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Welcome to Ben with Benefits. Here at Talking Wealth, we're talking all things retirement. Our guest today is Bob Posen. Bob is currently a senior lecturer at the MIT School of Management. Bob has helped oversee billions of dollars in assets at both MFS Investment Management and Fidelity Investments. He's a bestselling author of Extreme Productivity. Today we're talking about his 90/10 framework, what it means for investors trying to figure out the right asset allocation in retirement. Bob, you wrote a piece for the Wall Street Journal recently, and our inbox was full of questions from financial advisers and investors. And you said you're probably overinvested in bonds. I'm going to quote you from the article for those who haven't read it yet, or maybe those who don't have a subscription. You say most financial advisers tell their clients to hold a 60/40 portfolio—60% in stocks and 40% in bonds. Stocks are volatile, and bonds can provide a counterweight when share prices fall. But after more than 20 years in the money management business, I've concluded that many investors hold too much in bonds and not enough in equities. All right. Where did this conclusion come from?
Well, I spent a lot of time going through the data over the last 60 years, and we can see that stocks outperform bonds over any long period. So there is a much greater return for stocks than bonds. So the question is, why do people hold bonds? Now, there are people who need to live off their investment income, and I'm not talking to those people. If they need to live off their investment income, then they probably need a lot of bonds. But there are 6 to 7 million Americans who have over 1 million in investable assets. So that means that they usually are not dependent on their investment income to live on, to meet their living expenses. So why are these people giving up the big extra returns in stocks for bonds? So I go through the various arguments in the article and I rebut them, and I think it's persuasive. If we look, for instance, at if you invested $100,000 in a 90/10 portfolio, after 40 years you would have 5.8 million. In a 60/40 portfolio with the bonds represented by 10-year treasuries, you'd have 2.5 million. So that's a difference of 3.2 million. Or take 30 years—you'd have in a 90/10 portfolio, you'd have 1.569 million. In a 60/40 portfolio, you'd have 868,000. So that's a difference of 700,000. So the question is, if you're not living off your investment portfolio, you're not using that income to meet your monthly living expenses, why not get the greater returns from stocks? Why are you holding so many bonds? And that's my argument, and I'm sticking to it.
All right. So it's the people you're talking about. You said these six to seven million people, they have a million dollars in investable assets. That's people who generally work with financial advisers, right? And that's kind of the group we're talking to today. Listen, I'm in full agreement with you that you still need to take more risk in retirement than I think most people would assume, because people are living longer, right? So you could have 20, 30, 40 years in retirement. It's not like of the past where people didn't have as much time. So you obviously need to take some sort of equity risk, right, to grow your standard of living. I want to—but I still want to play a little bit of devil's advocate for you here before we get into my devil's advocate stuff, though. So if you take the data from the Federal Reserve that they take all of household wealth, right? It's like 47% in equities and 20% in fixed income as of the latest readings. So that's like a 70/30 portfolio in aggregate. But if you add cash in there, which you are too, you're saying, 'Hey, money markets is the fixed income component.' It's actually more like 50/50 in terms of overall household allocation to liquid assets. I guess my point is that on average, in aggregate, most Americans are fairly averse in their holdings. Why do you think there is this aversion to risk?
Well, I think there are at least three reasons, all of which aren't very good. The first is, as you suggest, a lot of people say when you get close to retirement or you're at retirement, you're at 60 years old or 65 years old, you're not going to have much of an investment horizon. It's going to be very short, and so it may be five or 10 years. But as you say, a lot of people at 60 or 65 are going to live another 20 years. So that's a pretty long horizon. Moreover, the people we're talking about who have over a million in investable assets—which, by the way, does not include your house—so those people, most of them are going to bequeath those stocks to their children. So if we think of their real investing horizon, it should include not only the rest of their lifetime but also the rest of the lifetime of their children. So somebody—
But you're investing for their time horizon, right? Or the grandkids or something.
And in fact, having stocks that have appreciated has a great tax benefit because we have a step-up in basis at death. So if you have an S&P 500 index fund which at the end of 30 years has—you've invested 100,000 but it's now at 1.57 million—that appreciation immediately steps up at your death, and so your children don't pay any capital gains on it. So it's a great advantage. So I think the first mistake is what is your actual investment horizon, and the answer is: a) you're going to live longer than you think, and b) you're going to bequeath a lot of assets to your children. These equity assets, those are the best assets to bequeath, and therefore you're going to have a much longer time horizon. The second argument has to do with whether bond prices offset down years in stocks. And so the argument is that bonds will go up in years when stocks go down—
Right, they're the balance of the portfolio. That's the idea. Like you have some sort of dry powder to rebalance into the pain when stocks fall.
