A Zero-Risk Market: Do The Numbers Add Up?
For most investors, 1987 was a difficult year. The Dow Jones Industrial Average dropped 22.6 percent in a single day, Black Monday. Stocks posted record losses that weren’t recovered until 1989.
So, when Professor of Mathematics Robert Muksian, Ph.D., went looking for money managers who had returns greater than 25 percent in 1987, just two companies turned up, and only one (the other was a hedge fund) offered the kind of transparency that accounted for the gains.
Moo Chuck Quong, a money manager in Torrance, CA, posted returns of 12.1 and 31 percent on portfolios that guaranteed losses of zero or no more than 10 percent.
Quong did it by buying U.S. treasuries at a discount and investing the discounts in options. Because the treasuries paid face value at maturity, Quong’s clients almost never lost money, not even when the stock market tanked.
“In a practical way this is a guy who used to go to the shopping malls and sit there and look at the number of people who carried shopping bags out,” Muksian says, describing one of Quong’s methods of measuring how the economy was doing.
To Muksian, who at the time was developing software that would enable a pension consulting company to measure the risk tolerance of its clients, Quong was on to something – and not just because he was able to make money while everybody else was losing their shirt.
Quong had developed a strategy that introduced certainty into the uncertain world of investing. Muksian found that strategy useful because his own work involves discovering ways of minimizing risk.
Stability for the risk-averse
In a paper published in the Journal of Financial Planning, Muksian adopted Quong’s method of buying treasuries and investing the discounts, modifying it so that the investments weren’t in options, which are volatile, but in mutual funds, whose stability would suit the sort of risk-averse investor Muksian had in mind.
Titled “Zero-Risk Market Returns for the Ultra-Conservative Client,” the paper offers an investment plan tailor-made for people unable to tolerate any loss of principal. It includes a caveat: The zero-risk strategy forgoes the larger gains that can be realized by investing in things, such as stock, that don’t guarantee principal. The strategy always works but the meaningful amount available for investment in the stock market will depend on inflation rates such that treasuries are sold at significant discounts, Muksian says, and it isn’t offered as an investment option in a typical 401(k).
Nevertheless, when Marcel G. Hebert, the professor emeritus of accounting who reviewed Muksian’s papers for publication, read the Journal of Financial Planning piece, he said, “I wish I had known this 25 years ago.”
The paper, published in January 2009, is characteristic of the writing Muksian has done since he began teaching the mathematics of finance at Bryant in 1971.
Do the math
In addition to three textbooks, there has been a steady stream of articles from Muksian using mathematical models to help small investors decide issues affecting their financial future. In a pair of articles published in the Journal of the American Association of Individual Investors, the first in 2000, the second this year, Muksian explored whether it makes sense to begin collecting Social Security benefits at 65 – full retirement age for people born before 1937 – or at age 70, when a delayed retirement benefit kicks in.
For another paper he is currently researching, Muksian aims to establish how much a retiree can draw out of a retirement fund every year without running the risk of running out of money before death.
The generally accepted rule of thumb – that annual withdrawals should be limited to 4 percent of the initial portfolio value with a 60/40 percent mix of stocks and bonds – offers only a 95 to 98 percent probability of a person not outliving a retirement fund, according to Muksian. That isn’t good enough. “I want 100 percent probability,” he says.