Is "stocks for the long run" a safe strategy for retirement savings?

Jon Chevreau · 06-15-2009, 11:28 AM

See my blog this morning on the PBS Newshour interview with Zvi Bodie, author of Worry Free Investing. See also sister thread on inflation in the main forum.

http://network.nationalpost.com/np/b...un-on-pbs.aspx

CanadianCapitalist · 06-15-2009, 02:04 PM

I'm going to check out the video but the problem with Real Return Bonds is the rather low returns that they provide. It would have been fantastic to buy these bonds when they were yielding 3% to 4% in the early part of 2000. For a long time now, these bonds are yielding 2%. To earn just $20K before taxes, investors would need a nest egg of $1 million. Clearly, saving such a large nest egg is beyond the capability of most people.

It is true that stock returns even over the long-term could fall within a wide range of possibilities. Still, a real return of 2% seems to me to be a low hurdle for stocks to overcome, especially now that stocks are much cheaper than they were at the peak. Just the dividend yield on the major indices is much higher than 2%. It is highly likely that stocks can be expected to handily beat real return bonds going forward.

MoneyGal · 06-15-2009, 02:20 PM

CC: I see your point, for sure, but Bodie's point is that stocks have been oversold as long-run investments.

There are a whole bunch of sequence of return risk issues that get tangled up in this discussion, too: stocks *are* cheaper now than they were last year, meaning higher returns are much more likely than they were at this point last year (leaving aside what actually happened).

I think the underlying messages of Bodie's "Worry-Free Investing" are (among other things) that fixed assets can provide a decent ("worry-free") standard of living and investment plan for risk-averse people, and that -- depending on the timing of your income needs -- the risks associated with stocks provide a much less certain (or "worry-filled") retirement asset accumulation plan.

I recommend reading Bodie's work in more depth, particularly his work on portfolio product allocation over the human life cycle. A similar recent Canadian reference would be Moshe Milevsky's "Are you a Stock or a Bond?"

HaroldCrump · 06-15-2009, 02:21 PM

Quote:

Originally Posted by CanadianCapitalist

It would have been fantastic to buy these bonds when they were yielding 3% to 4% in the early part of 2000. For a long time now, these bonds are yielding 2%. To earn just $20K before taxes, investors would need a nest egg of $1 million. Clearly, saving such a large nest egg is beyond the capability of most people.

Methinks holding RRBs in a retirement portfolio (or any portfolio, for that matter) would only make sense if your predicitons of inflation are significantly higher than what the broad market is factoring in by way of long bond yields.
And to your point, isn't it likely that you can keep your head above water with a ladder of GICs?
These days a 5 year GIC is about 3.65% and the rates have been higher in the last 5 years (around 5% during 2005 - 2006).

CanadianCapitalist · 06-15-2009, 02:37 PM

Quote:

Originally Posted by MoneyGal

I think the underlying messages of Bodie's "Worry-Free Investing" are (among other things) that fixed assets can provide a decent ("worry-free") standard of living and investment plan for risk-averse people, and that -- depending on the timing of your income needs -- the risks associated with stocks provide a much less certain (or "worry-filled") retirement asset accumulation plan.

I recommend reading Bodie's work in more depth, particularly his work on portfolio product allocation over the human life cycle. A similar recent Canadian reference would be Moshe Milevsky's "Are you a Stock or a Bond?"

I have read Worry-Free Investing. In fact, I reviewed it here:

http://www.canadiancapitalist.com/bo...ree-investing/

I have no problem with suggesting RRBs for a portion of a portfolio. But I do think that investing the entire portfolio in RRBs isn't without risks. One major risk is that real yields fluctuate and investors could find that yields are lower when the bonds mature. What then? An investor could find that 2% real yield isn't available anymore and the best they can do is just 1% and are now faced with a reduced income in retirement.

Jon Chevreau · 06-15-2009, 02:49 PM

Someone posted a comment on my blog to the effect that governments are always motivated to understate inflation in their CPI and other inflation indexes -- since they're on the hook with these inflation-linked bonds they issue. Reasonable point. Personally, I'm a 50/50 guy. As I told Zvi himself, that means 50% stocks to 50% bonds and the 50% bonds is then split 50/50 nominal vs real. So that means no more than 25% of the total portfolio in RRBs/TIPS. I agree that no one asset class -- even RRBs -- should make up 90 or 100% of a portfolio.

But then I'm still working for a living.

www.wealthyboomer.ca

P.S. I tweeted this discussion. RTs might help spread the word.

http://www.twitter.com/jonchevreau

MoneyGal · 06-15-2009, 03:07 PM

Jon: I'm not sure I would say this discussion is "raging."

CC: I was thinking not of Worry-Free Investing when I recommended reading more of Bodie, but of Bodie's (much) earlier work with Paul Samuelson and Robert Merton - they wrote an article in the early 1990s which was the first to treat human capital as a bond-like asset class. However, I think I'm straying from the main point here.

CanadianCapitalist · 06-15-2009, 03:34 PM

Quote:

Originally Posted by MoneyGal

I was thinking not of Worry-Free Investing when I recommended reading more of Bodie, but of Bodie's (much) earlier work with Paul Samuelson and Robert Merton - they wrote an article in the early 1990s which was the first to treat human capital as a bond-like asset class.

