private pensions, historic performance and asset price risk

[Arturo]

Hi again,

i have been reading some pensiones schemes papers, and there is one issue i dont understand at all. when crisis hit an economy, one of the worst consecuences that can happen to a private pension, is the drop of asset prices, and the time it takes to recover prices again. This is named "asset price risk". Its not the same being young so that you still have time to recover from the drop, than being near your retirement if you have your money invested on assets. If you have 1 million $ in assets, and at the next week only 500k$, its a big issue for the sake of a retirement investment. This is something that dont happend in public pension schemes (at least in the short run).

on internet you can find some historic stock and bond charts, some of them in nominal, some of them in real terms. for instance:

here a chart in nominal terms: http://www.bedfed.com/home/fiFiles/stat ... ngterm.jpg
here in real terms: http://www.aaii.com/files/images/articl ... gure-1.jpg

My doubt is the following. Which one should be used if you want to analize "asset price risk" in terms of number of years to recover from a maximum?

For instance, if you look at Tbonds in nominal terms, you can see that there are ups and downs, but "short" term. For instance, using ibbotson figures, and a total compound calc 1926-2014, the worst period happened in 1966-1970 (or 71), it means a 4 or 5 years to recover from the maximum hit on 1966.

But if you look at Tbond compound real calc, there is a period were one maximum was achieved on 1940, and it didnt recover until 1990. Almost 50 years! It can be seen just having a look at the charts.

So this is my doubt: if you have to analize historic "asset price risk" for different assets in terms of number of years to recover from a price drop, how should i study the results?

I mean, if we have to analyze in real terms, i do not find room to the famous advice that if you are near your retirement, or even enyoing it, you should move to bonds or bills, since they are "safe" asset that preserves against inflation and risk.

thank you very much in advance.

[MachineGhost]

Yes, you need to use real prices and ignore common wisdom.  Very few practice what they preach anyway.  It's all just regurgitation without critical thought.

And another idea you may find useful is the concept of portfolio duration.

[Arturo]

Yes, you need to use real prices and ignore common wisdom.  Very few practice what they preach anyway.  It's all just regurgitation without critical thought.

And another idea you may find useful is the concept of portfolio duration.

so then, from where is coming this consensus about using tbonds at the end of your savings and/or retirement period? 

[MachineGhost]

so then, from where is coming this consensus about using tbonds at the end of your savings and/or retirement period? 

The idea is to have more stable income than capital gain risk.  It's just a sloppy rule of thumb.  Like all simplistic ideas, they take on a life of their own.  You need to do proper retirement planning with proper software to see if such an idea has merit or not.  Most likely, it will not unless you have millions saved already.

[barrett]

My doubt is the following. Which one should be used if you want to analize "asset price risk" in terms of number of years to recover from a maximum?

I mean, if we have to analyze in real terms, i do not find room to the famous advice that if you are near your retirement, or even enyoing it, you should move to bonds or bills, since they are "safe" asset that preserves against inflation and risk.

thank you very much in advance.

Arturo,

Are you running a PP or something close to it? One of the traditional benefits of this way of investing is that it hasn't produced too many down periods. Generally any losses have been negated in a couple of years (from peak to trough back to peak).

Not sure where you are getting your advice about T-Bonds & T-Bills. There was a time, say early 1990s, where moving a large percentage of your money to T-Bonds may have made sense (for example, that was the main investment recommendation in the book Your Money or you Life). Now the rate of return is too low on long bonds to make that your only position. And bills pay almost nothing. The bonds/bills strategy could work if you have a ton of money, can live on the interest payments, and don't mind how long it takes for prices to recover.

If you think that T-Bonds can protect against inflation, well that's exactly what they won't protect you against. They are incorporated into the PP strategy because they can do really well if we see falling inflation or outright deflation. Held in isolation they are way too volatile, especially when interest rates are this low.

[mathjak107]

study after study show the more conservative and the more towards 0 percent equity's you go the bigger the risk in retirement  of running out of money before you run out of time  with anything above a 2% withdrawal rate inflation adjusted .

the best bernstein could come up with that was bullet proof was 2% using cash , short term bonds and inflation proof treasury's. he later also concluded that would be a poor choice at this time as well .

bill bengens work  and also the trinity study confirm the fact that to conservative can have more risk than higher volatility allocations.

[Arturo]

so then, from where is coming this consensus about using tbonds at the end of your savings and/or retirement period? 

The idea is to have more stable income than capital gain risk.  It's just a sloppy rule of thumb.  Like all simplistic ideas, they take on a life of their own.  You need to do proper retirement planning with proper software to see if such an idea has merit or not.  Most likely, it will not unless you have millions saved already.

