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Surprised not to see this mentioned anywhere. In finance, we don’t look at maximizing total return but rather risk adjusted return. Buying a lotto ticket has am

Surprised not to see this mentioned anywhere. In finance, we don’t look at maximizing total return but rather risk adjusted return. Buying a lotto ticket has amazing total return if you hit the jackpot but really bad risk adjusted return. The thing you should spend some time doing is deciding what your risk tolerance is and how much variance in your portfolio you can stomach. Then you can start talking investment strategies.

sushshshsh 6y ago
Ok so say I have enough risk tolerance to put my money in something other than cash, but not more aggressive than a fund that tracks the S&P, what precise steps should I do to live off of my cash stack while doing absolutely 0 work other than sitting on my couch?
- brianwawok 6y ago
  If it’s all in the market, most wisdom says you can take out 4% a year and never run dry. Is 4% of your stash enough to live on? Congratulations you are financially independent. You can read through mr money mustache if you want more depth..
  - tutfbhuf 6y ago
    Exactly this. Put your cash in S&P500 and live a peaceful life. For optimization: take out a little bit more when the price is considered to be high and take out a little bit less if it's low.
    - fratlas 6y ago
      Is this not timing the market? How do you calculate what is "high" and "low" - rolling average increasing 7% per year, compare current price to that expectation?
      - tutfbhuf 6y ago
        Mean reversion. > Mean reversion in finance suggests that asset prices and historical returns eventually revert to their long-term mean or average levels The avg. 7% per year will break down into very good years and bad years. Let's say the S&P500 is already down -5% YTD and has underperformed over recent years, then you would it considered to be low, because you would rather expect the performance to increase in order to match the long-term avg. of 7%. So at this point you would happily buy in and expect mean reversion. But of course there's no such thing as perfect timing (except in hindsight) and no guarantee for mean reversion to happen.
      - llampx 6y ago
        Timing the market is doable I'd say. Not all the time and not by everyone but it is completely doable. Sometimes you will buy too late or sell too early but even buying the dips is timing the market. If you partook in some stocks, more so than otherwise, during the March lows you were also timing the market.
  - Apes 6y ago
    The current risk free rate is absurdly low, which would suggest a much lower sustainable draw down than 4% for the next 10-30 years, probably only around .5 to 1.5% at most.
    - bluquark 6y ago
      I agree the 4% rule is too aggressive nowadays. But every .25% increment lower means a huge improvement in sustainability, so even adjusting down to 3% is profoundly more conservative than the original rule. At 1.5% you are going lower even than endowment funds aiming for perpetual maintenance of principal (they often use 2%-2.5%). The 4% rule of thumb was calculated to minimize risk of running out of money during the time period. 1.5% * 30 years = 45%, so an investment that simply keeps up with inflation would leave you with more than half your cash after 30 years. And note that the stock market almost always has positive real returns over periods as long as 30 years (see William Bernstein’s book Deep Risk), so the assumption “just keeps up with inflation” is already very pessimistic.
    - eloff 6y ago
      That's rubbish that you think you can predict a 1% return in the market over the next couple decades. It would be extremely unprecedented, and you'd need a very solid argument to have any confidence at all in that prediction.
      - arcticbull 6y ago
        Not to mention SPY has a 1.75% dividend yield.
    - marvin 6y ago
      Well, inflation is also absurdly low. The direct return on equity, globally, is around 5% for a pure stock portfolio. What is your basis for believing that the safe withdrawal rate will be less than half this, at less than 1.5%? That sounds excessively pessimistic to me.
      - anonymousiam 6y ago
  - marcusverus 6y ago
    To be clear, the 4% rule assumes a 30 year retirement (i.e. retiring at ~50-60). For early retirement you should target a 3.5% annual withdrawal rate. https://www.madfientist.com/safe-withdrawal-rate/ https://www.madfientist.com/safe-withdrawal-rate/
- edoceo 6y ago
  You'll need a fund with good dividend payout. SPY is currently at $1.30 and cost $327. If you put $450k into SPY you make $1870 per quarter. So, might need to buy $2MM of SPY. But there are other good dividend funds and/or individual equities.
  - WA 6y ago
    Dividends are left-pocket right-pocket. Dividends can help you psychologically, but in a way, it’s like forced selling once per year or per quarter. Edit: if it helps you to invest, by all means, do it. But since dividends are mostly psychological, there is no point in limiting your stock picks to companies with a high dividend.
