By Dr. Jim Dahle, WCI FounderHow much money you end up with eventually is a relatively simple math problem. There are just four variables:
- How much you have now
- How much you save each year
- How many years you save for, and
- Your investment return.
The first you cannot change. Improving the second and third involves additional pain—i.e. cutting your lifestyle, working harder, or working longer. That leads many people to wonder what they can do about the fourth variable—increasing their return on investments.
For example, let's assume you improve your investment return from 5% real (after inflation) to 7% real. Assuming you're saving $50,000 a year over 30 years, that means you end up with 45% more money—$5.1 million vs. $3.5 million. Or, alternatively, you could end up with the same money, but retire 4 1/2 years earlier. Or you could save 32% less ($34,000 a year instead of $50,000 a year). Those all sound really awesome, right?
Should You Try to Increase Return on Investment?
Unfortunately, there is a rule of thumb that basically says there is no free lunch. If you want a higher investment return, you're going to have to take on more risk. While that rule isn't always true—there are uncompensated risks out there, and that higher return is almost always just a higher EXPECTED return—it generally holds true.
One of the worst things that can happen to an investor is that you exceed your risk tolerance. This could cause you to fail to contribute in a down market; fail to rebalance; or, worse on this spectrum of bad investor behavior, cause you to actually sell low. There is some wisdom in the suggestion that you should take on just as much risk as you can stand but not an ounce more. If you're not sure how much risk you can stand emotionally, I would suggest erring on the conservative side until you've been through a bear market or two.
This post is all about how you can increase your return on investment. Most but not all of these suggestions will involve increasing your risk. Only you can decide if that is a good tradeoff for you. Taking risks that you don't have to take and then getting burned when the risk shows up seems awfully foolhardy.
9 Ways to Increase Your Investing Return
#1 Eliminate Uncompensated Risk
This is one of the easiest to do and probably the only one that doesn't add additional risk at all. There is no sense whatsoever in taking on risk that you are not paid to take on. Two risks you shouldn't expect to be paid to take on include:
- Manager risk (i.e. investing in actively managed mutual funds) and
- Individual security risk (i.e. putting a large percentage of your portfolio into a limited number of individual stocks or bonds).
Timing the market, even using valuations, could also be thrown in with these other uncompensated risks. Eliminating these risks may not improve your long-term returns, but they will certainly improve your risk-adjusted returns. And over the long run, it probably will decrease your investing costs and increase your return on investment.
More information here:
Risk vs. Reward — How to Find the Balance
#2 Decrease Taxes
There is very little risk involved in this step, too. Most high-income professionals I meet aren't maximizing their use of tax-protected accounts like 401(k)s, cash balance plans, Backdoor Roth IRAs, and HSAs. They also know precious little about investing tax-efficiently in a taxable account.
Becoming smarter about taxes is a great way to boost returns, but there can be additional risk when you decrease your taxes. For example, deferring taxes lowers your bill now and probably in the long run, but there is a potential risk there to increase your total tax burden in the long run in some situations.
#3 Decrease the Cost of Advice
Way too many physician investors are paying too much for their financial advice. That's not even considering the fact that many are getting bad advice despite spending a lot of money on it. Decreasing the cost of your advice by negotiating a lower rate with your advisor, moving to a lower-cost advisor, or learning to manage your own portfolio and becoming your own financial planner decreases your investment costs—thus boosting your after-fee returns.
There is some risk there too, of course. Firing a good advisor and becoming your own advisor without learning what you need to know to do that effectively could be “penny wise but pound foolish.” But many doctors have boosted their returns, increased their retirement spending, and shortened their required working years by doing their own investments.
#4 Increase Stock-to-Bond Ratio
Stocks have higher expected returns than bonds over the long run, primarily because the risk is higher. So, the more money that you put into stocks (and similarly risky assets), the higher your expected returns long-term. Want higher returns? Moving some of your money from bonds and cash into stocks and leaving it there will probably work.
#5 Choose Riskier Stocks
Just as stocks are riskier than bonds and have higher expected long-term returns, some stocks are riskier than others. Small value, microcap, and emerging market stocks have significantly higher risks than US large cap stocks like Apple, Alphabet, and Meta. Theory (and long-term past return data) suggests you will have higher returns by including these asset classes in your portfolio despite their higher costs.
