Expected real return
In this thread at the Get Rich Slowly forum, a question was asked about everybody's expected rate of real (inflation-adjusted) return. My brain first started working on the answer like so:
But this got me thinking a bit. How much return do I actually need? After all, my parents are retired very comfortably on 0% real return on their portfolio. The vast majority of their investments was in rental income (they have yet to sell anything so no bubble inflated housing capital gains to artificially bump this number up) and CDs -- both of which peg the rate of inflation after taxes.
How did they do it? Well they came to the United States in their late 30's and early 40's. Once here, they studied English well enough to get white collar jobs -- however, these jobs never paid more than lower middle class wages. What they did have was typical immigrant frugal lifestyle. They saved 40% of their income without fail. Of course, this meant the life for us kids was very spartan. I don't recall any Christmas or Birthday presents -- I remember one year where we had cake and a party for a birthday. Eating out was reserved for Chinese New Year. Vacations? Are you kidding me?
But back to my parents ... let's go through the math on such a scenario. Since we are talking real returns, we can throw out inflation and stick with the same wage through the working career.
As for myself, I may have gotten the best of both worlds. I emigrated to the United States very early in my life so I got all the opportunities but was able to build a base on my parents' money management habits. I make far more money than they did as I run a technology company but I also pay way more in taxes which makes it quite satisfying that I can exceed their savings rate.
Since I will probably be able to retire on 0% return given my extreme savings rate, why I don't I just stick with a lower volatility portfolio then? Unfortunately, my goals are different from my parents'. I have no idea whether I can pass on my money management skills to my offspring and knowing that the majority of inherited money is spent away after 2 or 3 generations, I have to shoot far higher. I either need to build up a portfolio in the tens of millions or build up businesses my kids can learn fiscal skills in (or hopefully do both).
For this reason, reading about my investing ideas is good but copying them might not since my goals are different from most people's. The entire range of real returns whether 0% or 5% will work out just fine for my personal retirement target. For this reason, my portfolio plan has an increased bond/commodity allocations with riskier equities to counterweight. The idea there is I will have the same expected return with a lower volatility. The side effect is the results set now includes the possibility of under-performing (and out-performing) a traditional portfolio. Under-performance would only affect the type of inheritance I would leave behind and at the moment, I still have conflicted philosophies on the strategy.
- 6% stocks (5% overall, I overweight in risker equity allocations)
- 2% regular bonds
- 1.5% inflation protected bonds
- 1% commodities futures (insurance premium)
- 0% gold
- 60% stocks
- 20% regular bonds
- 10% inflation protected bonds
- 5% commodity futures
- 5% gold
- 6 * 0.60 + 2 * 0.20 + 1.5 * 0.10 + 1 * 0.05 + 0 * 0.05 = 4.2%
But this got me thinking a bit. How much return do I actually need? After all, my parents are retired very comfortably on 0% real return on their portfolio. The vast majority of their investments was in rental income (they have yet to sell anything so no bubble inflated housing capital gains to artificially bump this number up) and CDs -- both of which peg the rate of inflation after taxes.
How did they do it? Well they came to the United States in their late 30's and early 40's. Once here, they studied English well enough to get white collar jobs -- however, these jobs never paid more than lower middle class wages. What they did have was typical immigrant frugal lifestyle. They saved 40% of their income without fail. Of course, this meant the life for us kids was very spartan. I don't recall any Christmas or Birthday presents -- I remember one year where we had cake and a party for a birthday. Eating out was reserved for Chinese New Year. Vacations? Are you kidding me?
But back to my parents ... let's go through the math on such a scenario. Since we are talking real returns, we can throw out inflation and stick with the same wage through the working career.
- Median household income: $50K
- Taxes: $5K (married couple w/ kids don't pay much at lower income levels)
- Spending: $25K
- Savings: $20K
As for myself, I may have gotten the best of both worlds. I emigrated to the United States very early in my life so I got all the opportunities but was able to build a base on my parents' money management habits. I make far more money than they did as I run a technology company but I also pay way more in taxes which makes it quite satisfying that I can exceed their savings rate.
Since I will probably be able to retire on 0% return given my extreme savings rate, why I don't I just stick with a lower volatility portfolio then? Unfortunately, my goals are different from my parents'. I have no idea whether I can pass on my money management skills to my offspring and knowing that the majority of inherited money is spent away after 2 or 3 generations, I have to shoot far higher. I either need to build up a portfolio in the tens of millions or build up businesses my kids can learn fiscal skills in (or hopefully do both).
For this reason, reading about my investing ideas is good but copying them might not since my goals are different from most people's. The entire range of real returns whether 0% or 5% will work out just fine for my personal retirement target. For this reason, my portfolio plan has an increased bond/commodity allocations with riskier equities to counterweight. The idea there is I will have the same expected return with a lower volatility. The side effect is the results set now includes the possibility of under-performing (and out-performing) a traditional portfolio. Under-performance would only affect the type of inheritance I would leave behind and at the moment, I still have conflicted philosophies on the strategy.
(Filed in investing)
2 TrackBacks
In my last entry, I wrote about my expectations for my real return. How has it played out during my limited investing career? After pulling my numbers together, I have: Nominal Real CPI Return Return --------------------------------------- 1996 2.93% 2... Read More
Just 2 weeks ago, I mentioned about the fear amongst common investors. To be honest, there's always fear -- just the words people use are different. You continually run into "financial porn" telling you something bad is about to happen... Read More
Very interesting blog - thanks for sharing your thoughts.
Just wondering, how did you go about learning all of this information? Did you study business in college.
Are you planning on staying in China?
There is no inheritance tax in HK - worth making note if it concerns you.
Seems like HK Chinese invest heavily in rental flats to counter balance all the stock risk taking.
Would your parents consider retiring to China - lower cost of living, less expensive health care, less crime, etc. What made you want to go to China?
Just wondering. :)
Hello Mei,
Thanks for your comments and questions. I studied computer science in college -- my business, economics, investment knowledge is all self-taught either from reading or doing (making mistakes). It helps that being good at computers, I am very analytical and can create spreadsheets/databases to model/calculate range of possibilities to throw out answers that don't fit reality.
For the time being, I will stay in China. My kids could use a few more years of Mandarin and my bank accounts some more accelerated savings. (You can click on Categories -> China to read through my original reasons.) Hong Kong is nice (although I like Singapore better) -- but perhaps in the future, a country with nationalized healthcare will be mandatory. If there's one thing that I can't plan for, it's exploding healthcare costs in the U.S. so I may have to pursue residency/citizenship elsewhere before my window of opportunity is closed.
My parents are fine living in the U.S. Combined with their social security payments, they've saved up more than enough to handle retirement. I don't think they could take the heat in China anyways.