    - betterunix2 6y ago
      On the other hand, companies with long histories of sustained and rising dividend payments also tend to outperform the S&P500 in terms of total return (dividends + capital gains), and do so with lower volatility. Reasons include having a business that is profitable and stable enough to sustain such payouts and a management culture that appropriately balances shareholder interest (by paying dividend) against the long-term viability of the business (and can therefore continue its dividend payments over multiple decades).
      - gruez 6y ago
        >On the other hand, companies with long histories of sustained and rising dividend payments also tend to outperform the S&P500 in terms of total return (dividends + capital gains), and do so with lower volatility. Source?
      - lmnice 6y ago
        Just a nitpick: > a management culture that appropriately balances shareholder interest (by paying dividend) In theory a company should invest in whatever has the most favorable risk-return profile. If it pays dividends, that means dividends are judged by management to be the best risk-return profile among all other alternatives. A company can pay zero dividends and still protect shareholders interests.
- fennecfoxen 6y ago
  Ordinarily, I'd say you want a product like Vanguard Managed Payout Fund. But they've just revamped them into the Vanguard Managed Allocation Fund (VPGDX): https://retirementincomejournal.com/article/vanguard-reboots-a-managed-income-fund/ https://retirementincomejournal.com/article/vanguard-reboots...
- krn 6y ago
  > what precise steps should I do to live off of my cash stack while doing absolutely 0 work other than sitting on my couch? I would put X% in Vanguard 500 Index Fund[1], and in Y% Vanguard Total International Bond Index Fund[2]. X% should represent the amount of money you can afford not to touch during the entire economic downturn. Y% should represent the amount of money you want to be able to cash out at any point during the economic downturn. Another alternative to S&P-500 for putting X% in is Nasdaq-100[3]. It has performed much better over the years, but it's significantly more tech-focused: > The table below and the charts above display historical performance figures for both the Nasdaq-100 TR and the S&P 500 TR between Dec. 31, 2007 and June 30, 2020. Despite recent overall market volatility, the Nasdaq-100 TR Index has maintained cumulative total returns of approximately 2.5 times that of the S&P 500 TR Index. [1] https://investor.vanguard.com/mutual-funds/profile/overview/VFIAX https://investor.vanguard.com/mutual-funds/profile/overview/... [2] https://investor.vanguard.com/mutual-funds/profile/overview/VTABX https://investor.vanguard.com/mutual-funds/profile/overview/... [3] https://www.nasdaq.com/articles/when-performance-matters%3A-nasdaq-100-vs.-sp-500-second-quarter-20-2020-07-13 https://www.nasdaq.com/articles/when-performance-matters%3A-...
- deleted 6y ago
  [deleted]
- nazka 6y ago
  Why not the Vanguard Target Retirement 20xx Fund? Unless you really know how to assess your risk or manage a portfolio I think it’s what you are looking for. (20xx is the year you should be retired)
beagle3 6y ago
A lotto ticket does not have a good return; most times it has negative expectation; after a few weeks with no winner, it is sometimes positive. Risk adjusted, almost independent of your risk metric, it is always horrible.
CydeWeys 6y ago
The lotto ticket is a bad example because it has negative expected return. A better example would be a positive expected return but with a very high amount of risk. Something like $FAS should fit the bill there.
perl4ever 6y ago
>In finance, we don’t look at maximizing total return but rather risk adjusted return People don't regard variance as the same thing as risk, and that's why they buy lottery tickets. It's a sign the math is wrong, not that the people are wrong.
ndesaulniers 6y ago
Perfect! I was going to say, without any consideration of risk, buy far OTM options. For maximizing your Sharpe or Sortino ratios, which is more likely what OP was curious about, well that is quite literally a trillion dollar question. That said, modern portfolio theory and portfolio optimization is pretty easy. Whatever you do OP, please don't put it all under your mattress. https://youtu.be/sHSaUqoKjkA https://youtu.be/sHSaUqoKjkA My chips are mostly off the table right now, in bond ETFs, but we'll see if the market tanks or not. I'm quite surprised that Q2 earnings this past week was not a bloodbath.
humank 6y ago
A lottery generally has negative expected return, so probably not the best example to use

sushshshsh 6y ago

Ok so say I have enough risk tolerance to put my money in something other than cash, but not more aggressive than a fund that tracks the S&P, what precise steps should I do to live off of my cash stack while doing absolutely 0 work other than sitting on my couch?

