Portfolio and retirement concepts - valid or not?

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Poe22
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Portfolio and retirement concepts - valid or not?

Post by Poe22 »

I admit I've fallen into a deep rabbit hole regarding portfolio and retirement concepts. The more I read about them, the less I seem to know. Before I go nuts: Is there any common ground among Bogleheads regarding the following questions? If not, what's your personal opinion?

a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?

b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?

c) Is the concept of "safe withdrawal rates" valid or faulty?

d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?

e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?

f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?

g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.
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SimpleGift
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Re: Portfolio and retirement concepts - valid or not?

Post by SimpleGift »

Poe22 wrote: Thu Sep 22, 2022 12:25 pm Before I go nuts: Is there any common ground among Bogleheads regarding the following questions?
The questions you've asked are all key to personal portfolio design and construction. However, to be a do-it-yourself investor, one can't rely on the opinions of others to answer them. The answers are all personal, personal, personal.

The Bogleheads Forum is an excellent resource to learn the ins-and-outs of portfolio construction, since there are at least two sides to every issue and question under discussion. But in the end, you need to decide for yourself what is right for you. It's the only way you can land upon a portfolio design that you will understand completely, and be able to stick with through thick and thin.
sailaway
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Re: Portfolio and retirement concepts - valid or not?

Post by sailaway »

For most of your questions, the more complicated solutions do not consistently perform better.

We have been 70/30 since just before we achieved FI and plan to maintain that allocation for the foreseeable future. We focus on tax efficiency when placing bonds in 401k vs stocks in Roth IRA and taxable (except ibonds, of course).

I read regularly, have skimmed through ERN's series, watch the Money Guy on YouTube, etc and just have not found a compelling argument to change anything going forward.
bloom2708
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Re: Portfolio and retirement concepts - valid or not?

Post by bloom2708 »

I'll give you my opinions:

a) Living off 2 or 2.5% dividends is just a very low withdrawal rate. Total return, sell shares as you need cash

b) Take as much risk as you need, that may translate to less stocks and more fixed income as you age.

c) 3.5% is safer than 4%, etc. "safe" is relative. Most will have too much left at the end.

d) Age - 15 or so still seems to apply. I am 51 and we are 65/35. If you have a pension that covers 100% of spend, your answer may be different.

e) Rising rates certainly brings other "fixed income" into play. Bonds were never risk free, but decades of falling interest rates made it seem that way.

f) REITS are in the Total US stock index. Gold and Commodities are not required. I stay away.

g) A target mix + 5% rebalance bands gives you some float during bad times and good times. Some choose to only rebalance on the up swings. Lots of room here for the "personal".

You may disagree with all my answers. That is the "personal" in personal finance.
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Re: Portfolio and retirement concepts - valid or not?

Post by seajay »

Poe22 wrote: Thu Sep 22, 2022 12:25 pmf) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?
Image
(clickable image)

Comparing TSM/TBM 60/40 to SCV/Gold 60/40 and the former had the better Sharpe ratio, but the lower SWR PV MC for 60/40 TSM/TBM versus PV MC for 60/40 SCV/Gold. So no, better Sharpe needn't reflect a better/safer WR. More volatile assets such as SCV instead of TSM, Gold instead of Bonds, isn't necessarily higher risk - subject to your definition of risk.
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Re: Portfolio and retirement concepts - valid or not?

Post by vineviz »

Poe22 wrote: Thu Sep 22, 2022 12:25 pm a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?
Usually, because they have - by definition - different objectives. But most people manage their portfolios in a slow transition, from one to the other.

Poe22 wrote: Thu Sep 22, 2022 12:25 pm b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?
Asset allocation glide paths are sensible during the transition phase from accumulation to decumulation. After retirement, asset allocation should probably be static.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
c) Is the concept of "safe withdrawal rates" valid or faulty?
The concept is valid. Implementation is tricky.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?
In decumulation, it's probably "good enough".
Poe22 wrote: Thu Sep 22, 2022 12:25 pm e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?
Yep.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?
No, Sharpe ratios (especially historic ones) are basically useless.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
A risk parity portfolio is just a particular flavor of fixed asset allocation. There are lots of risk parity portfolios.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.
Most people peddling "risk parity" portfolios don't know much about retirement planning. Or economics.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Poe22
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

Thanks for your inputs guys, very helpful! I'm sincerely lost in all the portfolio options there are to choose from.

@Vineviz: Appreciate! I've added my answers in italic
vineviz wrote: Thu Sep 22, 2022 3:39 pm
Poe22 wrote: Thu Sep 22, 2022 12:25 pm a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?
Usually, because they have - by definition - different objectives. But most people manage their portfolios in a slow transition, from one to the other.

The objective usually being? Less volatility for a retirement portfolio, as opposed to just staying with the accumulation portfolio?
Poe22 wrote: Thu Sep 22, 2022 12:25 pm b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?
Asset allocation glide paths are sensible during the transition phase from accumulation to decumulation. After retirement, asset allocation should probably be static.

Ok, but that's more of a psychological crutch to avoid too much volatility, right? In certain years you might end up better just switching directly from accumulation to decumulation?
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
c) Is the concept of "safe withdrawal rates" valid or faulty?
The concept is valid. Implementation is tricky.

Ok, but SWR are derived from backtesting alone, aren't they?
Poe22 wrote: Thu Sep 22, 2022 12:25 pm d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?
In decumulation, it's probably "good enough".

That's comforting :happy
Poe22 wrote: Thu Sep 22, 2022 12:25 pm e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?
Yep.

Ok, so you don't think that adding any other asset class to cover these periods might help?
Poe22 wrote: Thu Sep 22, 2022 12:25 pm f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?
No, Sharpe ratios (especially historic ones) are basically useless.

Sounds reasonable, but basically destroys the risk parity concept, I believe :)
Poe22 wrote: Thu Sep 22, 2022 12:25 pm g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
A risk parity portfolio is just a particular flavor of fixed asset allocation. There are lots of risk parity portfolios.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.
Most people peddling "risk parity" portfolios don't know much about retirement planning. Or economics.

So what do you think are the faults of the risk parity concept?
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Beensabu
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Re: Portfolio and retirement concepts - valid or not?

Post by Beensabu »

Poe22 wrote: Thu Sep 22, 2022 12:25 pm I admit I've fallen into a deep rabbit hole regarding portfolio and retirement concepts. The more I read about them, the less I seem to know.
Isn't it fun?
Before I go nuts:
Oh, you're definitely going to go nuts. You fell into the hole. It's a given. Welcome.
Is there any common ground among Bogleheads regarding the following questions? If not, what's your personal opinion?

a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?

Yes.

b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?

Yes and no.

c) Is the concept of "safe withdrawal rates" valid or faulty?

Valid.

d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?

It's an asset allocation that makes sense for some people.

e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?

Sure. The only other thing I have is a mortgage. You can have other stuff if you want.

f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?

They might if they persist into the future, which they might not.

g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.

I don't know. I'm just starting to explore the concept of risk parity. But it would mean I would have to change my AA, and I don't want to do that. Maybe later, in a pre-designated "reallocation green light year", which won't be for awhile.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
KlangFool
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Re: Portfolio and retirement concepts - valid or not?

Post by KlangFool »

OP,

If your portfolio is big enough, any AA between 70/30 and 30/70 would work fine. If not, you can play all kind of game and it won't matter.

So, is your portfolio big enough?

