# Is "stocks for the long run" a safe strategy for retirement savings?



## Jon Chevreau (Apr 4, 2009)

See my blog this morning on the PBS Newshour interview with Zvi Bodie, author of Worry Free Investing. See also sister thread on inflation in the main forum. 

http://network.nationalpost.com/np/...e-debunks-stocks-for-the-long-run-on-pbs.aspx


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## CanadianCapitalist (Mar 31, 2009)

I'm going to check out the video but the problem with Real Return Bonds is the rather low returns that they provide. It would have been fantastic to buy these bonds when they were yielding 3% to 4% in the early part of 2000. For a long time now, these bonds are yielding 2%. To earn just $20K before taxes, investors would need a nest egg of $1 million. Clearly, saving such a large nest egg is beyond the capability of most people.

It is true that stock returns even over the long-term could fall within a wide range of possibilities. Still, a real return of 2% seems to me to be a low hurdle for stocks to overcome, especially now that stocks are much cheaper than they were at the peak. Just the dividend yield on the major indices is much higher than 2%. It is highly likely that stocks can be expected to handily beat real return bonds going forward.


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## MoneyGal (Apr 24, 2009)

CC: I see your point, for sure, but Bodie's point is that stocks have been oversold as long-run investments. 

There are a whole bunch of sequence of return risk issues that get tangled up in this discussion, too: stocks *are* cheaper now than they were last year, meaning higher returns are much more likely than they were at this point last year (leaving aside what actually happened). 

I think the underlying messages of Bodie's "Worry-Free Investing" are (among other things) that fixed assets can provide a decent ("worry-free") standard of living and investment plan for risk-averse people, and that -- depending on the timing of your income needs -- the risks associated with stocks provide a much less certain (or "worry-filled") retirement asset accumulation plan. 

I recommend reading Bodie's work in more depth, particularly his work on portfolio product allocation over the human life cycle. A similar recent Canadian reference would be Moshe Milevsky's "Are you a Stock or a Bond?"


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## HaroldCrump (Jun 10, 2009)

CanadianCapitalist said:


> It would have been fantastic to buy these bonds when they were yielding 3% to 4% in the early part of 2000. For a long time now, these bonds are yielding 2%. To earn just $20K before taxes, investors would need a nest egg of $1 million. Clearly, saving such a large nest egg is beyond the capability of most people.


Methinks holding RRBs in a retirement portfolio (or any portfolio, for that matter) would only make sense if your predicitons of inflation are significantly higher than what the broad market is factoring in by way of long bond yields.
And to your point, isn't it likely that you can keep your head above water with a ladder of GICs?
These days a 5 year GIC is about 3.65% and the rates have been higher in the last 5 years (around 5% during 2005 - 2006).


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## CanadianCapitalist (Mar 31, 2009)

MoneyGal said:


> I think the underlying messages of Bodie's "Worry-Free Investing" are (among other things) that fixed assets can provide a decent ("worry-free") standard of living and investment plan for risk-averse people, and that -- depending on the timing of your income needs -- the risks associated with stocks provide a much less certain (or "worry-filled") retirement asset accumulation plan.
> 
> I recommend reading Bodie's work in more depth, particularly his work on portfolio product allocation over the human life cycle. A similar recent Canadian reference would be Moshe Milevsky's "Are you a Stock or a Bond?"


I have read Worry-Free Investing. In fact, I reviewed it here:

http://www.canadiancapitalist.com/book-review-worry-free-investing/

I have no problem with suggesting RRBs for a portion of a portfolio. But I do think that investing the entire portfolio in RRBs isn't without risks. One major risk is that real yields fluctuate and investors could find that yields are lower when the bonds mature. What then? An investor could find that 2% real yield isn't available anymore and the best they can do is just 1% and are now faced with a reduced income in retirement.


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## Jon Chevreau (Apr 4, 2009)

Someone posted a comment on my blog to the effect that governments are always motivated to understate inflation in their CPI and other inflation indexes -- since they're on the hook with these inflation-linked bonds they issue. Reasonable point. Personally, I'm a 50/50 guy. As I told Zvi himself, that means 50% stocks to 50% bonds and the 50% bonds is then split 50/50 nominal vs real. So that means no more than 25% of the total portfolio in RRBs/TIPS. I agree that no one asset class -- even RRBs -- should make up 90 or 100% of a portfolio. 