More information here:
The Nuts and Bolts of Investing
#6 Choose Riskier Bonds
The equity side is not the only place in your portfolio where you can take on additional risk. Some bonds have higher expected returns than others. While those bonds may not do as well in a financial crisis (and some of their higher return may be because those securities are really part equity and part fixed income), the long-term data on their returns is quite clear—taking on additional term and credit risk increases returns.
An extreme example of this includes peer-to-peer loans, an asset class I invested 5% of my portfolio in for a few years. While my very safe bonds in the TSP G Fund made 1%-2% a year, I made 8%-12% off peer-to-peer loans, even after the frequent defaults. I eventually liquidated that particular investment and moved it into real estate debt. There's lots more risk but also lots more return. Less extreme examples include just using more corporate bonds and extending the duration on your bond portfolio.
#7 Add Alternative Asset Classes and Accredited Investments
Ideally, you want to fill your portfolio with assets that all have high expected returns but very low correlation with each other. When you add an asset class, look for something with low correlation to the rest of your portfolio. That said, a pile of manure has low correlation to your stocks and bonds. If the investment doesn't also offer a decent rate of risk-adjusted return, take a pass on it.
The most common investment added is real estate, which enjoys similarly high returns to equities but fairly low correlation. In addition, physicians and other high-income professionals, by virtue of being accredited investors, have access to a whole slew of investments not offered to those with lower net worths and incomes. Whether those investments are worth exploring is a matter of debate, but there is no doubt that most of these at least promise higher returns than you can expect in the publicly traded stock and bond markets. Unfortunately, each investment is a totally separate deal, and it must be evaluated on its own merits. The equivalent of index funds in this space simply does not exist.
More information here:
You Can Dial Back Real Estate Risk
A Tale of 2 Sponsors: How My Real Estate Investments Have Had Vastly Different Results
#8 Add Sweat Equity
Another way to boost returns is to put in some work. I'm not talking about work researching Exxon on the internet; I'm talking about putting labor into a business. That business might be an investment like a rental property down the street, or it could be an outpatient surgical center, imaging center, or free-standing ED. It might also be a website you purchased. Real estate advocates often brag about their high returns; however, part of their high returns often comes from the fact that they've created value through hard work. Nothing wrong with that; it's a great way to boost returns.
#9 Add Leverage
Leverage works. Unfortunately, it works going both ways. Borrowing money at 2%-5% and earning money at 7%-15% is a winning combination. But nobody ever went bankrupt without leverage, meaning there's additional risk when you start levering up your investments.
The classic levered investment is real estate, but there are other ways to lever your investments. For example, purposely carrying low-interest rate student loans or mortgages while investing is leveraged investing. You can also open a margin account or even use some types of options. This may be my least favorite way of boosting returns, but it is an option.
Which of these should you do? It's hard to say. I can tell you this, though. I've done all nine of them in some way or other. Don't take any of them to extremes, but increasing your long-term returns by 1%-2% a year can make a huge difference in your financial situation.
What do you think? What have you done to try to boost your investment returns? Have you tried any of these steps? Anything else? Is it working?
[This updated post was originally published in 2016.]
Well Said. Asset Allocation is responsible for 90% of one’s returns. Young docs need to be more aggressive as they usually start later than most, but should fund iras in residency at the minimum. If you have a Roth, invest it ALL in equities. The axiom for AA is 100 or 110 minus age=stock allocation. Simple enough and REBALANCE YEARLY
120-age is the asset allocation for stock percentage that I’ve always seen. Regardless, I concur with your statement of investing more aggressively as a younger investor.
I guess I’ve done all of these things! Some seem bigger bang for the buck (decreasing cost of advice, taxes) and some are too early to tell (small-cap skew).
Can someone explain to me as if I were a high school student how to evaluate correlation between asset classes? And risk adjusted return of a given investment?
I found the most intuitive explanations in the “Uncle Fred” sections of William Bernstein’s “The Intelligent Asset Allocator.” His use of graphics makes the subject far more comprehensible than any written answer you will get here.