My AA is 60/40 at 30X with 2X in the emergency fund (not part of my portfolio). When I withdraw social security, it would be 60X. So, pretty much nothing matter to me. If I cannot retire, it is no longer a financial problem.

What is the size of your portfolio?

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Trance
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Re: Portfolio and retirement concepts - valid or not?

Post by Trance »

bloom2708 wrote: Thu Sep 22, 2022 3:04 pm e) Rising rates certainly brings other "fixed income" into play. Bonds were never risk free, but decades of falling interest rates made it seem that way.
I wanna weigh in on this because I had an epiphany recently with regards to the low performance bonds the last decade or so compared to stocks. The performance of equity has been unprecedented. Large cap domestic growth stocks have been beating everything. Mid/small, value, and international are all behind.

And I personally think this is because of the unprecedented low interest rate in America. Securities have had record low performance and savings accounts barely return anything. Its exactly the inverse of equity.

Equities out performance has been just as unprecented as the low performance of securities. Its easy to look at recent history and think this unusual time is the norm but its not. I don't mind the fact that my bonds aren't doing well because stocks have been outstanding.

To not invest in bonds would be market timing.
60% VT 40% BNDW (no bonds in Roth)
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Beensabu
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Re: Portfolio and retirement concepts - valid or not?

Post by Beensabu »

KlangFool wrote: Sat Oct 01, 2022 8:29 pm If your portfolio is big enough...

So, is your portfolio big enough?

What is the size of your portfolio?
I think you're awesome, but this is not helpful.

The people who can save enough can do whatever they want and it's fine.

It's the people who think they can't save enough that get suckered into silly shenanigans. This doesn't help them.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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Poe22
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

Beensabu wrote: Sat Oct 01, 2022 8:11 pm g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.

I don't know. I'm just starting to explore the concept of risk parity. But it would mean I would have to change my AA, and I don't want to do that. Maybe later, in a pre-designated "reallocation green light year", which won't be for awhile.
Thanks for taking the time to respond, very much appreciated. And yes indeed, it is great fun! In fact, I'd love to have 2 weeks of holidays right now just to dig even deeper into the rabbit hole.

As to the risk parity concept: I've found it to be fascinating, and I've learned a ton about the characteristics of different asset classes and subsets of asset classes by diving into it. Basically, I had hoped it might help finding asset classes / subclasses which do well when stock and bonds don't. Also, RP-Radio's (see next section) claim is that RP-portfolios can outperform 60/40 portfolios in retirement (when withdrawing from them), by providing higher SWR. I've been trying to figure out if that really holds true. My crude preliminary tests point to the contrary, there doesn't seem to be much of a difference between a RP and a 60/40 withdrawal portfolio: viewtopic.php?t=386897. Of course, that's just for one specific RP-portfolio, the Golden Butterfly, and only backtesting back to 1971.

If you're into podcasts, I can really recommend the "Risk Parity Radio" podcast. Make sure to listen to episodes 1-9 first. It's just a one-man show of a retiree who apparently doesn't do it for income, listeners can donate to charity. So not the flashiest podcast around for sure 😁

One caveat though: As you have correctly pointed out, Sharpe ratios and past correlations between asset classes or subclasses might not necessarily persist into the future (SCV is a good example for that, IMO). They have been fluid and persistently changing. That's why maybe static % allocations to assets, as proposed by RPR, may not be the best way to approach a RP-portfolio. Rather, you might need to rebalance your portfolio periodically to reflect current Sharpe ratios / correlations. That's just an idea I've read about, but haven't had the time to check in-depth yet.

Also, RP-concepts rely on backtesting Sharpe ratios / correlations (backtesting's always a limitation), and it's a pity we can only backtest most of assets and subclasses of assets using Portfolio Visualizer back to 1971 max. That's definitely not enough, even just for merely concluding any historical results.

For example, Big ERN found that adding a certain percentage of gold to a stock/bond portfolio would have increased the SWR of your portfolio since 1871. That, I do find interesting, although, of course, it still doesn't tell us anything about the future either.

So for now, my preliminary impression seems to be that RP-portfolio do not outperform the classic 60/40. And, the classic 60/40 is more simple (using less funds), and cheaper (because RP uses multiple funds costing more than just total stock/bond market ETFs).
Last edited by Poe22 on Sun Oct 02, 2022 7:26 am, edited 3 times in total.
KlangFool
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Re: Portfolio and retirement concepts - valid or not?

Post by KlangFool »

Beensabu wrote: Sat Oct 01, 2022 10:02 pm
KlangFool wrote: Sat Oct 01, 2022 8:29 pm If your portfolio is big enough...

So, is your portfolio big enough?

What is the size of your portfolio?
I think you're awesome, but this is not helpful.

The people who can save enough can do whatever they want and it's fine.

It's the people who think they can't save enough that get suckered into silly shenanigans. This doesn't help them.
It helps them by letting them know they should save more instead of playing game.

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Poe22
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

KlangFool wrote: Sat Oct 01, 2022 8:29 pm OP,

If your portfolio is big enough, any AA between 70/30 and 30/70 would work fine. If not, you can play all kind of game and it won't matter.

So, is your portfolio big enough?

My AA is 60/40 at 30X with 2X in the emergency fund (not part of my portfolio). When I withdraw social security, it would be 60X. So, pretty much nothing matter to me. If I cannot retire, it is no longer a financial problem.

What is the size of your portfolio?

KlangFool
I agree, in the end it doesn't matter if your portfolio's big enough, as long as you buy&hold broadly diversified index funds and don't do anything overly stupid. But I'm specifically interested in the question of what kind of portfolio will last the longest when living off it, without having any other sources of income / wealth. For example, think of a young FIRE guy who doesn't want to work one more day in his life (that's not me, to be clear :D ), but please don't get hung up on this specific example. Think of "perpetual withdrawal rates", and think of "permanent portfolios".

I hear anything thrown around from 20-40x and from 2.X to 5% SWR, without ever providing convincing background. Basically, risk parity might be a concept for finding the smallest size portfolio with the highest SWR (by maximizing Sharpe ratios and having the smallest possible correlation between asset classes/subclasses). Just having enough money is the easy answer, of course, but not what's my question here.

Also, I think it's fun and intellectually stimulating to play games, isn't it ?
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Re: Portfolio and retirement concepts - valid or not?

Post by djm2001 »

Here's my take on this. Hopefully it covers all your questions along the way.

