The Ages of the Investor: A Critical Look at Life-Cycle Investing

This is a not so brief summary that I wrote for this book. It was basically a work assignment and I believed that writing a "book report" would be the best way for me to read it actively. So here it is:

The book basically talks about what Bernstein thinks people should do with their money when they are young, old, and during the middle he years. He begins by touching on a few investment strategies that people follow such as the rule of 110 and the age equals bonds rule. He then dispels them and why they are not the most effective.

The Beginning

Lump sum vs. periodic investing. Most people do not have a lot initial capital outlay, so they are forced to use the periodic investing method, although lump sump would be superior. Inheriting money in lump sump amounts provides more dollar exposure to equities throughout your lifetime than working and saving which gives you almost no exposure relative to the size of your total capital when you’re young.

Young people have the most of their net worth in capital. They should invest aggressively, but the common problem is young people are more risk averse than they should be and once they experience their first financial crisis, they become even more risk adverse. There are also two things a young person needs to realize in why they should invest more aggressively: 1) when investing relatively constant stream of real income, stocks are less risky with time 2) young people have a small amount of capital to begin with.

To counteract this problem of not having your lifetime capital immediately:

Nalebuff/Ayres suggests 2:1 leverage until you reach about middle age and then deleverage from there. Leveraging early champs the rule of 110 and 100% stock exposure based on a study using Shiller’s securities returns. However, the problem with using 2:1 leverage is there is not any proper implementation. There are 2:1 leverage vehicles such as mutual funds and options, but the shortfall is high expenses and limitation to the S&P 500 respectively. There is no real way to leverage without using derivatives which strikes psychological terror to investors. Additionally, not many people can tolerate a 1.0 beta, let alone a 2.0 beta.

Fama and French small and value factors. Typically these types of stocks have high returns and low correlation to the U.S. market. Since the small/value strategy has higher volatility than the S&P, the small/value strategy will always beat the S&P because more opportunities to buy at a lower price. Pushes you in the direction of DFA funds, but if unavailable suggests a few ETFs.

The End Game

Nest Egg – sum you save up fore specific purpose – i.e. Retirement.

Liability Matching Portfolio (LMP) – adequate lifetime income

Risk Portfolio (RP) – excess to LMP for luxuries & request

This part of the book talks about what you should do once you reach the end. The investor should build two separate portfolios, the Liability matching portfolio (LMP) and the Risk Portfolio (RP). By age 70, an investor should accumulate enough safe assets to fund a bare minimum of 20 years after social security and pension payments.

 The three strategies that he presents is: 1) fixed annuities 2) deferring social security 3) TIPs ladders.

1) Fixed annuities in the form of longevity Insurance Combination of TIPS Ladder & deferred annuity that would not pay until age 85. Hard to actually get a quote. Downfalls: 1) Hard to find a real product 2) No inflation adjusted deferred annuity 3) Legal issues around required minimum distributions (RMD) 4) Hard to find joint lifetime deferred annuity 5) If company goes under = 100% loss.

2) LMP should have inflation adjusted highly secure annuity. The cheapest annuity is defer social security. In the meantime you should draw down your nest egg. (Most preferred – actuarially makes sense) Max out! Stocks/FI instruments thereafter.

3) TIPS Ladder – when using TIPS to fund retirement do with ladders whose maturities approximately matches your projected needs not a TIPS mutual fund which may suffer capital loss when you need it most.

Rules for retirement spending under 65:

2% bulletproof, 3% safe, 4% taking chances, 5% dying poor

The middle

This part of the book talks about the transition from the beginning to the end.  

The LMP magic number is 20/25 x annual cash flow beyond social security. Once you’ve reached this magic number, you should start bailing, once you acquire enough TIPS, CDs & treasuries, feel free to start adding to RP.

He talks about how depending when you were born, even a few years a part may have different lifetime investing experiences. He presents some data showing that those who were employed during disasters fared well, while those who were employed during the good times, did less well.