Ask an author: David Loeper here to answer your retirement planning questions!

[David Loeper]

Originally Posted by kristyr8

My husband and I are both 30 and have over 2x our annual salaries saved for retirement. We have about 30% invested in international mutual funds in our 401(k)s but every asset allocation tool I use says this is too aggressive. Do you think it's too aggressive given our age/savings? I want to make sure we capitalize on growth so our savings outlast us, not the other way around.

Congrats on getting a good start on saving for your future!

Normally I would not confirm conventional wisdom without debating individual circumstances, but in this case, I think what you have seen by allocation modeling tools is probably something that you should at least consider.

Here is why:

There is no rational expectation or argument that could be made that stocks that happen to be head quartered in a different country would on average have any higher return on average than those in the USA.

Of course, if you naively follow past performance, there will be times they perform better, or perform worse, but that doesn't mean there is a reason to expect it to continue either way.

Foreign stocks are no different than domestic stocks in regards to what they are doing...i.e. ....trying to make profits.

They are different in that they introduce an additional currency risk not present with domestic stocks.

Think of it this way...clearly stocks west of the Mississippi will perform differently than stocks east of the Mississippi. If a period of time passes where the west stocks beat the east stocks, does that mean I should expect companies in the east to perform better if they move their headquarter west? Of course not.

The reason foreign stocks make sense in a portfolio is therefore not because of the benefit of a higher return, but because of the introduction of currency risk, which lowers the correlation between equity exposure, and in theory the volatility.

No one really truly knows what a reasonable value would be from this diversification benefit since good diversified foreign stock data only goes back to 1968. But, the more you own, the more you are introducing more currency risk with no higher expectation for return.

The effect of this foreign diversification benefit therefore will diminish at some point. Keep in mind, it isn't a benefit of a higher return, but instead a reduction to volatility by adding a more volatile asset, which at some point will increase the volatility, not decrease it.

I wouldn't lose sleep over a 30% foreign equity exposure in a 100% equity exposure portfolio. But, the amount of currency risk it introduces and the long periods of time where it may cause material under performance would argue for a bit less foreign equity exposure...like half (15%).

[just_kelly]

Dave,

Thank you for answering my question! I appreciate your feedback. My company funds my retirement without me having to contribute right now.

[sast]

Wait, I thought I had this figured out...LOL Previous market performance cannot be used to predict future performance. Browsing the financial internet that seems a mantra. But can I statistically position myself with a comfortable (read high) probability of achieving goals like high return and low risk? If I can do that, then the other factors like sufficient income, having enough money to last my lifetime and leaving something to my heirs are covered. So what's the best strategy for low risk and high return? Trade every day, sell in May and buy in November? Rebalance as life situation changes? Whose assett allocation model do I use?
Thanks for you patience and generosity in sharing your knowledge.

[David Loeper]

Originally Posted by sast

Wait, I thought I had this figured out...LOL Previous market performance cannot be used to predict future performance. Browsing the financial internet that seems a mantra. But can I statistically position myself with a comfortable (read high) probability of achieving goals like high return and low risk? If I can do that, then the other factors like sufficient income, having enough money to last my lifetime and leaving something to my heirs are covered. So what's the best strategy for low risk and high return? Trade every day, sell in May and buy in November? Rebalance as life situation changes? Whose assett allocation model do I use?
Thanks for your patience and generosity in sharing your knowledge.

First, recognize when you are dealing with probabilities, it IS NOT the pass/fail grade you are implying of "acheiving" life goals, it is of EXCEEDING goals.

The next question is how high of confidence level is high, and is it possible to be too high?

Finally, if for example 83% confidence is sufficient now, how unlikely is it that the markets will keep you in that comfortable range of say 75-90% confidence? (The answer is near 100% certainty that even with high initial confidence, the markets are very likely to misbehave and cause you to need to change some aspect of your goals or allocation IN RESPONSE to the market misbehavior somewhere along the way.)

There are plenty of financial product sellers that will peddle something to you that says you can have your cake and eat it too (high return and low risk). I know you really want to believe that is possible, everyone does. Most of the financial services industry is based on the notion of manufacturing spin that preys on that natural desire. And, sometimes luck or even potentially skill MIGHT deliver that Xanadu to some, that you appear to be seeking.