To start with, let's assume that the goal of investing is to fund future consumption.  Then thinking in terms of consumption streams and payoff streams helps clarify the picture (ref. Portfolios for Long-Term Investors, Cochrane 2022).
  • A risk-free investment is one that perfectly offsets a future liability.  All other investments have risk relative to that particular liability.
  • As such, the concepts of risk and risk-free asset are relative.  In particular, assets should be evaluated relative to your personal net consumption / liability stream.
  • It is not enough to consider the correlation between assets.  You also have to consider the correlation with your personal income stream and consumption stream.
  • Investment allocation and consumption are a joint problem. One should specify the strategy for both investment and withdrawal jointly.
  • The notion of long-term correlation implicitly assumes a stationary distribution.  Distributions are almost certainly non-stationary over years and decades.
  • A lot of the analyses about returns, correlations, Sharpe ratios, etc. are based on one-period (i.e., "cross-sectional") models.  This reduces its relevance to someone thinking about funding their long-term personal consumption stream. It also causes confusion when people hear about "risk-free" assets in the one-period setting (e.g., short-term TIPS or T-bills) and then mistakenly consider them risk-free in the long-term setting.
  • One should not ignore outside income (e.g., salary, Social Security) and future liabilities (e.g., mortgage) when considering asset allocation.  That would be similar ignoring existing 401k allocation when deciding IRA allocation.  Basically, step back and look at the big picture of your entire risk exposure.
  • One of the biggest hidden assets for most people is their personal human capital (i.e., their future earned income).  This is large for young people and decreases over time until it hits zero at retirement. This is where glidepaths come from.
  • The structure and risks of personal human capital depends on your personal situation.  Salaried workers in stable jobs have bond-like (i.e., fixed) income.  Workers who get paid with restricted stock units have a stock-like component to their income.
  • The investment market can be thought of as an insurance market with people exchanging risk.  For example, employees of large growth companies might want to sell / short large growth stock to employees of small value companies.
  • Ideally, you'd want to short the company that you work for (if that were not considered insider trading by the SEC).
  • In my opinion, prices and returns are much less important than market caps and inflows / outflows. Investment is a capital allocation game. The presence of alternatives affects the allocations. Asset pricing models (e.g., factor models) that try to predict returns as a function of just the single asset in relation to the aggregate market miss some of the point.
  • The average publicly invested dollar is held in the (investable) market portfolio (by definition).
  • The above is often stated as "the average investor holds the market portfolio". One could say that the average investor holds the market portfolio if the Modigliani-Miller theorem were perfectly true since institutions would be "pass-throughs" in the sense that institutional investment would ultimately reflect the economic interests of individual investors.
  • The true market portfolio contains lots of illiquid and uninvestable assets (e.g., non-listed private real estate and equity). Illiquid assets are not competitively traded and hence not competitively priced.
  • Free-float adjustment of stock and bond indexes removes the portion of investments whose trading is restricted (e.g., founder shares, sovereign bonds held by the central banks).
  • Even better than free-float adjustment would be to consider only assets owned by investors very similar to you (e.g., US investors of a certain age who are employed by a certain sector). Unfortunately, this is hard to measure.
  • Publicly traded stocks and bonds comprise more than 95% of the investable market portfolio. Source: Historical Returns of the Market Portfolio, Section 4
  • TIPS, munis, and junk bonds are each very small slivers of the market portfolio (under 1.5% each). Source
  • Securitized gold is about 0.2% of the market portfolio (source).  Commodity futures ETFs have an even lower allocation (source).
  • Derivatives have zero net supply and therefore, in aggregate, do not contribute meaningfully to the investable market portfolio.
  • Personally, I limit my investments to securitized income-producing assets (e.g., no physical gold, no securitized gold, no securitized art, no crypto utility tokens, no non-securitized real estate for investment purposes).
  • The current stock/bond ratio of the global investable market portfolio (GIMP) is roughly 60/40 and has been that way for quite a while (source).  This can be seen as reasonable justification for a globally-diversified 60/40 portfolio.
  • In 2020, the stock/bond ratio of the GIMP dropped down to somewhere around 55/45 (actually a bit below that at the lowest point) during the COVID uncertainty, but went back 60/40 pretty quickly.  I was monitoring this and found this to be a fairly compelling reason to follow the GIMP allocations since I felt the adjustments it made were quite prudent for the information and uncertainty at the time.
  • A hard static allocation (e.g., 60/40) is a contrarian strategy that can move against of the market allocations. (See Adaptive Asset Allocation Policies, Sharpe 2009.)
  • My perspective is that the GIMP is a good default portfolio. It is simple and cheap. And it has a certain philosophical elegance to it, not to mention some theorems that it lies on the efficient frontier in various models (ref. Portfolio Advice for a Multifactor World, Cochrane 1999).
  • That said, an individual can (and should) deviate from it depending on how they are different from average. Sharpe and Fama say the same thing here and here.
  • Some people advise ignoring the GIMP and just building your portfolio entirely from scratch based on your assessment of your personal circumstances. This might be fine for some, but personally I don't have enough confidence in my ability to assess my risks and future consumption stream well enough to successfully build a portfolio from scratch. I'd rather pick a reasonable starting point and then make small adjustments from there.
  • To deviate from the market portfolio, you must understand how you are different from average (perhaps in terms of risk exposure, perhaps in terms of informational advantage).  If you know that you are average or if you don't know how you're different from average, then you're better off holding the market portfolio.
  • One possible reason to deviate from the market portfolio is if you clearly understand your unique personal human capital and its associated risks.  For example, if you are a salaried worker in a very stable job with many years of earnings ahead of you, you might decide to reduce your bond exposure (since your salary fulfills the same promise that bonds make).  As you approach retirement, your total future salary gets closer to zero, so you should increase your bond allocation.  This is the origin of glidepaths and the left half of the bond tent.
  • Picking a stock/bond ratio other than the market ratio is actually a factor tilt. So many Bogleheads already factor tilt whether they realize it or not.
  • There are rational reasons to factor tilt if your personal circumstances justify it. For example, an individual who works for a small value company might want to short SCV and/or go long on large cap growth. And as mentioned above, using a stock/bond ratio other than the market ratio is a factor tilt but can be justified if you have a lot of future salary earnings ahead of you.
  • In my opinion, concrete personal circumstances and risk exposures is the only rational reason to factor tilt. I find the idea of "diversifying across risk factors" in order to find trade-offs that better fit an investor's so-called "risk appetite" or "taste" unappealing both from a practicality and logical standpoint. For example, I suspect that most retail investors who factor tilt don't have a great answer (i.e., no principled method) for how they pick their factor weightings. (I have actually asked this question before on the forum and did not receive a really satisfactory answer.)
  • You can also consider the duration of bonds and how they match your future liabilities.  For example, with a high enough salary, you only need bond income (to replace your salaried income) once your retire, and so the first bonds you buy should be long-term bonds whose duration exceeds your retirement date.  This is a justification for vineviz's First 20% of bonds in long-term Treasuries advice. Ultimately, perhaps this is also where the right half of the bond tent comes from, as you phase out bonds whose durations start to exceed your life expectancy. Although arguably you be spending down stocks as well based on stock duration.
  • Real liabilities on a known schedule can be matched by individual TIPS of specific durations.  Real liabilities on an unknown schedule can be matched by I Bonds (since they can be redeemed at will any time between 5-30 years). Both TIPS and I-Bonds are issued by the US Treasury and have low default risk (since they can just raise taxes to pay back these debts).
  • Nominal liabilities (e.g., mortgage) can be matched by nominal Treasuries.
  • Longevity risk is best neutralized by Social Security, pensions with COLAs, and inflation-indexed annuities. You can't buy the latter anymore.
  • The market portfolio and a personalized liability-matching portfolio play the analogous roles in the long-term setting that the tangency portfolio and the risk-free asset play in the one-period setting of Modern Portfolio Theory, CAPM, and multi-factor models.
  • When investing in the market portfolio, you should buy what you measure and measure what you buy.  In other words, it's better to measure the market cap of the index that is actually used by the fund that you invest in.  Buying a fund that follows one index and measuring market cap using a different index can result in large errors (e.g., using FTSE bond index market caps results in a 5 percentage point allocation error compared to using Bloomberg market caps for BND and BNDX).  Even worse would be to buy REITs and pretend that it is a proxy for all real estate.
  • Equal-weighting allocation strategies (e.g., RSP) seem to be illogical given that market caps are public knowledge.  For example, if two companies merge, an equal-weighting strategy would suddenly reduce their combined allocation.  Equal weighting would only make sense if market caps (and history) were unknown.
  • The most common description of "risk parity" that I have seen is to equalize the volatility of all asset classes.  This seems illogical.  For one thing, it depends entirely on your definition of "asset class".  For another, the goal of equalizing total volatility as opposed to marginal volatility is quite arbitrary.  Finally, considering only volatility while ignoring return is just as flawed as considering only return while ignoring volatility.
Here's how all this boils down in my (relatively) simple personal investment and withdrawal strategy:
Portfolio construction
  1. While earning, save cash to match my critical known expenses over the next 12 months. (A crude form of short-term liability matching.)
  2. Create a pool of I Bonds (as much as I can buy each year) to match unknown future real (i.e., inflation-indexed) emergency expenses. (A crude form of long-term liability matching for expense shocks.)
  3. Invest the rest in an approximation of the global investable market portfolio, specifically the N-Fund variant here minus gold (which is a negligible sliver anyway, and is furthermore a purely speculative asset that does not intrinsically produce income).
I don't use a glidepath since I'm at the cusp of retirement. In fact, I early-retired in 2021 but then went back to work early this year in order to weather the sequence-of-returns risk that seemed likely to materialize (and indeed did!). However, if I could go back to earlier in my career, I might use something like:

