Retirement Income and the Myth of Equity Risk

Many baby boomers have been thoroughly indoctrinated in two concepts that have been widely promoted by the investment industry.

First, we have been told that equities, i.e., stocks and equity mutual funds, are the best investments for long term growth in excess of inflation. Second, we have been advised that “buy and hold” is the smart retirement investing strategy. Now I am not so sure either of these is correct.

Recently, I finished reading the book Worry Free Investing by Zvi Bodie. Bodie is a Professor of Finance at Boston University. The book tends to be simplistic in approach but the message from Prof. Bodie is clear: for many – if not most of us- stocks are too risky to rely on for retirement income. Bodie suggests a retirement income investing strategy based on government inflation protected securities.  (These are sometimes referred to as “real return bonds.”) Obviously, this kind of talk is heresy in the investment community.

Here is what Bodie himself said in an interview about his book:

The big lie the investment industry is propagating. There are several, but one is that there is no such thing as safe investing. You’ll read it at every so called investor information web site. They’ll say if you want safe assets, they are safe only for the short term. For the long run, they say, there is no such thing as a safe investment. The reason I wrote Worry Free Investing was I wanted to tell investors that’s not true. There IS a safe long run investment. There didn’t use to be but now every major government with no default risk is issuing long term bonds that are indexed for inflation. So how can the industry keep saying there’s no such thing as a safe investment?

Coincidentally, shortly after I finished Bodie’s book, I discovered this Retirement Portfolio Showdown. This article compares Bodie’s approach to retirement investing with that of famous buy and hold equity proponent, Jeremy Siegel. The author’s analysis through simulations and showdown conclusions are quite interesting:

The simulations described above show that the risk in equities is high enough that any investor has some probability of needing his or her money on a time horizon such that he or she may end up having been better off in bonds over even very long time horizons.  This is related to the outcome in game theory known as ‘gambler’s ruin.’  Even when the odds may be on your side, you can still end up having to leave the game before you get ahead.  After the bruising markets of 2008-2009, this is painfully obvious, and my analysis demonstrates this point before the actual market declined.

And regarding recent events as being a “blip” that will not be repeated:

There is a tendency to look at the downturn in 2008-2009 as a ‘black swan’ – an event beyond our capacity to anticipate – but the chart above suggests that, as we look at ten-year periods, such an event was not outside of the realm of possibility using straightforward statistical models.

I believe that any baby boomer (or younger) investor should take a very close look at Bodie’s arguments about the myth of equities as a long term inflation hedge.

Photo credit: phxpma

FREE UPDATES: If you enjoy what you read here, please consider subscribing to receive free updates automatically by RSS feed or by email. (I promise that your email address will not be shared or used for any other purpose.)

My Related Posts:

1. Should Stocks Be in Your Retirement Plan?
2. Risk Free Yield with I-Bonds and Other Boomer and Retirement Readings
3. Online Investing and Money Advice
4. Dollar Cost Averaging for Retirement Investing