Various asset classes have various correlations with each other that vary at times. That is, the correlation may be 0.8 at some point and 0.5 at another point. Ideally you would have a portfolio made of up assets that all have high returns and low correlations (0 is no correlation, -1 is perfectly uncorrelated- when one goes up the other always goes down and vice versa). So there is no way to know in advance what the correlation will be between any given set of assets over the next year or the next 30 years.
There are many ways to calculate the risk adjusted return. Perhaps the most common is the Sharpe Ratio. It is the average return in excess of the risk free return (think short term treasury yield) per unit of volatility.
Counterpoint: You’ve written, rightly before that physicians don’t need to gamble but rather merely to invest. If one can get to financial independence through sticking to index funds (and my favorite, robo-advisors such as Betterment that have a more complex portfolio than most would undertake on their own) then why bother with alternative investment classes? It’d probably save on estate planning, too, if you don’t leave much of one… (semi-serious)
The point of the game is to reach financial independence, and a simple index or even target date fund strategy in maxed out tax-deferred accounts + something like Betterment on the taxable side will do it with minimal fees and minimal sweat equity.
Nice article. A couple of comments:
~P2P loans are not bonds, maybe a distant cousin at best. I believe classifying them as such is misleading. It would be more accurate to include P2P loans in your alternative asset class.
~As much as I enjoy Ken’s comments, I could not disagree more strongly with his statement. Behavior, at least in my world, accounts for 90% of returns. I include annual rebalancing under the behavior descriptor. Dalbar studies indicate the same.
I have to agree 100%. Most studies show that most investors do not even meet the returns of the active managed manager on their own, let alone that of the index. Why? They exceed their risk tolerance and pull out at the wrong time. Frankly you are your worst enemy when it comes to investing and controlling your reactions to the market are the key driver of your success or failure.
They’re certainly not stocks. They’re a loan, just like a loan to a government or corporate entity or a mortgage borrower. Loans are bonds. P2P Loans are bonds. Very risky bonds.
Are you kidding me. All loans are not bonds. p2p loans (lending club) are unsecured loans that are backed up with nothing (big fat zero asset or personal guaranty)
So, the money we lent to our family/friends as loans should be counted a bonds in our portfolios?
I disagree. A bond is a loan, a loan is a bond. Some bonds have higher yields than others. Some bonds have a higher likelihood of returning your principle than others. Some bonds/loans are backed up with an asset and others are not.
Whether it is wise to invest in any particular loan/bond is obviously debatable. But what it is is not. A bond is a loan. A loan is a bond. A risky bond is not a stock. It’s a risky bond.
Bonds have coupons. All bonds are loans but not all loans are bonds.
True, but a minor issue. A loan provides you no equity, thus it is far more bond like than stock like. This is really an argument over semantics and I need to go pack for Belize, so you guys can win this one. I’ll try to remember to call P2P Loans “fixed income investments” instead of bonds.
Enjoy your trip! I thought “alternatives” was a good solution.
Kind of a broad term. Alternative to what? Who gets to decide what is alternative and what isn’t? Some people consider international stocks “alternatives” for instance whereas most of us think they’re pretty mainstream.
I was referring to your point #7 above, actually.
Enjoy the trip
Just to beat the dead horse one more time, you can loan out money without interest and be in compliance with IRS regulations.
Although the interest not charged is subject to gift tax rules.
And yes, the trip is awesome so far! The really cool thing about a “job” like WCI is being to do it even in a Belizean Jungle. I went SCUBA diving today for the first time. Can’t figure out why insurance companies want to charge so much more for that activity. Seems way safer than backcountry skiing and canyoneering that they don’t ask about at all.
Fight further simplify by saying you can either lend money or be an owner. Those are the two kinds of investments at the end of the day.
I’d add speculative ones to that list.
This statement disappoints me. Surprisingly disappointed. WCI, you surely know better than to say that just because a loan is not a stock it is a bond. For once, I agree with Sam.
