Portfolio Design: A Modern Approach to Asset Allocation

CONCLUDING COMMENTS

Foundations must recognize the new reality of investment returns. They cannot count on the bull markets of the 1980s and 1990s returning when spending seemed to have no limits. The new reality may be one where bonds and stocks provide the same level of real returns as they have over long stretches of the past. If so, foundations need to rethink their spending plans.

No set of simulations can give to the foundation a spending rule that is the correct one. So let’s summarize the key issues that the foundation must address. First, the foundation needs to focus on the risk that really matters, the risk of running out of money rather than market volatility this year or next. Second, the foundation needs to base its spending rate on the returns it expects to earn on its portfolio after inflation has been taken out. Third, the higher the proportion of bonds in the portfolio, the lower has to be the spending rate. Fourth, the spending rate has to be lower than the expected real, or inflation-adjusted, return because otherwise its risk of failure will be too high. Fifth, the foundation has to recognize that we are not sure about what average real returns will be in the future, so we may have to be even more conservative about return assumptions than past returns would indicate.

NOTES

1. As reported in Table 2.2, the average real return from 1926 to 2009 is 2.3 percent.

2. See Table 2.2.

3. In Chapter 7 on bonds, we showed that the medium-term bond is a better benchmark ...