By Dr. Jim Dahle, WCI Founder
Dr. William Bernstein trained originally as a neurologist but developed an interest in investing mid-career. I credit his book, The Four Pillars of Investing, with having the biggest influence on my investing career. I attended Bogleheads 8 when Jack Bogle couldn't go due to medical problems. But I wasn't too disappointed since I got to meet Bill Bernstein there. I was a Bernstein-head before I ever found the Bogleheads. He was a keynote speaker at WCICON22. I'm always interested in what he has to say. Plus, it helps that he can speak “Doctor.”
In conjunction with the marketing for his book, The Ages of the Investor, which was published in 2012, he did an interview with CNN. In that interview, there were several ideas worthy of discussion—most importantly, knowing when and how to reduce your level of risk to be a winner at the retirement game.
Stop When You Win the Game
Bernstein was asked, “How much exposure should people have to stocks?” He answered:
“A lot of people had won the game before the [2008] crisis happened: They had pretty much saved enough for retirement, and they were continuing to take risk by investing in equities. Afterward, many of them sold either at or near the bottom and never bought back into it. And those people have irretrievably damaged themselves.
I began to understand this point 10 or 15 years ago, but now I'm convinced: When you've won the game, why keep playing it?
How risky stocks are to a given investor depends upon which part of the life cycle he or she is in. For a younger investor, stocks aren't as risky as they seem. For the middle-aged, they're pretty risky. And for a retired person, they can be nuclear-level toxic.”
The reason why stocks aren't very risky for a young person is that you have a lot of “human capital” (the ability to make money working) left. On the eve of retirement, you don't have any of that.
More information here:
How Much Is Enough?
Bernstein recommends a rule of thumb, based on annuity payouts and spending patterns late in life, that you should have 20-25 times your residual living expenses (after pensions and Social Security) invested solely in safe assets. No stocks at all. This should be in TIPS, SPIAs, and short-term bonds. If you have more than that, that's your “risk portfolio,” which he describes this way:
“Anything above that, you can invest in risky assets. That's your risk portfolio. If you dream about taking an around-the-world trip and the risk portfolio does well, you can use it for that. If the risk portfolio doesn't do well, at least you're not pushing a shopping cart under an overpass.”
This is a little bit of a different way to think about things. The 4% rule was developed based on keeping a significant portion of risky assets in the mix. The Trinity Study showed that having fewer stocks in the retirement portfolio INCREASED your risk of running out of money early. But Bernstein suggests that once you hit your number (which is about the same number you'd hit using the 4% rule), you put all your money into safe assets. If you want a “risk portfolio,” then you need to keep working a while longer. If you buy into Bernstein's theory, you'd better plan on working a little longer, saving more, or spending less in retirement.
More information here:
I’m Retiring in My Mid-40s; Here’s How I’ll Start Drawing Down My Accounts
Fear of the Decumulation Stage in Retirement
A Framework for Thinking About Retirement Income
William Bernstein's Thought Experiment
“I did a little thought experiment in which I calculated how many years it took people starting work in different years to make their number. I realized that the cohort that started working during the worst of economic times is the one that did the best. The last cohort that actually was able to make their number started their careers in 1980, and they made their number in 19 years. And the graph ends in 1980, because no cohort that started work after 1980 actually made the number.”
I'm sure the book goes into more detail on this point, but it does illustrate that when you retire is at least as important as any other factor you can control. I have family members who retired in the late '80s and rode the bull market for the first decade of their retirement. They couldn't have timed it any better. Other family members who were going to retire in the early 2000s ended up having to work a few more years to get to a less comfortable retirement.
Determining When to Reduce Risk
“[In the middle of your career] you need to start bailing out of risky assets as you get closer to achieving that liability—matching portfolio—when you can ‘win the game' without taking so much risk. Instead of cutting your stock allocation one percentage point a year—the standard formula—in a year with absolutely spectacular returns, you might want to take 4% or 5% off the table. In a series of years when stock returns have been poor, you don't take anything off the table. And over time, you start laying down a floor of safe assets with the proceeds from the stocks you've sold.”