Yeah. But if you look at the history of the last 60 years, there have been only about 13 years where bonds' positive returns offset stocks' negative returns. So it's actually been a very small minority of the cases, and there have been a number of years, most notably 2022, when both stocks and bonds were down about 18%. So the idea that bonds are systematically going to offset negative returns in stocks is just not true. It's a very small percentage of the time. Then the third and probably the most important argument is that stocks go down. When they go down, they go down further than bonds. So these are the very negative years, and that's true. When stocks go down, they go down much more than bonds. But there is this phenomenon called reversion to the mean, and that is after we have these big negative years in stocks, they bounce back. Now, if we look at what are the three worst years in stocks over the last 60 years: one is 2008, where stocks were down negative 36%. What happened in the next two years? Well, they were up 44%. What happened in the next five years? They're up 126%. And it's the same thing for 2002 and 1974. 2002, the second most negative year, almost 22%. Stocks were up in the next two years 42%, and the next five years, 81%. And just to close it out, in 1974 stocks were down 26%. They rose over the next two years almost 70%, and over the next five years they were up 100%. So we have this repeated pattern, reversion to the mean. So that's the key. If you can sit still during those down years in stocks, then you could reap the benefits of the reversion to the mean, and over the long run you'll do much better. So those are the three main arguments for bonds, and I think they're all quite weak. We could also discuss why now is particularly a bad time to buy bonds, but we could go into that if you want to.
Okay. No, I'll get to that. I'm glad that you brought some market history here. I'm a big market history guy. So I guess a lot of people—the big worry for most retirees—and it's funny because a lot of retirees that I talk to are scared to spend any money because they're just worried they're going to run out, right? Even people who have a—like you said, this six to seven million households who have a million dollars. I'm curious what you think about the lost decades. So in the long bear market—so these are obviously few and far between. We had a lost decade in the 2000s, right? The dot-com bear market lasted almost three years. It took seven years for stocks to reach all-time highs from 2000. Then we hit like 13 new all-time highs and we crashed again. You didn't hit all-time highs again till 2013. So do you think that more diversification is necessary for these types of markets to account for sequence of return risk, or do you say no, it's just—it's more about sitting on your hands and kind of waiting for that mean reversion to kick in? Because obviously that—I think for most people, that first decade of this century, that's the big worry is, oh my gosh, we had a lost decade. The S&P 500 lost 1% per year for the entirety of that first 10 years in the stock market. It seems like a distant memory now, but I think a lot of people, that's the biggest concern: what happens if this hits right when I retire?
Yeah. So there, in the last 60 years, there's been only one instance of three down years in a row for the S&P 500.
Yeah, it was the dot-com bubble, right? 2000, 2002.
Correct. And if we look at that, the S&P was down a total of 37% during those three years, but these losses were more than recouped by the end of 1976. So that's the worst possible time in the last 60 years. And you had three down years—2000, 2001, 2002—and then—excuse me, I said 1976, I was wrong—and then they were more than recouped by the end of 2006. So you had three down years, 2000, 2001, and 2002, and then those losses were more than recouped by the end of 2006. Second of all, we have one instance in which we have two consecutive down years, 1973 and '74, due to the oil embargo, and those losses were more than recouped by the end of 1976. So it depends on two things. What's the time horizon you have? I think you shouldn't be heavily in stock unless you have a time horizon of at least 10 years. And as I said—
That's a great qualifier. I'm glad you said that.
Yeah. So if you need the money now, or you're really in a situation where if you had a medical emergency now, you'd have to sell your whole portfolio, then you shouldn't be that heavily in stock. So you got to have a bigger time horizon. And second of all, that cash is there to both give you a sort of insurance policy if there's an unexpected expense, and also to help you keep psychologically calm. We know that most investors, when the market goes down, sell, and that's why their returns are much lower than the S&P 500. Dalbar has proved that, and the loss of returns versus the S&P 500 by people who are stock investors is two or 3% per year. So we need something to help people stay calm during those down years.
Right. And you're saying like that's a money market fund, 10%. So let's say you dutifully follow the 4% rule. So I've had William Bengen on this show before to talk about his 4% rule. So if you do the 4% rule, back-of-the-envelope math here, so you have two, two and a half years' worth of cash in that money market. So you're saying, listen, if you do go through one of these down— you go through a '73-'74, you go through a 2000-2002—then if you have to spend on the portfolio for some reason, that's when you pull the money market, right? And you're not selling that 90% stocks, you're selling the 10%. And the hope is that can see you through. Now, I know you said that you're sticking with this 90/10. What if we split the difference, Bob, between a 60/40 and 90/10? There's a big gap there. What if we said 80/20, 75/25? Are you okay with that?