As a finance lawyer, I find this conversation quite amusing. If loans were bonds (i.e., securities) the entire loan market would cease to exist overnight for a variety of reasons. But admittedly, loans and bonds are very closely related as far as the basic economics are concerned. They are both debt instruments (speaking from the borrower/issuer perspective) and that’s what they should be called. P2P loans are definitely “alternatives”, though. You just can’t lump them together with bonds, it’s a completely different product.
You can get the same portfolio with Vanguard than you would get with Betterment at much LOWER FEES!
Respectfully disagree ITS YOUR ASSET ALLOCATION that is responsible for 90% of your wealth creation
Betterment’s portfolio from their website is compromised mostly of Vanguard Funds
Why pay the fees?? Which over 30-40yrs compounded is a boatload of money
lol, you don’t have to shout.
Q: If asset allocation (conventional wisdom) is 90%, why do most people with beautifully diversified portfolios have sub-optimal results?
A: It’s because they cannot control their behavior.
All you have to do is flip your numbers. Asset allocation = 10%, Behavior = 90%. Asset allocation is a piece of cake. You can learn the proper way to balance your portfolio in under a minute with Google. It’s the emotional aspect that separates investors from their money.
How about pick a a reasonable asset allocation and stick to it? That should cover make anyone wealthy over the long term.
Avoid the temptation to tinker. That tinkering bug is driving me crazy recently. I shed the complexity of of a financial adviser almost 2 years ago and then placed all of my investments in simple low cost 3 fund portfolios. 80/20 stocks/bonds, with 1/2 of the equity total US and 1/2 total international. But that is so boring. What if I start adding in value and REITs and emerging markets? Doesn’t that sound exciting? Everybody else is doing it.
No, I am going to stick with my simple portfolio. My wife understands it perfectly, so let’s leave it at that.
You nailed it. However, you may regret the fact that you have 805 allocation to stocks (even if you are still an teenager). Anyway, good luck
I’ve had a taxable account at Vanguard for several years. Recently opened a smaller taxable account at Betterment. Acquired $700 in harvested tax losses in the last month. I harvested $0 at Vanguard; just not worth the time/hassle for me to TLH there except in the event of a major market decline (major enough for me to know about it w/o following the market daily or even weekly). After my 6 month free trial at Betterment, I’ll pay 0.25% in annual fees, which will drop to 0.15% once the balance reaches $100k. So far, anyway, my tax savings for the year more than pay for the fees.
So, Tax Loss Harvesting might be added as #10, although it really falls under #2. And TLH is unlikely to have a major effect on overall investment returns. Guess I, like certain Presidential candidates, try to pay as little in taxes as possible 🙂
I do 1, 2, 3, 4, 7, and 8. I suppose I choose riskier stocks in a way by tilting towards EM & small value. I only buy passive index funds, though, no individual stocks (except Berkshire Hathaway).
I used to have leverage, but I prefer to be debt free.
Have a great weekend!
-PoF
I just feel if you put your portfolio on AUTOPILOT with yearly rebalancing and a stock allocation of 100 or 110 minus your age, emotion CAN be taken out of the equation or use a Target Dated Fund if you are very very lazy
Sub optimal results=not following your plan=foolishness=lack of discipline
Guess most would do better with Anyone but themselves, but its so darn simple to learn and implement, why throw away hundreds of thousands in fees!
From William Bernstein’s “The Investors Manifesto:
“Who’s our biggest enemy when it comes to investing? It’s not the stock broker or even Wall Street. Bernstein notes it’s the enemy in the mirror – ourselves. And in the forewarned is forearmed department, the book gives some great advice on how to protect our nest-egg from ourselves as well as from Wall Street. He covers the one technique of going against the crowd that actually works – rebalancing. It’s simple but not very easy to overcome our emotions.”
I think this is the first Brinson, Hood, and Beebow study which Ken references via his “allocation explains 90%” comments:
https://www.cfapubs.org/doi/pdf/10.2469/faj.v51.n1.1869
Toshi? I agree with you philosophically. 🙂
We all have faced or will face how to asset allocate at retirement age.