While this approach smacks of market timing, it's entirely based on past performance—not future performance—and requires no predictive ability. He's just suggesting that your gradual transition from a 75% stock portfolio to a 25% stock portfolio doesn't have to occur in an even manner. It's OK to reduce the risk level using broad strokes, especially after a good year or two. Seems wise to me.
More information here:
The Average Investor Needs a Financial Advisor
I had a long conversation with Bill about the ability of investors to do it on their own. I've mentioned before that each of us has two jobs—practicing the profession we trained for and then our moonlighting gig as a portfolio manager. Bill used to think that most people could manage their portfolios successfully. But the longer he's been in investing, the more he realizes that it's really quite a tiny sliver of the population that can successfully manage their own portfolio. He explains it this way in the interview:
“I've flown airplanes, and as a doctor, I've taken care of kids who can't walk. Investing for retirement is probably harder than either of those first two activities, yet we expect people to be able to do it on their own.
An alternative would be to have a pension system such as in Singapore, where the government forces people to put money into a dedicated investment pool that it manages at minimal expense. And when people get to be of retirement age, they are forced to annuitize some of those savings, which turns into safe income.”
I have to admit I share his opinion. When I first learned a little about investing, it seemed so easy that I figured anyone could do it. The more people I meet and talk to about money, the less I'm convinced that most doctors, much less most people, can do it on their own. Many readers of this blog are in this small, capable sliver, but you certainly shouldn't feel bad if you'd prefer having a financial advisor or two helping you out.
How to Choose an Advisor
Bill was asked, “How do you find a good advisor?” This was his suggestion:
“Interview one and say, ‘Look, this is my portfolio now,' and you show him or her a simple, cheap index-fund portfolio.
And if he says, ‘You know, this is really good, you've got the right idea, I think we can diversify you a little more by using some more cheap index funds.' That's the answer you want to hear. You've probably found an honest advisor. And someone who adheres to an index-fund portfolio will probably be more likely to adhere to the policy, because you've got someone who has some humility and realizes he doesn't know how to time the market.”
As usual, there's a lot of wisdom there. Thanks, Dr. Bernstein for all you've done for investors, doctors, and those of us who like to wear both hats.
If you aren't already a fan of Dr. Bernstein, here are links to a few of his best-selling books, many of which I review on my Best Financial Books for Doctors list. Enjoy!
If You Can
The Investor's Manifesto
Investing for Adults
The Four Pillars of Investing
The Birth of Plenty
A Splendid Exchange: How Trade Shaped the World
What do you think of Bernstein's rule of thumb? How have you reduced your level of risk in retirement? Comment below!
[This updated post was originally published in 2012.]
While it is certainly true that many people would have been better off if they had switched to a more conservative position once reaching their goal, it assumes you are very comfortable with the “number” you set. If you reach your goal early and become excessively conservative then there is a chance inflation will make it such that your “number” wasnt accurate. Additionally many of us have a roving goal bc maybe it just isnt about retirement any more which really means we are greedy and want to have tons of money for all kinds of other things. We dont want to admit the greed.
Interesting idea, but in this era of very low returns you are continually eating into your capital. Now if you can live off the income of your investments you never run out and leave something for your heirs. Time will tell if this theory works at least for me, but it requires that you take prudent risks with your money or have a very large amount of it. Safe investments yield like 3% and I would like 60K of income each year (excess early and social security later for inflation). That would mean 2 million required. Take some risk and get say 5% and the number decreases to 1.2 million. Many years difference unless you make a lot of money and spend little.
Barry Alexander:
Could you please name some safe investments that yield 3%? Is this pre- or post tax ?
Thanks very much.
Check out a counterpoint from Vanguard that basically states a continued allocation (although less risky than for a younger person) to both equities and bonds through retirement is superior to a fixed income approach only.
https://personal.vanguard.com/pdf/s557.pdf
Anon,
EE savings bonds held for 20 years will yield 3.5% nominal guaranteed. Tax can be deferred until redemption.
If inflation goes back up to 3% in the future, series I savings bonds would also yield 3% nominal although zero real by definition.
The much better approach to the idea of “stop when you’ve won” is called Value Averaging.
The idea there is you have your target and you have your return estimate that you need to get there. In a boom, you sell stocks to keep the portfolio on track, then when it busts, you reinvest those profits to get it back on track. That way you’re selling high(er than you need) and buying low(er than you need).
