Bernstein 1

Research on Safe Withdrawal Rates

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JWR1945
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Bernstein 1

Post by JWR1945 »

Bernstein 1

These are my comments from Chapter 1 of our currently featured book The Four Pillars of Investing by William Bernstein. I will not be reviewing the contents of each chapter. Instead, I will be extracting a limited number of quotes of great significance today. They will not even be close to being comprehensive. They should stimulate thought: sometimes because they have turned out to be wrong.

One thing that I will be looking for is where William Bernstein's numbers come from. I have found that he provides numerous plausibility arguments rules of thumb to show that they are reasonable. But I have found it difficult to find out exactly where his numbers come from.

As it turns out, this was not an issue in Chapter 1. He identified his data sources adequately.

The following is critically important when looking at graphs showing the long-term growth of the stock market. Refer to page 5, Figure 1-1:
Figure 1-1 is also deceptive because of the manner in which the data are displayed, with an enormous range of dollar values compressed into its vertical scale. The Great Depression, during which stocks lost more than 80% of their value, is just barely visible.
This is on page 20:
The monetary shocks of the twentieth century are among the most severe in recorded economic history, and it is more likely that inflation-adjusted bond returns going forward will be closer to the 3% to 4% rate of the previous centuries, than to the near-zero rate of the last ninety years.
From page 34:
In addition, the small stock advantage is extremely tenuous... it is less than a percent-and-a-half per year, and there have been periods of more than 30 years when large stocks have bested small stocks.
From page 35:
Thus, the logic of the market suggests that:

Good companies are generally bad stocks, and bad companies are generally good stocks.
From page 39:
Be especially wary of data demonstrating the superior long-term performance of U.S. stocks.
Have fun.

John R.
Mike
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Post by Mike »

Considering that inflation adjusted bonds are yeilding much less than 3-4%, I don't see why William thinks bonds will yield this in the 21st century. Regular bonds are not likely to outperform the inflation adjusted ones by a significant degree, unless the market is seriously mispricing one of them. I do agree with him that 20th century equtiy returns are not likely to be repeated. Too many people have moved from bonds to equity in response to the fed's destruction of bonds as an asset class for there to be decent returns from equity. After tax corporate profits are simply not large enough to give decent returns to the traditional holders of equity plus the refugees from the bond market. Especially since demographics has further reduced yield. So far, inflation adjusted bonds have made little difference in this trend.
JWR1945
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Post by JWR1945 »

I put up William Bernstein's bond prediction because I think that it is wrong. We need to understand why he got it wrong. I think that Mike has identified the underlying reasons.

My own way of thinking about the current financial markets follows this sequence:
1) There is a tremendous demand for financial investments caused by demographics (i.e., aging Baby Boomers).
2) The easy money during the bubble has attracted even more money, especially into stocks.
3) The perceived risk is low, especially for stocks.
4) As a result, current prices are high for both stocks and bonds.
5) I expect stocks to disappoint throughout the next decade, which will drive more people to choose bonds, which will cause bond prices to remain high and bond yields to remain low.

From this sequence of thoughts, I conclude that bond yield will remain much lower than William Bernstein predicted.

Have fun.

John R.
Mike
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Post by Mike »

5) I expect stocks to disappoint throughout the next decade, which will drive more people to choose bonds, which will cause bond prices to remain high and bond yields to remain low.
Another factor is that fixed income is not a free market. At the short end, interest rates are set by bureaucratic fiat, rather than the market. It does not matter whether there is any actual demand for commercial paper by investors, since the fed will just print money and give it to banks to lend it out at rates far below inflation. Investors have no chance of obtaining a decent return on commercial paper after taxes and inflation. This increases demand at longer maturities, further lowering long interest rates. In the past, fed policy also directly manipulated long rates by buying long bonds on the open market, which brings up the possibility that they may do so again in the future.
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Post by JWR1945 »

Mike wrote:At the short end, interest rates are set by bureaucratic fiat, rather than the market. It does not matter whether there is any actual demand for commercial paper by investors, since the fed will just print money and give it to banks to lend it out at rates far below inflation.
These days, the Federal Reserve sets the price of loans at the short end of the market (the overnight rate among banks). They offer to buy or sell an unlimited amount of money at their targeted interest rate.

