My daughter is a millionaire
 

Or at least that is the plan. She is 8 months old. I just bought her a $10k Vanguard variable equity/bond annuity, and by the time she reaches age 65, it should be worth around $1M in real terms (assuming the markets cooperate and inflation doesnt go crazy). Clever plan, no?

Re: My daughter is a millionaire
 

(assuming the markets cooperate and inflation doesnt go crazy).


you are a gambler sir

Re: My daughter is a millionaire
 

Sounds good. 65 years from now, a million dollars outght to buy her a nice family sedan for her retirement.

Re: My daughter is a millionaire
 

[ QUOTE ]
Sounds good. 65 years from now, a million dollars outght to buy her a nice family sedan for her retirement.

[/ QUOTE ]

don't be ridiculous, it'll probably buy at least 2 of them.

Re: My daughter is a millionaire
 

[ QUOTE ]
Sounds good. 65 years from now, a million dollars outght to buy her a nice family sedan for her retirement.

[/ QUOTE ]

Unless I'm confusing OP's post, didn't he mention that the $1M is going to be in real terms?

Re: My daughter is a millionaire
 

add 1,000 annually and it will be 2.4 mill.
you maybe do it for first 20 years, and she'll do it for last 45 years.

Re: My daughter is a millionaire
 

Congrats sir. Wish my parents did the same for me. Your daughter will thank you when she is old enough to understand what you did. I commend you for making your kids a priority. Best of luck!

Re: My daughter is a millionaire
 

[ QUOTE ]
Or at least that is the plan. She is 8 months old. I just bought her a $10k Vanguard variable equity/bond annuity, and by the time she reaches age 65, it should be worth around $1M in real terms (assuming the markets cooperate and inflation doesnt go crazy). Clever plan, no?

[/ QUOTE ]

Nope. Assuming 3% in annual inflation, this means you are assuming around 11.4% in annual return from an equity/bond annuity, after fees. Will never happen. At best you will see 8-9% annualized, or 5-6% after inflation, and end up with $440,000 in real money. Or worse given the forced insurance associated with annuities.

And why do you say "equity/bond" annuity. The moment you put bonds into the mix you are lowering your long term expectation. If you have such a long time horizon, I'm assuming you know to stick it all into an index fund?

In the end you'd might do better for her putting her in the total stock market index or some other index. You save .3%-.4% a year in annuity costs, and an index fund is almost as tax efficient as an annuity and has no 10% tax hit for early withdrawals.

But if you have to do an annuity, you've picked the right place, Vanguard's costs are very low. As has already been pointed out, add a thousand or so a year and you'll hit your goal pretty easily.

Re: My daughter is a millionaire
 

surely the money's going to be a lot more use to her at 21 than 65?

Re: My daughter is a millionaire
 

[ QUOTE ]
surely the money's going to be a lot more use to her at 21 than 65?

[/ QUOTE ]

Not a chance in hell (IMO).

Re: My daughter is a millionaire
 

[ QUOTE ]
[ QUOTE ]
Or at least that is the plan. She is 8 months old. I just bought her a $10k Vanguard variable equity/bond annuity, and by the time she reaches age 65, it should be worth around $1M in real terms (assuming the markets cooperate and inflation doesnt go crazy). Clever plan, no?

[/ QUOTE ]

Nope. Assuming 3% in annual inflation, this means you are assuming around 11.4% in annual return from an equity/bond annuity, after fees. Will never happen. At best you will see 8-9% annualized, or 5-6% after inflation, and end up with $440,000 in real money. Or worse given the forced insurance associated with annuities.

And why do you say "equity/bond" annuity. The moment you put bonds into the mix you are lowering your long term expectation. If you have such a long time horizon, I'm assuming you know to stick it all into an index fund?

In the end you'd might do better for her putting her in the total stock market index or some other index. You save .3%-.4% a year in annuity costs, and an index fund is almost as tax efficient as an annuity and has no 10% tax hit for early withdrawals.

But if you have to do an annuity, you've picked the right place, Vanguard's costs are very low. As has already been pointed out, add a thousand or so a year and you'll hit your goal pretty easily.