Code: Select all

current_stock_percent := (default_stock_percent * target_portfolio_size) / current_portfolio_size   (... but not to exceed your risk tolerance)
where default_stock_percent is the current stock allocation in the market portfolio (currently 60%). This is adapted from Gordon Irlam's Simple Rules of Thumb for Investing by changing his default stock allocation of 50% to that of the market portfolio. I might also adjust the above to account for the occasional restricted stock unit grants which would downweight by stock allocation rather than my bond allocation.

Withdrawal strategy
  1. Spend saved cash for the known short-term expenses for which it was earmarked. Refill only with any unspent 1/N amount.
  2. Use the 1/N withdrawal strategy from the market portfolio for remaining expenses. Spend dividends first. Withdraw remaining 1/N amount such that it leaves the remaining portfolio in market cap proportions.
  3. Use I Bonds for emergency expenses that 1/N withdrawals does not cover. Refill only with unspent 1/N amount.
A couple of notes on the 1/N withdrawal strategy:
  1. Gordon Irlam's Simple Rules of Thumb for Investing justify 1/N as an approximate solution to Merton's portfolio problem which is about optimal portfolio allocation and consumption over time.
  2. I conservatively use N = 100 - age rather than using life expectancy tables.
Practically speaking, I end up with a roughly 60/40 globally diversified portfolio, a bit of cash, a bit of I Bonds, and a 1/N withdrawal of 1.75% this year if I retired tomorrow. I suspect that this starting withdrawal rate is something that many Bogleheads will find unpalatable. It's pretty close to the perpetual withdrawal rate computed by Portfolio Visualizer with 1% failure in the Monte Carlo simulation. And there have been recent articles that caution people to plan for low withdrawal rates. So I think I'm in the rough ballpark of appropriate allocation and (conservative / very safe) withdrawal rate for the current conditions and for above-average length of my planned retirement.
Last edited by djm2001 on Mon Oct 03, 2022 6:09 am, edited 1 time in total.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
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Poe22
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

djm2001 wrote: Sun Oct 02, 2022 8:25 pm Here's my take on this. Hopefully it covers all your questions along the way.
Wow, thanks for your input, this is indeed very helpful, lots of food for thought. I'd love to go FIRE just to read up on all these subjects :D

I really love the idea of holding a "pure" market cap portfolio, and it's reassuring to see that TIPS/junk bonds hardly play any role in it. Gold maybe a tiny little bit. What I think is ingeniuous is that the market portfolio allows for including any new asset classes that might arise in the future, so it's really very adaptive and free from clinging to the past.

Btw, have I missed you mentioning commodities (e.g. oil, gas, wheat, rice etc)? Is that market not big enough to include in the market portfolio?
djm2001
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Re: Portfolio and retirement concepts - valid or not?

Post by djm2001 »

Poe22 wrote: Mon Oct 03, 2022 8:00 am Btw, have I missed you mentioning commodities (e.g. oil, gas, wheat, rice etc)? Is that market not big enough to include in the market portfolio?
Here are the relevant points from the post above.
  1. The general commodities market cap for retail investors is tiny.
  2. A lot of commodity investing is done through futures trading and, as mentioned above, derivatives (e.g., options, futures) have net zero supply and hence don't contribute to the market portfolio in aggregate. (On that note, it is an interesting question as to whether government bonds have net zero supply... Sharpe has an answer for this in RISMAT, Chapter 7 in the "Components of the Market Portfolio" section.)
  3. Commodities are not inherently income producing.
Poe22 wrote: Mon Oct 03, 2022 8:00 am What I think is ingeniuous is that the market portfolio allows for including any new asset classes that might arise in the future, so it's really very adaptive and free from clinging to the past.
Yes, that's the beauty of it. It is always forward-looking and does not require much speculation or information on your part. The 1/N withdrawal strategy has similar appeal -- the withdrawals adapt to the market portfolio's performance, and you don't need much information about the past or knowledge about the future (other than guesstimating the number of years you have left... which is something almost all other withdrawal strategies do anyway, with the notable exception of perpetual withdrawal rate).

Keep in mind that you will need to make a judgement call about what constitutes an "investment". So when a new (and perhaps controversial) asset appears, you need a principled way to decide whether or not to include it. As an armchair investor, I include only securitized, easily tradable assets that produce tangible income.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
Trance
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Re: Portfolio and retirement concepts - valid or not?

Post by Trance »

Alright let's go!!!
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?
Not sure exactly what you mean, do you mean having a retirement and separate investment account like a brokerage? If so I think it's fine to take money from the latter if you need it. The problem with "living off that portfolio" if you mean retirement is that you get penalized for doing it.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?
To an extent nothing is certain. You can't control it. But you can choose how to invest in order to choose how much risk you expose yourself to. You can choose to go all in on stocks, or stocks and bonds, or stock and bonds and something like ibonds. In general the more risk you have the more you can expect a greater a chance at reward. For something like retirement, the sweet spot is to invest in the entire global market and bonds, and then tweak how much. (For example, 60% USA and 40% international is the market average, if you went 80%/20% you'd be better on America which a lot of bogleheads would do and is fine)

Ideally the closer you get to retirement the less risky you make your portfolio.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
c) Is the concept of "safe withdrawal rates" valid or faulty?
As in FIRE? I think it still applies, people are just getting anxious and wondering what exactly that percentage is
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?
A gold standard? With Bogleheads?! Are you mad?!! Jokes aside, the gold standard is just "stocks and bonds" and you are free to choose that percent allocation. Just like above where I talked about international exposure, you can go 70/30 like me or even 80/20, or avoid bonds entirely until you're older. There are many successful ways to retirement, remember that you're simply choosing how much risk and reward you want. More stocks and less bonds? You're hoping for more reward. Which is perfectly fine when you are younger and far away from retirement.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?
Yep! Bonds and Stocks have an inverse correlation, where the longer the duration of bonds the bigger the difference. Now recent performance is because of unexpected inflation hence why everything except tips and ibonds is down. Long term? This won't matter for you. The bond funds/etf will swing back up with these new higher rates, and historically stocks have been the best long term hedge against inflation.