One of the problems until just recently has been that banks were either unable or, more likely, unwilling to lend out money. They chose instead to make a carry trade, taking money at the shortest maturities and buying Treasuries (notes and bonds) instead of making loans. The carry trade can be dangerous: it brought down the Savings and Loans. The key is that banks don't go out too far on the long end and that the Federal Reserve raises rates very gradually. Abrupt increases would cause big losses and they might bankrupt some banks. That is why the Federal Reserve telegraphs its intentions well ahead of time and increases rates in very small increments, seldom higher than 0.5% at a time.

Have fun,

John R.
peteyperson
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Post by peteyperson »

By 1980, the NYU almost completely abandoned the US equities market in favor of US bonds, selling equities when they had loss considerable capital value. At the peak their allocations were 90% bonds and 10% equities. One board member received a round of applause following the market crash in 1987..

By the late 90s, NYU had managed to "sit on the bench" for one of the best bull markets in history and lost over $1Bn of added return available to them.

My point? Bonds almost never outperform equities and betting that they will is a losers bet. All historic stats demonstrate this. Is it possible that bonds will match equity returns over the next decade? If the equity market reverts, then possibly. I doubt that the bond market will outperform however, bonds simply don't have that much upside potential in the long-run. Ownership interests represent the best investment returns, period. If mainstream equities are overpriced, look for other equity investments instead. Public timberland is presently priced 30% below private equity timberland per acre and historically has delivered return in excess of bonds and more recently has done so even with depressed timber pricing. REITs are priced around historical averages due to the current muddle thru US economy. Good bank stocks are priced close to their historic valuations and well below average market premiums. There are plenty of good investments out there for those who wish to look, instead of hiding in US bonds which simply don't deliver a good long-term return as the NYU found out to their detriment.

The most useful lesson from history? To learn from others mistakes.. :lol:

Come on, John! You keep coming out with this stuff that is nonsensical and not well considered. You can do much better.

Petey
JWR1945 wrote:I put up William Bernstein's bond prediction because I think that it is wrong. We need to understand why he got it wrong. I think that Mike has identified the underlying reasons.

My own way of thinking about the current financial markets follows this sequence:
1) There is a tremendous demand for financial investments caused by demographics (i.e., aging Baby Boomers).
2) The easy money during the bubble has attracted even more money, especially into stocks.
3) The perceived risk is low, especially for stocks.
4) As a result, current prices are high for both stocks and bonds.
5) I expect stocks to disappoint throughout the next decade, which will drive more people to choose bonds, which will cause bond prices to remain high and bond yields to remain low.

From this sequence of thoughts, I conclude that bond yield will remain much lower than William Bernstein predicted.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

peteyperson
Come on, John! You keep coming out with this stuff that is nonsensical and not well considered. You can do much better.
Please clarify your complaint.

Do I think that William Bernstein has overstated the likely return of bonds? Yes. I stand by that assessment.

Do I think that the stock market will disappoint over the next decade? Yes. I expect multiples to decline substantially. The exact times and so forth, I am unwilling to predict except in the broadest sense.

According to Yale (surprise!) the 1970s was a decade in which everything lost ground, the worst being stocks and the least affected being bonds. We can, in contrast, lock in a positive real yield today. That is, capital preservation is possible today. It was not during the 1970s.
If mainstream equities are overpriced, look for other equity investments instead.
There may be special considerations unique to the distribution phase of investing. We need to keep retirement needs in mind. I am quite amenable to looking at alternative investments among the equity asset classes. Timber especially and also REITs sound interesting.

Have fun.

John R.
Mike
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Post by Mike »

Timber especially and also REITs sound interesting.
My impressions is that we seem to come back to the central point that only a tiny minority of investors following small niche strategies designed to outperform the S&P have a reasonable chance of retirement success. The majority is doomed under this scenario, since the market cap of the entire REIT sector is less than that of MicroSoft. I don't think that the treasury currently issues sufficient numbers of TIPS to absorb the majority of equity investors at reasonable interest rates (there certainly are not enough old 30 year TIPS on the secondary market to absorb the majority of equity money). Plus they only work in IRAs anyway. Of course, the politiicians may be able to keep the S&P multiple expansion going by diverting part of Social Security money into the equity market, as is currently under discussion. Otherwise, pick your small niche stategy carefully, since you must be one of those in the tiny minority skillfull enough to beat the S&P in order to survive. You must also buy before the majority realizes that they are doomed, and look for alternatives.
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Post by Mike »

They offer to buy or sell an unlimited amount of money at their targeted interest rate.
Yes they do. My point is that one of the unintended consequences of this policy is that people who formerly saved by buying commercial paper have been forced to seek alternatives. The resultant increase in demand for their chosen alternatives have lowered their yield to the point that they may not now yield enough to support a retirement. The destruction of this asset class has been good for borrowers, but bad for savers/investors. The bottom 80% or so of the boomer cohort are thereby doomed to a poor retirement. An interesting trade off.

