High Cash Position in Asset Allocation

[Rocket_J_Squirrel]

I've watched the Retire Early forums for the past few years and have finally decided to post. Hi there!

I took ER a year ago from super-mega corp and received a nice package to say 'good-bye' - which was very nice. I have a great deal of experience in managing large budgets for super-mega corp and have been very fortunate in assembling a nice nest egg for my family and myself. I have analyzed, projected, and pro-forma'd, my expenses so I have a very firm handle on knowledge of my family operating expenses and have not cut back on anything from when I was employed full time. Medical is provided at a subsidized rate by super-mega corp.

DW is ten years younger than me and plans to work until 55 with a $50k income. Super-mega corp asked me back to work projects so I work about half-time and earn about $100k for this part time work (I could work more but do not want to). None of my income is used for living expenses - I'm funding my chilrens gratuate eduction or paying down the mortgage with this money - after taxes are taken - and the government takes a lot! Since I ER'd before age 55 I am not eligible to withdraw from a 401k so I rolled into an IRA where I take a SEPP withdrawal each year to cover living expenses. No debt except the mortgage, two of three kids through college and the third will begin next year and money has been saved to cover tuition/room & board/books/etc., for four years. I also have plenty of nice toys that I purchased before I ER'd so no real need to buy anything for a while.

So things are good...

The question I have is to find out if any others out there have as big of risk aversion as I do. My current overall asset allocation for me and DW is 75% cash, 4% fixed income, 1% REIT, 14% domestic equity, and 6% foreign equity. Most of the cash is with Vanguard and the other investments are with either, Vanguard, Fidelity, broker, banks, etc.

This combination throws off more than enough funding to cover my annual SEPP withdrawal - the SEPP withdrawal will take two-thirds of this year's earnings and the remaining one-third will be reimvested to grow the nest egg.

I can't see taking a big equity risk when I really don't have to.

I look forward to hearing from the board members from their experience and expertise with finance and life.

Thoughts?

RJS

[brewer12345]

Hi RJS. In answer to your question, your big risk in holding that much cash is that inflation can eat you alive over time (pretty much a certainty, unfortunately). Unless you have a really huge portfolio in relation to your income needs (say, 100X income needs), you pretty much have to reach for higher returns to keep up with inflation over time.

[Dawg52]

I keep close to 7 years worth of living expenses in cd's. That enables me to sleep well at night. Overall I'm roughly 50/50 stocks/bonds.(I included my cd ladder in the bond portion)

BTW, welcome to the forum!

[HobbyDave]

Welcome to the forum

As others I'm sure will say (and I may as well echo everyone's feelings), you will need in some way to raise your equity stake. As Dawg says, you can put X years of living expenses in CDs, and then the rest you can distribute into equity pots.

Just try to remember, inflation will happen. You are afraid of one risk, while the other will eat you alive. 50/50 stocks and bonds would be incredibly risk adverse (I won't feel comfortable with less than 70% stocks, even once I'm retired). The ratio you are at will most likely leave you slowly becoming poor over time

[Peter]

You might consider putting some of the cash into TIPS, which will provide a measure of protection against inflation.

Maybe not as much as equities have been historically, but probably better than short term cash instruments.

And who can say *for sure* that equities will do as well in the future as they have over the last 30 years or so?

Peter

[Coach]

Quote:

Originally Posted by Rocket_J_Squirrel I can't see taking a big equity risk when I really don't have to.

RJS, that's a good point. So many of us have to worry about trying to maximize return -- if you're in a position to do fine with lower risk and lower return, that's wonderful. Your situation sounds like a fun one to try and model in FIRECalc -- see the link at the bottom of the page.

Coach

[haha]

TIPS are in fact a contractual hedge against inflation. We can argue whether the index used-CPI-U- is adequate, but since it the same one that most indexed payments use- including the historical investigations that compare equity returns to inflation, I don't see that you can get a much better infaltion hedge than TIPS when bought at a decent real yield. Higher is better, but I would say anything above 2% qualifies for consideration.

