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Is that true? If you just use two asset classes, I would think a 100% equities position would be on one end of the efficient frontier, and 100% bonds on the other. Can you create a lower-volatility equivalent return portfolio with a mix of equities and bonds than with just 100% equities?
Nowadays, everyone who can spell "investing" knows the long-term annual ROI of owning equities (stocks) is much higher than the long-term ROI of owning debt (bonds). Here's just one of many reputable charts that show, year by year, the historical return of $100 invested beginning in 1928 in the S&P 500, in 3-month T-Bills, in long US Treasury Bonds, in corporate bonds, in real estate, and in gold: https://pages.stern.nyu.edu/~adamoda...histretSP.html
In 1994, economists Richard Thaler of the University of Chicago Booth School of Business (who went on to win the 2017 Nobel Prize in Economics) and Peter Williamson of Cambridge University presented strong evidence documenting the historical superiority of investing in 100% equities compared with a more common investment policy of 60% equities and 40% bonds (60/40).
In the same academic article ("College and University Endowment Funds: Why Not 100% Equities?"), Thaler & Williamson argued that organizations with extremely long (or infinite) time horizons such as universities ought to invest their sizeable endowments in 100% equities because their time horizons allow them to recover from bad years or decades while the concentrated exposure allow them to reap superior returns in good years and decades.
So, the obvious question is why bother to have any bonds in your portfolio if you are a long-term investor and can tolerate the risk?
But documenting the historical superiority of a 100% equities portfolio relative to a 60/40 portfolio doesn't answer the question "Why Not 100% Equities?"
1) How much risk should I incur?
2) What is the optimal portfolio for that level of risk? That is, how should I implement the risky strategy?
Recommending 100% equities ignores the separation of these two questions, and ignores the mathematical benefit to a portfolio's ROI of the inclusion of multiple asset classes with differing covariances.
First, you decide how much risk you are willing to incur. This is not a simple task, by the way, as people sometimes fool themselves by thinking they are willing to incur risk but in down markets they behave differently than they thought they would (they sell).
Second, you chooses a portfolio of risky assets to maximize the portfolio's Sharpe ratio (Sharpe, btw, won the 1990 Nobel Prize in Economics). This is the portfolio's expected return minus the risk-free rate of return, divided by the portfolio's standard deviation.
Third, given the maximal Sharpe ratio portfolio (let's call it "Portfolio P,") you then choose the proper mixture of P and riskless cash or cash equivalents or near-riskless investments such as short term CDs or short term T-Bills. This mix will vary from investor to investor because of differing tolerances for risk, but the relative weights among risky assets will stay constant. Feasible portfolios that maximize expected return for a given amount of risk are said to be "efficient" and are on the efficient frontier.
The following table gives the data from 1926 through 1993 (remember, the paper I'm summarizing was published in 1996):
Note that the comparison isn't really apples-to-apples, as the 100% equities portfolio has substantially more variability (risk) in it than the 60/40 portfolio or the 0/100 portfolio.
Constructing a new portfolio makes the comparison more fair (more apples-to-apples).
Imagine an investor has already determined that (a) the 60/40 portfolio is the optimal portfolio of risky assets, and (b) the desired amount of risk is the same as a 100% stock portfolio (risk means standard deviation, of course). For a $1 investment, a NEW portfolio can be constructed by purchasing 20.0/12.9= $1.55 of the 60/40 portfolio, financing the extra 55 cents by borrowing (that is, employing leverage).
The following charts restate the former, including this new "levered 60/40" portfolio:
*****
Legendary hedge fund manager Cliff Asness (who originally documented the momentum factor in his Chicago Booth PhD dissertation) published in the Journal of Portfolio Management in 1996 that for the exact same amount of risk as a 100% equity portfolio, one can instead have a levered 60/40 equity/bond portfolio that provides a higher compound annual return. Yes, a higher ROI for the same amount of risk. He uses his results to show that even very long term investors (e.g., 100-year investors such as university endowments) probably should not have 100% equities even in light of the historical superiority of equity returns relative to bond returns.
(He's financing the 55 cents of borrowing for each $1 invested by borrowing at whatever the then-current 1 month T-Bill rate is).
From 1926 through 1993, with the same initial investment of $1, the 100% equity portfolio grows to $800 while the levered 60/40 portfolio grows to $1291. Even though a 100% bond portfolio grows to only $40, using bonds in conjunction with stocks and leverage leads to an investment that grows to $1291. The investor who owns 100% stocks must bear the same risk and receive only $800.
Since then, several practitioners & financial advisors have extended the calculations for returns all the way through 2023, and the results are the same.
This is just a simple straight forward example; there are many others.
You'll be surprised how many people put their 401k in a money market fund. While it is tax deferred it isn't doing anything more than inflation.
I can't put my fingers on any data to support that right now, but it wouldn't surprise me if you are right, which argues for some financial education that everyone can understand, even those good people (and there are many) who are not inclined to learn such things on their own.