The key there is long term. In the short term the best inflation protection is ibonds and TIPS which you can choose to invest in when you are closer to retirement.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?
I don't have enough knowledge to comment heavily on this, but I will say gold and commodities do not perform well overtime. They are good for market timing which most bogleheads are against because it doesn't always work. Hence Gold actually being down this year
Poe22 wrote: Thu Sep 22, 2022 12:25 pm
g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.
It depends on the type of bonds. Most people mean a total bond fund when they talk about bonds. In which cause yes such a short term average bond fund/etf will help stabilize your portfolio so it won't drop as much during retirement if something goes wrong.

There is however those like myself who invest in long term bonds until we get closer to retirement. It's part of that idea of taking risk for the reward when you are farther from retirement, and then as you get closer you move your investment allocation to shorter term bonds and TIPS

Of course this is a lot of work, and there can be mistakes that are made. So is it okay for you to go just an easy 60/40 portfolio that consists of a total stock fund and a total bond fund? Absolutely. No one here would fault you for that. It might be the best option for you, and definitely the least stressful where you can just set your investments and forget about.
60% VT 40% BNDW (no bonds in Roth)
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calmaniac
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Re: Portfolio and retirement concepts - valid or not?

Post by calmaniac »

Poe22 wrote: Sun Oct 02, 2022 3:10 amIf you're into podcasts, I can really recommend the "Risk Parity Radio" podcast. Make sure to listen to episodes 1-9 first. It's just a one-man show of a retiree who apparently doesn't do it for income, listeners can donate to charity. So not the flashiest podcast around for sure 😁
Thanks for the podcast recommendation!
"Pretired", working 20 h/wk. AA 75/25: 30% TSM, 19% value (VFVA/AVUV), 18% Int'l LC, 8% emerging, 25% GFund/VBTLX. Military pension ≈60% of expenses. Pension+SS@age 70 ≈100% of expenses.
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Tyler9000
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Re: Portfolio and retirement concepts - valid or not?

Post by Tyler9000 »

Great questions, Poe22.

Here are my answers, and hopefully you won't mind me also linking to several articles that explain my ideas in more detail. I've thought a lot about the same things over the years, and it's hard to summarize it all without a blog. :D

Poe22 wrote: Thu Sep 22, 2022 12:25 pm a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?
b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?
I can see the argument that it could make sense to take more risk earlier in life when you can afford to make up the difference if things don't work out. But to me, finding a portfolio you're truly happy with is hard enough for most people that I think most people are probably better off seeking it out early and sticking with it.

Poe22 wrote: Thu Sep 22, 2022 12:25 pm c) Is the concept of "safe withdrawal rates" valid or faulty?
The concept of using history to set up reasonable guidelines is definitely valid, but the widely-circulated 4% rule of thumb is full of so many assumptions that it actually doesn't apply to most people. Are you a US-based investor who solely invests in the S&P500 and US treasuries, only needs your money to last for 30 years, and mechanically adjusts your spending by the formal inflation rate every year? Then it's a great place to start. But if you live somewhere else, invest in more than those two index options, want to retire early or leave money to heirs, or make rational spending choices every year, then the 4% rule by definition no longer applies to you. Luckily, you can now use the same techniques found in those early famous studies with modern computing power to easily personalize WRs to your own situation.

Poe22 wrote: Thu Sep 22, 2022 12:25 pm d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?
It's a fine option that I would agree is the default assumption in most asset allocation discussions. So I think it's a great benchmark. But I wouldn't say that it's the gold standard, because to me that implies that all other portfolios aspire to be like it. That's clearly not the case.

Poe22 wrote: Thu Sep 22, 2022 12:25 pm e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?
It can still work just fine if it meets your financial and emotional needs even with they both falter at the same time. And if it doesn't, there are other good portfolio options with different risk profiles.

Poe22 wrote: Thu Sep 22, 2022 12:25 pm f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?
All other things being equal, a portfolio with lower volatility will have a higher withdrawal rate than one with higher volatility. In fact, it's possible for a portfolio with a higher average return to have a lower withdrawal rate depending on the volatility. So while I wouldn't fixate on Sharpe ratios, I do think it's important to think beyond averages to understand how withdrawal rates work.

Poe22 wrote: Thu Sep 22, 2022 12:25 pm g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.
Portfolio theorists approach the same problem of risk management in different ways. Standard stock/bond portfolios seek to balance the risk of stocks with the stability of fixed income. Risk parity portfolios seek to smooth the overall portfolio returns by using complementary volatile assets. Either approach can work! The most important thing is to simply find one that you connect with and believe in so that you'll be comfortable staying the course in both good times and bad. Once figure that out, investing gets a lot easier.
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

djm2001 wrote: Mon Oct 03, 2022 8:55 am
Poe22 wrote: Mon Oct 03, 2022 8:00 am Btw, have I missed you mentioning commodities (e.g. oil, gas, wheat, rice etc)? Is that market not big enough to include in the market portfolio?
Here are the relevant points from the post above.
  1. The general commodities market cap for retail investors is tiny.
  2. A lot of commodity investing is done through futures trading and, as mentioned above, derivatives (e.g., options, futures) have net zero supply and hence don't contribute to the market portfolio in aggregate. (On that note, it is an interesting question as to whether government bonds have net zero supply... Sharpe has an answer for this in RISMAT, Chapter 7 in the "Components of the Market Portfolio" section.)
  3. Commodities are not inherently income producing.
Poe22 wrote: Mon Oct 03, 2022 8:00 am What I think is ingeniuous is that the market portfolio allows for including any new asset classes that might arise in the future, so it's really very adaptive and free from clinging to the past.
Yes, that's the beauty of it. It is always forward-looking and does not require much speculation or information on your part. The 1/N withdrawal strategy has similar appeal -- the withdrawals adapt to the market portfolio's performance, and you don't need much information about the past or knowledge about the future (other than guesstimating the number of years you have left... which is something almost all other withdrawal strategies do anyway, with the notable exception of perpetual withdrawal rate).

Keep in mind that you will need to make a judgement call about what constitutes an "investment". So when a new (and perhaps controversial) asset appears, you need a principled way to decide whether or not to include it. As an armchair investor, I include only securitized, easily tradable assets that produce tangible income.
That makes sense, I like the market portfolio more day by day 😊

Some more questions, trying not to bug you too much:
- Watching the video with Bill Sharpe, I believe he didn't mention holding cash, only TIPS? And it's short-term TIPS, isn't it?
- The question regarding currency-hedging is still haunting me. He didn't seem to like the idea of hedging very much in the video, or did he? In the other post you mentioned having mixed feelings about that too, if I'm not mistaken?
- The question of what assets to include is highly interesting. Also watching his video, he didn't seem to be opposed to buying whatever market cap tells us to hold, no matter if it's income-producing or not, or did I get this wrong? For now, market cap of precious metals / commodities is negligible anyway, as you rightly pointed out. But what if some day that would change? E.g. we discover some new super-material we'd need for pretty much everything? As you said, this may be a personal choice in the end I guess?
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

Trance wrote: Mon Oct 03, 2022 9:26 am So is it okay for you to go just an easy 60/40 portfolio that consists of a total stock fund and a total bond fund? Absolutely. No one here would fault you for that. It might be the best option for you, and definitely the least stressful where you can just set your investments and forget about.
Thanks a lot for your inputs, I think that's all perfectly reasonable, and since I'm kind of a lazy investor, I particularly like the idea of just having a total bond fund 👍
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Poe22
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

Tyler9000 wrote: Mon Oct 03, 2022 10:47 am Great questions, Poe22.
Great answers, thanks for taking the time! I am intrigued by permanent portfolios / risk parity concepts, and it has been very inspiring reading up on them. I agree, in the end it's probably a matter of personal choice if you prefer a market-portfolio or a RP-portfolio. Some issues have been pushing me slightly away from risk parity portfolios such as the all-seasons, golden butterfly etc.:

1. Simplicity: 60/40 is simpler, and often cheaper than RP-portfolios
2. RP is based on past correlations and past Sharpe ratios. So it's basically a backward-looking strategy, while the market is a forward-looking beast.
3. Asset correlations & Sharpe ratios are not static, they fluctuate. However, RP strategies tend to be based on static % asset allocations.
4. RP strategies often rely heavily on non-productive assets such as gold, commodities etc. In the long run, this will be a drag on returns
5. I haven't found any evidence of low vol portfolios like RP outperforming 60/40 when regularly withdrawing from them (e.g. in retirement).
6. Non-correlation, in and of itself, is meaningless.
What's useful is non-correlation + market-level risk and return.
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Tyler9000
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Re: Portfolio and retirement concepts - valid or not?

