I am re-reading a series called “Investing for Adults” by William Bernstein. By “Investing for Adults”, Bernstein means that he assumes that you already know the basics of investing and that he can skip to more advanced insights. There are four parts:
- The Ages of the Investor: A Critical Look at Life-cycle Investing
- Skating Where the Puck Was: The Correlation Game in a Flat World
- Deep Risk: How History Informs Portfolio Design
- Rational Expectations: Asset Allocation for Investing Adults
A commonly-cited part of the first book The Ages of the Investor is the question “Once you have won the game, why keep playing?”. If you have enough money to buy a set of safe assets like inflation-adjusted annuities, delayed (and thus increased) Social Security payments, and a TIPS ladder to create enough income payments for life, you should seriously considering selling your risky assets and do exactly that. (This is referred to as a liability-matching portfolio, or LMP. You can keep investing any excess funds in risky assets, if you wish.)
A wrinkle to this plan is that you won’t know exactly when the stock market will help make that happen. Before you reach your “number”, you’ll most likely be buying stocks and hoping they grow in value. Let’s say you saved 20% of your salary and invested it in the S&P 500*. How long would it take you to “win the game”?
Historically, it could be as little at 19 years or as long as 37. That’s nearly a two-decade difference in retirement dates! Same savings rate, different outcomes.
This paradigm rests on too many faulty assumptions to list, but it still illustrates a valid point: You just don’t know when you’re going to achieve your LMP, and when you do, it’s best to act.
If, at any point, a bull market pushes your portfolio over the LMP “magic number” of 20 to 25 times your annual cash-flow needs beyond Social Security and pensions, you’ve won the investing game. Why keep playing? Start bailing.
If you don’t act, the market might drop and it could take years to get back to your number again. This is one of the reasons why some people should not be holding a lot of stocks as they near retirement. Some people might need the stock exposure because the upside is better than the downside (they don’t have enough money unless stocks do well, or longevity risk), but for others the downside is worse than the upside (they DO have enough money unless stocks do poorly, or unnecessary market risk).
I find the concept of a risk-free liability-matching portfolio (LMP) much harder to apply to early retirement, as it is nearly impossible to create a truly guaranteed inflation-adjusted lifetime income stream that far into the future. Inflation-adjusted annuities are rare, expensive, and you’re betting that the insurer also lasts for another 50+ years if you’re 40 years old now. Social Security is subject to political risk and may become subject to means-testing. TIPS currently have negative real yields across the entire curve, and only go out to 30 years. (As Bernstein explores in future books, you’ll also have to avoid wars, prolonged deflation, confiscation, and other “deep risk” events.)
* Here are the details behind the chart:
As a small thought experiment, I posited imaginary annual cohorts who began work on January 1 of each calendar year, and who then on each December 31 invested 20% of their annual salary in the real return series of the S&P 500. I then measured how long it took each annual cohort, starting with the one that began work in 1925, to reach a portfolio size of 20 years of salary (which constitutes 25 years of their living expenses, since presumably they were able to live on 80% of their salary). Figure 11 shows how long it took each cohort beginning work from 1925 to 1980 to reach that retirement goal.
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For those of us who havent read the book yet, LMP is an acronym for what?
LMP = Liability Matching Portfolio, the portfolio that is constructed match all your future lifetime liabilities while taking minimal risk (no stock market risk, no interest rate risk, no default risk, etc).
LMP = Liability Matching Portfolio?
I read somewhere that in the past 20-30 years, the big rallies & rebounds have come in 4-5 days i.e. in quick succession. If you chickened out and pulled your money out of the market during a recession, it would be reallt difficult to put money back just to avoid missing out on the biggest rebounds.
Hence the age old wisdom to not time the market & stay invested.
Now you could still have your share of bad luck depending on when you entered the job market but at least this removes the additional factor.
Appologies if I missed it, but which book exactly are you referring to here: “As Bernstein explores in future books, you’ll also have to avoid wars, prolonged deflation, confiscation, and other “deep risk” events”
I find this the most interesting part of investing as there isn’t a simple formula you can plug into
The “Deep Risk” book listed above discusses this topic.
Bernstein is maybe my all-time favorite financial writer, so when you mention him you’ve got my attention.
I’m not rich but think I’m ready for LMP, as we have no debt.
What keeps me in stocks, though, is that they’re said to be the best hedge against inflation. Bonds can’t go lower. Cash pays almost no interest and loses its value when (not if) inflation hits us.
LMP doesn’t seem to protect us against inflation, my greatest fear, especially with the recent multi-trillion dollar giveaways by Congress.
I’m afraid I have to agree with you. While Bernstein suggests inflation-tracking investments like inflation-adjusted annuities (too expensive), TIPS (too expensive), the only reliable solution in my opinion is delaying Social Security if possible to increase your eventual paycheck that will be indexed to inflation. Otherwise, the Fed is purposely pushing interest rates to zero so that that TINA (there is no alternative) to buying some risky assets.
Yes, I long ago decided annuities of any kind didn’t work for me. I had TIPS for ten years, bought directly from the US Treasury, but now that interest rates are so low, they don’t work either. (Or am I confused?)
I waited until age 70 to start Social Security, but worry about means testing, especially if Democratic progressives take over the government, something that seems more likely every day.
Almost all my life’s savings comes from my life’s earnings, not investments, and it would pain me to to lose all that work to inflation, which I see as avoidable. I’d be grateful without measure for advice on how to keep what I’ve got.
In the meantime, our “solution” has been to give birthday gifts to our nine children and grandchildren, a hundred dollars times the new age. We want to die broke, but our balance increases every year even if we do nothing. (I’m aware that we’re fortunate.)
Any tips for how these figures / future figures might be impacted by the latest coronavirus pandemic and what investors can expect. What I mean here is how do you think your “number” will be impacted by the current pandemic and will our analysis and expectations have to change with it?