Personally, I drop the financial sector entirely (Thomistic prohibitions on usury) which leaves an even 10 funds which is easy to allocate mentally and in practice. For example, assuming a 60/40 allocation where one is holding the lion’s share in equities and the remainder in bonds (I substitute with a combination of gold, crypto, cash, and Swiss Franc here), one would allocate as follows:
XLC 6% XLY 6% XLP 6% XLE 6% XLV 6% XLI 6% XLB 6% XLK 6% XLU 6% XLRE 6%
(Note that XLF is consciously not taken as a position here, decide if it’s right for you. The Mortgate REITs which would make XLRE problematic are in XLF per the sector selection rules)
The remaining 40% is bonded debt if you are fine with usury, or some sort of asset negatively or neutrally correlated to equities.
I suppose it’s worse if your calculation is, “I’ll retire when my 401k hits $X absolute value,” but I think most people just retire at a certain age instead with risk spread across decades.
Presumably this is their total net worth. I think this is way more common than people on this type of forum realize. Most will work until they literally can't anymore, then scrape by on social security until they die. I think it's important to keep that perspective.
401k reduces your taxable income when depositing money.
The downsides are a 10% penalty for early withdrawal which makes them surprisingly bad for young people. They tend to start in lower tax brackets, have fewer reserves when unemployed, and face fewer risks from an unbalanced portfolio.
Pay down debt then Roth IRA when young 401k after 40 is often better than defaulting to a 401k, but saving anything tends to be more important than such optimizations.
Surely you need about 20 years?
It created an actual recession albeit thankfully short one for the case of dotcom (sadly not for 2007) and a really recessionary environment which causes unemployment and just straight up fear and panic.
I do understand what you are talking about and overall in long term, perhaps things flatten out but atleast speaking financially so, its better to be on a smooth sailing road rather than insane ups and downs with retirement money if preferable.
> I think most people just retire at a certain age instead with risk spread across decades.
The issue in my opinion is with people near that certain age you mention and who retire in the time during boom just before bust. They would then get the 50% hit on their savings instantly with an recession/inflation/unemployment environment which in my opinion might be genuinely devastating.
(supposing that they had their investments in stocks, I wouldn't consider that any retiree would have all their money in stocks but there have been some other comments which show a sizable amount, @kipchak's comment shows 50% stock for retirement. so a 50% shock on top of that could lead to a wipe out of 25% of your retirement fund which is honestly still pretty crazy.)
No person puts all of their retirement savings into QQQ or SPY at the peak and sell it off at the trough. Instead folks drip their savings into their weighted portfolio and withdraw money from their weighted portfolio as expenses accrue. Now obviously the GFC was a huge deal, but this sort of facile understanding of stock markets always leads to big misunderstandings. There's a reason Monte Carlo analyses of these events are used to model these scenarios.
(Though I imagine there were many people who tried to re-balance their portfolio into a less equity-heavy model abruptly during the GFC and based on equities performance at the time, it was probably the right move as long as taxes were taken into account.)
What do you think the cost would be for protective puts per $1M of equity exposure of a portfolio on a monthly basis? "Bubble Insurance" if you will. Going 100% bonds is simply intolerable for the time window for most retirees, but an equity wipeout of this magnitude is equally intolerable.
For example, you could have an S&P 500 fund that, over the next year, will have a maximum of 0% capital losses (it can't go down), you will only get the first, say, 5% of gains that the equity index makes. So if stocks go up 20% the next year, your return is capped at 5%, but if they crash 50%, you don't absorb any capital losses. In practice, the return cap is going to be just a bit above the corresponding Treasury bill for the same duration.
