It’s an age old question: “How much should I have in stocks?”
An equally old trick to answer it was to reply with the following:
“100 minus your age is how much you should have in stocks.”
So if you were 60 years old, you should have 40% in stocks.
It’s a pretty simple quick-fix to address a rather complex portfolio optimization problem. It is also actually quite accurate.
The PhDs reading this post this might be frustrated, but this quick fix (100 minus your age) will be more than mathematically sufficient.
Why? Because there is a larger inherent mathematical irony that no one wants to talk about: 8% returns may be gone forever. Warren Buffett has said this at many Berkshire Hathaway annual meetings, and McKinsey just highlighted this in their latest paper (Click here to read it).
What McKinsey has said is that decades of actuarial tables used in calculating what a fiduciary/prudent man would do when investing are now no longer viable. Previously used 8% US stock returns may now be between 4.00%-6.50%. US bond yields, previously assumed at 5.00%, may now be between 0.00% to 2.00%.
That’s a significant change of expectations. Let me give you an example from another perspective.
Several years ago, I did a segment on CNBC (click here to see it) wherein I showed that the Dow Jones Industrial Average would need to be over 23,000 for pensioners to break even. That was several years ago…look at the DJIA now. Are we even close?
How did I arrive at this? I took the market levels (high and low) from 2007 and extrapolated them out using an 8% equity return.
That is what everyone did with their financial planner/broker/wealth advisor then in 2007. Obviously the math did not work, nor did the markets cooperate.
And what have we done today?
We have programmed the robo-advisors to do the same calculation. The robos are using the exact same actuarial tables with the same expected market returns.
What does that mean for pensioners? By default, they will allocate a large portion of their portfolio (remember, it is 100 minus your age) to very low yielding bonds. The remainder will be in low return equities.
These are the same low yielding bonds that almost guarantee they cannot live on their pension distributions. Simply put, the interest rates are too low and they will spend their retirement faster than they expected.
Yet the robo-advisor will calmly and accurately drive them to that outcome. And, they will do it for very low fees.
So the pensioner, will slowly and methodically be driven to insolvency.
The young millennials get hit twice. One, by the actual lower market returns achieved, and two as society taxes them more, and saddles them with more debt, to make up for the pension shortfalls.
What should the robo-advisor do, or have done? It should tell its users to save more, work longer, and cut costs.
One last question for you to solve as you consider the above: What do you think the quick answer should be now? Is it “100 minus your age?” or is it something lower? Maybe 70? Let me know what you calculate.
In the interim, we can watch the robo-advisors economically and efficiently drive the pensioners in our global society to almost certain insolvency.