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On Zvi Bodie's "Worry Free Investing"

I don't recall which thread contained the reference to this book, but the poster cited this author as suggesting that one could/should invest in iBonds for truly 'worry free' retirement income. There were a series of unanswered questions such as "what multiplier is needed at retirement to provide the stream of income?" Any regular here is familiar with the rule of 25, which is the inverse of the 4% withdrawal rate one hopes a diversified portfolio will provide.

That said, I got the book and am far enough along to post my findings. First is the link

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which provides a downloadable spreadsheet. The first assumption is that the TIPS (he switches between TIPS and iBonds, I won't object as they are similar in that both are linked to the CPI) have a 3% return. This means 3% plus whatever CPI is running. He also assumes a replacement rate of 70% is the goal, as social security will provide some, and 100% isn't the target as one doesn't have to save 'for' retirement while retired. No arguments there from me either. The sheet comes up assuming that one starts saving at 35, retires at 65, and dies at 85. A savings rate of 21% is needed to accomplish this. I think 90 is more realistic, the rate has to jump to 24%. Start saving at 25, the rate drops to below 16%. I'd be great with this, only a visit to
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that the current rate on iBonds is 1.4%. The real return has dropped by half. Leave the changes I made above (start at 25, live to 90) and the required savings rate shoots back up to 27%. Had I read the book in 2003 and been sold on this plan, from a savings rate of 16% (which I wouldn't worry about), I'd find, that as the real rates dropped, the new bonds I purchased would require a saving rate over 27%. This is worry-free?

I appreciated his anecdotes of the people who were on the verge of retiring to then meet up with the crash of 2000-2. And the Enron widow. These stories only reinforced my belief that much planning is needed in those final years, but he suggests that no amount of diversification will protect an investor from a long term bear market. I'm not convinced either way, but I still lean toward the 5-6 years of spending in bonds or cash equivalent, and the rest diversified among stocks, local and foreign.

I wonder if he's changed some of his advice given the drop in yield of the instrument he suggested to use 100%.

Joe JoeTaxpayer.com

Reply to
joetaxpayer
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Any strategy that is *not* about investing in US government real return securities has risk

(that strategy has risks too: your own personal costs outstrip CPI, and/or the US government gets into credit problems).

My own thought is you need to assess:

- how much you have

- how much you will need

- whether you have other sources of TIPS-like income, eg US Social Security, in retirement

Monte Carlo simulation is the best technique available, then, for assessing your probability of meeting your retirement goals. You can assess different scenarios with, say, an 80% chance of meeting your retirement goals, or a 90%, or a 99%, and see what asset allocations give you those.

The William Sharpe website financialengines.com had some tools and ideas on this, and I think

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(if you search the back issues) had some links to some tools.

The UK, being the UK, is 15 years behind on this ;-).

Actually it's dropped 50% or so. 100% would mean no yield at all ;-).

There was an exchange on efficientfrontier.com a couple of years back between Bernstein and Bodie.

Bodie admitted that a problem with his approach is that if everyone does it, that may change the real interest rate offered by TIPS or other real return bonds. He refers to it as a 'general equilibrium' problem.

Part of the problem is the publication delay lag between an author writing a book and it hitting the shelves. When Bodie was first pushing his viewpoint (about 1998) the consensus was that markets could only go up, and TIPS were yielding 4% real. But the book didn't come out until 2002-03, from memory.

In retrospect, stocks were overvalued, and TIPS were the buy of the century.

My view is real estate is now in the position that stocks were in

1999, ie as the 'sure' retirement bet.

At 1.5% real yields, it is much less clear that TIPS are a bargain.

Reply to
darkness39

I just read this book too. I thought it was easy reading, with the following interesting ideas:

1) Stocks are risky, even in the long run. The market can drop just as you intend to cash out. This is perhaps the one big takeaway from the book. Of course, this is worse in an overvalued market (Japan in the 80s, US 1999). 2) Due to #1, target retirement funds may be a poor investment. Imagine that the market drops every time the fund changes holding percentages. Bodie says to change holdings based on portfolio performance. I'm not 100% sure I understand this advice, but it sounds interesting. I think he's saying that when limiting risk (due to getting closer to your target withdrawal date) to change holdings to more bonds when the market is up, not based on an arbitrary date. 3) An alternative to buying stocks is to put enough in a CD to recover your principal and buy LEAPs for the market. You don't risk the principle, but get some, albeit limited, upside if the market goes up. I assume this is only intended for those who are time constrained, otherwise you could wait out the bear market. 4) Use I bonds or TIPS to protect principal. I'm not sure about this either (see next post about I bonds).

There's also advice and simple calculations to help you plan, set goals, etc...

Overall I thought it was a good reality check about risk, although I'm not going to run out to put any excess cash in I bonds right now.

Reply to
johnrichardson_us

It would seem that no strategy is risk free. In the endgame, an inflation adjusting immediate annuity (there, I said it) would seem to be close, but of course the risk there is you die shortly after buying it, and the money is gone. There are tradeoffs, but no way to eliminate all risk. The intent of my post was to highlight the irony in the fact that this proposed 'worry free' strategy requires twice the deposits it did just four years ago. I'd compare the S&P which dropped from 1500 to

800 a drop of 40% (after dividends) to the iBond real component dropping from 3.6% in May, 2000 to 1.4% Nov 2006, a 60% drop. Copywrite date on the book says 2003, the rate had already dropped below 2% in Nov 02, but I guess you don't pull a book from release just because its premise is faulty. You are correct, in hindsight the 3.6% was quite the buy.

JOE

Yes, my wording was less than clear, but you knew that. He suggested to invest 100% in iBonds/TIPS. Their real yield fell 50% (actually 60%). And right now, post tax, their real yield is about 0%.

Reply to
joetaxpayer

Your point (which is a good one) is that it would be much harder to implement his proposed strategy now, than it was then.

This is reflected here in the UK. When you retire, you have to buy an annuity with the retirement funds you have saved in personal pension schemes.

The income you would receive from those funds has more than halved in the last 10 years. Someone retiring in 1996 with £100k, has twice the retirement income of someone retiring in 2006 with £100k.

This is essentially why our pension system is in severe trouble. It's not so much the performance of the stock market 1999-2005 (still not reached its previous peak), it's the collapse in gilt (government bond) yields which underpin the pensions both of DC and DB systems. If you run a company DB scheme, the cost of insuring your pensioners' pensions has effectively doubled.

The reaction of individuals has been to lean more towards property markets, and particularly residential property-- both owner occupied and investor. Since residential housing prices have risen by nearly 4- fold in that time, this has been a good bet (for some). But it won't be if prices stop rising, or start to fall.

Individuals are not, through personal or company plans, saving enough for retirement, and the gap is large, and growing wider.

Reply to
darkness39

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