Interview With Zvi Bodie

Advisor Perspectives posted a lengthy interview with economics professor Zvi Bodie from Boston University. He has co-authored text books and has made interesting comments about asset allocation over the years. The current interview has several useful talking points.

First up was debunking the idea that the longer the time horizon the less risk in equities. The argument put forth was not crystal clear to me but he seemed to be saying that as your investment life goes on you are exposed to more tail events that should be rare events but lately have been coming closer to each other.

I don't quite agree with how this is framed. Someone who today is 40 years old who might have started investing in earnest via a 401k ten years ago has a long time to recover. Someone today at 50 years old has less time. If you believe in anything remotely close to the 18 year theory then you would expect the current malaise to continue a few more years to then be followed by roughly 18 years of a pretty good returns. How does such a big macro, should it pan out, play into your situation? The answer is different for a 30 year old, 40 year old, 60 year old and so on.

For some people the next six-eight year malaise (working on the premise of the 18 year theory) will unfortunately loom large but for others mean very little. The risk can be different for different people. For a 30 year old the risk might be less than the 60 year old as the 30 year old definitely has longer to recover.

The conversation then moved on to discuss the trade off between risk and return. Return was more important during the 1990s but now risk seems to be more important. Again he tries to debunk the long term investor having less short term risk but the way I would frame this is to say that no matter your age or where we are in the cycle (18 year cycle or otherwise) is to heed warnings from the market when they come like the 200 DMA or inverted yield curve or anything else you think is important.

These things are not infallible but for long term investors, going down 20% in a down 30% world adds meaningfully to the average annual return which compounds nicely for a financial plan. I believe this can be appropriate for any aged investor (a trader would view this differently).

The interview concludes with a discussion about asset allocation in retirement. He said that in retirement you want to have as little in risk assets as possible. As I read it he seemed to be saying that if you put every nickel in to a "risk free" portfolio how much income would it produce? That number is either enough or it isn't. If not, then how does the income picture change if 10% is allocated to risk assets? Again, it is either enough or it isn't. For each person there is an equilibrium, the more money saved/accumulated the less that needs to be in risk assets.

The flip side that Bodie notes is that if you put 10% in risk assets that you need to be prepared to lose that 10% and if that happens you need to understand ahead of time where that leaves you. I don't quite agree with that one. It is very unlikely that an allocation to risk assets will go to zero if it is allocated to a balanced equity portfolio or even very volatile ETFs. There are not too many indexes that go to zero. If 10% equals $100,000 and that money went into some combo of the GlobalX Lithium ETF (LIT), iShares Malaysia (EWM), EG Shares Emerging Market Energy ETF (EEO) and Market Vectors Egypt ETF (EGPT) then the ride would no doubt be quite bumpy but it is a very good bet than none of the underlying indexes go to zero. Putting the $100,000 into options or poorly chosen microcap stocks might be a different story.

Saving more as a means of needing less exposure to risk assets is a fascinating concept to me and what my wife and I try to do--hoping to keep this same job until I'm 100 doesn't hurt either. Interestingly I think people who can least afford risk (closer to preferred retirement age) can most afford saving more. It is reasonable to think that most workers 50 or over who have been able to stay in their chosen career are at their earning maximum and very close to paying off their mortgage if they have not already done so. Obviously this can only be a generalization as many people have been displaced out of their careers and those that have are very likely underemployed but hopefully anyone able to benefit from that situation is smart enough to do so.

The picture is of the paper mill in Oregon City.