Good point about the carry trade. Another interesting consequence of offering unlimited supplies of more or less free money. It is fascinating to ponder how all of these pieces of the puzzle fit together.
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Post by peteyperson »

Well more investors are putting cash into timberland and REITs. This is likely to continue as investors seek the assurance of yield now and in the future. Also only in the past handful of years has information about the benefits of REITs become more widespread. There are only a handful of books on REITs and only a couple that are really useful, this compares with too many to count of stock market investing. Besides, a flood of money into the asset class with depressed returns by causing more shares to be issued and possible overbuilding like that happened in the last real estate slump. So I'm certainly not one to complain about a slow but steady increase in interest in REITs or timberland.

Petey
Mike wrote:
They offer to buy or sell an unlimited amount of money at their targeted interest rate.
Yes they do. My point is that one of the unintended consequences of this policy is that people who formerly saved by buying commercial paper have been forced to seek alternatives. The resultant increase in demand for their chosen alternatives have lowered their yield to the point that they may not now yield enough to support a retirement. The destruction of this asset class has been good for borrowers, but bad for savers/investors. The bottom 80% or so of the boomer cohort are thereby doomed to a poor retirement. An interesting trade off.

Good point about the carry trade. Another interesting consequence of offering unlimited supplies of more or less free money. It is fascinating to ponder how all of these pieces of the puzzle fit together.
peteyperson
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Post by peteyperson »

John,

The data comes from the main reporting indexes and not Yale directly. It was related by Yale as an example of capital erosion during the 70s.

My other point was relating to how you are taking snapshot quotes from part of a book and overlaying your points on top of them. This is highly misleading to readers of your excerpts. You are not looking at the bigger picture or questioning the validity of the claims taken in isolation. Bonds deliver low returns. Recommending them instead of equities is a dangerous suggestion as my examples illustrated. At the very least, such a discussion should include alternative investment ideas that deliver more satisfactory returns, as I did by including details on REITs and timberland.

The snapshot approach is misleading, John. And your chapter excepts keep doing it repeatedly which becomes a disservice to readers rather than an aid.

Petey
JWR1945 wrote:peteyperson
Come on, John! You keep coming out with this stuff that is nonsensical and not well considered. You can do much better.
Please clarify your complaint.

Do I think that William Bernstein has overstated the likely return of bonds? Yes. I stand by that assessment.

Do I think that the stock market will disappoint over the next decade? Yes. I expect multiples to decline substantially. The exact times and so forth, I am unwilling to predict except in the broadest sense.

According to Yale (surprise!) the 1970s was a decade in which everything lost ground, the worst being stocks and the least affected being bonds. We can, in contrast, lock in a positive real yield today. That is, capital preservation is possible today. It was not during the 1970s.
If mainstream equities are overpriced, look for other equity investments instead.
There may be special considerations unique to the distribution phase of investing. We need to keep retirement needs in mind. I am quite amenable to looking at alternative investments among the equity asset classes. Timber especially and also REITs sound interesting.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

My other point was relating to how you are taking snapshot quotes from part of a book and overlaying your points on top of them. This is highly misleading to readers of your excerpts.
My intention has been to stimulate thought and to create discussion. It has not been to substitute for reading the books. It has not been to summarize the contents of the books.

Very definitely, my comments can be at variance with the intention of an author. I am focusing on what I think are important issues. At times, an author has touched on my subjects only briefly and without much thought.

Have fun.

John R.
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Post by JWR1945 »

peteyperson
Bonds deliver low returns. Recommending them instead of equities is a dangerous suggestion as my examples illustrated. At the very least, such a discussion should include alternative investment ideas that deliver more satisfactory returns, as I did by including details on REITs and timberland.
I have been recommending capital preservation for the time being. I have sufficient information so as to show how bonds can help. I do not consider bonds necessarily to be a good final solution. Rather, they provide a starting point.

I have identified focusing on dividends as an alternative to investing in bonds. This does not always mean a very narrow range of investments. REITs fall into the high dividend category. Some of the companies listed in Mergent's book about Dividend Achievers surprised me. [Thank you for the reference, unclemick.]

There are special considerations unique to the distribution phase of a portfolio. They can influence the selection of equities.

Have fun.

John R.
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