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Review: Worry-Free Investing by Zvi Bodie

I recently read Zvi Bodie’s Worry-Free Investing. It’s a brief book that makes basically one argument.

Bodie (a Professor of Finance and Economics at Boston University) points out that the reason stocks have high expected returns is that they’re risky. And no matter how long we hold them, there’s always a chance that that risk will show up in the form of poor returns.

Bodie argues that the long-term riskiness of stocks is dramatically understated by conventional investment wisdom and that most investors have far too much allocated to stocks and far too little allocated to safer, inflation-indexed investments such as TIPS and I Bonds. In many cases, Bodie recommends a portfolio comprised exclusively of TIPS and I Bonds.

100% TIPS?

The problem, in my opinion, is that Bodie significantly understates the rate of savings that would be required for most people to reach their goals using a 100% TIPS portfolio. The reason for this underestimate is that he makes a few shoddy assumptions:

  1. He assumes every investor will die at or prior to his/her life expectancy.
  2. He assumes that you’ll earn a 2% real return from TIPS over any time period.
  3. He assumes that the amount you pay into Social Security will also earn a 2% real return.

Life Expectancy

In Bodie’s calculations, if someone retires at 65 and has a life expectancy of 90, Bodie does the math assuming that the investor needs enough money to last for 25 years.

The catch, of course, is that approximately 50% of people will live beyond their life expectancy. Planning to only meet your life expectancy hardly seems worry-free to me.

(Real) interest rates change.

Throughout the book, Bodie assumes that you can earn a 2% real return with TIPS. This works reasonably well for an investor with a lump sum to invest, who is already some years into retirement, and who can currently buy TIPS with a 2% real return.

Of course, that overlooks a great many scenarios. For example, for the 30-year-old investor, even if TIPS are currently yielding 2% (or even more), there’s no way to know what rate of return he’ll get on the TIPS he buys at age 40, 50, or 60.

I’m not arguing that a 2% real return is unreasonably optimistic. But relying on a given return (even from a portfolio comprised entirely of TIPS) is neither risk-free nor worry-free.

Social Security is risk-free?

In most of Bodie’s examples, his math shows that the hypothetical investors need to save somewhere from 20% to 40% of their income in order to reach their goals. Bodie argues that that’s not as hard as it sounds because they’re already saving 15% of their income in the form of social security taxes.

The unspoken assumption here is that you will earn that same 2% real return on your Social Security tax payments that Bodie assumes you will earn from a TIPS portfolio.

For younger investors especially, this assumption seems questionable. Again, neither worry-free nor risk-free.

Is it worth reading?

To be clear: my point in all of this is not that TIPS are riskier than stocks. They aren’t. My point is simply that an investor following Bodie’s plan is not 100% certain of success. Not even close.

That said, Worry-Free Investing provides a thought-provoking counterpoint to the conventional wisdom of stock-heavy allocations. And for that, I’d say it’s worth reading.

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  1. This idea seem to be another one of the fool-proof ideas that will allow you to retire in style. I recently heard about one that propagated that you should set up income streams that allow you to live off these income streams forever. Some examples would be rental properties and setting up businesses that throw off regular dividends. Like “Worry-free investing”, these ideas are good but the executions are entirely different games. The reality is such that most people would be very happy if they were well enough organized to retire in style or if they were able to makee enough money so that they can put some away for the golden years.

  2. Running out of money at 90 is a very very bad thing and not a risk I would be willing to take. I’ve run the numbers I would have to work until I was almost 80 to retire with inflation + 2% and not worry about running out of money.

    If I could get inflation +4% I would consider going 100% TIPs- although it would mean giving up any possibility of early retirement. The long term averages for a stock portfolio is inflation + ~6%. Even if stocks underperform the averages for the rest of my life it seems a good bet that a stock + bond portfolio should return inflation + 4%.

    -Rick Francis

  3. Not to completely support Mr. Bodie’s argument, but what I think you are all missing is that people are exposed to lots of risks with traditional investment techniques – risks they are not even AWARE they are taking.

  4. I wrote about this some time ago (linked to my name above).
    Bodie’s advice was excellent. For about an hour. Well, to be fair, from Sept ’98 thru May of ’01. During that period, the fixed rate i.e. growth, was 3% or higher. At retirement, that’s not a bad basket to put many eggs. Unfortunately, Zvi’s book was published in 2003, and the fixed return on TIPs was down to 1.1%, which turns his math on its head.
    The current rate is .1% by the way, making this strategy all but useless.