These can be constructed in various different ways and institutionally I'm sure there are more bespoke ways that are more efficient from a fees/returns and tax perspective, but one way to do this on your own without going the ETF route is:
- Pick an amount you'd like to invest. - Buy a Treasury bill for some duration. Treasury bills are discounted at the time of purchase and return the target amount when the bill matures. For instance, if you buy a $100k 1-year Treasury bill, it might cost $96.5k today. - Now you have $3.5k in your pocket and a guarantee that you'll get $100k in a year when the bill matures. Use that $3.5k now to purchase call options or vertical spreads on the S&P 500 index to capture the upside that you can. Your return is limited by the structure of that options trade and what its maximum payoff is.
If you're willing to accept more than 0% downside, then you can achieve a higher potential upside cap as well.
You can use a collar for this at somewhat reasonable cost. Not sure how rolling that would compare to just using it to defer until you can cheaply sell and buy some fixed income ladder. Probably badly.
Also, there’s no capital gains to defer if you use a retirement account, which will be a better place for fixed income anyway.
I expect that would not be a cost-effective way of attaining the risk profile you'd be looking for.
I expect there won't be a more cost-effective way of managing your portfolio risk than by simply adjusting your split of broadly-diversified equities vs bonds.
That was the message that I got from a financial podcast I listened to a couple weeks ago anyway.
I'm saying that for the cost of buying puts to hedge against equity downside in a retirement portfolio, for any given level of risk, you'd probably be better off just selling some of the equities and buying bonds instead.
e.g. try and find any equity-focused ETF with downside protection that generally outperforms a bog-standard stock/bond split total-market ETF for whatever measure of volatility/downside protection that you want.
And more specifically, it's not low growth/high inflation that kills bond portfolio returns, it's interest rates increasing that devalue bonds, i.e. the transition from low inflation to high inflation. So yeah, you can construct a portfolio that hedges against that... but I'd be surprised if you can do it without decreasing your risk-adjusted expected returns below a plain stock/bond index fund - whatever hedging method you use is either going to increase your interest-rate risk (bonds), or your inflation-rate risk (cash), or is going to limit your upside (buffer etfs), or is just going sap your upfront returns (protective puts).
Investment companies have to remain profitable or at-worst neutral as such they would generally charge a decent bit of money for this type of setup. (If they end up having too big of losses then perhaps it could be similar to the the 2007 Banking/Investment companies crisis.)
Generally speaking I am not a financial advisor but you can take a look at international index funds/ETF's in general which have less exposure to AI in general.
and you can follow the age rule created by Mr Bogle where you have (age)% in bonds and (100-age)% in stocks, so at 70 you have 70% bonds, 30% stocks.
So again taking the example of dot com bubble, International Index funds fell from my understanding 30-40% and suppose that you had 30% stocks and 70% bonds.
So that would only have a 30% times 30 % which is 9% which perhaps might be more managable as compared to the previous 25%. There might be some other strategies as well which can help in diversification
Hope this helps!
SPY260821P00738000 (OCC symbol: PUT on SPY expiring the 21th of August 2026 at a strike of $738) is $12.20 as I type this, so $1220 per lot. So $16 800 to protect for a month. So $200 K per year.
A solid 20% yearly, unless my math is way off.
Now of course you can buy, instead of a PUT, a PUT debit spread, or you can buy further from the strike, or you can finance or partially finance your PUT or PUT debit spread with a CALL you'd sell (turning it into a covered strangle) etc. That's not the point of this exercise though. And anyway I doubt many retirees have the know-how to do that.
In any case it's well known that the costs to hedge are extremely high.
In 1929 those who had 10% gold for example "only" lost 25% overall: gold has value since thousands of years. My dumb thinking is that if gold has value since thousands of years, there's an extremely high probability that it'll keep value for the few decades I've got left at most.
ATM options cost approximately 0.4 S sigma T^0.5 (do a Taylor expansion of the "N"s in the Black Scholes formula), so indeed, for current index vols of about 16% we are talking 0.4 * 16% * (1/12)^0.5 = 1.85% for a 1 month option, and 12 of them indeed cost 22% of your portfolio. Not a good idea.
However, if you hold the options only half the way to expiry, you lose only 1/4 of the time value. And if you buy OTM, you have convexity coming your way on the way down.