I didn't see too many people choosing the money market option in their 401K. They may have put a certain percentage of money in one just to diversify. If anything, I remember people going for the highest return and often that was the company stock. As long as the company stock was doing well and their investment was going up, up, up they were happy. But when the stock took a hit....oh, boy, the sad faces.
Luckily, with 401Ks you learn as you go. By the time you have a sizable amount, you are no longer gambling.
Nowadays, everyone who can spell "investing" knows the long-term annual ROI of owning equities (stocks) is much higher than the long-term ROI of owning debt (bonds). Here's just one of many reputable charts that show, year by year, the historical return of $100 invested beginning in 1928 in the S&P 500, in 3-month T-Bills, in long US Treasury Bonds, in corporate bonds, in real estate, and in gold: https://pages.stern.nyu.edu/~adamoda...histretSP.html
In 1994, economists Richard Thaler of the University of Chicago Booth School of Business (who went on to win the 2017 Nobel Prize in Economics) and Peter Williamson of Cambridge University presented strong evidence documenting the historical superiority of investing in 100% equities compared with a more common investment policy of 60% equities and 40% bonds (60/40).
In the same academic article ("College and University Endowment Funds: Why Not 100% Equities?"), Thaler & Williamson argued that organizations with extremely long (or infinite) time horizons such as universities ought to invest their sizeable endowments in 100% equities because their time horizons allow them to recover from bad years or decades while the concentrated exposure allow them to reap superior returns in good years and decades.
So, the obvious question is why bother to have any bonds in your portfolio if you are a long-term investor and can tolerate the risk?
But documenting the historical superiority of a 100% equities portfolio relative to a 60/40 portfolio doesn't answer the question "Why Not 100% Equities?"
1) How much risk should I incur?
2) What is the optimal portfolio for that level of risk? That is, how should I implement the risky strategy?
Recommending 100% equities ignores the separation of these two questions, and ignores the mathematical benefit to a portfolio's ROI of the inclusion of multiple asset classes with differing covariances.
First, you decide how much risk you are willing to incur. This is not a simple task, by the way, as people sometimes fool themselves by thinking they are willing to incur risk but in down markets they behave differently than they thought they would (they sell).
Second, you chooses a portfolio of risky assets to maximize the portfolio's Sharpe ratio (Sharpe, btw, won the 1990 Nobel Prize in Economics). This is the portfolio's expected return minus the risk-free rate of return, divided by the portfolio's standard deviation.
Third, given the maximal Sharpe ratio portfolio (let's call it "Portfolio P,") you then choose the proper mixture of P and riskless cash or cash equivalents or near-riskless investments such as short term CDs or short term T-Bills. This mix will vary from investor to investor because of differing tolerances for risk, but the relative weights among risky assets will stay constant. Feasible portfolios that maximize expected return for a given amount of risk are said to be "efficient" and are on the efficient frontier.
The following table gives the data from 1926 through 1993 (remember, the paper I'm summarizing was published in 1996):
Note that the comparison isn't really apples-to-apples, as the 100% equities portfolio has substantially more variability (risk) in it than the 60/40 portfolio or the 0/100 portfolio.
Constructing a new portfolio makes the comparison more fair (more apples-to-apples).
Imagine an investor has already determined that (a) the 60/40 portfolio is the optimal portfolio of risky assets, and (b) the desired amount of risk is the same as a 100% stock portfolio (risk means standard deviation, of course). For a $1 investment, a NEW portfolio can be constructed by purchasing 20.0/12.9= $1.55 of the 60/40 portfolio, financing the extra 55 cents by borrowing (that is, employing leverage).
The following charts restate the former, including this new "levered 60/40" portfolio:
*****
Legendary hedge fund manager Cliff Asness (who originally documented the momentum factor in his Chicago Booth PhD dissertation) published in the Journal of Portfolio Management in 1996 that for the exact same amount of risk as a 100% equity portfolio, one can instead have a levered 60/40 equity/bond portfolio that provides a higher compound annual return. Yes, a higher ROI for the same amount of risk. He uses his results to show that even very long term investors (e.g., 100-year investors such as university endowments) probably should not have 100% equities even in light of the historical superiority of equity returns relative to bond returns.
(He's financing the 55 cents of borrowing for each $1 invested by borrowing at whatever the then-current 1 month T-Bill rate is).
From 1926 through 1993, with the same initial investment of $1, the 100% equity portfolio grows to $800 while the levered 60/40 portfolio grows to $1291. Even though a 100% bond portfolio grows to only $40, using bonds in conjunction with stocks and leverage leads to an investment that grows to $1291. The investor who owns 100% stocks must bear the same risk and receive only $800.
Since then, several practitioners & financial advisors have extended the calculations for returns all the way through 2023, and the results are the same.
This is just a simple straight forward example; there are many others.
the problem is more of investor behavior .
there is no question one should be 100% equities thru their accumulation stage , period ..