The pundits say you have a 30yr horizon, god willing but we know that’s not always the case
Emotions do come into the equation when you have no earned income and depend 100% on ira distributions and ss
Very conflicting / contradictory advice in this article. You state to keep it simple, avoid actively managed funds/avoid manager risk and market timing. Then you go all crazy and tell folks to increase exposure to stocks, and buy riskier stocks and riskier bonds. You also recommend to look into alternative asset classes. Basically, although unintentionally, you are introducing complexity, management risk by portfolio owner rather the mutual fund manager) as well as market timing.
Let me tell you all, and please never forget this, the only two asset classes that most of you need for risk management and consistent diversification are stocks (sp500 fund or global stock fund) and treasuries. Gold, physical real estate, commodities, international bonds, emerging market, these are all off shoot of stock and US treasuries.
Once you have enough experience, then dabble into extreme opportunities stock and bond market through at you. For example, late last year I bough gold miners (they will be sold soon), and municipal bond CEF from my home state ( they were selling at discount of 22% from NAV), now the same CEF is selling at 3% premium to NAV.
Besides my regular monthly investment, this year I bought mid stream master limited partnerships and nothing else, and have locked in 24% annual dividend payout which is expected to increase by 8% annually as long as oil price does not drop below $40 dollar per barrel
Writing calls and leverage are a good thing, for the very seasoned investor
Typically, I do not invest more then 40% in stocks, rest in US treasuries, and just hang out tight until market has another sale. I am hoping and preying for a bear market. This is when the real money is made b/ folks with 70 and 90% of portfolio in stocks learn realize that their risk tolerance is not at robust as they presumed it to be.
Lastly, and especially if you are <45 yrs old and in good health whole life insurance.
Thank you for sharing your opinion on what a wise investment portfolio looks like. I’ll let the reader determine what they wish to invest in. I suggest you do the same.
And I thank you, because not withstanding this particular blog, this web site has done a good job informing both the novice as well as seasoned investor.
Wait so you’re suggesting investments in gold, oil, whole life insurance and less than 50% stocks? I think you may have misjudged the audience of WCI. I’m interested, what experiences have lead you to these recommendations? Did this change after a significant down turn like early 2000s or 2008?
I love CEFs. They are a completely different animal. I got myself in trouble with them during the Covid Crash because i didn’t understand how leverage was a double edged sword. Now I’m a student of z scores!
In the medium to long term I would love to get into hard money loans. What has your experience been thus far? I know you have done a number of real estate investments, but how much of your real estate investing at this point is in shorter term hard money? I’m reading about real estate note investing and thinking about that as a possible opportunity in the future
I use groundfloor.us and have had very nice results so far, 9 pct give or take over 5 years. I’m a diversification nut, and the 10 bucks per loan makes that easy. I would LOVE to get into doing direct hard money or tax lien certificates but diversification is expensive
WCI, where do you find your hard money loan deals? How do you evaluate the ability of the debtor successfully pay you back? Do you subscribe to a credit scoring company like Equifax, or do you base the decision on things like net worth and previous deals?
I’ve moved on to using funds primarily for that asset class. I basically hire a professional to make those assessments and pay him a fee. This also spreads my bets across dozens or even hundreds of loans and several managers.
Thanks for the reply. I imagine that the professional likely prices out a lot of younger investors like me. Perhaps a post in the future on the mechanics of hard money loans is in the works? As always, appreciate the good content!
Depends, minimums are not always high. AlphaFlow for instance has a very low one. Others are higher. See my real estate updates twice a year or so for details.
Absolutely will do. Thanks again
Is this a good time to move money from annuity to the stock market?
That question doesn’t make any sense, but I think I can tell what you meant to ask and the answer to that would require a working crystal ball.