Lastly, index vols were very low (until yesterday, ha), as so many firms entered the dispersion trade: they wanted to go long dispersion (some firms do well with AI, some lose out), so short correlation, therefore long single stock vol and short index vol. Which means you could buy index vol (ie protection) quite cheap.
As the boomers die off - if they have these accounts - their kids are quickly going to be forced to liquidate them over the course of 10 years. With some of them having to sell a chunk annually.
Still, if NVidia lost 50% of their market share, we would probably see a big collapse of the stock market.
EDIT: to note, the top ten companies in SP500 make up an unprecedented concentration but they're not "mostly AI".
This is what caused the 08' crash. Everything was all tied together so as one massive bank failed it sent a cascading ripple effect through the entire industry which became a sort of black hole that took down many seemingly stable, profitable banks with it.
I can easily see the same happening with AI.
They're mostly either AI proper, or hardware manufacturers benefitting from AI boom, or provide cloud services to AI companies...
It wasn't like, "Nvidia took a hit and everyone else was fine". It was more like, "One or two companies were fine, and ALL others took a hit"
For the people who are close/early to retirement and can't do that, well, they need to manage sequence of returns risk.
Edit: I think some ppl might interpret this as me being bullish on the SP500. I'm not, I'm bullish on everything evens out and returns to the mean.
https://investor.vanguard.com/investment-products/etfs/profi...
No correlation with future returns.
On the other hand the world is leveraged to insane levels not seen since world wars or global recessions.
At the same time yields are low while inflation is high.
There is definitely a high level of risk in the financial markets.
A risk nobody, especially politicians, want to look at, because it would unavoidably lead to some major pains, so procrastinating until it's unavoidable seems the way to go.
If one is over concentrated its easily avoided.
The sound advice for the past decades has been, just invest in a low-cost ETF tracking the S&P instead of picking stocks to minimize risk and invest in the market broadly.
So a huge number of people have done that, believing they're diversified, while tech makes up 40% of the index.
Yes you could sell your S&P and find things to invest in least likely to be impacted by a potential bubble, but your average 9-5'er with automated contributions to their 401k is probably not sophisticated enough to do that.
And that's assuming only these companies would be affected if there was a massive draw-down in tech/AI related stocks. We haven't really seen a situation like this before, so it's not easy to predict what effects there might be in the broader economy.
Most people in actual retirement I know do something like keep ~2 years of cash in short-term treasuries and everything else in equities. That gives you a lot of buffer to time-shift equity drawdown, which is the main risk with equities, while retaining almost all of the benefit of equities. Simple and relatively robust.
What you propose takes on a huge amount of inflation risk. How are you hedging that risk? A guaranteed yield doesn't mean you aren't getting poorer. Obsessing over one type of risk and ignoring another isn't rational.
Reducing variance of net worth has a very high cost. Over-indexing on that singular property, particularly when most people can afford some variability, is a recipe for relative impoverishment.
not if you're 80 dude...
Right now it's not clear that is true.
Usually the financial services company will offer several options: more aggressive/high risk, or less aggressive/lower risk. Most people will just go with whatever is the default option.
So much of the American S&P 500 is dominated by handful of companies that the risk is not that easy to avoid. If or when the AI bubble pops, it's going to take down a lot of the economy with it. You can direct your retirement savings into the lowest yield/lowest risk assets offered by the firm, but you'll forego whatever growth happens in the mean time.
Will the bubble pop next week? Next month? Next year? Who knows. Timing the market is incredibly difficult.
There's a famous quote, attributed (perhaps apocryphally) to John Maynard Keynes: "The market can remain irrational longer than you can remain solvent."
Like my country pension scheme. It went through ups and downs for a hundred years but has always come on top. All you need is a long horizon and a trillion dollars and you basically can't lose.
https://workplace.vanguard.com/content/dam/inst/iig-transfor... (page 78)