Equities may increase faster than inflation. OTOH, they might do as they did during the 70s and go down in nominal terms, and way down in real terms.

If one does not need or want the speculative return that may be present in equities, or the risk that definitely is present in equities, TIPS are a powerful competitor for core dollars.

Ha

[twaddle]

Welcome, RJS (same name as my cat, BTW).

Sounds like you'd be a prime candidate for Swedroe's nifty "reduced risk dispersion" portfolio.

Basically, designate a portion of your nest egg for capital preservation and another portion for risk taking. For example, Swedroe puts 70% in bonds and 30% in risky assets.

The bond allocation is split between TIPS and nominals. And the risky chunk is invested in assets with high historic returns and low historic correlations. Like a mix of small-cap value, int'l value, emerging markets, and commodities.

The high bond allocation preserves capital and keeps overall portfolio volatility low, while the small risky allocation should boost your overall returns to around 10-11%/year if history is a guide.

I believe he's detailing this strategy in a new book on "alternative" investment strategies.

[brewer12345]

Quote:

Originally Posted by haha We can argue whether the index used-CPI-U- is adequate, Ha

Did you have to go there?

[Rocket_J_Squirrel]

Thanks to everyone for their comments and views on the approach I am taking to a low risk assett allocation. Much appreciated. Yesterday was a warm, sunny, fall day in the mid-west and I took full adavantage by putting about 150 miles on the Harley riding the farm country and watching the farmers combine beans and corn as the fall harvest is in full swing.

After reading through the comments to my original post, I didn't see anything that really sways me to take more risk. If we happened to have a 3,000+ point drop in the DJIA I might move some funds to equities, but for now most equities and commodities seem premium priced. I do take a rifle shot approach to individual stocks I think have large upside opportunity, but these targets are getting much harder to find.

My aversion to high portfolio risk is based on watching two of the managers I worked for take early retirement in the late 1990's, each very well versed in finance and money management, do all the right things as far as asset allocation only to get creamed by the market tech bust. Many of the 'great' funds at the time had their returns 'juiced' by getting too far outside the fund what they were supposed to be investing in and loading up on tech stocks - how come these fund managers never seem to wind up in jail or faciling civil penalities for their creativeness?

On the inflation issue you need to take a very careful look at what you are doing that the price is going up on. Not all inflation is created equal! What the government is taxing us and the fees charged for services by the government are probably the highest inflation area there is. Food prices and the cost of eating out have gone up and these higher costs are due to the rise in the minimum wage - higher labor cost - and the price subsidies for ethanol - higher prices for corn lead to higher animal feed costs - beef - and higher prices for anything made from corn. Other crop prices are going up since more and more land is devoted to corn production leaving a shortage of other crops not being planted. The falling dollar against foreign currencies will zap those of who who like to purchase things not made in the US or who travel overseas or to Canada. So look at what your personal inflation rate is, don't use some index that may have nothing to do with your personal situation. Hard to do, but well worth the effort to study this.

So for now I'm very satisfied in working a 7-8% total portfoilo return and taking a 3% withdrawal rate letting my overall portfolio grow at 3-4% per year with minimal risk.

Good luck to those with the high equity positions in the coming years. I guess time will tell what the best path was. In the meantime, I'm sleeping very well not worrying about taking a big financial hit when the markets tank.

Everyone have a great week. RJS

[Maurice]

Quote:

Originally Posted by Rocket_J_Squirrel So for now I'm very satisfied in working a 7-8% total portfoilo return and taking a 3% withdrawal rate letting my overall portfolio grow at 3-4% per year with minimal risk.

It seems highly unlikely you'd get that return with 75% of your money in cash over any reasonable timeframe. That would mean you're earning better than 30% on your equity and fixed income positions.

[Rocket_J_Squirrel]

Maurice, you must have had a different finance professor than I did. I calculate that I only need to achieve a 12% annualized return to hit a total 7% return with the 75% cash allocation that I currently maintain.