That way you also don’t need to guess whether a year has been “absolutely spectacular” or not, it’s all defined by your spreadsheet.
Bernstein is well-aware of that method to build wealth. In fact, most of us have heard of it only because he promoted the obscure book by that title. WCI has written about that too. But this concept is about preserving wealth rather than building it. And about surviving a crash in retirement.
Bill Bernstein is an absolute genius. I first learned of him over 20 years ago. Financial writers and Wall Street professionals were calling him to get his thoughts on market events and possible stories to write. And he was a practicing neurologist at the time.
I like that he keeps writing books that get easier and easier to understand. I have read everything he wrote and am slowly beginning to understand them! Thank you, Jim, for promoting him and his work.
We can dive into the weeds about where to get a safe return or whether maybe 2% or 3% is the real SWR. But I generally agree with this concept. I started reducing my risk exposure. I’m not 100% government securities, but I’m only 30% or so in public stocks. If I lost all of that I could still recover and be fine. Most of us have “human capital” even late in life since work isn’t always back-breaking.
After a certain point, it is okay to invest in growth again since that money will be for your descendants and charities and the SOR risk isn’t important for that purpose. Once you have your LMP (riskless) you can further build your RP (risky assets). This isn’t just his theory either. It is all well-studied in financial literature.
Follow up quote from his book, “The Investor’s Manifesto”
Regarding SWR (safe withdrawal rate) from an investment portfolio
2% reasonably safe and secure
3% fairly/probably safe
4% taking real risk/chances
5% will likely run out
So for every $50K of living expenses you would need a $1.67M nest egg to be fairly secure or $2.5M to be perfectly safe.
Ouch!
Bernstein has always been fairly pessimistic with his estimates of future returns. Nothing new there. So far, he’s been wrong. Doesn’t mean he always will be. There was a good post recently by Clements that may explain why. Maybe future stock return is more than just dividends plus dividend growth. For example, consider the impact of stock buy backs on returns.
I started de-risking my portfolio this year and converted a chunk of equities into bonds. I did this because I feel like I am in the 5 year window prior to retirment and thus in the most dangerous time for SORR risk.
I created a decent floor with income producing assets (primarily real estate) that hopefully will not be too impacted if we do enter a recession. I am hoping this would prevent me being forced to sell at market lows and lock in losses when I do retire.
You cannot protect against every risk but by having a portfolio very heavy in low risk assets you leave yourself open to inflation risk. Even a period of moderate inflation could decimate a bond and cash portfolio.
when the tide goes out you will know who is swimming without trunks-warren buffett
the bucket approach seems like a wise move at retirement to lock in fixed expenses for 10years and the balance can be put in riskier vehicles
Kitces discusses safety first versus probability based retirement income in his writings
I think Bernstein’s strategy is solid – in the right context. For a person of typical retirement age, who needs to be saved from her worst tendencies (e.g. panicked selling during a crash), having a floor of safe assets makes sense.
Many of the physicians who frequent this site, however, are younger than the typical retirement age. Some of us hope to achieve the “RE” part of FIRE sooner rather than later. An early retiree who needs her portfolio to last 50 years needs to assume a fair amount of risk to decrease the odds of failure – any retirement calculator (cfiresim, firecalc, etc) will validate that statement.
It is important to realize, though, that Bernstein’s philosophy can still guide the aspiring early retiree, above. Take my case:
My wife and I are both physicians in our mid 40’s. She has retired within the last year, while I work part-time. On two occasions over the past few years, we realized that our portfolio had grown beyond expectations. The retirement calculators showed that – starting with a much higher “number” for assets – we could have a lower percentage of assets allocated to equities than previously. As such, we twice changed our Investor Policy Statement to reflect a 5% lower allocation to equities, such that we are now 10% lower in equities and 10% higher in bonds than just a few years ago. We have taken money off the table, as Bernstein suggests, but without increasing our chances of the portfolio failing before the 50 year mark.
As an additional hedge against having to sell equities in a down-market, we keep roughly 4 years of living expenses in a CD ladder, currently earning an average of about 2.5%. We consider this money outside our portfolio, so our 70/25/5 portfolio is equities/bonds/real estate – the CD cash is totally separate. Mentally, this helps me sleep at night, knowing that I can retire at will, without worrying so much about SOR if the market crashes upon my retirement.