[/ QUOTE ]

Check your math. The Vanguard Balanced annuity (60-70% equity, remainder fixed income) has been around since 1991 and has returned 10.5% net of fees; inflation in the US has been historically 3%. In 65 years, this 7.5% real return compounds to 110x the original contribution, or $1M+

Think the return is too aggressive because the last 20 years have been atypical? No matter, I'm planning to make $10k contributions annually for the indefinite future. An additional $10k (contributed early) lets me hit the same $1M+ nut with a 1% lower rate of return.

Re: My daughter is a millionaire
 

[ QUOTE ]
And why do you say "equity/bond" annuity. The moment you put bonds into the mix you are lowering your long term expectation.

[/ QUOTE ]

Also, this statement is totally wrong.

Re: My daughter is a millionaire
 

[ QUOTE ]
Or worse given the forced insurance associated with annuities.

In the end you'd might do better for her putting her in the total stock market index or some other index. You save .3%-.4% a year in annuity costs, and an index fund is almost as tax efficient as an annuity and has no 10% tax hit for early withdrawals.

[/ QUOTE ]

The annuity is the perfect vehicle for this, because it is 100% tax efficient. No federal/IRS paperwork is generated. There are not filing/accounting fees associated with annuity ownership.

The only thing that even comes close is buying an ETF, but the problem with that solution, is that I won't be able to rebalance to a constant equity/fixed income ratio without incurring capital gains. (Rebalancing of low correlation assets = lower std. deviation for same return, at certain points on the risk/reward curve.).

Most importantly, the variable annuity (unlike the ETF/index fund, is invisible to her. Im not planning to tell her about this fund at all. I've written a letter that is sealed, and stored it with our wills, and the letter has instructions that it is to be opened upon the death of the second parent.

Hopefully, that will happen a long long time from now, at which point in time she will be mature enough to not do something stupid like raid it for beer money, or trade it around looking for the next internet bubble.

Re: My daughter is a millionaire
 

Contributing 10k annually to your daughter's retirement is a really friggin nice gesture. I oughta leave that post up on the computers my mom and dad use [img]/images/graemlins/tongue.gif[/img]

Re: My daughter is a millionaire
 

Unfortunately, if you're old enough to play poker and use a computer, it is too late. This plan requires early action to work. You can't afford to lose even a single doubling cycle (i.e., 10 years). Of if you do lose a doubling cycle, you need to double the size of the initial investment.

How can I deprive my daughter of security in her old age, when I probably blow $10k a year on absolute crap?

Re: My daughter is a millionaire
 

[ QUOTE ]
Unfortunately, if you're old enough to play poker and use a computer, it is too late. This plan requires early action to work. You can't afford to lose even a single doubling cycle (i.e., 10 years). Of if you do lose a doubling cycle, you need to double the size of the initial investment.

How can I deprive my daughter of security in her old age, when I probably blow $10k a year on absolute crap?

[/ QUOTE ]

I don't need a million real as a gift, I would still appreciate 10k a year to invest. The age of the recipient doesn't negate the "frikkin nice"ness of the gesture : )

Re: My daughter is a millionaire
 

[ QUOTE ]
[ QUOTE ]
And why do you say "equity/bond" annuity. The moment you put bonds into the mix you are lowering your long term expectation.

[/ QUOTE ]

Also, this statement is totally wrong.

[/ QUOTE ]

Historically, it hasn't been wrong.

Re: My daughter is a millionaire
 

not sure how well you are off, but this might be better used as tuition money?

Re: My daughter is a millionaire
 

[ QUOTE ]
The only thing that even comes close is buying an ETF, but the problem with that solution, is that I won't be able to rebalance to a constant equity/fixed income ratio without incurring capital gains. (Rebalancing of low correlation assets = lower std. deviation for same return, at certain points on the risk/reward curve.).

[/ QUOTE ]

Any fixed income you add is going to lower your returns... rebalancing bonus is not going to overcome the equity risk premium.

Re: My daughter is a millionaire
 

[ QUOTE ]
The annuity is the perfect vehicle for this, because it is 100% tax efficient. No federal/IRS paperwork is generated.

[/ QUOTE ]

By this you mean gains aren't taxed until withdrawn right?

Re: My daughter is a millionaire
 

You might be better off seeing what kind of life insurance you can get. My parents are recieving their share of $500K my grandfather had in annuities and all the gains are taxed. If the money had been in life insurance it would be included in the estate and tax free because of the $2.5M estate tax allowance.

Re: My daughter is a millionaire
 

Another option is to open a ROTH and max it every year but never touch it. It gets passed on to her tax free and all gains accumulate tax free.