For simplicity assume one has a $1,000,000 portfolio at the first of the year. To earn a 7% return, you'll need to add $70,000 during the year and wind up with $1,070,000.

With a 75% cash allocation - $750,000 - invested primarily in the Vanguard Prime MMF which has earned an annualized 5.23% during the past year along with some good rate CD's and high interest rate checking accounts, you should earn very close to if not exceed $40,000 in interest. Since you have a $70k target, you'll need to earn $30k from the remaining $250,000 in your portfolio.

I have very little in fixed income - 4% - that earns a little over 4.25% - about $500 for this example. Not much, but everything helps to get to the 7% target. So the remaining $240,000 needs to work hard - this is where my rifle shot approach works. I heavily invested in energy the first part of this year when many stocks were on sale - HP for one. I also loaded up on the Canadian energy trusts that pay a great monthly dividend and have also given me some nice capital appreciation this year after buying them when their prices crashed when the Canadian government decided to change the way the trusts are taxed - things like AAV, PGH, CNE, etc. Timing is key on these and the appreciation of the Canadian dollar has helped. I also have done very well this year with Vanguard's VWO ETF. I also look for private stock placements when businesses first go public - I am lucky and have built up many excellent business friends over the years who continually create investment opportunities and $10k - $20k investments with them have worked out very well for me - 40 to 100% gains over a couple of years are not uncommon - talk to your friends in small business that you trust and listen closely to what they are doing.

So for this example, I've achieved $38k this year in domestic and foreign equity dividends and appreciation. I should wind up with a little over $79k total for the year, close to an 8% annualized return - again, with very little risk or loss of sleep.

2008 may be more of a challenge since the government is pushing interest rates down to save the banking and private equity fund bozos. I'm still a big fan of energy - always listen to T. Boone Pickens and read Hubbert's Peak! I also see opportunity in the real estate carnage being caused by the bozos so will be hunting amongst the wreckage for bargins to be had.

RJS

[Maurice]

Sounds like a good year, Squirrel. I also own VWO, its certainly done well this year. Anyway, I hope you can continue to see 7-8% returns on a portfolio with 75% cash - that would certainly make it something of an historical outlier, to say the least.

[twaddle]

Maurice, do you have access to any backtesting tools?

Try this: 70% bonds + 30% mix of EM, ScV, Intl ScV, and commodities.

You should get something similar to the returns of a 100% S&P500 portfolio.

Sounds like Squirrel is doing something similar, but with more active trading. Good luck with the active part, especially if you want to relax in retirement.

[haha]

Quote:

Originally Posted by twaddle Maurice, do you have access to any backtesting tools? Try this: 70% bonds + 30% mix of EM, ScV, Intl ScV, and commodities. You should get something similar to the returns of a 100% S&P500 portfolio. Sounds like Squirrel is doing something similar, but with more active trading. Good luck with the active part, especially if you want to relax in retirement.

I think he knows what he is about, and should have no trouble at all meeting his 12% target for the equity portion. From one POV it is risky, but remember he has taken 70% of his portfolio off the table completely.

BTW Squirrel, congrats on choosing Helmerich and Payne. These guy have so outshone any other land driller this past year it isn't even a contest.

And Twaddle, just remember, another word for relaxation is boredom.

HA

[Dawg52]

Quote:

Originally Posted by haha just remember, another word for relaxation is boredom. HA

I eliminate the boredom factor by actively managing 10% of my portfolio. Try not to do anything stupid though. The balance pretty much on auto pilot. Similar to our 'who dat gonna beat them Saints' fan.....Unclemick.

Squirrel, interesting approach. I retired at 53 and have always used the 100 rule as a guide for my allocation approach. May not be the best way to go but a simple approach for my little brain. As I age, my allocation will take on a more conservative mode. I like your high octane approach on your non cash position. Not sure how it would affect my sleep at nights though.

Just goes to show that there is more than one way to skin a cat. Hmmmmmm.........sounding more like our 'who dat' friend every day.