I think that Bernstein’s advice here is very poor for many reasons. First, it assumes that a multiple of 20-25 a retiree’s expenses is enough, which is ludicrous. Most 65 year old physicians have a good shot at surviving to beyond age 90, and if we include joint mortality involving their spouse, I believe that it’s around 50%. And I wouldn’t count on SS benefits riding in to save the day for many reasons (e.g. less beneficial to those with significant incomes in retirement, SS benefits are slated to be cut in 15 years across the board, the sociopolitical environment would be much more favorable to reducing or eliminating SS benefits for those with significant assets than those without them).
Second, in today’s low yield environment, investors with taxable accounts can’t even break-even with inflation with muni bonds or barely so, so telling them to put all of their portfolio into such instruments is very likely to result in real losses for a long while at least. Long-term TIPS still provide a barely positive real pre-tax return, but this will result in after-tax losses for most retired physicians.
Third, while Bernstein’s comment implies that stocks are like gambling, the data tell a different story. Jeremy Siegel found decades ago that over about 17 years or longer, stocks have actually been much less likely to have an inflation-adjusted loss than nominal bonds, what Buffett would call less risky.
Fourth, a portfolio comprised of 30% stocks and 70% intermediate-term Treasuries has, over the last nearly 50 years, been no more volatile than a portfolio of 100% intermediate-term Treasuries, even though the portfolio with stocks has earned over a 1% higher return. So there has been virtually no reason to favor an all bond portfolio. Rick Ferri missed this important point in an article earlier this year too.
Fifth, if Bernstein’s real problem is bad investor behavior, there are much better ways to address it. One of these is a good all-in-one fund, either low-cost target-date funds or fixed-AA funds like Vanguard’s Wellesley Income fund. These can help to obscure losses in one specific asset class with gains in another (e.g. stocks are down but bonds are stable or up). Yes, these are usually less optimal for those with taxable accounts, but they are still likely to come out far ahead of an all-bond portfolio, and in the withdrawal phase (i.e. retirement), retirees don’t have to worry so much about taxable income because they are likely to need some at that point. Another option is to turn management of one’s finances over to a fiduciary that you trust very well.
Sixth, rather than put all of one’s portfolio into bonds, buying a single-premium immediate annuity with a cost-of-living adjustment with a portfolio of those bonds may be better for several reasons. These provide lifetime income, unlike what Bernstein recommends, and are very secure instruments. Retirees who buy them with a portion of their portfolio can likely invest the remaining funds more aggressively than otherwise. This is something that Wade Pfau has been recommending for years (e.g. ‘income flooring’).
I agree with Bernstein that many retirees’ AA is too aggressive, but his recommendation throws the proverbial baby out with the bathwater.
I think that Bernstein greatly oversimplifies this topic, kind of like Bogle did with all topics.
And the consequences of this oversimplification are that retirement will be put off for many years, due to some very conservative approaches.
And, as it applies to this audience, unless the goal is to retire as soon as you are able to financially, he ignores the reality that many people will keep working AFTER they reach their “number”. For that group it makes no sense to go to a totally conservative asset allocation.
Overly conservative advice has significant consequences. Those need to be acknowledged more openly by Dr Bernstein.
I’m not sure if you are both commenting on the blog post, or Bernstein’s overall sentiment. Unless I missed it, I saw no where in the post where it suggests being 100% out of equities which is what you are suggesting. The broad gist of this post is about paring your risk with advancing age, which most would agree with. Going from 90-100% stock portfolio when you are age 25 to something that may be closer to 30/30/20/10/10 (across stocks, bonds, real estate, gold…yes gold, private equity) is something to be considered strongly as one approaches retirement….or when they have “won”. Sequence of Returns is a real risk and something to be aware of. I doubt Bernstein or WCI are suggesting moving to 100% bonds.
Why would retirement be put off if you don’t stop until you are able to retire? That doesn’t make any sense.
If you keep working afterward, then you can take more risk with the additional savings.
But I agree with your overall point that there are real consequences to this approach of going super conservative with “enough” once you get to “enough.”
Retirement would be put off by being too conservative, too soon. And he didn’t suggest instantly going conservative, it was kind of a long process.