Post by Tyler9000 »

Poe22 wrote: Mon Oct 03, 2022 2:43 pm 5. I haven't found any evidence of low vol portfolios like RP outperforming 60/40 when regularly withdrawing from them (e.g. in retirement).
For evidence of relative portfolio performance in retirement, try this Portfolio Matrix and sort by the Safe WR or Perpetual WR. The results may surprise you.
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Re: Portfolio and retirement concepts - valid or not?

Post by martincmartin »

Poe22 wrote: Thu Sep 22, 2022 12:25 pm Before I go nuts: Is there any common ground among Bogleheads regarding the following questions?
No. You've done a great job on your research, and the remaining questions are ones that don't have an agreed upon answer. You have to do your own research, evaluate different arguments and draw your own conclusions.

For example, glide paths. There are argument for increasing bonds over time in retirement. There's also arguments decreasing it. I don't know the arguments for keeping it fixed, maybe they're just "nobody can agree so split the difference." So you have to read all those and think for yourself.
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Re: Portfolio and retirement concepts - valid or not?

Post by patrick »

djm2001 wrote: Sun Oct 02, 2022 8:25 pm [*] Ideally, you'd want to short the company that you work for (if that were not considered insider trading by the SEC).
[...]
[*] Even better than free-float adjustment would be to consider only assets owned by investors very similar to you (e.g., US investors of a certain age who are employed by a certain sector). Unfortunately, this is hard to measure.
These two ideas might work in opposite directions because many workers overweight their own company.
[*] Publicly traded stocks and bonds comprise more than 95% of the investable market portfolio. Source: Historical Returns of the Market Portfolio, Section 4
[*] TIPS, munis, and junk bonds are each very small slivers of the market portfolio (under 1.5% each). Source
https://www.sifma.org/resources/researc ... tatistics/ shows a much higher amount in muni bonds (4 trillion versus 0.7 trillion) than the spreadsheet's value. I don't think float adjustment would have this dramatic an effect, though perhaps some muni indexes screen out most munis based on liquidity or something. The spreadsheet also seems to omit inflation-protected bonds and junk bonds from outside the US.
[*] That said, an individual can (and should) deviate from it depending on how they are different from average. Sharpe and Fama say the same thing here and here.
[*] Some people advise ignoring the GIMP and just building your portfolio entirely from scratch based on your assessment of your personal circumstances. This might be fine for some, but personally I don't have enough confidence in my ability to assess my risks and future consumption stream well enough to successfully build a portfolio from scratch. I'd rather pick a reasonable starting point and then make small adjustments from there.
[*] To deviate from the market portfolio, you must understand how you are different from average (perhaps in terms of risk exposure, perhaps in terms of informational advantage).  If you know that you are average or if you don't know how you're different from average, then you're better off holding the market portfolio.
Compared to the average person in the world, I am more exposed to inflation in my own country and less exposed to inflation in other countries. This seems a clear reason to overweight my own country's inflation-protected bonds compared to those of other countries.

The low fraction of inflation protected bonds in the US is mainly because the US government doesn't issue many of them. I'll also note that some institutions have reasons to hold nominal bonds that don't apply to individuals.
[*] Real liabilities on a known schedule can be matched by individual TIPS of specific durations.  Real liabilities on an unknown schedule can be matched by I Bonds (since they can be redeemed at will any time between 5-30 years). Both TIPS and I-Bonds are issued by the US Treasury and have low default risk (since they can just raise taxes to pay back these debts).
Since the usual purpose of a retirement portfolio is to fund future consumption expenses, it seems almost everything would be real except paying off a mortgage. Right now there is a much lower yield on I bonds versus TIPS. The current difference is 1.44% at 10 years and even higher at other maturities which seems like a rather high price to pay to mitigate interest rate risk.
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Re: Portfolio and retirement concepts - valid or not?

Post by Ben Mathew »

Poe22 wrote: Thu Sep 22, 2022 12:25 pm I admit I've fallen into a deep rabbit hole regarding portfolio and retirement concepts. The more I read about them, the less I seem to know. Before I go nuts: Is there any common ground among Bogleheads regarding the following questions? If not, what's your personal opinion?

a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?

b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?
Lifecycle investing models derive an optimal glide path that generally glides down during accumulation and turns fixed at target AA in retirement. If there is a gap before retirement income begins (e.g. delayed Social Security), then it would make sense to have an upward sloping glidepath during the gap years (due to consuming the bonds that cover the gap before SS begins.) This post shows an example glide path under these conditions.

The reason for the downward sloping glide path during working years is that future savings are not yet in the portfolio. So in early years, the portfolio is small relative to lifetime wealth. So you have to hold a larger portion of your portfolio in stocks to obtain the same risk as you would with a smaller AA in later years. The reason AA turns flat in retirement is that there's no more future contributions coming in. Everything is already in the portfolio, so the AA remains constant.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm c) Is the concept of "safe withdrawal rates" valid or faulty?
Faulty. It does not make sense to fix withdrawals based on a calculation made at the start of retirement and ignore new information coming in. It would be better to follow a variable withdrawal strategy such as amortization based withdrawal (ABW). If the portfolio does well, you can take out more. If it does badly, you should take out less.

You can model variable withdrawals using the Monte Carlo simulator spreadsheet in the ABW wiki or online at tpawplanner.com. I strongly believe that variable withdrawal simulations give a more coherent and clear view of retirement than SWR simulations.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?
I think 60/40 is likely to be too risky for most people if the portfolio (as opposed to pensions and Social Security) is the primary source of retirement income. 60/40 may seem like a good idea if you look only at historical returns. But if you switch to forward looking expected returns based on yields and assume some reasonable variation in returns, it will look riskier than I suspect most people will be willing to tolerate. Stocks are risky in the long run, and that risk is obscured by fantastic historical returns.
Poe22 wrote: Thu Sep 22, 2022 12:25 pm e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?
Yes, it's still recommended. Duration matching inflation indexed bonds will effectively eliminate bond risk. Bond volatility then become irrelevant. Stocks and bonds can still fall at the same time, but it just won't matter. (A similar effect applies for stocks as well, because some of the drop can be because of a rise in expected returns, but the effect is murkier for stocks than for bonds.)
Poe22 wrote: Thu Sep 22, 2022 12:25 pm f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?
I don't have enough confidence in the historically estimated correlations and betas of these subclasses of investments. REITS are like stocks, but you will have enough exposure through stock funds. Gold and commodities don't make much sense to me from a fundamental point of view (as opposed to raw historical performance).
Poe22 wrote: Thu Sep 22, 2022 12:25 pm g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.
I think a straight allocation to stocks and bonds works well. See answer to (f) above.
Last edited by Ben Mathew on Mon Oct 03, 2022 9:26 pm, edited 2 times in total.
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djm2001
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Re: Portfolio and retirement concepts - valid or not?