I suggest you get an investing plan that doesn’t require a working crystal ball for you to reach your financial goals. This post may help:
https://www.whitecoatinvestor.com/investing/you-need-an-investing-plan/
Hi Dr. Dahle, thanks for a reprise of this good article from 2016. In regard to option #4 (Increase your stock allocation), I am wondering if you have read the study that was published in December 2024 about an all-stock portfolio being superior to a mixed stock/bond portfolio? (“Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice”; Aizhan Anarkulova, Scott Cederburg, Michael S. O’Doherty; December 6, 2024). Surprisingly, in that study they concluded that a roughly 70% international/30% domestic stock portfolio was the optimal portfolio allocation. There were very few scenarios in which having any bonds in the portfolio improved the outcome. They looked at a number of variables including ending portfolio balance, retirement income, drawdowns, volatility, etc. across a number of different scenarios in arriving at their conclusions. The study included stock, bond, bills, and cash across I think 39 developed countries over the last 120-140 years. Now as I have read others’ reviews of the study it has become apparent that the 70% int’l/30% domestic recommendation is the optimal across investors from all the included developed countries, and that the optimal recommendation for a US-based investor might be different. One article I read suggested that it is probably somewhere around 30% Int’l/70% domestic for US-based investors. One could debate about the proportion of int’l stocks, but the overall conclusion about an all-stock portfolio being superior to a balanced portfolio (even in regard to drawdowns and volatility) when looking at the issue from the standpoint of a long time horizon (say 30 years) was a bit surprising to me. Obviously the behavioral implications over shorter time horizons are a concern and one of the main reasons people include bonds in their portfolios. Just wondering what your thoughts are and whether you would consider writing a review of the study??
Hey John I have a few thoughts on that article as well as the Bogleheads here: https://www.bogleheads.org/forum/viewtopic.php?t=418189&start=50
Bascially of course a 100% equity portfolio which you start at the age of 25 as in the article will result in a HUGE retirement nest egg to draw down from compared if you started with a balanced 60/40 at the age of 25. Then when you draw down from a HUGE nest egg, you can remain 100% equities and can make it through bad bears in retirement.
Assuming equities perform in the future like they have in the past. Which isn’t guaranteed. Which is why many of us choose to own bonds in our portfolios, even when we’re not all that old.
Hey Rikki,
I’d love to hear your (or Tyler Scott’s) take on this:
https://earlyretirementnow.com/2017/09/13/the-ultimate-guide-to-safe-withdrawal-rates-part-19-equity-glidepaths/
A bit long to get thru but it’s kind of going against the conventional wisdom target date funds take ….
Big ERN’s long and growing series about withdrawal rates/retirement spending is awfully hard to give a quick “take” on. Anybody who says it’s “good” or “bad” hasn’t read it or at least understood it. He likes to really get into the numbers, but like any calculation, it’s garbage in/garbage out. So the really interesting stuff to me isn’t the end results of any of those posts, but the assumptions used to start with. He did convince me of one thing though. That is that if your plan is to “be flexible”, you might have to be a lot more flexible than you think.
Definitely did have the impression of garbage in/garbage out and wary of the assumptions and relying so heavily on these numbers without understanding the basic concept of why they act the way they do….
Hi Sarah! I’m honored you want my opinion, given Tyler is brilliant newly converted CFP and Jim is, well Jim more financially knowledgeable than other experts. I’m just a guy who got scrwed buying whole life.
Anyway, whatever it’s worth, I think ERN’s assumptions are pretty reasonable in calculating a rising equity glidepath SWR, as Jim mentions this checks out that it doesn’t seem garbage in. Please note that one of those assumptions is “A 60-year retirement horizon”!!!!! So really geared toward the FIRE crowd. But it does make sense when you think about a rising equity guidepath in retirement vs. a TDF which has a lowering equity guidepath given for the former YOU ARE NOT SELLING EQUITIES. So if you do have a bad bear at the start or near the start of your retirement when SORR can kill you, you are not selling equities low, giving them a chance to recover. Drawing off a TDF during a bad bear near or at your retirement means selling equities low as the TDF there is no way to separate and not sell stocks.
For me and wifie in retirement we plan to really only sell stocks if they have gone up according to our asset allocation, and if stocks tank then we have to sell bonds when we need the money every month or 2 months. We will likely sell assets when we need the money soon. I think this withdrawal strategy will be just as good as a rising equity guide path given we are dynamically selling stocks high and not selling when they are low. Am I smart enough to test it like Big ERN. Not even close!!! But going back to Jim’s assumption point, most studies assume a static allocation where you rebalance every year. I myself am assuming rebalancing with withdrawals every so often throughout the year will be more effective in raising my safe withdrawal rate then just a yearly rebalance assumed in retirement studies.
