Friday, July 18, 2008

Going For Broke

Lori got an awesome graph in her mail the other day - it was her Van Guard 401k statement from a former employer. This is a "2040" plan - that is, they mix the stocks and bonds for you according to theoretical models so that you can retire in the year 2040. As 2040 draws closer, they move from stocks to bonds so you get higher return on higher risk when young, but the bottom doesn't drop out of your retirement 3 days before you need it.

Due to the employment duration and market performance, the graph was a simple straight line going from "more" to "less". The caption had some marketing drivel about preparing for retirement...extrapolate the line out and Van Guard will have carefully lost all of her money by the time 2040 rolls around.

Now it could be a lot worse - the expense ratios on Van Guard's plan are really low, and we have to accept that stocks are risky and there will be periods like this when the market gets the hell beaten out of it.

But what caught my attention was the mix. For someone retiring in 32 years Van Guard recommends 90% stocks and only 10% bonds! Wow! (By comparion, the "old" models would have been 70% stocks.) did we get here?
  • Nerdy analysts look at historical stock-bond returns and recommend a 70-30 mix.
  • Lots of people put 70% of their retirement into stocks via mutual funds.
  • This increases demand for stocks, their value goes up and up and up.
  • Stocks now have a higher historical return.
  • Nerdy analysts recalculate. The mix should be 80-20 because stocks are even better than we thought.
  • People put even more money into stocks!
  • Stocks go up even more.
  • Now stocks have an even higher historical return.
  • Nerdy analysts recalculate...
I think I hear Adam Smith laughing at us...