The way I read this blog post was that he advocates for all the “enough” to be in either SPIA, bonds or TIPs. Only money beyond that would be in equities.
That flies in the face of historical data.
It is one thing to advocate for decreasing sequence of returns risk by creating a balanced portfolio. It is another thing to advocate that 100% of “enough” be in bonds and SPIAs. That is a bridge too far for me.
Especially since “enough” in SPIAs, TIPS, and short term bonds is a much higher number than “enough” in a diversified portfolio.
I entirely agree Bob. This notion that 20-25X, the upper end of which should be ‘enough’ for most physicians in their mid- to late-60s, should be placed wholly in fixed income instruments is just not supported by the data. The data do not support an equity allocation lower than 30% to be logical in that such an AA is no more volatile than 100% bonds, but just a 30% allocation to stock can give the retiree good protection against inflation and at least some upside potential.
The vast majority of retirees should maintain a growth-oriented allocation with more stocks than bonds, remain well-diversified across asset classes including international exposure and a healthy mix of small/value equities, rebalance to maintain risk, and realize that they’ll be fine unless we live through another Great Depression.
The stakes are high here–annuitizing your retirement sacrifices your ongoing future income growth potential and ensures there will be no money left after your retirement for family or charity. Opting for an inflation-adjusted annuity dramatically sacrifices current income potential and also erases any chances for a legacy.
We’ve lived through 8 bear markets in the last 50 years and the evidence is an investor retiring on the eve of any of them, with a well-balanced portfolio, has survived and ultimately flourished IF they stayed the course.
I share Bernstein’s concerns for investors bailing out at the wrong time if left to their own devices or paying for part-time advice, but hiring a good full-time advisor basically takes that risk off the table.
I disagree that just hiring an advisor takes that risk off the table for two reasons. # 1 Some people bail out anyway against the advice of the advisor and # 2 Some advisors recommend bailing out.
These aren’t very compelling.
(1) Not everyone can handle the challenges of investing. Nothing is foolproof. But with a good advisor, it’s far more likely. That’s for sure.
(2) If you don’t know how to find a good advisor with the right investment approach who can help you avoid making emotional errors, you don’t have a snowball’s chance of doing this by yourself or with the aid of a few hours of advice.
I’ve seen the “best” DIY portfolios. I’ve seen the portfolios recommended by hourly advisors and those on fixed fees. They’re not great.
I’ve listened to DIY investors try to work their way through a bear market or a period of underperformance without making changes. It’s not pretty.
I saw what Vanguard reported was the asset allocation of their DIY investors before hiring their advised service. It was scary.
I read the rhetoric, but the reality is far different.
I’ve seen the “best” advisor portfolios, they’re not necessarily great either. But given your prior comments on this site, you strongly believe (way too strongly in my opinion) that basically that any portfolio that doesn’t look like what you recommend is terrible.
I’ve seen plenty of crummy portfolios put together by advisors charging AUM fees. An AUM fee doesn’t somehow magically get you better advice than paying the exact same amount of money as a flat fee. Give me a break. That’s a dumb argument.
Indeed. I remember very clearly in Jan 2009 the financial advisor of a good friend of mine told her she should get out of the market because stocks had become “too risky” and wait until the market settled down. Fortunately her brother convinced her to fire that advisor.
Trading at least some of one’s allocation to bonds for an inflation-adjusted annuity with a cost of living adjustment has some merit. Yes, the retiree and heirs permanently lose access to the annuitized assets, but this can enable the retiree to take on a more aggressive (i.e. stock-tilted) asset allocation with the remaining portfolio. It may be a good balance between having one’s cake and eating it too.
What is it that makes him question the ability of 90-some percent to “do it themselves”? Is it just the tendency to give-in to temptations that frequently lead to buy high, sell low behavior? Passive Investing, including how he recommends, seems to be rather simple if you can follow the plan. I really don’t see the value of an advisor but maybe I’m missing something in his point?
He has said this for a long time. I forget the exact points he mentioned, but it was a multifactorial thing. He said only 10% can do the math, and only 10% can do something else, so 0.10X0.10 = 0.01 It may have been in one of his early books.
Ask him. But I think he’ll tell you there is both a knowledge/skill component and a behavioral component and that a very small sliver of the population has both.