There is no financial logical reason a long term investor should be investing in less capable assets like bonds to mitigate temporary dips while permanently hurting long term returns.
now one could argue lack of pucker factor is a reason for adding bonds .
some can’t handle high volatility . however the data by ibbotsen and morningstar show that more conservative investors just tend to have lower trigger points to bad behavior and balanced funds show no better investor behavior then growth funds when volatility kicks up .
vanguard , the grand pappy of do it yourself investing concluded the same thing and Found most small investors hurt themselves by their own behavior regardless of how aggressive or conservative they are
most would do better allowing someone else to handle their money and keep them away from being in or out or direct control .
i wouldn’t think of being anything but 100% equities in my accumulation stage
Last edited by mathjak107; 12-07-2023 at 10:02 AM..
Kiyosaki let's the good times roll. Whoops, that's the slogan for Kawasaki! I disagree completely. The 401k let's you save pretax and pre-paycheck, and may even match part of it. Maybe the fees are a bit higher, but you still come out ahead. The major issue is not all employers offer it, and not all employees take advantage.
Actual job interview I had many years ago:
Me: Do you offer a 401k plan?
Interviewer: No. Our employees don't want it.
Me: Why not?
Interviewer: Because they're stupid.
Needless to say, I decided not to work for them!
Last edited by pvande55; 12-07-2023 at 10:24 AM..
Reason: Add lines
Kiyosaki let's the good times roll. Whoops, that's the slogan for Kawasaki! I disagree completely. The 401k let's you save pretax and pre-paycheck, and may even match part of it. Maybe the fees are a bit higher, but you still come out ahead. The major issue is not all employers offer it, and not all employees take advantage.
My kids could contribute to a 401K at their food service job assuming they worked enough hours to be eligible (one did). I could have participated in a 401K at one of my former retail jobs had I stayed long enough to be eligible.
401Ks may not be offered at all jobs but they are certainly pretty common these days. And there are always IRAs that people can elect to invest in, too.
The employees who don't invest their 401Ks are also likely not going to invest in an IRA. These will be the folks who hit 50 or 55 and realize suddenly that they've gotta start saving. Dave Ramsey has callers like this on his show quite often.
it can pay to watch the tax levels of those who may inherit your ira’s too.
our kids are in much higher brackets then we are so anything passed on can get hit very hard .
usually the kids are lower when they are younger but in my son and his wife case they both are very highly paid professionals so anything they inherit in ira’s will be hit high
I have that issue with my nephew. He is now Vice President of Legal and I am sure he is going up the ladder from there. He was making bank in Australia and returned to the US with a 40% raise (to the already mid-six figures). I was going to leave him my house (due to the tax advantage); but, instead I am leaving that to a much younger friend locally who will help me out with decisions and paperwork in my dotage and also is local so can deal with emptying the house and unloading it or renting it, etc. I realize my nieces and nephew are all really highly paid professionals that are not going to have time to deal with my issues from out of state. I feel they will appreciate not having to deal with my shxt and just receive cash.
...In 1994, economists Richard Thaler of the University of Chicago Booth School of Business (who went on to win the 2017 Nobel Prize in Economics) and Peter Williamson of Cambridge University presented strong evidence documenting the historical superiority of investing in 100% equities compared with a more common investment policy of 60% equities and 40% bonds (60/40).
Dick Thaler was at Cornell in 1994 not Chicago. His work is obviously a behavioral economist - not so much on investments. The long-term returns from equity being superior over the long-term is best attributable to Professor Jeremy Siegel of Wharton (long before 1994) https://en.wikipedia.org/wiki/Jeremy_Siegel
The example above does not include any investor behaviour.
Quote:
Originally Posted by mathjak107
there is no question one should be 100% equities thru their accumulation stage , period ..
Then you didn't understand my post above.
Quote:
Originally Posted by mathjak107
There is no financial logical reason a long term investor should be investing in less capable assets like bonds to mitigate temporary dips while permanently hurting long term returns.
Then you didn't understand my post above .
Quote:
Originally Posted by mathjak107
now one could argue lack of pucker factor is a reason for adding bonds .
As noted above, the first step is for the investor to determine the level of risk they are willing to incur, and that varies from person to person, and can be difficult to obtain. Numerous risk profile surveys have been verified that do a reasonable job across large numbers of people, but any individual person can be irrational.
Quote:
Originally Posted by mathjak107
some can’t handle high volatility .
As I said above, the first step is to determine the level of risk the investor is willing to accept.
Quote:
Originally Posted by mathjak107
however the data by ibbotsen and morningstar show that more conservative investors just tend to have lower trigger points to bad behavior and balanced funds show no better investor behavior then growth funds when volatility kicks up .
That's orthogonal to my post.
Quote:
Originally Posted by mathjak107
vanguard , the grand pappy of do it yourself investing concluded the same thing and Found most small investors hurt themselves by their own behavior regardless of how aggressive or conservative they are
That is orthogonal to my post.
Quote:
Originally Posted by mathjak107
i wouldn’t think of being anything but 100% equities in my accumulation stage
I'm not surprised.
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