Asset allocation books are outdated

Books on asset allocation were written decades ago, at a time when bonds had steady returns of 4-5-6-7%.  The decision to go from stocks to bonds was very simple. As a person would age, they would switch into bonds. The opportunity cost was minimal. Any aging person would gladly forgo higher returns in exchange for volatility.

When Harry Markowitz ( Nobel Prize winner in Economics) wrote his paper “Portfolio Selection,” about Modern Portfolio Theory,  published in 1952 by the Journal of Finance, the life expectancy of a white male (The was no record on non-whites at that time) was 65.1 years. With retirement at 65 years, if a person didn’t get his asset allocation right if a person went into bonds prematurely, it didn’t make much of difference. It was mostly an intellectual exercise as opposed to a real-life event.

Life expectancy has shifted

Today life expectancy in the U.S. is for females is 81.6 and for males is 76.9. Actuaries calculate that for kids being born today, we can expect the future life expectancy of over 100 years. In fact, reaching 100 of age is no longer extraordinary.

He loves me = stocks / He loves me not = bonds

Think about this for a second. If you retire today at 65, your money has to last you 11.9 year if you are a male; 16.6 years if you are female. If you are a couple, the wife will live an extra 4.7 years. If he loves you, he will invest the money in stocks. If he loves you not, he will invest the money in bonds.

To make matters worse, The average age difference for a couple in the U.S. is 2.3 years. This means that a wife will outlive her husband by 7 years.

If we also consider that generally, a woman earns less than men during their lifetime, their portfolio will be smaller and often times not enough.

Moral of the story. Guys, if you don’t love your wife, get a portfolio with a big bond allocation. If you love her, get a portfolio 100% in equities.

Related post: Woman builds a $9 million portfolio on a secretary’s salary

Real-life example

Imagine this scenario: A couple starts sharing their lives when both of them are 25 years old, exactly 40 years ago. What would be the outcome if they would have invested $100,000 in long in Long-Term Treasury vs. $100,000 in the Vanguard 500 index?

The Long-Term Treasury would be $2,528,865 while the Vanguard 500 Index would be $7,999,944. More than three times as much.

Let’s put the 4% rule into practice. Let’s imagine that we withdraw 4% of this portfolio. With the bond portfolio the couple would have $101,145 to spend, while with the stock portfolio, the couple would have $319,997 to spend. Which one of those two portfolios would you rather have?

How to prepare psychologically for a portfolio in stocks?

The math and the probability of having a higher return in stocks that in bonds will not change. 20% of the U.S. population who knows basic math could figure this out.

Many people invest in bonds in order to better withstand, psychologically the ups and downs of the market.

We are talking about a big difference in return, over a 40 year period, of stocks vs. bonds. In my opinion, instead of buying bonds in order to have the psychological fortitude of dealing with the fluctuation, an investor should just hire a psychologist at the going price of $75-$150/hour. The investor will make more than enough money to compensate for her services and they will have a nice topic of conversation for the next cocktail party.

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