That’s where all-in-one funds, such as target date funds and fixed AA funds, can really help. By obscuring the relative performance of the various asset classes they hold, investors are less likely to engage in performance chasing, such as selling their ‘stocks that are tanking’ for ‘stable bonds’, for instance. Research has shown this to be true for many, although certainly not all, investors.
Simply ignoring one’s investments when the markets are doing poorly is a simple, though not necessarily easy, approach to staying the course as well.
The S&P 500, with dividends reinvested, is up 145% since this post was first published in November of 2012.
I’ve “won the game” but I keep playing. If not for me, for heirs and charity.
Cheers!
-PoF
POF…Very true. However what happens if you retire now and next year has a 50% market sell off? Your 145% return just got slashed to approx 20%. I’m sure you have pared down from 100% market equities? Or maybe you have 100% of your portfolio in VFINX and like to gamble.?.?
We’ve only had 2 declines of 50% or more in 90 years. If you had a 100% stock portfolio (DFA Equity Balanced Strategy) starting in 2008 (one of the -50% declines, the other being the Great Depression), wanted income of 5% per year adj for inflation, 12 years later you have more than you started with in 2019 net of withdrawals. The “sequence of returns risk” Bernstein and others constantly warn us against is mostly a mirage. Here: http://bit.ly/2NHSkm1
If you held a big bond allocation, despite doing better in 2008, you’re well below your starting value & in deep trouble because interest rates and bond returns are so low! By trying to avoid the risk you’re afraid of, you got the very result you were trying to avoid!
The vast majority of investors get the risks wrong in retirement (volatility vs. purchasing power) and it costs them considerably over their lifetime. This is important information investors deserve to know that is unfortunately hidden under the veil of “low fees are all that matter.”
Eric,
If you want to back test things and pick and choose dates, how about we pick August of 1929 until August of 1949. Or more recent January of 1969 to January of 1982. You will notice that these draw downs were large and very slow to recover. If you were 65 in 1969 and 100% invested in the market, you would have been in some serious hurt had you just retired.
Yes, 50% draw downs are rare and I was being extreme. But actually 2008-9 was an extreme example that thankfully rebounded very quickly. Unfortunately there have been multiple times in history where draw downs occur that do not rebound quickly. Whether you choose bonds or another medium to diversify, I will stick with more diversification with continued aging. For reference, I am fairly young and still heavily invested in the market. But having “won the game” at this point, I am paring down my risk for major draw downs as I cannot predict the future.
But hey…don’t listen to me as I’m just a doctor.
https://www.linkedin.com/pulse/diversifying-well-most-important-thing-you-need-do-order-ray-dalio
It’s pretty easy to choose the winners retrospectively. There is no guarantee that stocks will outperform bonds over my lifetime. Is it likely? Sure. How much are you willing to bet on it? That’s the question every investor must ask themselves, and that isn’t even taking volatility tolerance into consideration.
BINGO.
I publish and update my portfolio regularly on my site: currently about 90/10 with my publicly traded assets with some additional money invested in alternatives (real estate, small business, etc..)
If I were no longer earning an income, I’d dial back the stock portion a bit to account for sequence of return risk, although with a withdrawal rate at around 2% and decreasing by the year, there may be no good reason to dial back when I retire completely someday.
Cheers!
-Pof
I think this is fantastic. I wish more investors had your foresight.
I’ve done all the heavy lifting for you. Every bear market in the last 50 years including drawdown & time to recover…it’s sure to surprise you. http://static.fmgsuite.com/media/documents/b108d1b1-0da7-4aab-96fe-dac7d3cec5a8.pdf
You can choose to believe another Great Depression is right around the corner, or have more realistic/reasonable expectations.
A fixed income heavy retirement portfolio would have been killed in the 60s/70s, btw. 100% diversified stock portfolio worked best here too. More stocks usually work better, even in retirement.
Those critical of Dr. Bernstein might do well to read “Ages of the Investor” (it is very short) rather than build critiques on a few snippets from an article or blog post. I think there is a lot of wisdom behind his approach.
