Question: I’m curious how you might evaluate the thinking of Zvi Bodie, who notes, in this link, that 100% of the money he is setting aside for retirement is held in treasury-inflation-protected securities, and that all of one’s income needs for retirement be comprised essentially of social security plus TIPS in an IRA account. The reasoning being you will protect your nest egg plus 2% or so. Does this hold water, in your view, to some degree? (I’m guessing no, but would be interested in your evaluation of the content in the link.)
Answer: Actually, Bodie’s argument does hold water. Virtually any investment strategy will work if you save 20% of an uninterrupted income stream throughout your working life, don’t retire before the age of 75, and have no goals other than dying before you run out of money. This is the context in which Bodie is describing his own retirement strategy, and he should be able to achieve his goal without a hassle. A half-century of massive savings to fund a mere decade of retirement (Bodie’s life expectancy at 75 will be just over 10 years) works fine without growth.
But are these reasonable assumptions? Most people save far less than 20% of their lifetime earnings and, in any event, few have the uninterrupted high income stream of a tenured professor, as Bodie himself notes. Seventy-five is not the target retirement age of most people. And quite a few retirees actually have important legacy goals to help their offspring or favorite charities. (I should also mention that 2% is no longer available in TIPS, although it was at the time of that article.)
Bodie offers no reason to believe a diversified stock portfolio won’t offer a positive real return over long periods of time other than the fact that nobody is willing to guarantee it. Ironically, he fails to note that the first tier of his retirement plan, Social Security, isn’t guaranteed either and can be changed at any time by legislative fiat. Nor are TIPS guaranteed a positive real return once the IRS has entered the picture. People who live in glass houses shouldn’t throw stones.
So instead of platitudes about who is offering a guarantee and who isn’t, let’s acknowledge that nobody is guaranteeing anything. What a globally diversified equity portfolio offers is an ownership interest in a wide variety of the businesses that are providing the world’s goods and services. What Social Security and TIPS offer are the promises of politicians who bear no personal financial accountability for their promises and are dependent on the future tax base provided by those same businesses. So if businesses fail over the long term to generate a healthy profit, we’re all going down, not just the stockholders.
I did find one 25-year period in American history when equities gained less than 2% per year after inflation: during 1907-1931 the total real return of U.S. stocks was only 59%, or 1.87% per year. That still beats what TIPS offer today. In an average 25 years, stocks rose 478%. Over the average investing lifetime, the conservative TIPSter would have given up around 80% of his retirement income in comparison to the wild-eyed gambler who chose to own a diversified portfolio of the businesses providing the world’s goods and services. Think about supplementing your Social Security with only $20,000 a year from savings instead of $100,000 a year, and you have an idea of what you are being asked to sacrifice for your guarantee.
Sure, Bodie is right: there is no GUARANTEE stocks will beat TIPS over any particular time period. But here on Planet Earth, where we deal with probabilities and not certainties, betting my life on an unlikely failure of equities that somehow leaves government promises untouched is an idea only a tenured professor who doesn’t really plan to ever retire can adopt.
One minor point: the reporter in that interview asked: “Is it true that you didn’t lose a penny in the market downturn?” Bodie never actually answered that question directly, referencing some other investments he held but failing to point out that TIPS themselves dropped during the bear market, at one point falling 15% from their peak because of an increase in the real returns people were demanding in that panic-stricken period. Oh, and those Target Retirement 2010 funds that lost 30% in the bear market which Bodie mentioned were unlikely to recover those losses? They recovered the losses in full and went onto new all-time highs less than 15 months after the date of the article.