    I am not anti – Bodie, to be clear, when he was writing, the ideas he presents are valid, and at the peak 3.6% could provide just what the title suggests. But that ship has sailed. Too bad.

  5. @John

    I agree that investors should understand all the risks- returns may be lower than you predict, inflation may be higher than you predict, and you may live longer than you think, you may not be able to work as long as you plan. I really hope it is clear to investors that there are no performance guarantees with stocks.

    I would rather deal with market risk while I am working because if things DON’T go as planned I have more options- save more, work longer, lower retirement expenses.

    If I’m ~90 and running out of money there just aren’t that many options. I can’t get behind any plan that requires me to die early! Even if I did die early it would not be good enough- my wife is 6 years younger and women live longer than men. Once I am dead she may need 10 years or more of living expenses.

    To make the 2% solution work you need to pass off the longevity risk. I can think of the following strategies:
    #1 Maximize your Social Security payment- and let the government take more longevity risk by starting benefits at a later age.
    #2 Get an annuity and let the insurance company take the longevity risk. That strategy isn’t perfect either as the insurer could go out of business! So you would also need to diversify across companies.

    -Rick Francis

  6. Mr. Buerger: Not to completely support Mr. Bodie’s argument, but what I think you are all missing is that people are exposed to lots of risks with traditional investment techniques – risks they are not even AWARE they are taking.

    Quite the contrary, I think it entirely possible that some of are not missing the risk element at all, and that’s precisely why we would continue to invest in stocks – to expose ourselves to as much diversification among asset classes as possible, and thereby spread the risk over the entire portfolio. If TIPS underperform, or if Social Security dries up, etc., a portfolio that includes both stocks and bonds in reasonable proportion to one’s time frame and risk tolerance may reduce risk although it is never possible to eliminate it.

  7. @Larry –

    I appreciate your love for well-balanced and diversified portfolios. As a CFP® and RIA, I have been touting these same ideas for years. That does not mean, however, that the average American understands the risks that they are exposed to with even a very safe, widely balanced portfolio. Maybe you understand those risks, but my experience has been that most don’t – There is too much vested interest in the financial services industry to keep the products flowing, the advice coming and the fees rolling in. Meanwhile, most Americans think they can spend willy-nilly, not save out of cash flow and their butts will be saved by market returns that are CPI+6% or higher. From my perspective, that is delusional and ignorant thinking.

    Is Bodie’s method the answer? Clearly not. As pointed out here, the real ROR on TIPS is 0% or even negative. Global asset allocations tuned to each investor’s situation IS the still the best way to approach investing … just let’s quit kidding ourselves that the average investor (the ones reading this blog) is aware of all the risks this relatively riskless process offers. They aren’t – and we aren’t doing them any favors by trashing discussion of some alternatives.

  8. Problem is, John, that it works both ways too – with the people who think they’re “safe and sound” by putting all their money in FDIC-insured cash or under a mattress. These folks are safe from volatility risk but completely exposed to inflation risk, which is at least as great a drain on their resources (and also, like hypertension, a silent killer, whereas the effects of volatility are obvious). And these people are aided and abetted in this delusion by a pop financial guru like Soozie Orman, who wants her adoring fans to believe they are “safe and sound” by staying out of the market.

  9. To John:

    In case I wasn’t clear in the above article, my complaint isn’t with TIPS or a TIPS-heavy portfolio. My complaint is with the way Bodie does his calculations. (And two of my three disagreements with him have nothing whatsoever to do with TIPS but rather with Social Security and life expectancies.)

    I’m in agreement with Bodie that TIPS can be used to create a (relatively) “worry-free” portfolio/investment plan. I just think that he dramatically understates the rate of savings that would be required to implement such a plan. And, therefore, anyone following his strategy to the letter is in for a nasty surprise.

  10. The older I get, the more I’m convinced a 100% approach to any particular asset class is folly, whether it be 100% stocks, 100% bonds, 100% cash, 100% rental properties, even (especially!) 100% gold holdings held in some squirrel-eating quarters of the Internet.

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