As you approach retirement consider putting much of your new savings into safe government bonds.
This is “safer”, but it introduces new problems. Since your investment has lower expected returns, you need significantly more money saved up. The S&P 500 has historically returned around 10% per year over 25 year periods, and has almost never returned less than 5%[1]. Right now, as far as I can tell, government bonds return 1-2% depending on their length. With 5% expected returns, you need 20x your expenses saved up, but with 2% you need 50x, and with 1% you need 100x. Most of these are probably possible for high income/low expense Lesswrongers to save up, but I’d expect that we have higher value things to do with 30x our expenses than to hold onto it in case of very unlikely personal risks.
It is possible to live for a long time while withdrawing more than you earn. For example, with 5% expenses and 2% returns, you would last about 26 years[2] before running out of money. Considering point #19 though, guessing how long we’re going to live seems like a pretty big risk too.
How else would you compare them? The values I chose are meant to be the expected returns. For bonds I chose the listed rates, since those are (I think?) guaranteed, so historical rates would be meaningless. For stocks I chose the historical rates since that’s all we have. Did I use the wrong rates for bonds somehow?
Stocks: It is difficult to predict future returns, but I would at least calibrate my expected returns based on inflation expectations. Research indicates that equity expected returns and expected inflation move together…
…then, all else equal, current expected stock returns should be lower than historical stock returns.
Bonds: I agree with you that the yield to maturity for high quality government bonds is the best estimate for their expected returns, I would just make sure the maturity matches the time horizon. For a 25 year time horizon, I look at bonds that mature in 25 years.
This is “safer”, but it introduces new problems. Since your investment has lower expected returns, you need significantly more money saved up. The S&P 500 has historically returned around 10% per year over 25 year periods, and has almost never returned less than 5%[1]. Right now, as far as I can tell, government bonds return 1-2% depending on their length. With 5% expected returns, you need 20x your expenses saved up, but with 2% you need 50x, and with 1% you need 100x. Most of these are probably possible for high income/low expense Lesswrongers to save up, but I’d expect that we have higher value things to do with 30x our expenses than to hold onto it in case of very unlikely personal risks.
It is possible to live for a long time while withdrawing more than you earn. For example, with 5% expenses and 2% returns, you would last about 26 years[2] before running out of money. Considering point #19 though, guessing how long we’re going to live seems like a pretty big risk too.
[1] http://financeandinvestments.blogspot.com/2015/01/historical-annual-returns-for-s-500.html
[2] http://ideone.com/0K2Uhd
You are comparing the historical return of one asset class to the prospective return of another.
“Apples and Oranges”
How else would you compare them? The values I chose are meant to be the expected returns. For bonds I chose the listed rates, since those are (I think?) guaranteed, so historical rates would be meaningless. For stocks I chose the historical rates since that’s all we have. Did I use the wrong rates for bonds somehow?
Stocks: It is difficult to predict future returns, but I would at least calibrate my expected returns based on inflation expectations. Research indicates that equity expected returns and expected inflation move together…
http://www.federalreserve.gov/pubs/feds/1999/199902/199902pap.pdf
…and if expected inflation is lower than average (which I think it is)…
http://www.tradingeconomics.com/united-states/inflation-cpi
http://www.tradingeconomics.com/euro-area/inflation-cpi
…then, all else equal, current expected stock returns should be lower than historical stock returns.
Bonds: I agree with you that the yield to maturity for high quality government bonds is the best estimate for their expected returns, I would just make sure the maturity matches the time horizon. For a 25 year time horizon, I look at bonds that mature in 25 years.
Disclaimer: this is not investment advice.