brianwawok 6y ago
If it’s all in the market, most wisdom says you can take out 4% a year and never run dry. Is 4% of your stash enough to live on? Congratulations you are financially independent. You can read through mr money mustache if you want more depth..
- tutfbhuf 6y ago
  Exactly this. Put your cash in S&P500 and live a peaceful life. For optimization: take out a little bit more when the price is considered to be high and take out a little bit less if it's low.
  - fratlas 6y ago
    Is this not timing the market? How do you calculate what is "high" and "low" - rolling average increasing 7% per year, compare current price to that expectation?
    - tutfbhuf 6y ago
      Mean reversion. > Mean reversion in finance suggests that asset prices and historical returns eventually revert to their long-term mean or average levels The avg. 7% per year will break down into very good years and bad years. Let's say the S&P500 is already down -5% YTD and has underperformed over recent years, then you would it considered to be low, because you would rather expect the performance to increase in order to match the long-term avg. of 7%. So at this point you would happily buy in and expect mean reversion. But of course there's no such thing as perfect timing (except in hindsight) and no guarantee for mean reversion to happen.
    - llampx 6y ago
      Timing the market is doable I'd say. Not all the time and not by everyone but it is completely doable. Sometimes you will buy too late or sell too early but even buying the dips is timing the market. If you partook in some stocks, more so than otherwise, during the March lows you were also timing the market.
- Apes 6y ago
  The current risk free rate is absurdly low, which would suggest a much lower sustainable draw down than 4% for the next 10-30 years, probably only around .5 to 1.5% at most.
  - bluquark 6y ago
    I agree the 4% rule is too aggressive nowadays. But every .25% increment lower means a huge improvement in sustainability, so even adjusting down to 3% is profoundly more conservative than the original rule. At 1.5% you are going lower even than endowment funds aiming for perpetual maintenance of principal (they often use 2%-2.5%). The 4% rule of thumb was calculated to minimize risk of running out of money during the time period. 1.5% * 30 years = 45%, so an investment that simply keeps up with inflation would leave you with more than half your cash after 30 years. And note that the stock market almost always has positive real returns over periods as long as 30 years (see William Bernstein’s book Deep Risk), so the assumption “just keeps up with inflation” is already very pessimistic.
  - eloff 6y ago
    That's rubbish that you think you can predict a 1% return in the market over the next couple decades. It would be extremely unprecedented, and you'd need a very solid argument to have any confidence at all in that prediction.
    - arcticbull 6y ago
      Not to mention SPY has a 1.75% dividend yield.
  - marvin 6y ago
    Well, inflation is also absurdly low. The direct return on equity, globally, is around 5% for a pure stock portfolio. What is your basis for believing that the safe withdrawal rate will be less than half this, at less than 1.5%? That sounds excessively pessimistic to me.
    - anonymousiam 6y ago
- marcusverus 6y ago
  To be clear, the 4% rule assumes a 30 year retirement (i.e. retiring at ~50-60). For early retirement you should target a 3.5% annual withdrawal rate. https://www.madfientist.com/safe-withdrawal-rate/ https://www.madfientist.com/safe-withdrawal-rate/
edoceo 6y ago
You'll need a fund with good dividend payout. SPY is currently at $1.30 and cost $327. If you put $450k into SPY you make $1870 per quarter. So, might need to buy $2MM of SPY. But there are other good dividend funds and/or individual equities.
- WA 6y ago
  Dividends are left-pocket right-pocket. Dividends can help you psychologically, but in a way, it’s like forced selling once per year or per quarter. Edit: if it helps you to invest, by all means, do it. But since dividends are mostly psychological, there is no point in limiting your stock picks to companies with a high dividend.
  - betterunix2 6y ago
