February 17, 2016

Dangerous Investment Advice

A recent New York Times article titled “How Much of Your Nest Egg to Put Into Stocks? All of It” makes an unusual argument that investors should invest all or nearly all of their retirement assets in stocks. The author, David Levine who previously founded and ran the fixed-income department at Sanford C. Bernstein & Company, now a unit of AllianceBernstein, misses several significant issues, following are three of them…

Magnitude of Losses Matters to Most People
Levine attempts to bolster his argument by pointing out that investment legend Warren Buffet recommends a 90% allocation to equities and has established a trust for his wife which implements that allocation. Unfortunately, Levine misses a major point here. If Mr. Buffet or his wife losses fifty percent of their net worth due to market losses, they would still have billions of dollars to support them in retirement. Most investors don’t have this luxury. To them, downside risk matters.

Cherry Picking
Levine uses US stock market history to make his case. However, as Levine quotes Paul Samuelson “We have only one history of modern capitalism. Inferences based on a sample of one must never be accorded sure-thing interpretations.” Levine goes on to say that Samuelson was “exaggerating to make his point”. I don’t see how that is an exaggeration.02-17-16 chart

To make my point, let’s take a look at how an investor in another modern developed country would have fared had he taken Levine’s advice back in March 1989 and held through January 2016. During that twenty-seven-year period, Japanese bonds recorded a cumulative return of over 400% compared to a cumulative loss of almost 14% for Japanese stocks. Sounds like Samuelson was right to me.

Sequence of Return Risk
Particularly for those just entering their retirement, taking portfolio distributions at the same time equity markets collapse can be disastrous to a retirement portfolio even if long-run returns ending up matching expectations.

According to Wade Pfau, Professor of Retirement Income at The American College, in a paper titled “The Lifetime Sequence of Returns: A Retirement Planning Conundrum”, the return sequence during the first ten years of retirement explains 77% of the final retirement outcome compared to only 5% based on the returns generated over the final twenty years of a thirty-year retirement distribution period.

A recent retiree who is unlucky enough to begin portfolio distributions at the beginning of a bear market will have a much lower safe withdrawal rate for their retirement even if equity returns improve later in retirement. What this research shows is that when returns happen is critically important not just the returns themselves.

The basis for asset allocation and diversification is that asset class returns are unknowable beforehand and for those who wish to reduce the range of potential investment outcomes, globally diversified portfolios matched to the risk tolerance of investors is the best long-term strategy.

Mr. Levine should stick to selling bonds and leave investment advice to others….