There is such a thing as too much math — Useful Finds #17
Hi from Stefan,
Welcome to the seventeenth issue of this biweekly newsletter.
Nothing here is sponsored or written for compensation.
“90% of financial products are crap.”
So says Barry Ritholz on the Rational Reminder podcast (Spotify, Apple).
But he does like buying lightly used cars as soon as they come off of lease. So do I.
There is such a thing as too much math
William Bernstein opines on the Merton Share and why he doesn’t use retirement calculators.
My education as a statistician taught me to appreciate the power of mathematical models and also to be cautious about their limitations. Merton’s Lifecycle Investing Model is directionally correct and, I think, broadly helpful.
But I wouldn’t make any decisions based on the “Merton Share” formula for asset allocation. It follows from clever economic theory, and the mathematics are elegant, but the output is highly sensitive to four parameters: the mean and variance of stock returns, the risk-free interest rate, and your personal constant-relative-risk-aversion parameter.
The forward-looking values of the first three are unknowable; the fourth is personal but hardly more knowable, and its associated utility function has little empirical support as a description of how people actually think about risk.
I settled on The Best Third methodology because it is empirical, it doesn’t require speculative assumptions about future returns, and focuses on desired outcomes without asking risk-tolerance questions that people don’t really know how to answer.
A summer road trip
Irene and I spent last week in Santa Fe, New Mexico, our first visit there. The landscape on the drive down through southern Colorado via Crested Butte was spectacular, and the art and food in Santa Fe were terrific.
We especially enjoyed the Georgia O’Keeffe Museum and the New Mexico History Museum. We also caught two performances at the open-air Santa Fe Opera: Tchaikovsky’s Eugene Onegin and Handel’s Rodelinda.
We’re already planning to return next year for The Barber of Seville — which many of us first encountered as kids through the Bugs Bunny version.
Product update
The app can now import information about any existing TIPS holdings and account for them before recommending additional TIPS for your portfolio.
If you link your investment accounts through Plaid, your TIPS positions will be imported automatically. You can also manually enter TIPS held in unlinked accounts.
A short video walks through how to enter and manage the data on your TIPS holdings.
The downloadable spreadsheet also has a new worksheet listing the TIPS issues recommended for purchase.
If you already own TIPS and want to incorporate them into your plan, check it out!
Reader mail
Michael asked “Why do you think TIPS are at 3% real yield?”
Explaining why markets do what they do is above my pay grade.
But Michael Lebowitz writing in Advisor Perspectives examines the history of TIPS yields and offers some theories for today’s relatively high yields: inflation risk, deficit woes, and safe-haven status.
Kevin pointed me to this post by Cullen Roche, arguing that “long bonds still stink”.
Roche notes that today’s 3% real yield on 30-year TIPS is meaningfully lower than the worst case return on stocks for any rolling 30-year period of the last 100 years, and much lower than the median stock return.
My view, which I think is consistent with Kevin’s, is that the TIPS yield is known, while there is no guarantee that future stock returns won’t be worse than the historical worst case.
Securing some portion of one’s long-term needs with TIPS, insulated from the roller coaster of uncertain stock returns, is good for one’s peace of mind. How much should be in TIPS vs stocks? That’s more of an emotional and personal decision than a mathematical one.
Warmly,
Stefan Sharkansky, PhD
Founder of The Best Third