One, he does not recommend going 100% safe assets to cover the whole retirement budget. He does recommend safe assets to cover essential expenses in excess of SS and any pension. If one enters retirement with a paid off house, it will not take much beyond one’s SS check to cover the essentials. That SS check will keep up with the CPI, and so too will the TIPS ladder he recommends (not nominal bonds, and maybe not after-tax). Oh, and he allows that half of the dividends from one’s equities can be considered safe for covering one’s essential expenses. (This is based on data from the Great Depression, when dividends fell by half in real terms.) He prescribes using ANY allocation within the retiree’s risk tolerance for the Risk Portfolio. So go ahead and fund your luxury SUV, resort condo, and annual overseas trip with equities. Just bear in mind that these are non-essential and might go away with sustained poor equity returns. WCI readers probably have a fairly high ratio of non-essentials to essentials and so could well end up with lots of equities even if they do Bernstein’s liability matching. Do the math for your own situation. (I did and retired at 58/42. We are spending down the 42. The 58 has grown to 68 in 3.5 years for our beneficiaries, or for our own future extravagance. Once one has liability matched, why rebalance?)
Two, he was a practicing financial adviser during the great recession. He saw first hand how badly people can behave when financial market chaos is trashing all prior assumptions about how funding the future will play out. The brave commenters here might want to question whether they will continue to be so brave next time. This goes double if they were working and saving the last time around but might be retired and drawing down the nest egg during the next upheaval. Even if said brave commenters could stay the course, would their spouse be capable of doing so if they had to take over portfolio management?
Three, Dr. Bernstein knows a good bit of financial history world-wide and therefore is aware that worst-case scenarios elsewhere have been worse than those endured in the US. I think it is folly to believe that US history guarantees us that nothing to come will be worse. I started my retirement investing in 1982 (Dow at about 800). We have had a remarkably good run over 3.5 decades. I think that props up the current enthusiasm for equities, but I don’t want to bet on it continuing. Some think another Great Depression is unlikely. Maybe so. But the historical worst year to retire was 1966, not 1929. Plain old, dragged-out stag-flation was enough to set the historical low withdrawal rate at 4%. Next go round, the 1980’s-style bull market may not come riding to the rescue in time.
“One, he does not recommend going 100% safe assets to cover the whole retirement budget. He does recommend safe assets to cover essential expenses in excess of SS and any pension.”
That’s not what’s represented in this blog post (i.e. 20-25 times one’s ‘residual’ living expenses, with no distinction between essential and discretionary spending, wholly in fixed income with no stocks at all). But I am totally on board with what you’re suggesting, and for most of this audience, this should still leave them with a reasonable overall asset allocation (i.e. at least 30% stock).
“If one enters retirement with a paid off house, it will not take much beyond one’s SS check to cover the essentials.”
That depends on many factors, in particular the cost of living where the retiree lives. But considering that most of this audience will get at least close to the maximum SS benefit themselves plus 50% more for their spouse, that comes out to almost $68k annually if benefits are deferred until age 70. Even $50k should go a long way toward covering a physician’s essential retirement spending with a paid off home.
Tom,
Very well stated. And similar (albeit more eloquent) to what I have been trying to say above.
Thanks,
I may well be a simpleton, but the more and more I read about retirement allocation, the more I default back to William Bengen’s 1994 paper introducing the 4% rule (along with some of his subsequent elaborations suggesting some additional diversification).
An allocation of 50% equities and 50% fixed income, both reasonably diversified, seems to make me the most comfortable. Though shifting these based on your perception of valuations up to +/-10% (a la Bogle) is probably OK.
If you read Bengen’s research, a number of interesting findings are there that never found their way into the popular press. Many advisors don’t even know them.
#1 – the “safe” spending rate from a 50/50 portfolio was defined as the rate that worked in almost every single scenario; it’s not the “base” case but the “worst” case scenario
#2 – it was 4.1% per year on a 50/50 stock and bond mix
#3 – that stock mix was 100% S&P, no international diversification, and small-cap or value stocks included despite the fact that a small-cap value index has outperformed the S&P 500 since 1973 by the SAME amount as stocks beat bonds
#4 – the simulations found that 50/50 did NOT produce the optimal result, 75% stocks and 25% in bonds worked far better, even given poor portfolio construction
#5 – a major finding of the article was that most retirees should hold far more in stocks than they do (or the simple 50/50 mix) and that they need to understand that volatility isn’t the risk they should fear, purchasing power risk (and too much in bonds) is
#6 – the periods where most failures occurred was not the Great Depression, but the 60s and 70s, because longer-term bonds and the large growth stocks that dominate the S&P 500 did poorly compared to inflation. You would have been far better off including value, small-cap, and small value stocks and with bonds, shorter maturities were far better.