Post by djm2001 »

Poe22 wrote: Mon Oct 03, 2022 1:57 pm That makes sense, I like the market portfolio more day by day 😊
One additional nicety of the market portfolio is that it generally just floats at its correct weight. You don't need to rebalance much. (There is some small slippage when you hold the market portfolio in separate index funds (e.g., VT + BNDW, or VTI + VXUS + BND + BNDX) due to individual assets entering or leaving the indexes tracked by those funds -- e.g., stocks getting listed / de-listed, and bonds maturing and new bonds being issued.)
Poe22 wrote: Mon Oct 03, 2022 1:57 pm - Watching the video with Bill Sharpe, I believe he didn't mention holding cash, only TIPS? And it's short-term TIPS, isn't it?
In the video, Sharpe just says TIPS, not short-term TIPS. In his RISMAT book, he implies that TIPS can be used as a proxy for the risk-free asset if duration-matched to some real (i.e., inflation-indexed) liability. I outlined where he implied this in this post.

Note that TIPS are only risk-free for the liability corresponding to the CPI-U basket of goods. If your liability has some other characteristics (e.g., is nominal liability, or is some basket of goods other than what the CPI-U index uses), then it isn't risk-free.

I use cash as a liability-matching tool for nominal expenses up to 12 months out (e.g., insurance premiums). It is a legit risk-free asset relative to those expenses. (Btw, when I say "cash", I really mean "money market fund" which is really mostly Treasury bills which is often considered the one-period risk-free asset in Modern Portfolio Theory narratives.)
Poe22 wrote: Mon Oct 03, 2022 1:57 pm - The question regarding currency-hedging is still haunting me. He didn't seem to like the idea of hedging very much in the video, or did he? In the other post you mentioned having mixed feelings about that too, if I'm not mistaken?
Sharpe says "allocate by market weight (and adjust for personal circumstances)". Chalk currency hedging down to the "adjust for personal circumstances" part, just as we did for personalized liability matching with TIPS and cash. Some argue that US investors should USD-hedge at least some of their foreign income. Personally, I don't know the "right" amount of hedging. It is worthwhile noting that currency hedging in international bond indexes affect only returns, not their market cap.
Poe22 wrote: Mon Oct 03, 2022 1:57 pm - The question of what assets to include is highly interesting. Also watching his video, he didn't seem to be opposed to buying whatever market cap tells us to hold, no matter if it's income-producing or not, or did I get this wrong? For now, market cap of precious metals / commodities is negligible anyway, as you rightly pointed out. But what if some day that would change? E.g. we discover some new super-material we'd need for pretty much everything? As you said, this may be a personal choice in the end I guess?
Sharpe lays out some principles for what to include in the "Components of the Market Portfolio" section of RISMAT, Chapter 7. The asset should have non-zero net supply, should be liquid, and should have a claim on the earnings of some productive enterprise (e.g., earnings of corporations via corporate stocks and bonds, or taxes on earnings of future generations via goverment bonds).
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
djm2001
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Re: Portfolio and retirement concepts - valid or not?

Post by djm2001 »

patrick wrote: Mon Oct 03, 2022 5:23 pm https://www.sifma.org/resources/researc ... tatistics/ shows a much higher amount in muni bonds (4 trillion versus 0.7 trillion) than the spreadsheet's value. I don't think float adjustment would have this dramatic an effect, though perhaps some muni indexes screen out most munis based on liquidity or something.
The SIFMA numbers include a huge amount of private equity and debt (which is different from the restricted holdings subtracted from public equity and debt as part of float adjustment).
patrick wrote: Mon Oct 03, 2022 5:23 pm The spreadsheet also seems to omit inflation-protected bonds and junk bonds from outside the US.
Yes, there are (small) holes in the portfolio for which I couldn't find easy-to-invest index funds whose indexes released factsheets with market cap data.
patrick wrote: Mon Oct 03, 2022 5:23 pm The low fraction of inflation protected bonds in the US is mainly because the US government doesn't issue many of them. I'll also note that some institutions have reasons to hold nominal bonds that don't apply to individuals.
My (unfounded) guess is that TIPS are in low supply (and demand) because Social Security exists (which is inflation-indexed and therefore fulfills a similar role).
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
invest4
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Re: Portfolio and retirement concepts - valid or not?

Post by invest4 »

The pursuit of portfolio optimization can be a consuming endeavor with no guarantee that you will be rewarded for the effort.

One of the great learnings I have had since joining this forum is the value of simplicity and “good enough”.

I would encourage you to consider same.

Of course, that does not mean you shouldn’t continue educating yourself which is fun, interesting and helps you make informed decisions along the way.
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Poe22
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

Great, thanks for all your support!

Regarding currency-hedging and TIPS, just spitballing: Maybe in the end it doesn't matter that much if you hedge or not, and if you inflation-protect or not, because our currency can get stronger or weaker over time, and inflationary periods can be followed by deflationary periods.

So maybe over time, periods of currency strength and weakness / periods of inflation and deflation will just even out? So you could choose either or, or just split bonds 50/50 into hedged/inflation-linked, and non-hedged/non-inflation linked?
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Poe22
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

Tyler9000 wrote: Mon Oct 03, 2022 3:24 pm
Poe22 wrote: Mon Oct 03, 2022 2:43 pm 5. I haven't found any evidence of low vol portfolios like RP outperforming 60/40 when regularly withdrawing from them (e.g. in retirement).
For evidence of relative portfolio performance in retirement, try this Portfolio Matrix and sort by the Safe WR or Perpetual WR. The results may surprise you.
Backtesting a retirement drawdown-portfolio (withdrawing 40k annually) with portfolio visualizer (data only goes back to 1978), 60/40 and the Golden Butterfly performed more or less equal:
https://www.portfoliovisualizer.com/bac ... tion6_2=40

Without withdrawing from the portfolio, 60/40 outperforms the Butterfly.
https://www.portfoliovisualizer.com/bac ... tion6_2=40

There might be some start date sensitivity to it all. I'd love to see data going back to 1871 for the Golden Butterfly.
chassis
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Re: Portfolio and retirement concepts - valid or not?

Post by chassis »

Poe22 wrote: Thu Sep 22, 2022 12:25 pm I admit I've fallen into a deep rabbit hole regarding portfolio and retirement concepts. The more I read about them, the less I seem to know. Before I go nuts: Is there any common ground among Bogleheads regarding the following questions? If not, what's your personal opinion?

a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?

b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?

c) Is the concept of "safe withdrawal rates" valid or faulty?

d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?

e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?

f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?

g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.
a. No. Money is fungible. Portioning funds into separate cookie jars may be useful for investors with less fiscal discipline.

b. Not sure what this means. Spending can be estimated. Not predicted. But rather estimated with reasonable accuracy.

c. It’s a guideline. Like speed limit signs and guardrails. SWR is a way to frame the thought process around spending.

d. No. My risk tolerance, apparently, is far higher than the average poster on this site. I’ll bet many people agree with me on this, but they either don’t post or don’t want derision from the peanut gallery.

e. Individual stocks + cash. See above.

f. Sharpe ratio doesn’t put money in your pocket or brokerage account. Return does. Sharpe ratio is a characteristic of risk (volatility) vs reward (return). Sharpe ratio is neither volatility nor return.

g. Forget the saccharine named portfolios. Build one on holdings you believe in, guided by your personal life experience. Warren Buffett and Peter Lynch wrote books and based careers on this.
alex_686
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Re: Portfolio and retirement concepts - valid or not?