Re: My daughter is a millionaire
 

[ QUOTE ]
[ QUOTE ]
And why do you say "equity/bond" annuity. The moment you put bonds into the mix you are lowering your long term expectation.

[/ QUOTE ]

Also, this statement is totally wrong.

[/ QUOTE ]

Care to offer evidence of this? Because bonds have traditionally returned less than equities over long periods.

Re: My daughter is a millionaire
 

[ QUOTE ]


Check your math. The Vanguard Balanced annuity (60-70% equity, remainder fixed income) has been around since 1991 and has returned 10.5% net of fees; inflation in the US has been historically 3%. In 65 years, this 7.5% real return compounds to 110x the original contribution, or $1M+


[/ QUOTE ]

Yes, the return has been entirely too aggressive. Note that in those 15 years the bond portion has benefited from declining interest rates. In 1991 the 30 year treasury was 8.14%, last year it was 4.91%. That caused a huge increase in the value of carried bonds, and you can't count on similar declines in the future. In fact, an increase in interest rates will almost guarantees the bond portion of your investment will do very poorly.

[ QUOTE ]

Think the return is too aggressive because the last 20 years have been atypical? No matter, I'm planning to make $10k contributions annually for the indefinite future. An additional $10k (contributed early) lets me hit the same $1M+ nut with a 1% lower rate of return.

[/ QUOTE ]

Like I said, you'll have to, because you won't come close to 10.5%. Long term equity returns have been roughly 10%, and there are those who argue given the higher PE ratio of todays market (than is typical historically) implies equity returns of 8-9% going forward.

Re: My daughter is a millionaire
 

[ QUOTE ]


The annuity is the perfect vehicle for this, because it is 100% tax efficient. No federal/IRS paperwork is generated. There are not filing/accounting fees associated with annuity ownership.


[/ QUOTE ]

The annual gains from an index fund (or possibly an ETF) is over 95% tax efficient (depending upon the yearly turnover of the index). And that's without losing 3/10 of 1% of your yearly gains to an annuities insurance wrapper (.3% of 8% reduces the annuity tax efficiency to 96%). And an index fund allows your daughter to get the lowest possible tax rate (LT capital gains) when she cashes out, which adds as much as 15% or so at the end date. So I think it's more than questionable whether the annuity is the better choice.

In fact, you are much better off setting up an IRA for her. Now you are "100% tax efficient", and don't have to pay .3% per year in excess fees. But you lose the long term capital gains from your cash out. If you can do a Roth IRA for her, it might make even more sense, since she'll pay no taxes after establishing it.

[ QUOTE ]

The only thing that even comes close is buying an ETF, but the problem with that solution, is that I won't be able to rebalance to a constant equity/fixed income ratio without incurring capital gains. (Rebalancing of low correlation assets = lower std. deviation for same return, at certain points on the risk/reward curve.).


[/ QUOTE ]

Rebalancing from an 8-9% long term return asset into a 6-7% long term return asset always gives you a lower return, even if it lowers beta. And why would you care about beta with a 65 year time horizon?

[ QUOTE ]

Most importantly, the variable annuity (unlike the ETF/index fund, is invisible to her. Im not planning to tell her about this fund at all. I've written a letter that is sealed, and stored it with our wills, and the letter has instructions that it is to be opened upon the death of the second parent.


[/ QUOTE ]

You can do this with any of the approaches, index fund, annuity, IRA, even 401k, etc.

[ QUOTE ]

Hopefully, that will happen a long long time from now, at which point in time she will be mature enough to not do something stupid like raid it for beer money, or trade it around looking for the next internet bubble.

[/ QUOTE ]

You don't think she'll want to buy a house or send her kids through college? You might think about which approach allows her to do this without paying a 10% surtax before she's 65 years old.

Re: My daughter is a millionaire
 

By the time your daughter reaches 65 the world is going to be a huge piece of crap and it will hardly matter where your money was invested.

-Michael

Re: My daughter is a millionaire
 

Im surprised that my plan has evoked so many questions/critiques, because I think it is flawless. Anyhow, let me lay out my thinking more clearly:

1. The biggest reason my plan will fail is human intervention in the investment process. Either the annuity will get raided early, or investment decisions will be made on a non-passive/indexed basis that result in crappy returns. If either of those things happen, the plan stands a greater risk of failure.