But then I'm still working for a living. 

www.wealthyboomer.ca

P.S. I tweeted this discussion. RTs might help spread the word.

http://www.twitter.com/jonchevreau


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## MoneyGal (Apr 24, 2009)

Jon: I'm not sure I would say this discussion is "raging." 

CC: I was thinking not of Worry-Free Investing when I recommended reading more of Bodie, but of Bodie's (much) earlier work with Paul Samuelson and Robert Merton - they wrote an article in the early 1990s which was the first to treat human capital as a bond-like asset class. However, I think I'm straying from the main point here.


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## CanadianCapitalist (Mar 31, 2009)

MoneyGal said:


> I was thinking not of Worry-Free Investing when I recommended reading more of Bodie, but of Bodie's (much) earlier work with Paul Samuelson and Robert Merton - they wrote an article in the early 1990s which was the first to treat human capital as a bond-like asset class.


I found this paper online by Bodie, Merton and Samuelson:

http://www.people.hbs.edu/rmerton/laborsupplyflexibility.pdf

I haven't read this but if this is the paper you were thinking of, I'd definitely read it.


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## MoneyGal (Apr 24, 2009)

That's the one! I've been doing a lot of reading lately on life cycle investing and human capital, and that's one of the foundational articles in the field.


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## KeithSharp (Jun 16, 2009)

*Real return bonds and retirement*

Bodie seems to be about right, but few of us much want to believe him. But most of us are very risk-averse when the downside is bagging groceries at age 80 So the finance theory says that TIPS or RRBs, as the least risky investment available long-term, are appropriate for us. 

End result is that we all need to be saving way more than eg the 18% tax limit for our retirements. More at

www.utstat.utoronto.ca/sharp

Keith Sharp


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## FeeOnly.ca (Jun 4, 2009)

Below is my post on Jon's blog reference RRBs & Zvi Bodie:

I like RRB's as a vehicle for the safe accumulation of retirement assets. 

I’ve known Zvi Bodie for years and we have common views about risk. When he asked me to review the manuscript of Worry Free Investing and provide a review for the jacket I was honored to do so. At the time and even today there are 1000's of books on stock investing for every 1 book on bond investing. A whole book on inflation-indexed bonds (TIPS or RRBs), my favorite, was irresistible. 

Personally I like RRB's as a vehicle for the safe accumulation of retirement assets. I've owned ladders of stripped RRB's, most accumulated ~3.5% real +/- 0.25%. It's been a great strategy for balancing out our equities during accumulation. 

All the RRB's however are ultimately destined to be sold to purchase life annuities. The annuities will deliver trouble-free income efficiently & reliably over the entire span of our retirement. I'll see what rates look like when the time comes. The annuities might be Level, Indexed to CPI or Fixed/Escalating annuity, or a combination of all three. 

My experience with RRB's tells me that attempting to use our current series of RRB's to deliver a retirement income stream over 30 plus years would be a pain in the butt. 

People who might want the risk free, inflation protection utility of RRBs in retirement without the hassle would do well to consider an inflation-indexed life annuity instead. It works like your MP’s inflation-indexed pension plan and will provide a higher cash flow (retirement income) than you could draw from ladder of RRBs. 

As a wealth advisor I think RRB's are a great vehicle for anyone who is adverse to taking stock market risk with thier savings. RRB's are also a great no risk vehicle for safely accumulating capital in your RRSP or DC plan in preparation for purchasing an inflation-indexed life annuity (your very own risk-free inflation-indexed life pension).

IMO, the main points are:

1. You don't have to take stock market risk with your savings. You can beat inflation by 2% with out any stock risk at all.