    On the other hand, companies with long histories of sustained and rising dividend payments also tend to outperform the S&P500 in terms of total return (dividends + capital gains), and do so with lower volatility. Reasons include having a business that is profitable and stable enough to sustain such payouts and a management culture that appropriately balances shareholder interest (by paying dividend) against the long-term viability of the business (and can therefore continue its dividend payments over multiple decades).
    - gruez 6y ago
      >On the other hand, companies with long histories of sustained and rising dividend payments also tend to outperform the S&P500 in terms of total return (dividends + capital gains), and do so with lower volatility. Source?
    - lmnice 6y ago
      Just a nitpick: > a management culture that appropriately balances shareholder interest (by paying dividend) In theory a company should invest in whatever has the most favorable risk-return profile. If it pays dividends, that means dividends are judged by management to be the best risk-return profile among all other alternatives. A company can pay zero dividends and still protect shareholders interests.
fennecfoxen 6y ago
Ordinarily, I'd say you want a product like Vanguard Managed Payout Fund. But they've just revamped them into the Vanguard Managed Allocation Fund (VPGDX): https://retirementincomejournal.com/article/vanguard-reboots-a-managed-income-fund/ https://retirementincomejournal.com/article/vanguard-reboots...
krn 6y ago
> what precise steps should I do to live off of my cash stack while doing absolutely 0 work other than sitting on my couch? I would put X% in Vanguard 500 Index Fund[1], and in Y% Vanguard Total International Bond Index Fund[2]. X% should represent the amount of money you can afford not to touch during the entire economic downturn. Y% should represent the amount of money you want to be able to cash out at any point during the economic downturn. Another alternative to S&P-500 for putting X% in is Nasdaq-100[3]. It has performed much better over the years, but it's significantly more tech-focused: > The table below and the charts above display historical performance figures for both the Nasdaq-100 TR and the S&P 500 TR between Dec. 31, 2007 and June 30, 2020. Despite recent overall market volatility, the Nasdaq-100 TR Index has maintained cumulative total returns of approximately 2.5 times that of the S&P 500 TR Index. [1] https://investor.vanguard.com/mutual-funds/profile/overview/VFIAX https://investor.vanguard.com/mutual-funds/profile/overview/... [2] https://investor.vanguard.com/mutual-funds/profile/overview/VTABX https://investor.vanguard.com/mutual-funds/profile/overview/... [3] https://www.nasdaq.com/articles/when-performance-matters%3A-nasdaq-100-vs.-sp-500-second-quarter-20-2020-07-13 https://www.nasdaq.com/articles/when-performance-matters%3A-...
deleted 6y ago
[deleted]
nazka 6y ago
Why not the Vanguard Target Retirement 20xx Fund? Unless you really know how to assess your risk or manage a portfolio I think it’s what you are looking for. (20xx is the year you should be retired)

beagle3 6y ago

A lotto ticket does not have a good return; most times it has negative expectation; after a few weeks with no winner, it is sometimes positive. Risk adjusted, almost independent of your risk metric, it is always horrible.

CydeWeys 6y ago

The lotto ticket is a bad example because it has negative expected return. A better example would be a positive expected return but with a very high amount of risk. Something like $FAS should fit the bill there.

perl4ever 6y ago

>In finance, we don’t look at maximizing total return but rather risk adjusted return People don't regard variance as the same thing as risk, and that's why they buy lottery tickets. It's a sign the math is wrong, not that the people are wrong.

ndesaulniers 6y ago

Perfect! I was going to say, without any consideration of risk, buy far OTM options. For maximizing your Sharpe or Sortino ratios, which is more likely what OP was curious about, well that is quite literally a trillion dollar question. That said, modern portfolio theory and portfolio optimization is pretty easy. Whatever you do OP, please don't put it all under your mattress. https://youtu.be/sHSaUqoKjkA https://youtu.be/sHSaUqoKjkA My chips are mostly off the table right now, in bond ETFs, but we'll see if the market tanks or not. I'm quite surprised that Q2 earnings this past week was not a bloodbath.

humank 6y ago

A lottery generally has negative expected return, so probably not the best example to use