2. To defeat both of these risks, the annuity needs to remain a secret from my daughter. The annuity is the best mechanism for this, because it generates no federal paperwork that requires a tax filing. Thus, there is a lower risk it will be discovered. Plus, I'll elect to receive statements electronically, if possible.

3. The next biggest risk is that the market won't perform as I want over the next 65 years. I can overcome this risk in two ways. First, I increase the initial funding by $10k every year, as long as my wife and I are working (which hopefully, will be about 5 more years). Second, I include bonds in the portfolio because I want to lower the std. deviation of the portfolio. The problem with a 100% equity mix is that the portfolio, as she comes within 15 years of retirmement age, will be at risk of a sustained downturn. So the lower std deviation helps. I suppose I could personally rebalance the portfolio every year while I'm alive, but I want to really try to remove the human aspect from the investing process as much as possible, myself included. I dont trust my own decision making. So I'm going to try to make this an entirely blind investment portfolio. One thing I will do, however, is that as I add $10k tranches, I'll add them in different asset classes, principally international, REIT, and small cap. This will add extra asset class diversification, and I'll be done in 3 years.

4. I agree that an IRA would be the best tax deferred vehicle, however my daughter can't make a contribution w/out earned income. When she gets old enough to have a job, I'll sit down with her and have the Roth IRA talk, and I will try to convince her to make contributions, and I will match whatever additional is needed to hit the Roth cap.

5. The only other thing that concerns me is that "knowing" she has a retirement "taken care of" may instill bad habits in my daughter. She may not "get religion" until later in life, or maybe she might never get it. So my plan is to teach her about retirement savings as she gets older with frank discussions about 401ks, IRAs, etc. The annuity is really intended as a backup plan for her.

6. Somebody mentioned life insurance. My wife and I each have 30-year policies set up in life insurance trusts, but those are hedges against dying early. Not a way to create a larger inheritance for my daughter. I'll be a happy man if the life insurance company keeps all of my money and never pays me a dime.

7. DesertCat, I actually agree with you that 10.5% is too aggressive going forward, because I think we've been in a historically atypical invesmtent environemnt since 1991, and we're due for some mean regression. But I dont have a crystal ball, so the best I can do is diversify my bets, and to invest as much as I can up front to take advantage of compound interest.

8. Finally, some of you guys have asked about college tuition, buying a first home, etc. The short answer is that my daughter's 529 plan is already adequately funded for a 4-year private education (and probably some graduate school). As for buying a first house, I think that is her responsibility, and if she wants to own a home, she will need to save up for the downpayment.

Re: My daughter is a millionaire
 

[ QUOTE ]

1. The biggest reason my plan will fail is human intervention in the investment process. Either the annuity will get raided early, or investment decisions will be made on a non-passive/indexed basis that result in crappy returns. If either of those things happen, the plan stands a greater risk of failure.


[/ QUOTE ]

This is the biggest problem everyone faces. Making too many trading decisions without trading skills, for a passive investor letting emotions overrule the plan and try to market time. Also not saving as much as they plan. Sounds like you understand these things and I doubt you will fail.


[ QUOTE ]

The problem with a 100% equity mix is that the portfolio, as she comes within 15 years of retirmement age, will be at risk of a sustained downturn. So the lower std deviation helps.

[/ QUOTE ]

Why not rebalance only when she's within 15 years of tapping the funds? Without bonds you'll have to deal with more volatility, but you sound like you have the right temperament to deal with that. It also gives you the opportunity to better benefit from "dollar cost average", make an extra contribution when the market gets crushed badly.

[ QUOTE ]

4. I agree that an IRA would be the best tax deferred vehicle, however my daughter can't make a contribution w/out earned income. When she gets old enough to have a job, I'll sit down with her and have the Roth IRA talk, and I will try to convince her to make contributions, and I will match whatever additional is needed to hit the Roth cap.


[/ QUOTE ]

I'm not a tax expert, but I'm wondering if you can create income for your daughter, without incurring too much in the way of taxes. If you can a 65 year ROTH Ira would be awesome.

Look, I'm really just nit picking here. You seem like you definitely have your head on your shoulders about this. The difference between an annuity and an IRA is at most .3% per year, it's not going to kill you. And the difference between putting some bonds in the mix, is likely to be less than 1% per year (assuming you do something like 30% bonds for the first 50 years). Congratulations on being so forward thinking and I know it will work out very well for you, and your daughter.

