More stocks for the rich

General Discussion on the Permanent Portfolio Strategy

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Pointedstick
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More stocks for the rich

Post by Pointedstick » Sun Jan 18, 2015 10:33 am

This has come up a couple of times before and I thought it might be worth exploring. The general idea is that once you are financially independent and your investments get large enough relative to your annual spending (i.e. you could survive on a 1% or 2% withdrawal rate), volatility becomes so unimportant to your financial affairs that you are better off investing in things with a higher average CAGR rather than the best alpha.

Imagine you are a person who spends $40,000 a year, and this spending level is sustained by a portfolio of $2 million, all in stocks. This represents a 2% withdrawal rate. Now imagine that the stock market tanks, so your portfolio falls to only, say, $1 million. Even with this disastrous decline, you are still able to withdraw the same amount safely, this time at "only" a 4% rate! You still have enough money to sustain your lifestyle with no changes, and as a result, you can wait out the decline and reinvest your dividends in now-super-cheap shares, priming you for an even higher sum of money after a few years when the market recovers.

Of course this requires an ironclad psychological state. Losing $1 million of paper wealth would sure hurt. So you can't be the kind of person who will panic sell. And this won't work during a protracted, multi-decade long stock stagnation unless your withdrawal rate was even lower to start out with (like 1%), and it will suffer in the event of a currency collapse or hyperinflation. But the point is that having more money insulates you from the effects of volatility and lets lets you ride these events out in a similar manner as hedging a smaller sum, and also allows you the benefits of a simpler portfolio with a higher expected return.

But of course, if you have $2 million and live on $40,000, you surely don't need any more, so what point is there in keeping it in stocks for the growth? Well, perhaps giving it away to charity, or starting a foundation or a capital-intensive business you believe will benefit humanity and want to keep from having to please outside investors. I can think of lots of non-greed-related reasons. Once you become truly rich, you start to think this way.

Thoughts?
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barrett
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Re: More stocks for the rich

Post by barrett » Sun Jan 18, 2015 11:00 am

Pointedstick wrote: Thoughts?
Well, the most obvious one that comes to mind is that you are "all in stocks" so you don't really have any dry powder to buy up loads of shares when they are cheap. You'd maybe have a few thousand in dividends that have been spit off but, for a portfolio of that size, you would really want a lot of cash & to be able to act fast! As CraigR loves to point out, rebounds in the stock market can often happen really quickly.

Without a cash cushion you basically look like me in 2008. And believe me, you don't want that to happen! :)

Again, to me this is another vote for the heavy PP cash allocation. If I had held 25% in T-Bills during the last crash, I could have vastly increased the number of shares of stock I owned. As it was, all I could do was sit, wait & hope. NOT a good investment strategy.
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Re: More stocks for the rich

Post by TripleB » Sun Jan 18, 2015 11:11 am

You assume the max decline of stock in the future is 50%. What if it declines 90%?

What if it declines 50% in one year. Then 50% again in the next year and 50% again in year 3? Now you're down to 12.5% of the original.

A smarter strategy would be to have enough money in a HBPP to survive comfortably off 2% SWR. Any additional money beyond this, do whatever you want with. Put it all in stocks.

For example, suppose you need $100k/year to live comfortably as a wealthy person. Put $5M in the HBPP so you can always safely withdraw 2% a year forever. Then put the rest of your money in stocks.

Side note: $2M is not wealthy by any means.
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Re: More stocks for the rich

Post by rickb » Sun Jan 18, 2015 11:23 am

TripleB's point is not theoretical.  From its high in 1929 the stock market actually did tank 90% to the subsequent low in 1932.
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Re: More stocks for the rich

Post by barrett » Sun Jan 18, 2015 11:36 am

TripleB wrote: Side note: $2M is not wealthy by any means.
I think it's all relative. Pointedstick is a master of living way within his means. He once survived off of shoe leather for three years during a weak market. :)
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Re: More stocks for the rich

Post by EdwardjK » Sun Jan 18, 2015 11:37 am

"Once you become truly rich, you start to think this way."

No, you really don't.

Back in 2007, my wife and I had a combined wealth well into the seven figures.  We both came from lower-middle class families but were fortunate to finish college, earn graduate degrees and have good jobs.  But clearly remembering our background, we did not in any way consider ourselves rich.

Then 2008 came along and our portfolio went down 31%.  Although we were still working, that decline hurt - a lot.  However, we kept our heads together, reduced our spending, and rebalanced our portfolios.  Today we are retired and are wealthier than we were in 2007.  However, we still do not feel rich.

Why?  Because my wife and I both know that something like 2008 can happen again, and maybe even worse. 

Wealth is nice, but fleeting.  It is easier to lose than to create.  And with our country being $18 trillion in debt and growing, the Federal government is always looking for opportunities to take more.
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Re: More stocks for the rich

Post by dualstow » Sun Jan 18, 2015 11:37 am

I'd have to have a little more of a buffer than that. That 2% withdrawal rate is often equal to the S&P dividend these days. If stocks were cut in half, and the dividend along with it, I'd have to actually sell stocks to get my 40K, and that would hurt.

