me. Tomlinson does a study that compares 60/40 to a TIPs ladder so that the reader can compare the possible pros and cons of holding stocks to the baseline of a TIPs ladder. Not recommending or advocating -- just providing some info to consider.
"Risk is what’s left over when you think you’ve thought of everything." ~ Morgan Housel
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firebirdparts
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by firebirdparts »

Well, you know, if you predict a drawdown every day, sometimes you'll be right. In drawdown, money in coffee cans outperforms equities. In a rising rates scenario, money in coffee cans outperforms bonds. This is nothing new, but what is new is that interest rates can't really drop all that far below zero, and we're in that area. There's some limit here on how future cash flows can be discounted. And really, it's all fundamentally true. And yet, you can't say "put all your money in coffee cans" is good investment advice. You can't say that even after a period of proven superiority.

Short term Tips are predictable, right? They are what they are.
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SGM
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by SGM »

Joe is looking at the increased risk due to expected lower returns on stocks. He is really looking at the risk for those who depend on stock returns and bonds was well as SS for their expenses. If an individual has other sources of income so that they don't have to sell stocks when they are doing poorly then they can survive a 30-year retirement without running out of money.

For those who depend only on SS and a portfolio for retirement income he suggests considering SPIAs. I have read several of Joe's studies of SPIAs.

I met Joe at the Social Security Research Symposia held at the National Press Building every year. I didn't start reading his research until he had already moved from Maine to the United Kingdom. Joe was introduced to me by Bobcat2 who has done a lot of work with various authors.

Joe's work has convinced me that setting up several income streams outside of one's portfolio is a good safety feature.
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Leesbro63 »

SGM wrote: Tue Jan 18, 2022 9:41 am Joe is looking at the increased risk due to expected lower returns on stocks. He is really looking at the risk for those who depend on stock returns and bonds was well as SS for their expenses. If an individual has other sources of income so that they don't have to sell stocks when they are doing poorly then they can survive a 30-year retirement without running out of money.

For those who depend only on SS and a portfolio for retirement income he suggests considering SPIAs. I have read several of Joe's studies of SPIAs.

I met Joe at the Social Security Research Symposia held at the National Press Building every year. I didn't start reading his research until he had already moved from Maine to the United Kingdom. Joe was introduced to me by Bobcat2 who has done a lot of work with various authors.

Joe's work has convinced me that setting up several income streams outside of one's portfolio is a good safety feature.
And how does an SPIA protect you in today's high inflation environment?
dbr
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by dbr »

The article quotes the TIPS ladder at 0% real yield. Today real yields on TIPS are much less than 0% Rather than getting a 3.33% safe withdrawal today's TIPS investor is down to more like 2.4%-2.7% If TIPS real yields would increase to 1% then the payout would be 3.8%.

A problem today is that there may be no place to run and no place to hide. But that is today; tomorrow may be sunnier.

I would not take an article like this too seriously.
Leesbro63
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Leesbro63 »

dbr wrote: Tue Jan 18, 2022 10:24 am
A problem today is that there may be no place to run and no place to hide.
Exactly! https://youtu.be/WR9pvGtyiHg
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Fremdon Ferndock
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Fremdon Ferndock »

dbr wrote: Tue Jan 18, 2022 10:24 am The article quotes the TIPS ladder at 0% real yield. Today real yields on TIPS are much less than 0% Rather than getting a 3.33% safe withdrawal today's TIPS investor is down to more like 2.4%-2.7% If TIPS real yields would increase to 1% then the payout would be 3.8%.

A problem today is that there may be no place to run and no place to hide. But that is today; tomorrow may be sunnier.

