6/14/2013 5:15 PM ET|
The hidden threat to your portfolio
The so-called balanced portfolio, mixing higher-volatility stocks and 'safer' bonds, is the bedrock behind most portfolio management. But it could leave you broke.
If I suggested that you hand your grandmother's retirement savings over to a cardshark in the hope that he might gamble with them on a riverboat casino, you would probably give me a very funny look.
But grandma's savings are being gambled right under her nose. And there's a good chance she doesn't have a clue it's happening.
Your grandma -- like most investors -- is likely being told by the Wall Street marketing machine that some variant on the "60/40" portfolio of stocks and bonds will see her safely through her golden years. The so-called balanced portfolio, mixing higher-volatility stocks and "safer" bonds, is the bedrock behind most portfolio management. It underpins the "life cycle" and "target date" funds that Wall Street is busy selling to all the baby boomers heading into retirement. As you get older, you are supposed to hold fewer stocks and more bonds, to reduce volatility, in a "glide path" to retirement. But the fundamental principle—that balancing stocks with bonds will help you navigate all environments—doesn't change.
I've been banging on for some time about the flawed logic behind this idea. I've noted that a balanced portfolio of stocks and bonds has failed investors miserably in the past and may do so again. Such portfolios lost money, when adjusted for inflation, in the 1940s and again in the 1970s. Stocks and bonds have only "balanced" one another when one or the other was undervalued. In 1982 both were undervalued, so investors have done very well since then. Today, however, both are almost certainly overvalued. Investors are taking a huge risk.
I hadn't realized how big that risk was until a chance meeting this week with Mark Hanus, who has just launched an independent mutual fund designed to hedge inflation risk, the Inflation Hedges Strategy Fund (INHIX). Hanus used to be at Wellington, the blue-chip Boston fund company. Before that he was a co-founder of Absolute Investment Advisers.
In the course of our conversation I looked through some investment slides which Hanus had prepared. And one struck me so hard I did a double-take.
I've missed a trick. Yes, I've already reported that "balanced" portfolios have served older investors very badly at stages in the past. But I hadn't included an additional factor -- the cost of the withdrawals those investors had to make each year.
If you held money in a portfolio of 60% stocks and 40% bonds starting in 1966 -- a year when stocks and bonds were both high-priced -- and rebalanced once a year, over the following 15 years your portfolio lost about two-thirds of its purchasing power. (So much for "safe.")
But what about if you had just retired, and you had to withdraw some money from that portfolio every year to live on?
If you withdrew 5% of the portfolio in the first year, and just increased your withdrawals each year to keep pace with inflation, something alarming happened. Within about 18 years your entire portfolio was gone. Kaput.
What killed the portfolios was rising inflation -- coupled with poor returns from both stocks and bonds.
To check the numbers, I went home and built my own spreadsheet, using returns for stocks and bonds compiled by NYU's Stern School of Business, and inflation data from the U.S. Labor Department. Result? Hanus was spot on. The portfolio was gone by 1984.
What's more, the higher the percentage of bonds you held, the sooner the money ran out.
It is yet another piece of bad news in the national retirement crisis. Many Americans are retiring with less than $25,000 in savings. They are going to need "winning" portfolios if they are to have any decent chance of a dignified old age. But right now, with bond and stock markets so high, there is every chance that the best they can hope for from here is a portfolio that doesn't lose too badly.
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"right now, with bond and stock markets so high, there is every chance that the best they can hope for from here is a portfolio that doesn't lose too badly."
Yep, that slogan, “Where else ya gonna go”, which every broker and talking head has been pitching recently to lure folks into the stock market doesn’t ring so well when suddenly there is no safe and profitable place to go anywhere.
My modified approach to investing now has two additional facets:
- 1-Diversify beyond stocks and bonds to things like commodities and precious metals. These things sometimes move contrary to stocks and bonds and help smooth out the bumps in your portfolio value. Consider diversifying in non-financial assets too, like physical real estate and small businesses that generate income.
- 2- Assume no matter what you do your investments are going to lose purchasing power after taxes in the range of 2% per year, and budget your spending accordingly. That’s right, even if you spend none of your wealth it will decline in real value. Assume any financial advisor or financial salesperson trying to convince you otherwise is probably trying to make more money off your money for themselves than they will ever make for you.
The best thing I can recommend is never panic
when the markets go into a tail spin. I have been through
the era of quality bonds re-named to junk bonds, the internet bubble,
the real-estate bubble, I have seen red my eyes looked blood shot,
and yet today, I am 79 years old with 99% of my assets still in the market,
I am in the green. But, I cannot re-call the times, I was going to throw
my TV out the window when I saw a sea of red. The Market always comes back,
history has proved that. At 79 years of age, I would rather wake up dead, with a bank load
of finances, rather than wake up alive with just a penny. Maybe I am wrong, maybe I am foolish,
but then who knows?
Complete garbage. I have several "balanced" funds, and they have proven over decades to be a great way to make decent money without that much risk. The funds performance and most of all the fund manager are important.
vbasx, Vanguard's 5 star balanced fund, going back to before the crash, has returned a 6.7% year to year return, like I said including 07, 08, and 09, with ZERO dollar cost averaging.
someone said the stock market does better under Democrats than Republicans. Well.....
This is because Republican are responsible people as opposed to irresponsible spend spend borrow borrow Democrats. This means that Republicans do the RIGHT thing not the popular thing. This means that righting the ship is painful and therefore results in a bit of pain to clean up the Democrat messes and the market suffers. This is logical. Of course people party while the spend spend party is rolling. then there is a hangover. Get it!
Think about it. Obama is irresponsible (by his own words borrowing is "irresponsible and unpatriotic" google it!!!!!!, he said it, then again he says a lot of BS and then does whatever he pleases) adding 10 trillion in debt, you don't think the next administration will have to deliever some pain when the Obama part spend spend spend is over?
So we get a history lesson about '66 to '81. Does he suggest that same situation is at hand? If so, it would have been nice if he told us what the investors who thrived did over that period. Hell, he got me to read the damn article so I guess he earned his pay.
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