2. Using stocks to finance your retirement is much riskier than you have been lead to believe. 

3. Don't ask a barber if you need a hair-cut and don't ask someone who sells equities for a living how much (if any) stock you should be holding.​
Graham Cook


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## Jon Chevreau (Apr 4, 2009)

Graham, when you say getting income from RRBs may be a pain in retirement, I presume you're talking about getting their income in sync with RRIF minimum withdrawal strategies? Your fellow BC-based advisor, Fred Kirby, views the new TFSAs as the natural home for RRBs since they're not subject to minimum annual withdrawals. For aging boomers who won't have much TFSA room, he suggests growing them with equities aggressively while still earning, then switching them out to RRBs when real yields reach 4%. 

http://www.wealthyboomer.ca


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## FeeOnly.ca (Jun 4, 2009)

Jon said: _"Graham, when you say getting income from RRBs may be a pain in retirement, I presume you're talking about getting their income in sync with RRIF minimum withdrawal strategies?"_

There is a much easier and IMO better alternative to employing RRBs in your RRIF or TFSA for generating a safe retirement income. An inflation-indexed life annuity will provide similar protection, a higher income and much better utility. Investment management is included and all the issues with RRIF withdrawals go away. 

Any strategy I recommend has to be practical, appropriate and fully understood by the client. Most retirees I meet have other things they are doing with their time and they don’t want to worry about the market

Even if you have the desire to DIY with RRBs, a great idea/strategy can easily get botched in the execution. Unless you are familiar with bond trading, the complexities specific to RRBs and most importantly sustainable income planning, I wouldn’t recommend that approach

As an advisor, if a strategy isn’t doable by my mother and/or my grandmother then it doesn’t pass my “low-stress & simplicity” sniff test. 

That said, a straight forward RRB “accumulation” strategy in an RRSP or TFSA is much less complex. Especially with stripped RRBs.

My motto:


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## Jon Chevreau (Apr 4, 2009)

There's another new book coming out, titled Enough Bull, that tells investors to swear off stocks and equity mutual funds "forever." It's by chartered accountant David Trahair, who previously wrote Smoke & Mirrors. Details in my blog today:

http://network.nationalpost.com/np/blogs/wealthyboomer/default.aspx


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## CanadianCapitalist (Mar 31, 2009)

Jon Chevreau said:


> There's another new book coming out, titled Enough Bull, that tells investors to swear off stocks and equity mutual funds "forever."


I'm assuming that the argument made in the book is that just because stock returns were bad over the past 10, it would continue to be bad. Not so. Valuations are improving all the time and for the patient, stocks are likely to deliver handsome returns over the long-term. Long periods of poor equity returns are not unprecedented.


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## Jon Chevreau (Apr 4, 2009)

Trahair touched on this in Smoke & Mirrors. Chapter 4 is entitled "Myth 3: Don't worry about your investments: you'll be fine in the long run." He's skeptical about stocks then too and remember this was well before the 2008 crash. He compares the TSX return over 20 years to bank prime lending rates, finding the TSX returned 6.6% from 1987 to 2007 (Sept to Sept)and 7.2 over the last 10 years. Meanwhile since 1997 he says the average chartered bank prime lending rate has been 5.5%. Then he gets into mutual fund fees, market timing etc. Then he looks at alternatives that are no doubt the thrust of the new book: GICs, term deposits, bonds "etc."

Question for forum members here: Did they read Smoke & Mirrors? What did they think of the arguments? Because I suspect the new one is just a repackaging of the old, rejigged to include the 2008 stock crash.


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## CanadianCapitalist (Mar 31, 2009)

Jon Chevreau said:


> Trahair touched on this in Smoke & Mirrors. Chapter 4 is entitled "Myth 3: Don't worry about your investments: you'll be fine in the long run." He's skeptical about stocks then too and remember this was well before the 2008 crash. He compares the TSX return over 20 years to bank prime lending rates, finding the TSX returned 6.6% from 1987 to 2007 (Sept to Sept)and 7.2 over the last 10 years.
> 
> Question for forum members here: Did they read Smoke & Mirrors? What did they think of the arguments? Because I suspect the new one is just a repackaging of the old, rejigged to include the 2008 stock crash.


I read "Smoke and Mirrors" and blogged about it in three parts:

Smoke and Mirrors Myths: Part 1
Smoke and Mirrors Myths: Part 2
Smoke and Mirrors Myths: Part 3

Despite the market swoon of 2008, I still think DT's Myth # 3 is the weakest one in the book. I re-ran the Stingy Investor calculator for 10 and 20 years ending 2008 for the same asset allocation referred to in the post (20% bonds, 30% Canadian, 50% US).