There are no shortage of such product sellers, be it some magical trading software, due diligence process, "optimal" allocation model, etc. etc. etc.

They sell because people buy them and want to believe. Wouldn't you rather have some honesty though? Instead of being sold by one of the carnival barkers that claim they have cracked the code that no other being on the planet has figured out or that everyone has figured out and all you need to do is copy them, how about considering the honest and objective answer that the future is uncertain, that we do not have a time machine to go back in time, economics leave little if any room for the free lunch, that attempts of getting such free lunches ALWAYS introduce the risk of someone eating YOUR LUNCH and in the end it is wealth that matters and your wealth result may be unrelated to your risk and return?

You said you read my whitepapers. Try to think about how hard it would be to perceive a material difference in the returns generated from the two materially different portfolio allocations over 80 years highlighted in two of my papers (Measuring Temperature with a Ruler- Is Your Wealth Manager Really a Return Manager in Disguise? [see page 8] and Efficiency Deficiency- A Hard Look at How Asset Allocation is Really Being Practiced [see page 3] Both are available free and without registration at: http://www.financeware.com/f_frame.a...hitepapers.asp)

I fear you are focusing on finding the free lunch that many are selling. Be skeptical and evaluate your decisions on honesty and full disclosure, lest you subject yourself to the risk that someone eats your lunch in retirement.

[sast]

Thank you for your honesty. It is truly refreshing. It is also disheartening for us who hoped for some way to edge the odds in our favor. So what's the path forward for diehard hopefuls to beat the system?

[Will]

This week, the lucky winners of David's book are houstontexas and sast.

We're giving away two copies of the book per week so there are plenty of chances to win.

[GreerAngell]

Did everyone get a PM for a copy of his book for free?

[sast]

Check the first message in the forum from Will. You won!

[David Loeper]

Originally Posted by sast

Thank you for your honesty. It is truly refreshing. It is also disheartening for us who hoped for some way to edge the odds in our favor. So what's the path forward for diehard hopefuls to beat the system?

Edging the odds in your favor means understanding what the odds really are, what winning any bet buys you and the risk introduced for making such bets.

Unfortunately, unless you are a black jack card counter or a statistics geek, few people really understand the odds and end up as victims of well packaged pitches. How odds are presented can easily fool people into completely irrational actions. Actually, the work many statisticians do today is packaging statistics into compelling pitches that prey on the lack of understanding and we see this evidenced in so much of the fake science today.

For example, Marin County CA was reported as having a 20% higher breast cancer rate than the rest of the country and this simple statistic launched investigations by activists into environmental causes, work stress, plastics used in bottled water among others. The real cause was bad census data. (see http://www.imaginis.com/breasthealth...ews6.01.03.asp)

What does this have to do with investing? Well quite a bit if you think about the bet you are making in "trying to beat the system."

Bets against the markets have some chance of paying off which is a reward for making the bet but introduce the risk of materially underperforming, a risk you can have certainty of avoiding. What is the relative value of eliminating the bottom half of results from entering the equation? Is it worth the opportunity you are foregoing of performing in the top half? Statistically, this is a no brainer...but the active activists that make their living preying on "diehard hopefuls" won't position it objectively.

If you are stuck on trying to beat the system, recognize that it is no different than playing black jack. You might win, just as you have with your Chevron or any number of blackjack players win every weekend in Vegas.

However, when the real odds in a bet have a negative value, the best thing to do is avoid the bet. You have no chance of losing in blackjack if you don't make the bet. If you make the bet, you might win, or you might lose, but overall the casinos (Wallstreet) will profit by you playing the game.

At that point if you cannot resist the temptation to beat the system, all I can do is tell you the same thing I would tell a friend stepping up to the craps table in Vegas...and that's "good luck" because that is what you need to make the winning bet pay.

[beren]

I've been hearing a lot of ominous things about the US economy. What is the best investment strategy if you want to hedge against an US economic collapse?

I'm thinking of investing in a fund that tracks the MSCI Emerging Markets index. But my friends tell me that if American economy collapses, foreign markets will go down too. What's left? Gold and oil? Help!