I think it’s simplistic to describe 100% stocks as “superior.” You mean, had higher returns in the past or higher expected returns? I agree with that. You mean better for someone who for sure needs the money in 7 months no matter what or their family goes out on the street? No way that’s “superior.”
Dr. Dahle,
As I mentioned in my comment and as is clearly described in the study findings, the focus is clearly on someone who has a long-term time horizon (like 30 years or more). This is obviously not someone who needs the money in 7 months.
And as I also mentioned in my comment/question, they looked at a number of variables besides return, including volatility and drawdown.
I would appreciate a more thoughtful response.
So you’re arguing that stocks generally outperform bonds/CDs etc. over periods of 30+ years if you can avoid selling them in downturns? Seems a pretty strong argument, based on both theory and historical data. Although it does not appear to be any sort of new knowledge. Even in 2016 that wasn’t particularly new knowledge. Why do you find it interesting/fascinating/surprising at all? That’s pretty much been investing dogma for many, many years. Decades really.
But does that mean a particular individual investor should be 100% stocks? No way. There’s risk tolerance. There’s the possibility that the future is not like the past. There’s the possibility that circumstances change and that money IS needed in less than 30 years etc. Aside from the obvious counterargument that if 100% stocks is good, 120% stocks must be better.
You will notice that I have not been arguing for anything. I merely was mentioning a study that was published in December that suggested that based on their data and analysis, a 100% stock portfolio (especially with a high % of international) was superior to a balanced stock/bond portfolio or a target date portfolio or other similar portfolios over a long time horizon across a number of dimensions including total return, portfolio value at retirement, retirement income draw, volatility, and drawdown. It was relevant to your 4th point in your article about increasing your stock allocation and therefore I brought it up. I was asking for your thoughts on the study and suggesting that perhaps you could do a review of it.
The thing that was particularly surprising to me was the conclusions in the study that over a longer time horizon the all-stock portfolio was equal or superior in terms of volatility and drawdown. I was also surprised with the conclusions about having a high % of international in the portfolio. I was not surprised that an all-stock portfolio would have higher total return or ending value. I understand the points about behavioral finance and how human risk tolerance is a major factor in whether people can stick to their portfolio strategy during bad times. In fact I mentioned that in my original comment/question. But nonetheless, I thought it was interesting and relevant, especially given the study’s conclusions about risk (volatility and drawdown). And it might be especially relevant to younger high earners.
I’m not as surprised as you are. Being more aggressive early on makes for a bigger nest egg. When you start retirement with $5 million instead of $4 million, it’s no surprise the money lasts longer even if drawdowns are larger.
Well, the higher ending balance in the 100% stock portfolio was not surprising at all. As I have been saying, I was surprised that the volatility/drawdown was not generally higher in the “optimal” portfolio of 67% int’l/33% domestic stocks. I just checked the actual study and here is what it says:
Average max drawdowns across 1 million Monte Carlo simulations during working period:
100% domestic stocks: 67%
60% stocks/40% bonds balanced portfolio: 54%
Target Date Funds: 52%
“Optimal” Portfolio: 55% (lower than domestic stocks and roughly the same as balanced portfolio & only slightly higher than TDFs)
Average max drawdowns across 1 million Monte Carlo simulations during retirement period:
100% domestic stocks: 62%
60% stocks/40% bonds balanced portfolio: 50%
Target Date Funds: 40%
“Optimal” Portfolio: 48% (lower than domestic stocks, slightly lower than balanced portfolio & a bit higher than TDFs)
Interestingly, they had a risk-aversion parameter in the models that they used and the “optimal” portfolio model weights did not change much based on value of the risk-aversion parameter.
I understand that you have a strong bias toward wanting bonds in anyone’s portfolio, but it might be worth your time reading the actual study rather than continuing to debate this in the comments here. By the way, my portfolio is not 100% equities and probably never will be, and I’m not arguing for it for anyone else either. I just think the study is interesting and the long-term volatility/drawdown results were surprising to me, having always thought that bonds would substantially dampen the volatility in portfolios (much like you).
