Sunday, January 16, 2011

Should I hold 280% Stocks or 0% Stocks? I'm confused!

Let's meet two well-respected and well-published academic financial economists, Moshe Milevsky of York University and Zvi Bodie of Boston University.  Professor Bodie may have a slight edge in overall fame, but both of these men can lay claim to being leading financial scholars.  They've even both been featured in the 10 Questions column of the Journal of Financial Planning (Milevsky in November 2009 and Bodie in February 2010).  They both produce rigorous academic research published in leading academic journals, and they both also write books geared toward household investors.  They could hardly be more similar, except that when it comes to the issue of asset allocation for long-term retirement savers, they could hardly be more different!

Zvi Bodie and Michael Clowes contribution is the 2003 book, Worry-Free Investing: A Safe Approach to Achieving Your Lifetime Financial Goals. In this book, they advise readers to invest their retirement savings 100% in TIPS.  No need for stocks.  Someone should only consider investing stocks when they've already saved enough to cover their expenses and otherwise have additional funds that they can afford to lose.  Since most households tend to not be saving enough for retirement, this means that most households should be invested 100% in TIPS and 0% in stocks.

On the other hand, Moshe Milevsky's contribution in the 2009 book, Are You a Stock or a Bond? Create Your Own Pension Plan for a Secure Financial Future. This is an accessible discussion of relatively recent developments in financial economics that human capital should be considered as a part of one's asset allocation.  The future salary of an investment banker is more like a stock, because job prospects are very much tied to the fortunes of the stock market.  But the future salary of a tenured professor is more like a bond.  Every year the tenured professor will receive a bond coupon payment (their salary) that has little risk and has little relation to the stock market.  Asset allocation should consider the nature of one's salary, and those whose salary behaves more like a bond can afford to take on more risk in their investment portfolio.  On page 69 of his book, Milevsky indicates that a tenured professor who is 45 years old and who has a dependent spouse and children should have a stock allocation of 280%.  Personally, I'm much younger than 45 so I guess I should be borrowing very heavily to buy stocks on margin, according to Milevsky's advice.

How can two men who are otherwise so similar arrive at such different conclusions about asset allocation for retirement savers?  That is a bit of a puzzle to me. Any thoughts?