WSJ Warns Stocks Are Riskier Than We Think

WSJ Warns Stocks Are Riskier Than We Think: Yesterday the WSJ ran this article which was a follow up to this article. Article number one (the followup) took reader questions and posed them to Zvi Bodie for answers. Article number two (the original) was about the extent to which stocks don't become less risky with longer time horizons. Stocks are riskier than we think is what Bodie would have us take away.

Zvi Bodie is a professor at Boston University and has done a lot of work on this. His bottom line, as I read him, is not that far away from Nassim Taleb's idea of putting 90% in t-bills from around the world and using the last 10% for risk taking. Instead of t-bills from around the world Bodie likes TIPS and related inflation products.

The logic is easy to understand and something we've talked about here before. Getting great returns for 20-30 years doesn't mean much if you get cut in half right before retirement (paraphrase from the WSJ article). The idea of stocks being less risky with a longer time horizon stems from having more time to recover from a large loss and so the idea of stocks having more risk with a long time horizon is tied to the idea of a large decline coming when you can least afford it.

The big drawback that I think I see with Bodie's idea is the consequence of forgoing the opportunity for growth with so much of the portfolio. If 60-70% in equities is "normal" for many people then for anyone following Bodie's strategy there would be 50-60% of the portfolio that would be giving up the opportunity for growth. Maybe I am missing something but that will have to be made up with a much higher savings rate and based on various studies published we are collectively terrible savers.

As I have said before there is something intellectually appealing about these sorts of alternative asset allocations but they may not be practical for people who cannot save 30% of their income which is going to be most folks.

The stock market has an up year a little more than 70% of the time and the original article acknowledges that in the same sentence as saying but if you then lose half of it at the wrong time which is why I continue to believe that for most people having a normal portfolio while adhering to some sort of trigger point for taking defensive action makes the most sense.

On the way to down a lot for the market it is going to go through all sorts of potential trigger points. Having to alter retirement plans because your portfolio dropped by 50% a year or two before you plan retire certainly would be a deathblow but a 10% decline should only be an inconvenience.

On the surface, down 10% in a down 50% world might seem wildly optimistic but maybe not under the following scenario. I have been pretty clear over the years that zero in equities is a very large bet that I am not willing to make for clients but maybe it makes sense for someone who is very close to retirement to sell all of their equities upon a breach of their favored trigger point?

I've never thought about this before so bear with me as I work through this. For someone who is about to start taking an income from their portfolio a 2008-like decline is very likely going to be plan altering. However the risk of selling out is that it was a head fake and the market rockets higher. So the choice becomes opportunity cost or real loss.

Each person comes that equation in their own way but of course someone could split the difference by getting very aggressive upon a breach of their trigger point (the context is a year or two from needing the money) like maybe selling down 50% of their equity exposure. The risks are the same but the consequences are potentially smaller.

Anyone who would do this would need to come back to equities at some point because they will still be in their 60s (probably), could easily live much longer and so need growth again, hopefully after the dust settles.

I will give this more thought, I'm not sure what I think of this idea.

DIGITAL JUICE