Enough Already

Jonathan Clements

“WHEN YOU’VE WON the game, stop playing with the money you really need.” That’s something my longtime friend and fellow author William Bernstein is fond of saying—and lately it’s been on my mind.

There’s been much handwringing over 2017’s stock market rally. Looked at objectively, it hasn’t been that startling. As of Sept. 29, the S&P 500 was up 14.2% for the year-to-date, with dividends reinvested—a good year, but nothing compared to the 25%-plus years we saw in 1991, 1995, 1997, 1998, 2003, 2009 and 2013. Moreover, this year’s gain follows two years when the market notched an average 6.5% a year, so arguably we aren’t exactly on a hot streak.

On the other hand, the S&P has soared an average 13.8% a year over the past eight years and U.S. stock market valuations are undoubtedly rich. Moreover, it appears memories of the 2007-09 market collapse have finally faded. It took many years and a huge stock market rally, but it seems not owning stocks is now the one investment strategy that’ll draw looks of pity at the neighborhood cocktail party.

In recent years, I’ve comforted myself by occasionally rebalancing back to my portfolio’s target percentages and by noting that foreign markets—which account for more than 40% of my stock exposure—are much better value. But lately, this hasn’t been all that comforting.

The reality is, if U.S. stocks dropped sharply, foreign stocks would likely also swoon and my nest egg would take a huge hit. To make matters worse, I have less time to recover from a market decline and less regular monthly savings to take advantage of lower stock prices.

Ten years ago, the world looked very different. My 44-year-old self would be rooting for a bear market, knowing that I was still saving voraciously and still had decades to retirement. But I’m not 44, but rather 54, and as I eye retirement, I think about Bill Bernstein’s comment. If I have already won the game, why would I keep playing?

Risk Unrewarded. As I see it, if you own a globally diversified portfolio of index funds, there are only four legitimate reasons to ease up on stocks. First, you might sell as part of a regular rebalancing program. Second, you might unload stocks as you approach retirement—and continue to do so once retired—as you look to draw income from your portfolio. Third, you might sell if you no longer need to take so much risk, because you’re financially well ahead of where you need to be. Fourth, you should probably lighten up on stocks if you can’t afford to take so much risk, because the consequences of a big market decline would be so devastating.

In a 2015 article for The Wall Street Journal, Bill offered a series of benchmarks: You should aim to have at least 25 years of required portfolio withdrawals socked away if you retire at age 60, 20 years if you retire at 65 and 17 years if you retire at 70. Need $40,000 from your portfolio and plan to call it quits at 60? Bill’s rule suggests you need a $1 million portfolio.

“The fear, of course, is that we arrive at modest long-run stock returns by having atrocious short-run results.”

What if your nest egg is smaller than Bill’s benchmarks? He argues you should favor a more conservative portfolio, perhaps with 60% in bonds. That way, you run less risk that your need for income—coupled with a vicious stock market decline—will eviscerate your portfolio and leave you eating cat food.

Those who are at, or comfortably above, Bill’s benchmarks have more of a financial cushion—and can afford to keep more in stocks. But should you? You’ve won the game. Should you continue to play aggressively, with a view to enriching your heirs or your favorite charities, or dial down the risk, so you can live out your days knowing that only financial Armageddon could derail your comfortable retirement? Bill’s article is available online, but you may need to subscribe.

Calling It Quits. I think Bill’s benchmarks are a great guide. But I’d throw in an additional caveat: It strikes me that the range of possible U.S. stock returns is especially large right now. As I discussed in a relatively recent blog, we have unusually high valuations, historically fat profit margins and an economy destined to grow slowly because the labor force is growing slowly.

This is a recipe for modest long-run stock returns. Those returns should be better than bonds, which will likely fare even worse, given today’s low bond yields. And if that’s what we get every year—modest stock returns that are somewhat better than bonds—we should consider ourselves lucky.

The fear, of course, is that we arrive at those modest long-run stock returns by having atrocious short-run results. That’s not a problem for younger workers, who will be able to buy shares at bargain prices. But it’s a grave danger for those near or in retirement: Selling stocks at fire-sale prices, either out of panic or because you need income, can cause massive financial damage.

What are the portfolio implications? My assumption is that a global stock portfolio will return 5% to 6% a year over the long haul and a mix of high-quality corporate and government bonds might return 2.5% to 3%, while inflation runs at 2%. Let’s assume results come in at the lower end of the range, with stocks at 5% and bonds at 2.5%.

Let’s also assume we’re aiming to fund a 30-year retirement. We want a portfolio that permits us to withdraw 4% in the first year, equal to $4,000 for every $100,000 saved, and thereafter allows us to step up our annual withdrawals with inflation. To make it through 30 years without running out of money, our investments need to earn an average 3.4% a year if inflation is 2%. Based on my assumed returns, investors could hit that 3.4% with a mix of 36% stocks and 64% bonds.

This calculation is, I admit, a tad unrealistic, because it assumes we earn the same return year after year. Depending on whether we get good or bad results early in retirement, we might need a lower or higher average return. Still, it gives a sense of how conservative investors could potentially be.

And yet I’m not about to cut my stock holdings to 36%. Not even close. Partly, it’s because I would like to earn more than 3.4%, so there’s more money left over for my children. Partly, it’s because my retirement might last longer than 30 years—and taking a little additional risk should deliver a higher portfolio return and give me a financial cushion.

But truth be told, I’m also not yet ready to quit the game—which suggests that perhaps I’m not being entirely rational.

Getting Exercised

MY GOAL IS TO WORK OUT for at least 40 minutes every day, pretty much no matter what’s happening in my life. I figure that, if I’m saving for a 30-year retirement, I should make sure my body lasts almost as long as my money. During my daily 40 minutes, I get to see my fellow humans at play. This can be a source of some consternation. A few examples:

  • Those who hold phone conversations while running. Are the folks on the other end of the line at all bothered? Or did they dial a 900 number and are happily paying to be recipients of heavy breathing?
  • Those who slump, unmoving, on the exercise equipment for minutes at a time. Surely the couch would be a better place to take a nap?
  • Those who eat while exercising. I remember a gentleman on the neighboring exercise bike at a Beverly Hills hotel, who talked to a friend and ate a muffin while slowly pedaling. All I could think was, “speed up, my good man, or you’ll take on more calories than you’re shedding.”

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