I’m not sure why you think I have some sort of weird bond bias. I own bonds in my portfolio, but I don’t dictate anyone else’s asset allocation. I think it’s a good idea to use an asset allocation less aggressive than you think you can handle until you go through your first bear then ramp it up if indicated, but I don’t have any problem with someone using 90% or 100% or 120% stocks or whatever if that’s right for them.
The study data you’re quoting to me is exactly what I would expect. A portfolio with bonds in it has less volatility, a smaller percentage drawdown in a big bear, and a lower expected long term return. It’s not clear to me what you find surprising about this data. Is it that diversifying internationally is a good idea? I agree with that. That’s why I invest internationally. Or are you arguing for 2/3 international and only 1/3 domestic? It’s not clear to me what you are arguing for exactly and why you think I disagree with anything you’ve said.
Not sure, but I think what you’re starting to hit upon, which was recently a discovery/revelation to me, is rising equity glidepaths and that optimal asset allocations being more 80/20 vs 60/40 once you retire. Part of it is natural (during your sequence of return risk years you’re drawing from your cash/bonds) and naturally stocks rise in percentage.
Links for the rabbit hole:
Start here: Kitces.comwww.kitces.comThe Benefits Of A Rising Equity Glidepath In Retirement (https://www.kitces.com/blog/should-equity-exposure-decrease-in-retirement-or-is-a-rising-equity-glidepath-actually-better/)
Another easier read: Kitces.comwww.kitces.comThe Portfolio Size Effect And Optimal Equity Glidepaths (https://www.kitces.com/blog/managing-portfolio-size-effect-with-bond-tent-in-retirement-red-zone/)
If you really want to get in the weeds….this guy is too much trees for forest a bit in the end but nice to see numbers backing the idea… not that I profess to understand : The Ultimate Guide to Safe Withdrawal Rates – Part 19: Equity Glidepaths in Retirement – Early Retirement Now (https://earlyretirementnow.com/2017/09/13/the-ultimate-guide-to-safe-withdrawal-rates-part-19-equity-glidepaths/)
Sharing a couple of things from a lifetime of experience. First, have a sound financial life. Probably means LIVE LIKE A RESIDENT if you’re not. Second, do not permit anyone purporting to be an advisor ever to take an assets under management fee from your account. If you think you need one, pay cash and fit it into your expense budget. Third, at least for stocks and folks making WCI money, set a goal of achieving the returns of the market. Bernstein has some great writing on this. VTI is a great way to do it, Vanguard charges 3bp to manage and earns it back from extraneous activities like securities lending. Last, be very careful about trying to be smart. Remember this site exists is because all of you are targets and the predators appeal to the combination of intellect and work ethic that made you docs.
Thanks for an excellent article. What are some of the favorite Bond funds where investors prefer to park the money.
Vanguard offers particularly excellent bond funds. It’s pretty hard to go wrong there. You just need to decide what kind of bonds you want to invest in and they likely have a good fund or ETF for it.
I would consider leveraged ETFs and funds such as PSLDX as way of utilizing leveraging in your investments too. Also increasing risk and reward. If you are 100% VOO and want more exposure for the money, add some SSO to increase it. Just some food for thought.
I prefer to see the leverage separate from the fund. Most leveraged funds are trying to provide something like “3X the daily return” of an index. I don’t care about daily returns. Chasing those tends to have you taking on 3X risk and getting 1.4X results. Not sure that’s worth it. Want to use leverage? Mortgages and student loans and margin loans are usually plenty. More info here:
https://www.whitecoatinvestor.com/how-to-think-about-debt/
Thanks for the update. Regarding #7, what is your opinion of private equity and private credit, and what role they should play in an eight-figure portfolio?
Optional. And you had darn well better do the due diligence because every private investment is unique and they don’t all turn out well. “Private equity” for instance is one of the most vague terms in investing. That just means the company isn’t traded on the public stock market. It literally tells you nothing else. WCI is private equity. That restaurant on main street is private equity. Twitter is also now private equity. So how can anyone give an opinion that applies to all private equity?