Re: My daughter is a millionaire
 

[ QUOTE ]

3. The next biggest risk is that the market won't perform as I want over the next 65 years. I can overcome this risk in two ways. First, I increase the initial funding by $10k every year, as long as my wife and I are working (which hopefully, will be about 5 more years). Second, I include bonds in the portfolio because I want to lower the std. deviation of the portfolio. The problem with a 100% equity mix is that the portfolio, as she comes within 15 years of retirmement age, will be at risk of a sustained downturn. So the lower std deviation helps. I suppose I could personally rebalance the portfolio every year while I'm alive, but I want to really try to remove the human aspect from the investing process as much as possible, myself included. I dont trust my own decision making. So I'm going to try to make this an entirely blind investment portfolio. One thing I will do, however, is that as I add $10k tranches, I'll add them in different asset classes, principally international, REIT, and small cap. This will add extra asset class diversification, and I'll be done in 3 years.


[/ QUOTE ]

Right, but you have to realize you're trading a lower standard deviation for weaker returns. Given the long timeframe of your plan, concerns about standard deviation don't make much sense to me. Of course there could be a sustained downturn in the equity portion of the annuity, but stocks are still +EV for what you're attempting to do. But kudos to you for planning for your child's future.

Re: My daughter is a millionaire
 

[ QUOTE ]
The problem with a 100% equity mix is that the portfolio, as she comes within 15 years of retirmement age, will be at risk of a sustained downturn.

[/ QUOTE ]

this is the kind of "conventional wisdom" you need to avoid.

let's assume an portfolio made up of 100% equities would return 10%, while your equity/bond portfolio may only return 8%.

over 65 years, the equity portfolio would be worth 490.4 times its current worth, while the equity/bond mix would increase in value 148.8 times.

so you're giving up 70% of your expected value for a little bit of "diversification".

to illustrate this another way, let's figure out how big of a downturn the equity portfolio would have to have to have on the last day to make the mixed portfolio a better investment if the portfolios otherwise perform as expected. let's call this downswing at the end d, which is a percentage from 0 to 100. and let's assume the equity/bond mix is 70% equities, 30% bonds, and that the bonds are immune to this downswing.

let's find out for what value of d,
equity portfolio return = mixed portfolio return
(1-d) = (148.8/490.4) * [0.3 + 0.7 * (1 - d)]
(1-d) = 0.30343 * (1 - 0.7*d)
(1-d) = 0.30343 - 0.21240*d
0.6970 = 0.7876d
d = 0.885

so if the portfolio's perform as expected until the last day and then the stock market drops 88.6% on that last day, you should be indifferent in choosing between the two portfolios.

to put it another way, if in 65 years, the stocks are worth even 12% of what they're expected to be worth, the 100% equity portfolio is a better investment.

invest in equities. you can handle the risk over 65 years. for more than 3 times the expected return, you can afford the marginal increase in risk.


[ QUOTE ]
7. I think we've been in a historically atypical invesmtent environemnt since 1991, and we're due for some mean regression.

[/ QUOTE ]

we're not due for anything.

EDIT: i think i fixed it, let me know if the math is still wrong

Re: My daughter is a millionaire
 

I think assuming a 10% return on equities is a little optimistic. Your call, but lately I've been playing around with a number like 6.5%.

Re: My daughter is a millionaire
 

65 years is a hell of a long time. After peak-oil, the food wars and then the water wars it's anyones guess what your investment will be doing, if it even exists [img]/images/graemlins/smile.gif[/img]

Re: My daughter is a millionaire
 

[ QUOTE ]
65 years is a hell of a long time. After peak-oil, the food wars and then the water wars it's anyones guess what your investment will be doing, if it even exists [img]/images/graemlins/smile.gif[/img]

[/ QUOTE ]

I agree with you, and I'm not kidding. In addition to preparing for good times by purchasing an annuity, etc., I'm also planning to prepare her for bad times, by sending her to Gunsite for firearms training, and stockpiling rifles and ammunition.