I found this paper online by Bodie, Merton and Samuelson:

http://www.people.hbs.edu/rmerton/la...lexibility.pdf

I haven't read this but if this is the paper you were thinking of, I'd definitely read it.

MoneyGal · 06-15-2009, 03:52 PM

That's the one! I've been doing a lot of reading lately on life cycle investing and human capital, and that's one of the foundational articles in the field.

KeithSharp · 06-15-2009, 09:57 PM

Bodie seems to be about right, but few of us much want to believe him. But most of us are very risk-averse when the downside is bagging groceries at age 80 So the finance theory says that TIPS or RRBs, as the least risky investment available long-term, are appropriate for us.

End result is that we all need to be saving way more than eg the 18% tax limit for our retirements. More at

www.utstat.utoronto.ca/sharp

Keith Sharp

06-15-2009, 11:28 AM	#1
Jon Chevreau Senior Member Join Date: Apr 2009 Location: Long Branch, Ont. Posts: 203	Is "stocks for the long run" a safe strategy for retirement savings? See my blog this morning on the PBS Newshour interview with Zvi Bodie, author of Worry Free Investing. See also sister thread on inflation in the main forum. http://network.nationalpost.com/np/b...un-on-pbs.aspx

06-15-2009, 02:04 PM	#2
CanadianCapitalist Administrator Join Date: Mar 2009 Location: Ottawa, Ontario Posts: 886	I'm going to check out the video but the problem with Real Return Bonds is the rather low returns that they provide. It would have been fantastic to buy these bonds when they were yielding 3% to 4% in the early part of 2000. For a long time now, these bonds are yielding 2%. To earn just $20K before taxes, investors would need a nest egg of $1 million. Clearly, saving such a large nest egg is beyond the capability of most people. It is true that stock returns even over the long-term could fall within a wide range of possibilities. Still, a real return of 2% seems to me to be a low hurdle for stocks to overcome, especially now that stocks are much cheaper than they were at the peak. Just the dividend yield on the major indices is much higher than 2%. It is highly likely that stocks can be expected to handily beat real return bonds going forward. __________________ Canadian Capitalist -- A Canadian Personal Finance Blog

06-15-2009, 09:57 PM	#10
KeithSharp Junior Member Join Date: Jun 2009 Posts: 1	Real return bonds and retirement Bodie seems to be about right, but few of us much want to believe him. But most of us are very risk-averse when the downside is bagging groceries at age 80 So the finance theory says that TIPS or RRBs, as the least risky investment available long-term, are appropriate for us. End result is that we all need to be saving way more than eg the 18% tax limit for our retirements. More at www.utstat.utoronto.ca/sharp Keith Sharp

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06-15-2009, 02:20 PM	#3
MoneyGal Senior Member Join Date: Apr 2009 Posts: 1,045	CC: I see your point, for sure, but Bodie's point is that stocks have been oversold as long-run investments. There are a whole bunch of sequence of return risk issues that get tangled up in this discussion, too: stocks are cheaper now than they were last year, meaning higher returns are much more likely than they were at this point last year (leaving aside what actually happened). I think the underlying messages of Bodie's "Worry-Free Investing" are (among other things) that fixed assets can provide a decent ("worry-free") standard of living and investment plan for risk-averse people, and that -- depending on the timing of your income needs -- the risks associated with stocks provide a much less certain (or "worry-filled") retirement asset accumulation plan. I recommend reading Bodie's work in more depth, particularly his work on portfolio product allocation over the human life cycle. A similar recent Canadian reference would be Moshe Milevsky's "Are you a Stock or a Bond?"

06-15-2009, 02:49 PM	#6
Jon Chevreau Senior Member Join Date: Apr 2009 Location: Long Branch, Ont. Posts: 203	Someone posted a comment on my blog to the effect that governments are always motivated to understate inflation in their CPI and other inflation indexes -- since they're on the hook with these inflation-linked bonds they issue. Reasonable point. Personally, I'm a 50/50 guy. As I told Zvi himself, that means 50% stocks to 50% bonds and the 50% bonds is then split 50/50 nominal vs real. So that means no more than 25% of the total portfolio in RRBs/TIPS. I agree that no one asset class -- even RRBs -- should make up 90 or 100% of a portfolio. But then I'm still working for a living. www.wealthyboomer.ca P.S. I tweeted this discussion. RTs might help spread the word. http://www.twitter.com/jonchevreau

06-15-2009, 03:07 PM	#7
MoneyGal Senior Member Join Date: Apr 2009 Posts: 1,045	Jon: I'm not sure I would say this discussion is "raging." CC: I was thinking not of Worry-Free Investing when I recommended reading more of Bodie, but of Bodie's (much) earlier work with Paul Samuelson and Robert Merton - they wrote an article in the early 1990s which was the first to treat human capital as a bond-like asset class. However, I think I'm straying from the main point here.

06-15-2009, 03:52 PM	#9
MoneyGal Senior Member Join Date: Apr 2009 Posts: 1,045	That's the one! I've been doing a lot of reading lately on life cycle investing and human capital, and that's one of the foundational articles in the field.