Here are the index returns from 1966-1985, one of the common periods of depletion for the 50/50 mix (but not for small/value tilted stock portfolios that used short-term bond maturities):
***CPI = +6.4%***
20-YR T-Bonds = +6.0%
1-Mo T-Bills = +7.3%
5-YR T-Notes = +8.0%
1-YR T-Notes = +8.4%
S&P 500 Index = +8.7%
CRSP 6-10 Small Cap Index = +13.4%
Fama/French Large Value Index = +13.8%
Fama/French Small Value Index = +18.6%
“Sequence of”
• accumulation say 30 years
• returns say 60 years
• withdrawals say 30 years
Now a 25 year old is 85 years old and look to see how much is left in the pot! The knowledge/skill component, the behavioral component, need also to consider the “luck component” (when you were born). Investment returns are different than volatility, why change your allocation and defeat the returns by choosing an allocation the is suboptimal for a retirement portfolio? Now it’s a different question if one wants “retirement portfolio” defined as “cash equivalents” and keep investments in a separate bucket. Changing you AA impacts significantly the returns on “average” for your specific fears in the relatively short term. I don’t get it. Smacks of market timing and emotional investment choices and defeats the longer term returns due to compounding (heavily weighted towards the last years).
https://awealthofcommonsense.com/2019/04/the-life-cycle-of-wealth/
My rule of thumb in retirement-If you can lose 50% of your equities and maintain your lifestyle and not lose sleep, you are secure
I am totally with Bernstein and did the same leaving a certain # in stocks and the rest in cds, bond funds, hi yield, and now from Ric Ferri preferred stock fund(PFFD and etf)
Swedroe talks as well about marginal utility of wealth in his books-LEARN IT
SPIA’s do not solve the problem. Eve if inflation adjusted, that adjustment will be limited. No one will sell you an annuity that will adjust for inflation no matter how high. Even a few years of double digit inflation will greatly reduce the real value of the annuity payments.
Allocation to short term bonds may be expected to produce ~ 0% real returns. This means you can save enough money to fund your retirement by
Accumulating X times your annual spending in retirement, where X is the number of years you want to provide for. Call it an outside estimate of how long you or surviving spouse may live. If you retire at 70, then maybe this is 30 years. Make it 40 to allow for longer than expected survival.
Put that money in short term bonds. You expect zero real return, but by allocating enough to cover your annual expenses at 0 return, you should have enough. Use a higher multiple to get a margin of safety.
If you allocate any to SPIA’s recognize that you are betting that inflation will never be higher than the inflation adjustment available from your annuities. Not a good bet.
Put money above this amount in portfolio of stocks or maybe some stocks, some bonds, some real estate…
I would imagine SPIA pays better than 0% real return because benefits of those who die will go to fund the benefits of those who live.
That’s correct. It’s not a high return on average, but it is positive. Plus the mortality credits. Think of it as fixed income plus some guarantees.
Look at PFFD-preferred stock index fund paying 5+ %
Why does he keep the 4% recommendation from the Trinity study while throwing out the asset mix recommendation?
Ignoring the fact that you’ll likely die with a big pile in any case using that withdrawal rate, 100% in conservative investments clearly showed the highest risk of running out of money during retirement. Bill’s advice has to be tied to projected years of retirement to be usable.
Thanks for this post and all of your work, you are the new Dr Bernstein. We have reduced our retirement risk by debt freedom and having our fully loaded expenses with 2 homes at about 75% of social security and pension cash flow. Both have Colas and it looks like total expense increases will be about half of the cola cash flow. Want to have debt? Need a way to properly value a pension? His math on residual expenses is of course correct, maybe doesn’t do enough justice to the mental and emotional aspects.
Not sure Bernstein can ever be replaced and besides, he’s still with us fighting the good fight!
Sounds like you’re set though! Congrats and well done.