Re: My daughter is a millionaire
 

pete, is it your contention that for a 65 year time frame that an all equity portfolio will outperform a bonds + equity portfolio (forgetting about a more widely diversified portfolio for a second)?

if so, then you are flat wrong. the main problem goes to how you are thinking about these things. it isn't like you're getting 10% return with equities and 8% return with bonds at the same level of risk. 10% return of equities is higher risk than 8% return of bonds.

to avoid this problem, you can simply leverage bonds to get to the same risk/return tradeoff as equities and thus get the diversification without sacrificing any of the returns.

your expected sharpe ratio of equities is about .25 and same for bonds.

but by combining both leverage and diversification over that time frame you can CRUSH an all equity portfolio with a widely diversified one and it isn't even a close comparison. the expected sharpe ratio of the latter can be >.6 but can be conservitively put at .5

Barron

Re: My daughter is a millionaire
 

[ QUOTE ]
this is the kind of "conventional wisdom" you need to avoid.

let's assume an portfolio made up of 100% equities would return 10%, while your equity/bond portfolio may only return 8%.

[/ QUOTE ]

Just so we're on the same page fact-wise, the Balanced portfolio I cited has been around since 1991 and has returned 10.6%

The Vanguard Equity Index has been around since 1991 and has returned 10.5%.

The Growth annuity has returned 5.99% and has been around since 1993.

The Equity Income annuity has returned 11.1% and has been around since 1993.

The International index has been around since 1994 and has returned 9.4%

All other Vanguard annuities lack a comparably long track record.

Net net: it's hard to make assumptions like I'm automatically giving up 2 points forever. I'm probably giving up something, but I do it for lower volatility.

Obviously, I understand that more compounding earlier, results in more headroom at the end to weather downturns.

But what you guys dont seem to get is that I'm not trying to maximize returns here. I will take lower returns for lower standard deviation. My daughter gets rich at retirement if I can make base hits; absolutely no point swinging for the fences.

Lower volatility investment + higher initial contribution = greater likelihood of success.

The poker analogy would be whether you want to push every small edge, even if +EV, or if you dont push edges but you dont have as much variance.

[ QUOTE ]
I think we've been in a historically atypical invesmtent environemnt since 1991, and we're due for some mean regression.

we're not due for anything.

[/ QUOTE ]

If by this comment you mean that the past is not a predictor of the future, then yes, I agree. There is no guaranteed "mean reversion", particularly if you believe the data set has any heteroschedasticity due to fundamental and enduring changes in things like interest rates, productivity gains, global competition, etc.

However, that said, absent heteroschedasticity, datasets to tend to exhibit mean reversion, and thus simply as a matter of correlation--not causation--I do think we're in for worse times in the future. You could also point to fundamental problems in the economy, like the long term weakening of the dollar, the twin deficit expansion, the demographic shift of retiring boomers and the lack of a large tax payer base behind the boomers--all as negative factors that will drag returns in the future below what we have experienced for the past 30 years.

Re: My daughter is a millionaire
 

If you add $10,000 every year it should be worth $20M in 65 years. Teach your daughter to do the same for her kid and your grandkids+ should be set for life.

Re: My daughter is a millionaire
 

[ QUOTE ]
[ QUOTE ]
this is the kind of "conventional wisdom" you need to avoid.

let's assume an portfolio made up of 100% equities would return 10%, while your equity/bond portfolio may only return 8%.

[/ QUOTE ]

Just so we're on the same page fact-wise, the Balanced portfolio I cited has been around since 1991 and has returned 10.6%

The Vanguard Equity Index has been around since 1991 and has returned 10.5%.

The Growth annuity has returned 5.99% and has been around since 1993.

The Equity Income annuity has returned 11.1% and has been around since 1993.

The International index has been around since 1994 and has returned 9.4%

All other Vanguard annuities lack a comparably long track record.

Net net: it's hard to make assumptions like I'm automatically giving up 2 points forever. I'm probably giving up something, but I do it for lower volatility.

Obviously, I understand that more compounding earlier, results in more headroom at the end to weather downturns.

But what you guys dont seem to get is that I'm not trying to maximize returns here. I will take lower returns for lower standard deviation. My daughter gets rich at retirement if I can make base hits; absolutely no point swinging for the fences.

Lower volatility investment + higher initial contribution = greater likelihood of success.

The poker analogy would be whether you want to push every small edge, even if +EV, or if you dont push edges but you dont have as much variance.

[ QUOTE ]
I think we've been in a historically atypical invesmtent environemnt since 1991, and we're due for some mean regression.

we're not due for anything.