Post by alex_686 »

Poe22 wrote: Thu Sep 22, 2022 12:25 pm I admit I've fallen into a deep rabbit hole regarding portfolio and retirement concepts. The more I read about them, the less I seem to know. Before I go nuts: Is there any common ground among Bogleheads regarding the following questions? If not, what's your personal opinion?

a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?

b) Are retirement glide paths a mirage, because you ultimately cannot time/avoid the risk of your investing life period?

c) Is the concept of "safe withdrawal rates" valid or faulty?

d) Is 60/40 still the go-to portfolio allocation (not necessarily the best, but sort of a "golden standard")?

e) Is holding just stocks and bonds still recommendable, despite them being able to perform poorly at the same time?

f) Holding some other assets like REITs, Gold or Commodities improves Sharpe ratio when backtesting. Do higher Sharpe ratios matter in terms of withdrawal rates (just WR, not safe WR)?

g) Is a fixed stock/bond portfolio more recommendable for retirement than a "risk parity" portfolio? If so, why?
Risk parity as in: optimized for the least correlation between asset classes, and highest Sharpe ratio. Examples of risk parity portfolios: Golden Butterfly, Permanent Portfolio etc.
a. In theory no, it makes no sense. This runs afoul of various cognitive errors as described in behavioral economics. That being said, there are worse errors one can make.

b. Not exactly. It is because you have "spent" all of your relatively "safe" human capital (i.e,, income from your job). As you spend that you need to replace it with another safe asset, bonds. Note, this is a heuristic rule. There are many cases where one should actually increase equity allocation as time goes on. High levels of financial assets. Having a high pension which acts as a bond-liked asset.

c. If you don't have a intellectual framework to govern your long term plans then what? As they say: All models are wrong, some are useful. SWR falls into this category.

d. Another heuristic rule. Given 2 asset classes of stocks and bonds this rule has vaguely a decent level of risk and return. You can throw more theory and math at the problem and get a better answer. A example of that would be risk parity.

e. If not stocks and bonds, then what? These have the advantage of being simple to implement, cheap to own, and liquid.

f. REITs are equities. I am modestly in favor of overweighting them. I have a low opinion of commodities, including gold. These are not economic assets. They don't pay dividends or interest. There is a fair amount of debate on these subjects. As for the Sharpe ratio, technically no because that is not what the Sharpe ratio is measuring. From a practical side the answer is vaguely yes. Higher returns with lower risk should help you portfolio out. Note, I have a low opinion on back testing. For context, I do work in risk management so this is kind of my day job.

g. It depends on who you are. Following a fixed portfolio is simpler. While based on heuristics (i.e., no logic or theory, just gut instincts) it is harder to make cognitive or behavioral errors. The more correct answer is to update your asset allocation to best meet your goals. Since the risk and returns of assets vary over time you should update to asset allocation to represent these new facts. This does involve extra complexity.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Poe22
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Re: Portfolio and retirement concepts - valid or not?

Post by Poe22 »

alex_686 wrote: Mon Oct 10, 2022 11:49 am
Poe22 wrote: Thu Sep 22, 2022 12:25 pm a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?
a. In theory no, it makes no sense. This runs afoul of various cognitive errors as described in behavioral economics. That being said, there are worse errors one can make.
Thanks guys, appreciate your contrarian views, that's what I've thought all along :D
chassis wrote: Mon Oct 10, 2022 11:28 am f. Sharpe ratio doesn’t put money in your pocket or brokerage account. Return does. Sharpe ratio is a characteristic of risk (volatility) vs reward (return). Sharpe ratio is neither volatility nor return.
What about maximizing your portfolio for return and low correlation?
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Re: Portfolio and retirement concepts - valid or not?

Post by vineviz »

Poe22 wrote: Mon Oct 10, 2022 1:39 pm
alex_686 wrote: Mon Oct 10, 2022 11:49 am
Poe22 wrote: Thu Sep 22, 2022 12:25 pm a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?
a. In theory no, it makes no sense. This runs afoul of various cognitive errors as described in behavioral economics. That being said, there are worse errors one can make.
Thanks guys, appreciate your contrarian views, that's what I've thought all along :D
I'm going to disagree with alex_686 here.

By definition the investor's goals, circumstances, resources, and constraints are different during the accumulation period and the decumulation period. How can it not be important to take those differences into account?

Poe22 wrote: Mon Oct 10, 2022 1:39 pm
chassis wrote: Mon Oct 10, 2022 11:28 am f. Sharpe ratio doesn’t put money in your pocket or brokerage account. Return does. Sharpe ratio is a characteristic of risk (volatility) vs reward (return). Sharpe ratio is neither volatility nor return.
What about maximizing your portfolio for return and low correlation?
No good comes from trying maximize Sharpe ratios. Ever.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
alex_686
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Re: Portfolio and retirement concepts - valid or not?

Post by alex_686 »

vineviz wrote: Mon Oct 10, 2022 4:32 pm
Poe22 wrote: Mon Oct 10, 2022 1:39 pm
alex_686 wrote: Mon Oct 10, 2022 11:49 am
Poe22 wrote: Thu Sep 22, 2022 12:25 pm a) Does it even make sense to differentiate accumulation and retirement portfolios (as in: living off that portfolio instead of adding to it)?
a. In theory no, it makes no sense. This runs afoul of various cognitive errors as described in behavioral economics. That being said, there are worse errors one can make.
Thanks guys, appreciate your contrarian views, that's what I've thought all along :D
I'm going to disagree with alex_686 here.

By definition the investor's goals, circumstances, resources, and constraints are different during the accumulation period and the decumulation period. How can it not be important to take those differences into account?
I suspect that we are actually pretty close on this. I am going to rest my cases partially on Mental Accounting.

I would suggest that the portfolio of a working 62-year-old should be about the same as a retired 62-year-old-plus-1-day. That one has stepped from accumulation to deaccumulation over this single day has not changed much.

Most investors have multiple goals with different time horizons and priorities. All investors have a single portfolio. As such we should see a smoother glide path than one with many discontinuities.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
chassis
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Re: Portfolio and retirement concepts - valid or not?

Post by chassis »

Poe22 wrote: Mon Oct 10, 2022 1:39 pm
Thanks guys, appreciate your contrarian views, that's what I've thought all along :D
chassis wrote: Mon Oct 10, 2022 11:28 am f. Sharpe ratio doesn’t put money in your pocket or brokerage account. Return does. Sharpe ratio is a characteristic of risk (volatility) vs reward (return). Sharpe ratio is neither volatility nor return.
What about maximizing your portfolio for return and low correlation?
Yes. I like return if driven by sound fundamentals. This gets into how one chooses stocks, and the rabble here on this site won't tolerate it. So I will skip the explanation and leave it with: yes.

Be sure to account for all assets including cash (all cash) and real estate in the portfolio. It is furthermore useful to account for the present value of Social Security as a bond position, when guiding asset allocation in the portfolio ex-Social Security.
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