Comments on: The High Cost of Low Risk Investing http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/ personal finance tips, tricks, and commentary Sat, 21 Nov 2009 22:51:28 -0500 http://wordpress.org/?v=abc hourly 1 By: Dylan http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79651 Dylan Thu, 06 Sep 2007 15:12:44 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79651 J, the standard deviation for cash is based a composite of historical periods from short-term Treasury indices. The methodology was developed by the creators of the Monte Carlo engine I used to serve as a proxy for cash and equivalents. A standard deviation as low as you’re referring to would mean that Treasuries would almost never lose value or achieve double-digit returns, neither of which is accurate. I suspect that you are thinking in terms of simply buying T-bills, holding them to maturity, and then reinvesting instead of maintaining a portfolio with a 90-day maturity, which is what was modeled. J, the standard deviation for cash is based a composite of historical periods from short-term Treasury indices. The methodology was developed by the creators of the Monte Carlo engine I used to serve as a proxy for cash and equivalents. A standard deviation as low as you’re referring to would mean that Treasuries would almost never lose value or achieve double-digit returns, neither of which is accurate. I suspect that you are thinking in terms of simply buying T-bills, holding them to maturity, and then reinvesting instead of maintaining a portfolio with a 90-day maturity, which is what was modeled.

]]> By: J at Home Finance Freedom http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79603 J at Home Finance Freedom Thu, 06 Sep 2007 09:52:57 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79603 Dylan, the T-Bill sd is greater than the mean, which indicates that T-Bills will give a negative return fairly often. I do not have a number in my pocket but my recollection is that the sd would be closer to 33% of the mean rather than over 100% of the mean so I was wondering where you obtained the data. Thank you. Dylan, the T-Bill sd is greater than the mean, which indicates that T-Bills will give a negative return fairly often. I do not have a number in my pocket but my recollection is that the sd would be closer to 33% of the mean rather than over 100% of the mean so I was wondering where you obtained the data. Thank you.

]]> By: MoneyNing http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79570 MoneyNing Thu, 06 Sep 2007 05:35:00 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79570 Dylan, Thanks for the explanation. I would hate to have a 30 year average return of 1.71%!!! I guess there is a chance that this can happen if we are extremely unlucky. Dylan,

Thanks for the explanation. I would hate to have a 30 year average return of 1.71%!!!

I guess there is a chance that this can happen if we are extremely unlucky.

]]> By: Dylan http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79442 Dylan Wed, 05 Sep 2007 12:17:19 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79442 J, the standard deviation used for cash does not imply a loss of principal. Standard deviation represents the frequency and extent to which values deviate from a statistical mean. Is there a different figure that you feel would be more appropriate? J, the standard deviation used for cash does not imply a loss of principal. Standard deviation represents the frequency and extent to which values deviate from a statistical mean. Is there a different figure that you feel would be more appropriate?

]]> By: J at Home Finance Freedom http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79408 J at Home Finance Freedom Wed, 05 Sep 2007 06:48:40 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79408 When have T-Bills lost principal (as the deviation implies they can)? When have T-Bills lost principal (as the deviation implies they can)?

]]> By: Dylan http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79374 Dylan Wed, 05 Sep 2007 00:01:57 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79374 MoneyNing, this does not assume the same return year-over-year. Yes, that would be way too optimistic using these numbers, which are just statistical averages. This was based on a simulation of the ups and downs that similar portfolios may experience over 30 years. Those average return numbers help to create the simulated returns but will not necessarily be the resulting average of the simulated returns. For example, the 60/40 portfolio that resulted in an 80% probability for success had 800 out of 1,000 separate simulations result in $1,000,000 or more, and the 30 year average returns for those 800 simulations ranged from 5.86% to 14.63%. Of the 200 that missed the target, returns ranged from 1.71% to 7.41%. MoneyNing, this does not assume the same return year-over-year. Yes, that would be way too optimistic using these numbers, which are just statistical averages. This was based on a simulation of the ups and downs that similar portfolios may experience over 30 years. Those average return numbers help to create the simulated returns but will not necessarily be the resulting average of the simulated returns.

For example, the 60/40 portfolio that resulted in an 80% probability for success had 800 out of 1,000 separate simulations result in $1,000,000 or more, and the 30 year average returns for those 800 simulations ranged from 5.86% to 14.63%. Of the 200 that missed the target, returns ranged from 1.71% to 7.41%.