10 years - 1.34%
20 years - 8.69%

Granted the 10-year returns are not encouraging but over 20 years, the portfolio returns were not that far off from the 8.91% (Arithmetic average) from bonds.

Even if we concede the point that 20 year returns from stocks were bad, I don't see how that is bad news. We are investing for the future and what matters is future returns. Future returns depend to a large extent on starting valuations. Depressed recent returns only mean that starting valuations are good. It tilts the odds in stocks' favour even more.

Of course, there is no guarantee with stocks. But, experts counselling investors put 100% of their portfolio in fixed income are glossing over the fact that investors are swapping a very low risk of low return from stocks for a high risk of their savings falling short due to low returns from fixed income.


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## MoneyGal (Apr 24, 2009)

CanadianCapitalist said:


> But, experts counselling investors put 100% of their portfolio in fixed income are glossing over the fact that investors are swapping a very low risk of low return from stocks for a high risk of their savings falling short due to low returns from fixed income.


Hmmm. I'm not sure that you can compare those two risks. The risk of not having enough is related both to investment performance (however you are investing) and to investor behaviour (whether you are saving a sufficient amount). The risk that the equity premium will not materialize is not behavioural.


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## MoneyGal (Apr 24, 2009)

Also: in some ways I hesitate to even wade into this discussion, but the reality is that many, many peoples' entire investing horizons are 20 years -- or less. 

It may be true *for you* (or for me, I am 41) that future returns are the most important, but there is an entire generation of boomers who invested expecting an equity premium which (more and more of these micro-studies are proving) has failed to materialize. 

It isn't helpful to say to someone who is *retiring now* that the long-run RoR from stocks will beat bonds. _That hasn't been the case over the last 10-20 years (depending on your asset allocation), and we don't know how much time will be required to get the premium. _

The prudent course of action is to base future return expectations and thus saving behaviour on the risk-free return, not on an equity premium which may not actually deliver returns over the risk-free rate in any given 20 or 30-year period.


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## CanadianCapitalist (Mar 31, 2009)

MoneyGal said:


> Hmmm. I'm not sure that you can compare those two risks. The risk of not having enough is related both to investment performance (however you are investing) and to investor behaviour (whether you are saving a sufficient amount). The risk that the equity premium will not materialize is not behavioural.


But investment performance and saving behaviour are related. If investments don't provide generous returns, I have to make up the shortfall through savings. With fixed income, I have to save lots -- the expected returns are much lower. With stocks, there is a small risk that I have to save lots because my realized returns are lower than expected. But chances are I won't have to because most of the time stocks do provide generous returns.

Of course, if I can easily reach my financial goals with bonds alone, it's game over. I wouldn't have to be in stocks. But it is not true for most people.


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## CanadianCapitalist (Mar 31, 2009)

MoneyGal said:


> Also: in some ways I hesitate to even wade into this discussion, but the reality is that many, many peoples' entire investing horizons are 20 years -- or less.
> 
> It may be true *for you* (or for me, I am 41) that future returns are the most important, but there is an entire generation of boomers who invested expecting an equity premium which (more and more of these micro-studies are proving) has failed to materialize.
> 
> ...


It is hard to make the case that someone retiring today doesn't have a long time horizon. A senior couple retiring today have to plan for an investment horizon of 30 years. Assuming they started saving at age 55, they would have had a time horizon of 40 years.

Some retiring today shouldn't be 80 percent in stocks. They should have a generous allocation to fixed income. The thumb rule is age in bonds and I'm not saying every penny belongs in stocks. Just that they should have a well diversified portfolio with well thought out allocation to stocks and fixed income.

I just showed that 20 year returns have not been overly generous but definitely respectable. Stock returns have been only a smidgen less than bonds.

Of course, that's the past, so let's talk about today. Bonds yield 3.5%. US stock *dividend* yields are close to 2.5%. In Canada, close to 3.5%. Stocks don't need to do much to easily beat out bonds from here.


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## MoneyGal (Apr 24, 2009)

Thanks for the response. Yes, a long investing horizon -- but a much shorter accumulating phase. And yes, of course heavy on the FI as you get close to retirement. But you are presuming everyone is rational. 