[/ QUOTE ]

If by this comment you mean that the past is not a predictor of the future, then yes, I agree. There is no guaranteed "mean reversion", particularly if you believe the data set has any heteroschedasticity due to fundamental and enduring changes in things like interest rates, productivity gains, global competition, etc.

However, that said, absent heteroschedasticity, datasets to tend to exhibit mean reversion, and thus simply as a matter of correlation--not causation--I do think we're in for worse times in the future. You could also point to fundamental problems in the economy, like the long term weakening of the dollar, the twin deficit expansion, the demographic shift of retiring boomers and the lack of a large tax payer base behind the boomers--all as negative factors that will drag returns in the future below what we have experienced for the past 30 years.

[/ QUOTE ]

first, everybody needs to understand that return=X*risk. basically, you can target a level of risk OR return and for all intents and purposes be targeting the same thing. this conclusion results from the fact that the expected sharpe ratio for ANY asset class (save commodities) will be between .2 and .3 (about .25).

what level of risk is acceptable to you? 5%? 8%? 15%? at any level of risk you choose, you can create a portfolio that will vastly outperform the return you get from bonds alone, bonds + equities, or equities alone.

that is it.

Barron

also, "mean reversion" is pretty meaningless since we'll never have a "mean." if you mean, instead, that prices of risky assets have a cyclical predisposition then i agree because the underlying factors that drive them tend to move cyclically, i.e. the business cycle....and given that we are at the tail end of the latest (global) cycle, yes i agree the prices of risky assets are in danger of a correction, but flows can still push them higher before that correction comes due.

Re: My daughter is a millionaire
 

[ QUOTE ]
pete, is it your contention that for a 65 year time frame that an all equity portfolio will outperform a bonds + equity portfolio (forgetting about a more widely diversified portfolio for a second)?

if so, then you are flat wrong. the main problem goes to how you are thinking about these things. it isn't like you're getting 10% return with equities and 8% return with bonds at the same level of risk. 10% return of equities is higher risk than 8% return of bonds.

to avoid this problem, you can simply leverage bonds to get to the same risk/return tradeoff as equities and thus get the diversification without sacrificing any of the returns.

your expected sharpe ratio of equities is about .25 and same for bonds.

but by combining both leverage and diversification over that time frame you can CRUSH an all equity portfolio with a widely diversified one and it isn't even a close comparison. the expected sharpe ratio of the latter can be >.6 but can be conservitively put at .5

Barron

[/ QUOTE ]



i made the assumption that the bonds aren't leveraged. if i'm wrong about that, ignore everything i said. and i realize that there may be better ways to take on more risk than just by switching from bonds to equities. my main point was that he can afford to take on more risk than he seems to think.

also, tell me how i can get my money into a highly leveraged portfolio with a 0.5+ sharpe ratio most easily. i want to be rich and i'm willing to gamble.

Re: My daughter is a millionaire
 

[ QUOTE ]

if so, then you are flat wrong. the main problem goes to how you are thinking about these things. it isn't like you're getting 10% return with equities and 8% return with bonds at the same level of risk. 10% return of equities is higher risk than 8% return of bonds.


[/ QUOTE ]

Over multiple decades the risk is the same. Because you have zero risk of loss with both approaches and don't have to use any leverage.

[ QUOTE ]

to avoid this problem, you can simply leverage bonds to get to the same risk/return tradeoff as equities and thus get the diversification without sacrificing any of the returns.


[/ QUOTE ]

I can't do this, and wonder how you can. Specifically where can you borrow margin cheaper than the yields on the bonds you buy with it?

And even if you can overcome this obstacle, this approach has other problems. To max returns you have to stay heavily margined. So you are taking a huge risk of a black swan (an event outside your expected volatility ranges) hitting your windshield as you are driving 100 mph, and wiping you out.

Even if you can avoid this, you have the psychological problem that occurs when the market turns and your leveraged assets decline in value, increasing your leverage substantially. Even if your porfolio is built to ride out that storm (because it falls within historical volatility ranges), many investors can't deal with the stress and will sell their portfolio at the point of maximum losses.

Essentially LTCM (long term capital management) was built using similar theories (by guys who helped write those theories) and it worked for a few years until they hit a black swan and wiped out.

Re: My daughter is a millionaire
 

You have zero of risk of loss in the stock market over multiple decades?

i think not...