Well, I think 80/20 is a lot better than 60/40. And I would say this, Ben: it depends on people's risk appetite and their risk aversion. If they really have great anxiety as soon as we have a down year in the market, even if they have a 20-year portfolio horizon, well, that shows that they need something, they need a cushion, and that's what the cash is there for. So if 20% in cash makes you feel psychologically safe, then that's better than 40% in fixed income.
So let's talk about the fixed income component because you mentioned it. So when the Fed held rates at or near zero for basically a decade coming out of the Great Financial Crisis, like it made no sense to me that investors were—it made more sense to me that investors were taking more risk. Like we had a lot of clients who said, 'Listen, I would have been a 60/40, but now I'm an 80/20 because I need my expected return to go up because bonds aren't providing anything.' So now today, you're looking at bond yields in the four to 5% range for high-quality bonds, right? Does that change the calculus for you at all in terms of like bonds being a decent investment? And I guess the follow-up question there would be, what if we get another world of very low cash yields, right? Where your T-bills or your money markets are yielding 1%, 1.5%, 2% again? Are you more concerned with the liquidity component and the interest rate risk component of that cash piece than the actual yield? Like I'm curious how you think of that because to me it seems like bond yields are much better today, even though on a real basis maybe they're not as good as some people would think because inflation's higher. Like what do you think about the fixed component today?
Well, I think we have to look in the future, not in the past, not in the present. And the question is, what are interest rates today relative to what they're going to be in 5 years or 10 years? And in my view, given the fact that both Republicans and Democrats have become fiscally very undisciplined, and so we're running federal deficits of 5 or 6% every year, fiscal deficit. Second of all, what are called the price-insensitive investors of treasuries, buyers of treasuries, they've fallen roughly in half. So it used to be that we had lots of central banks, lots of sovereign funds that just automatically bought treasuries. That's not true anymore. And the third thing is, what's the prospect for inflation? And I think the prospect for inflation is not good. It's not just the Iran crisis and oil prices. We have a different built-in expectation about inflation, and the Fed's going to have a real hard time getting those expectations back to 2%.
So you think we're going to be in an environment of rising yields then, essentially?
That's correct. Well, I think if we look at this over 10 or 20 years, the combination of chronic large fiscal deficits. Second of all, remember Social Security and Medicare are going to crater in the next decade, and I don't believe Congress has the will to reform them, and instead they're just going to appropriate more money. So that means you're going to have to issue even more treasuries. And third of all, the stable buyers of US treasuries, the stable buyers are declining, and they are diversifying away from treasuries.
So we've talked about Social Security on this show before. It's funny. I totally agree with you on that. I think people worry about, oh, in 2034 the trust fund is going to run out. They're just going to borrow more money to fill the gap, right?
Absolutely. In 2005 and 2006, I went public with a three-part solution to Social Security: change the schedule for high earners to make it grow less quickly—not to cut it, but to grow less quickly. Second of all, to index normal retirement age to the longer life expectancy. And third of all, I proposed a surcharge of 2% above the wage cap that would go all the way up. And if you had done those three things in 2006, we'd have a solvent system by now. So what's happened since then? Congress has acted twice to increase the benefit of Social Security. No one has the political will to cut even one dollar from Social Security benefits. And it's not really cutting, it's just changing the benefit schedule so they grow less quickly. But that subtle distinction is lost. So I agree totally. What's going to happen when we get to 2032 or '33? Social Security won't stop flowing—right—in theory there could be a 23% cut. In practice, what's going to happen is Congress will just appropriate that money, and that means a big increase in the federal deficit and the amount of debt that has to be sold and bought by investors. That's why I'm bearish on interest rates.
Yeah, it's interesting because yeah, Social Security seems like the easiest one to fix. It's not like it's that—other things are complicated. I'm curious, do you think it's—I find it interesting, like 4.6%. Are you surprised that rates aren't higher now given the state of, you know, whatever 6% fiscal deficits and debt to GDP as high as it's been since World War II and stickier inflation than anyone could have foreseen versus the 2010s? Are you surprised that rates aren't already higher than they are?
No, I'm not, because I think it takes a while for people to get realistic about what's going to happen. And some people believe that Congress will start to rein in the deficit. Some people believe that the Fed will get very aggressive on rates. I don't believe either of those things are true. And there are even people who believe that we're going to, when push comes to shove in 2033, that they're going to reform Social Security at the last moment. But I don't think that's true either. I don't think any of these things are true. So the reason why rates aren't higher is people haven't gotten realistic about any of those three factors.
All right. If I'm an optimistic person, my optimism would be if rates do keep going higher, that's higher future returns, right? Bad present returns, higher. That's me trying to look at the spin as well.