If I could pay my expenses from the interest on a bunch of short-to-mid-term treasuries, then I would happily invest the rest in things like stocks.

This probably shouldn't make a difference, but it's likely that I could not help investing differently if that $2 million fell into my lap abruptly, say from a lottery jackpot. If I keep making money from savings and the growth of the HBPP, I am more likely to keep growing that pp organically to $2 mil and changing nothing as I pass that and other milestones.

If, on the other hand I suddenly receive a big blob of wealth, I guess I might do something risky with part of that windfall while keeping my theretofore holdings the same.
Last edited by dualstow on Sun Jan 18, 2015 11:40 am, edited 1 time in total.
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Re: More stocks for the rich

Post by Kriegsspiel » Sun Jan 18, 2015 12:14 pm

Personally, I would rather have a core of investments that could handle basic living expenses (food, housing, health insurance), like the PP and some real estate. Then afterwards yea, invest the surplus in stocks. At least that way, you have some optionality. Like if stocks have a good year like we just had, you could

a) convert a chunk of your stocks into your core investments, to raise your basic standard of living a bit.

b) sell some stocks and buy something you've had your eye on.

c) sell some stocks and travel with the proceeds + your usual expenses.

d) let the stocks ride some more.

e) get a dog....

Etc etc... At least that way you don't need to be worried about a huge drop in your only asset. It's almost like you haven't 'really' won the game yet.
I hated all the things I had toiled for under the sun, because I must leave them to the one who comes after me. Who knows whether that person will be wise or foolish? Yet they will have control over all the fruit of my toil into which I have poured my effort and skill under the sun. . . Nothing is better for a man than to eat and drink and enjoy his work.
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Re: More stocks for the rich

Post by pugchief » Sun Jan 18, 2015 12:49 pm

EdwardjK wrote: And with our country being $18 trillion in debt and growing, the Federal government is always looking for opportunities to take more.
What a timely comment. Obama is expected to ask for more taxes in his upcoming State of the Union address. Thankfully, most of this is a non-starter due to a GOP controlled congress.
"Congressmen should wear uniforms, you know, like NASCAR drivers, so we could identify their corporate sponsors."
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Re: More stocks for the rich

Post by iwealth » Sun Jan 18, 2015 12:49 pm

EdwardjK wrote: "Once you become truly rich, you start to think this way."

No, you really don't.

Back in 2007, my wife and I had a combined wealth well into the seven figures.  We both came from lower-middle class families but were fortunate to finish college, earn graduate degrees and have good jobs.  But clearly remembering our background, we did not in any way consider ourselves rich.

Then 2008 came along and our portfolio went down 31%.  Although we were still working, that decline hurt - a lot.  However, we kept our heads together, reduced our spending, and rebalanced our portfolios.  Today we are retired and are wealthier than we were in 2007.  However, we still do not feel rich.

Why?  Because my wife and I both know that something like 2008 can happen again, and maybe even worse. 

Wealth is nice, but fleeting.  It is easier to lose than to create.  And with our country being $18 trillion in debt and growing, the Federal government is always looking for opportunities to take more.
Fleeting for sure. I have no idea how long it would take a typical working family earning various amounts of money to amass a $2 million portfolio. Too many variables. But I'm fairly certain that it would take a working couple earning a combined $200k/yr a substantial number of years. And given that a typical stock market correction, not crash, just a run of the mill correction, is considered 10% from peak to trough, that's an entire year's worth of pre-tax earnings...poof.

It's hard to consider oneself "rich" because the word "rich" doesn't have a definitive definition. All that happens as one's wealth increases is that you get closer to being able to afford that next tier of purchasable goods. Not sure what the highest tier is, but I imagine it requires billions in wealth before you can afford it.
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Re: More stocks for the rich

Post by iwealth » Sun Jan 18, 2015 12:54 pm

TripleB wrote: A smarter strategy would be to have enough money in a HBPP to survive comfortably off 2% SWR. Any additional money beyond this, do whatever you want with. Put it all in stocks.
But what is the PP's SWR? The portfolio's only been investable since the 70s. And the first few years came right after we came off the gold standard. And then the last 35 years have been a runaway bond bull market. I still don't think the PP has been tested in all market conditions.
Side note: $2M is not wealthy by any means.
Doesn't this depend entirely on your required yearly spending?
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Re: More stocks for the rich

Post by Pointedstick » Sun Jan 18, 2015 12:58 pm

Wonderful comments, everyone. It seems to be a topic that provokes strong reactions!

For the record, I agree that a core PP that provides your living expenses with a VP of 100% stocks makes a lot more sense than a portfolio of pure 100% stocks, no matter the size. If  ever have a humongous amount of money, I would never abandon the PP; at the minimum, I would keep it as my "core" safe and stable investment.
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