I would not take an article like this too seriously.
I don't think assuming a real yield lower than 0% changes the essential finding of the study -- which is that a lower equity risk premium makes stocks less attractive for retirees going forward. The expected return is lower, but the expected volatility and downside risk haven't diminished. I think that's worth considering. I think there may be better strategies than having a high equity allocation in retirement portfolios -- at least for people who don't have a great deal of discretionary income.
"Risk is what’s left over when you think you’ve thought of everything." ~ Morgan Housel
Zosima
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Zosima »

Fremdon Ferndock wrote: Tue Jan 18, 2022 11:06 am
I don't think assuming a real yield lower than 0% changes the essential finding of the study -- which is that a lower equity risk premium makes stocks less attractive for retirees going forward. The expected return is lower, but the expected volatility and downside risk haven't diminished.
I am not sure the equity risk premium is lower than its historical equity risk premium. The best source for historical equity risk premium I have found is Dr. Aswath Damodaran of NYU who has estimated historical equity risk premiums back to 1960. According to him, the current equity risk premium is 4.24%, which is higher than it was in the 1990s and early 2000s (pre GFC). I am not able to copy the chart, but one can find it by clicking on the link "2. Implied ERP (annual) from 1960 to Current" from the link below which will open an excel spreadsheet. The Tab "Implied Premiums" has a chart with the ERP going back to 1960.

http://pages.stern.nyu.edu/~adamodar/


The challenge is low bond yields which make absolute returns on everything low, which is compounded by assuming historical volatility of stocks during drawdown. Even with a 4.24% ERP as of 12/31/21, with a 10-year treasury of 1.51% as of that date, the total nominal expected equity return was 5.75%.

I agree with the author's conclusion however:

"Reacting to the prospect of a lower-than-historical investment returns and a lower risk premium from stock investing (sic) creates a dilemma for clients and advisors – whether to invest more heavily in stocks to increase expected cash flows and bequests or take a more defensive posture and reduce the equity allocation to hold down the negatives.

For practitioners, this analysis would need to focus on customized projections that reflect client specifics. For example, if a client has a solid base of lifetime income from Social Security and perhaps pensions or annuities, such income may be enough to cover basic living expenses and make it easier to tolerate a higher equity allocation for the investment portfolio. But if a client has more limited lifetime income sources, the negatives discussed above will loom larger, and the best approach might be to use a lower stock allocation. It may also be worth exploring delaying Social Security and other options such as an annuity (e.g., a SPIA) or setting up a reverse mortgage to provide more secure lifetime cash flow and reduce potential damage from poor investment performance."


FWIW, I am nearing early retirement in my 50s with a 60%/40% allocation. I am definitely not loading up on equities but there is also a significant risk of being underweight equities for a longer retirement.
Northern Flicker
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Northern Flicker »

Why would the market price in a lower equity risk premium? Did stocks become less risky?

Perhaps the author meant that stocks currently have an expected real return lower than historical real returns (just like more or less every other asset)?
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Fremdon Ferndock
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Re: Joe Tomlinson: Is investing in stocks still as attractive for retirees?

Post by Fremdon Ferndock »

gjlynch17 wrote:

I agree with the author's conclusion however:

"Reacting to the prospect of a lower-than-historical investment returns and a lower risk premium from stock investing (sic) creates a dilemma for clients and advisors – whether to invest more heavily in stocks to increase expected cash flows and bequests or take a more defensive posture and reduce the equity allocation to hold down the negatives.

For practitioners, this analysis would need to focus on customized projections that reflect client specifics. For example, if a client has a solid base of lifetime income from Social Security and perhaps pensions or annuities, such income may be enough to cover basic living expenses and make it easier to tolerate a higher equity allocation for the investment portfolio. But if a client has more limited lifetime income sources, the negatives discussed above will loom larger, and the best approach might be to use a lower stock allocation. It may also be worth exploring delaying Social Security and other options such as an annuity (e.g., a SPIA) or setting up a reverse mortgage to provide more secure lifetime cash flow and reduce potential damage from poor investment performance."



Thanks for noting the author's commentary. I had overlooked it, and it agrees with my thinking on the matter - specifically that retirees without a large cushion consider how to optimize alternatives to a large equity allocation going forward. Maybe not an easy path, but a prudent one.
"Risk is what’s left over when you think you’ve thought of everything." ~ Morgan Housel
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