In the example you gave, the couple has a 10-year accumulation phase (assuming retirement at 65). Lots of people are still convinced that the 80's bull market was the way markets "really work" and they expected a minimum of 10% return on equities, and "would be willing to settle for a solid 8%." People even post that here (and elsewhere, on other money forums).

And the original point stands: depending on your allocation, stocks *have not* produced an equity premium for the last 20 to 30 years. Lots of people who invested expecting that premium would have been better off in T-bills. 

And given the events of the past two years, I personally feel as though MPT has less and less predictive value. I personally think that people should not bet on the equity premium (that said, I'm still mostly in the classic couch potato -- but I am a very conservative investor and I'm the only person I know who went all cash last year, in July). 

Respectfully, MG.


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## FrugalTrader (Oct 13, 2008)

MoneyGal said:


> I'm the only person I know who went all cash last year, in July.


MoneyGal,

Why did you go to call cash last year in July? Was it fundamental indicators or technical?


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## MoneyGal (Apr 24, 2009)

Fundamentals. I also needed to make some other changes in my accounts, so rather than redeploy into equities, I held all cash. I started getting back in the market in October, and I'm still not 100% back.


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## Spidey (May 11, 2009)

I think it depends how much you paid for your stocks, their quality, yield and what your needs are. For example, if you need the entire investment within a few years, then stocks are usually a very poor choice. However, if you're just looking for income and not overly concerned about the stock price fluctuations, I think an argument could be made for buying and holding relatively stable, dividend paying stocks when they are on sale. The yield is often better than real return bonds, the income is treated better tax-wise (in a non-registered account) and future dividend increases are likely if the company's profits grow.


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## FeeOnly.ca (Jun 4, 2009)

*You can be risk averse & have a long horizon*

You may find these remarks of interest, I do.

http://www.yourwealthadvisor.ca/apps/videos/videos/view/3860097-the-conventional-wisdom-is-wrong

http://www.yourwealthadvisor.ca/BodieSiegelGreatDebate.pdf


http://www.yourwealthadvisor.ca/The Great Debate Excerpts.pdf


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## Jon Chevreau (Apr 4, 2009)

Good discussion. Most people here are going to have a fair bit of "non-stock" exposure anyway: their principal residence is of course real estate; CPP and OAS is in effect fixed income; and those in a traditional DB pension are also exposed to the equivalent of fixed income. 

So this discussion is really about the tradeoffs of stocks and bonds in registered and non-registered plans. Tax-wise, the old solution of stuffing your registered plans (including the new TFSA) with fixed income, and putting equities in taxable plans (especially Canadian dividend paying stocks qualifying for the dividend tax credit) seems to take a fair bit of risk off the table, while still providing some growth to offset all those fixed-income equivalents. 

Personally, I also have maybe 50% equity in my RRSP but that's because I'm in a DB plan and I prefer to shelter US dividend income from the high tax rate they'd suffer non-registered. Hopefully in advanced old age, their dividend increases will more than make up for inflation.

And if by chance the bet fails and the equity premium fails to manifest, well then you can always keep working longer and maybe work part time in retirement, as per my blog this weekend:

http://network.nationalpost.com/np/...e-years-quot-a-panacea-for-2008-s-losses.aspx


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## Rickson9 (Apr 9, 2009)

"Is "stocks for the long run" a safe strategy for retirement savings?"

All of our "retirement savings" is in stocks (RRSP, TFSA, pension).

Having cash and waiting in a bull market was like having a full bladder and waiting for your boss to end the conversation. This financial collapse was a god-send!

We'll see how it pans out.


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## Rickson9 (Apr 9, 2009)

Spidey said:


> I think it depends how much you paid for your stocks, their quality, yield and what your needs are. For example, if you need the entire investment within a few years, then stocks are usually a very poor choice. However, if you're just looking for income and not overly concerned about the stock price fluctuations, I think an argument could be made for buying and holding relatively stable, dividend paying stocks when they are on sale. The yield is often better than real return bonds, the income is treated better tax-wise (in a non-registered account) and future dividend increases are likely if the company's profits grow.


This advice is good for people who need dividend income. For those who don't need dividend income, buying and holding profitable companies is great as well.


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