]]> By: MoneyNing http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79371 MoneyNing Tue, 04 Sep 2007 22:22:04 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79371 Can we really safely assume that we can get 12% return year over year for stocks and even 10% return if we have 60% in stocks and 40% in bonds? Isn't this being too optimistic? Can we really safely assume that we can get 12% return year over year for stocks and even 10% return if we have 60% in stocks and 40% in bonds? Isn’t this being too optimistic?

]]> By: Dylan http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79367 Dylan Tue, 04 Sep 2007 20:33:53 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79367 Walt: I certainly agree that real-life would be much more complex. These numbers were used to illustrate risk and return as it relates to saving. To keep it simple, the standard deviations are based only on large cap stocks, long-term gov’t bonds, and T-Bills. This wasn’t meant to make a case for or diversification but rather to contrast a higher risk/higher return investment with a lower risk/lower return investment. You are correct in your observation that these may not represent the most efficient investment portfolios. Walt: I certainly agree that real-life would be much more complex. These numbers were used to illustrate risk and return as it relates to saving. To keep it simple, the standard deviations are based only on large cap stocks, long-term gov’t bonds, and T-Bills. This wasn’t meant to make a case for or diversification but rather to contrast a higher risk/higher return investment with a lower risk/lower return investment. You are correct in your observation that these may not represent the most efficient investment portfolios.

]]> By: Walt Padabney http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79364 Walt Padabney Tue, 04 Sep 2007 19:43:52 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79364 The problem with the deviation numbers is that there is quite a bit of other information not included... Things that an advisor or analytial service must disclose in calculating these numbers. For example, are international positions used to reduce volatility and if so how much? Is the term stock just representative of a broad index or does it more appropriatly follow the size and styles suggested by MPT (modern portfolio theory)? Were bonds just investment grade corporates or is a diversified portfolio used, including agencys, governments, corportate bank loans, munis and higher yeild debt? All this can improve up capture and reduce volatility. Things that may cost more than 20 basis points but be well worth a reasonable additional fee... The problem with the deviation numbers is that there is quite a bit of other information not included… Things that an advisor or analytial service must disclose in calculating these numbers. For example, are international positions used to reduce volatility and if so how much? Is the term stock just representative of a broad index or does it more appropriatly follow the size and styles suggested by MPT (modern portfolio theory)? Were bonds just investment grade corporates or is a diversified portfolio used, including agencys, governments, corportate bank loans, munis and higher yeild debt? All this can improve up capture and reduce volatility. Things that may cost more than 20 basis points but be well worth a reasonable additional fee…

]]> By: Aaron http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79362 Aaron Tue, 04 Sep 2007 19:23:32 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79362 This is an area that many of those who know little about the stock market understand. They think that the low risk solution is perfect and they can't afford to invest in the stock market. In reality, the numbers show you can't afford to stay out of the stock market over the long run. This is an area that many of those who know little about the stock market understand. They think that the low risk solution is perfect and they can’t afford to invest in the stock market. In reality, the numbers show you can’t afford to stay out of the stock market over the long run.

]]> By: The Dividend Guy http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79335 The Dividend Guy Tue, 04 Sep 2007 14:38:54 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79335 Interesting article. The key in my opinion is that no matter which allocation you choose, you must be willing to stick with it. The extra return potential with a higher risk allocation can be a detriment to a portfolio if you are prone to panic and would sell into a falling market. I follow a riskier allocation myself but am comfortable with the fluctuations. The Dividend Guy Interesting article. The key in my opinion is that no matter which allocation you choose, you must be willing to stick with it. The extra return potential with a higher risk allocation can be a detriment to a portfolio if you are prone to panic and would sell into a falling market.

I follow a riskier allocation myself but am comfortable with the fluctuations.

The Dividend Guy

]]> By: Dylan http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79333 Dylan Tue, 04 Sep 2007 14:26:44 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79333 J, the cash standard deviation is based on the 90 day T-Bill and the distribution is lognormal. J, the cash standard deviation is based on the 90 day T-Bill and the distribution is lognormal.

]]> By: J at Home Finance Freedom http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/comment-page-1/#comment-79331 J at Home Finance Freedom Tue, 04 Sep 2007 14:06:49 +0000 http://www.fivecentnickel.com/2007/09/04/the-high-cost-of-low-risk-investing/#comment-79331 Hello. How did you get the standard deviations so that, assuming normal distributions, cash has about a 15-20% chance of negative nominal returns but there is almost no chance of a bear market in the next 30 years? Hello. How did you get the standard deviations so that, assuming normal distributions, cash has about a 15-20% chance of negative nominal returns but there is almost no chance of a bear market in the next 30 years?

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