Hi Machine,

maybe you are right, but my assumptions are based even on Vanguard advices. For instance, on its asset allocation web page (https://investor.vanguard.com/mutual-fu ... rview/0682), you can find that from 5 years to retirement, and including it, they advice an allocation of minimum 40% tbonds and some cash for the first, and even 60% when you are retired.

the thing is that even with allocations of 30% stocks & 70% tbonds (my calcs are based on 20y tbonds using ibbotson numbers), or 1/3 stocks & tbonds & cash, you get periods like the one starting in 1972, where the first allocation recovered after 11 years, or the second after 12 years, both in real terms.

its a little bit confusing, because when you want to simulate how much compounded 1$ since, lets say 1972, like Crowling Road does on his web page, you use nominal terms, not real. When he provides numbers for each asset, to see how it behaved on recessions, they are studied in nominal, not real.

thanks :-)

[MachineGhost]

maybe you are right, but my assumptions are based even on Vanguard advices. For instance, on its asset allocation web page (https://investor.vanguard.com/mutual-fu ... rview/0682), you can find that from 5 years to retirement, and including it, they advice an allocation of minimum 40% tbonds and some cash for the first, and even 60% when you are retired.

the thing is that even with allocations of 30% stocks & 70% tbonds (my calcs are based on 20y tbonds using ibbotson numbers), or 1/3 stocks & tbonds & cash, you get periods like the one starting in 1972, where the first allocation recovered after 11 years, or the second after 12 years, both in real terms.

its a little bit confusing, because when you want to simulate how much compounded 1$ since, lets say 1972, like Crowling Road does on his web page, you use nominal terms, not real. When he provides numbers for each asset, to see how it behaved on recessions, they are studied in nominal, not real.

Like I said, the proper way to do it is calcualte your portfolio duration because that is what you need to reduce as you get closer and closer to retirement.  The PP has it around 11 years at present, I think.  Adding bonds is a rules-of-thumb way to reduce the duration of stocks which is almost always higher than bonds.  Right now the S&P 500 is about 50-years so if you don't plan on retiring in in exactly 50 years, then you need to reduce the duration by using other assets, i.e. less than 100% into stocks.

Everyone is used to nominal returns because it feels better.  Just subtract inflation from the returns if you want to make sure you're actually gaining ground with a portfolio.

Without some kind of real asset, you're going to suffer big time in a crisis of systemic confidence.  That is what happened in the 1970's.  I expect we'll start to repeat that decade by the end of this decade.

[MachineGhost]

[quote=https://www.researchaffiliates.com/Prod ... lusion.pdf]
The  late  economic  historian  and  consultant  Peter  Bernstein  was  fascinated by  the  distinct  difference  between  risk and  uncertainty.  Risk  is,  to  borrow  from former U.S. Secretary of Defense Donald Rumsfeld’s  decision  tree,  the  “known unknowns.” Uncertainty is the “unknown unknowns,” the black swans, the fundamental changes that can’t be anticipated. The  dispersion  in  outcomes  in  Tables  1 or 2, the spread between best and worst outcomes,  exemplifies  risk.  We  can quantify  it;  we  can  predict  the  breadth of  the  range;  we  cannot  predict  where, within  the  range,  our  own  experience may lie.

For  most  investors,  the  difference between  Table  1  and  Table  2  exemplifies  uncertainty.  The  implications  of  a structural change in our starting yield are just  too  jolting  to  bear  thoughtful  consideration. Today’s world of negative real yields is, for most of us, a black swan, an “unknown unknown.” We want to draw our lottery samples from the past, rather than  to  think  about  the  implications  of a starkly different world. But a world of lower  yields—and  negative  real  yields on  “riskless”  assets—is  neither  risk  nor uncertainty. It simply is our current reality. We can choose to accept this new reality, and accept that Table 2 more accurately spans  our  current  reasonable  return expectations in a low-yielding world, or we can choose to pretend that the investing world hasn’t changed in this profound way. For investors who prefer to pretend that the old norms have not changed, this “new normal” will feel like a black swan, and they will suffer accordingly.

Our message remains largely unchanged. Investors  who  are  prepared  to  save aggressively,  spend  cautiously,  and work a few years longer (because we’re living  longer),  will  be  fine.  Those  who do  not  follow  this  course  are  likely  to suffer perhaps grievous disappointment. Glidepath—with less risk taken late in our working lives—is inferior to its counterintuitive inverse. But it is entirely secondary whether we choose a Glidepath strategy, an Inverse-Glidepath, or a simple 50/50 rebalanced blend. No strategy can make up for inadequate savings or premature retirement.

As  always,  please  don’t  shoot  the messenger.
[/quote]