For example, your Social Security investment, when you're say 60 or 65, has a capitalized value of something like $300,000, and it's going to continue to pay. It may pay a little bit less. I hope we can solve that problem, but it's not going to go away.
"And so, if you have a $100,000 to invest, I don't see why you would not put it all in stocks at that stage of your life. That would be 25% then in equities and 75% in effect fixed income with an inflation hedge [via Social Security]. It's a good investment."
So the sad thing is that most people don't have $100,000 accumulated (depending on what you read the average 401k balance could be as low as $45,000). Also, I am leery of over reliance on social security and medicare. With those two points from me out of the way...the big picture concept is interesting.
If your social security is best thought of as a $300,000 fixed income portfolio (probably more like an annuity) what does that mean for the rest of your financial picture, specifically the allocation of assets you have in brokerage accounts?
The road to answering this question for yourself probably needs to start with understanding why you own fixed income at all. Over long periods of time there is a numerical argument for 100% equities--they grow (the last decade notwithstanding) and bonds mature in the future at their par value. Of course bonds can be used for speculation seeking capital gains, most people probably use bonds for income and offsetting equity volatility.
But if Bogle's premise is correct then investors would need more equity exposure and would need to learn to live with more volatility. Someone who is 55 years old with $350,000 in a brokerage account targeting 60% in equities and 40% in bonds (this mix is well within the realm of normal) presumably has $250,000 in capitalized value from social security would think of their portfolio as being $600,000 targeting $360,000 in equities and $240,000 in fixed income. Since the brokerage account only has $350,000 this person will be slightly under their equity target.
So are you on board? Neither am I. Building a financial plan and investment portfolio requires an understanding of how the numbers should work and then implement an asset mix that lets the person be comfortable enough that they don't panic sell. Since the capitalized value of social security cannot be seen it can be somewhat hazy. All an investor knows is how much their (in the context of this post) 100% equity portfolio is up or down over whatever period of time they care about.
A well constructed $350,000 100% equity portfolio will obviously be more volatile than a well constructed $350,000 60/40 portfolio and at a moment of maximum market puke down this investor is very unlikely to think about the capitalized value of their social security benefit.
Maybe I am wrong but people very rarely think about what it will be like for them during a real market panic which often leads to an emotional response when the panic comes. To the extent this is true, the concept set forth above by Bogle is likely a bad idea for a lot of people. Well unless they have some sort of objective trigger point for taking defensive action but of course he doesn't believe in doing that.
13 comments:
Your rationale for disagreeing with Bogle seems to be that you believe investors are overly emotional and stupid. Ok, I will not disagree with you.
But for enlightened individuals who can detach themselves emotionally I think Bogle is correct.
Concur with Anon 5:37. I have always thought of my pension and soon-to-be-started social security in the way Bogle suggests. How else can one value those assets? A problem with both (in my case) is that their values go to zero upon my demise, so I have to accumulate a personal portfolio for the benefit of my heirs (and myself as supplemental income when needed).
Mike C.,
can you post when valuations are ok. Tx
Jeff from Milan, Italy
Kind of funny, but I view my potential social security benefits (33 years away) as a lottery ticket... Great if it pays off, but I am not banking on anything.....
Adding to Anon 9:48's thought. Everyone in their 20's or 30's, and probably 40's and 50's, is going to get far less in real inflation adjusted dollars from SS than today's retirees. One reason, the gov't cannot afford what they have promised. Another reason, the official inflation rate upon which SS increases are based is a farce.
As we cannot predict the future it is impossible to make accurate generalizations for all personal situations.
It certainly seems right to me to take more responsibility for one´s financial health as early as possible. Roger tirelessly advocates this. And it certainly seems wrong to hand over all power, control and knowledge to an entity/company/brokerage which may well not have that individual´s best interest at heart. That is how it is going in our family anyway.
The ability to tolerate risk seems to me to be based on various factors and circumstances - some of which change and some which are out of our control. If I am mentally/physically able, I am going to actively trade stocks until the end of my time. Also admit that some pension/soc. sec./fixed income stability is greatly desired.
thanks to all who make this blog super!
Bogle also says "not to peek" at your portfolio balances during volatile times. Ha.
Mike C.,
can you post when valuations are ok. Tx
Jeff from Milan, Italy
Hi Jeff,
My preference for valuation purposes is to triangulate across all the various long-term normalized valuation metrics. In my view, the Fed model and all the variants that compare forward estimates to interest rates are complete garbage in terms of giving you an entry price with an adequate margin of safety.
Interestingly, ALL the normalized metrics here basically point to the same level. I'm talking Shiller's P/E, Tobin's Q, Grantham's estimate based on normal multipe of normal profit margins, and Hussman's Price to Peak ratio. All these give you a fair value around 800-850 which to me coincides well with your target and other technical targets yielding 870.
So far this market has also followed the secular crash script well (search Ritholz's site for the graph of typical market post secular crash). Assuming 1220 was a top of significance, we had a 12 month 80% rally. That follows the template well. The next move is a 25-30% drop which coicidentally gets you around that 870 level. After that a multi-year trading range unfolds according to the script (maybe ending in 2014-2017) and then the birth of the next secular bull (unless we are turning Japanese).
I'm still mostly long, unhedged, but sitting on 10% GLD purchased quite some time back at much lower prices, but I'm ready to go majorly defensive if 1040 breaks. I'm thinking 10-15% SDS which gets me mostly hedged ala Hussman.
Your previous post on Jim Montier was interesting, so I read his lastest "Little Book on Investing." He reiterates alot of the same themes you do, which was pretty cool. What I can't figure out is why GMO doesn't have better performance during the drop, if they were watching the financials and speculative bubble form. Re todays post, I've treated SS and my pension as an annuity, but have not included them in the portfolio allocation due to lack of faith in their being there when I need them.
Sam
Roger, I have to say that your complaint here sounds somewhat like when you feel you have to defend the multitude of ETF's as not being a "bad idea" (simply because some investors misuse it, or chase past performance). Boogle's premise seems sound; are investors going to be able to withstand the "puke down" - who knows?
Just like those decrying thinly sliced ETF's, you shouldn't be throwing the baby out with the bathwater.
The concept Boogle talks about is similar to Milevsky's "human bond" concept (something I talked about here: http://confusedcapitalist.blogspot.com/2006/03/risk-your-human-capital-stock-or-bond.html )
Can it be misused? Sure. So what else is new in the world of finance?
20 years ago when I entered the investment field my branch manager made this exact same argument. He also argued that buying a house and paying off the mortgage was less efficient than renting or taking out 100% of your equity and investing the difference. That's going to work great until it doesn't.
If you are going to try and capitalize Social Security, why not Medicare? Figure out the NPV of that future cash flow, consider it all invested in bonds and bam - you aren't poor anymore. It's not really something you can access (the NPV) but that's not really important.
In allocating an investment portfolio between equities and bonds, Jack Bogle uses the "100 minus your age" stock portfolio ratio.
In order not to wrongly estimate the equity portion any expected stream of income such as social security or an annuity or a private pension must be accounted for by discounting it to present value and treating it as a "bond" investment if Bogle's preferred ratio is used.
Note: For GenY Cassandras the discounted value of your social security entitlement is so low that it isn't worth worrying about when you apply the Bogle formula to your own situation.
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