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AA vs Buckets during the bridge to SoSec
Old 07-12-2018, 09:12 PM   #1
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AA vs Buckets during the bridge to SoSec

This question bubbled up while reading some of the most recent posts on the class of 2018 thread.

I think I understand the popularity of finding the AA that fits your risk tolerance and sticking with it, especially when most of ones ER revenue comes from ones portfolio. I say "I think I understand" because I am continually learning from this group as well as other good sources.

Repeating myself from other threads my RE revenue is 75% covered by my non-cola pension and my wife's SSDI. I am 58 and four years out from the possibility of starting SoSec. I had planned on something like a 65/30/5 AA immediately when I retired and take monthly distributions from that, but with two years expenses in my 401k stable value for pre-59.5 monthly withdrawals, and with 75% of budgeted revenue coming from reliable non-portfolio sources, I am leaning more toward a bucket approach until I start SoSec.

By doing this I would be more equity heavy, perhaps 80 to 85 percent and refill the stable value bucket each year. I know the risk of a bear in the next couple of years which would kick the chair out from under my plan to a degree, but the longer we keep the bear at bay the better my performance should be and help me put off starting SoSec longer. And as I have mentioned elsewhere once I start my SoSec my portfolio will fund a raise, cost of living increases and lumpy expenses.

I have read some of the threads debating bucket vs hybrid bucket/AA vs AA and tend to agree that AA with rebalancing will be my choice once I start SoSec. I could put 4 years distributions in stab LOL e value or cash-like funds to bridge to 62 but I don't want to put 7 (65) 9 (FRA) or 12 years (70) distributions in a cash-like fund up front thereby take it out of equities. I need the chance for that money to grow and outpace inflation.

I guess the question really is does the bucket approach make more sense in a situation like mine were my budget is funded so heavily by pension and my spouses SSDI? Who else is doing this or something like it.

As an FYI I could cut back on normal budget needs by about 8 grand if the bear arrives at a bad time for me.
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Old 07-13-2018, 04:07 AM   #2
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We are about 1/3 covered by non-cola pension, no SS yet, and my AA is 60/40. I do not personally believe in buckets. I manage the portfolio overall and draw income as needed from dividends, distributions, and maturing bonds, rebalancing to hold the AA as needed. Also, my risk tolerance is not variable, it is steady.
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Old 07-13-2018, 06:10 AM   #3
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Similiar approach here except my non-COLA pension is smaller... only ~18% of what we spend. I just rebalance to 60/35/5 and withdraw ~2.4% (0.2%/month) from the 5% in cash for spending, then I rebalance at the end of the year.

In the OP's case, he could create a side fund equal to 4 years of SS payments and then draw on that from 58 to 62 and then base his other withdrawals on the remainder and a SWR. OTOH, the OP seems to have a good risk appetite so I think either approach would be ok.
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Old 07-13-2018, 06:22 AM   #4
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Up until this year, non cola-ed pensions accounted for half of our budget, the other half, 401k withdrawals. I increased our rate from 3% to 4%, and our rental income, because it could widely fluctuate( but hasn't in 19 years), doesn't even get put into the spend BUDGET, but does get spent. We plan on DW to take SS at 65, and me at 70, unless my health fades, or the SHTF. A FA years ago, who we promptly fired after he did what we told him what we would never do, introduced us to the bucket theory. We had already inadvertently planned a bucket strategy, although it was planned just to give us multiple income streams. We recently found out that there may be one more bucket or stream in the mix, as we have 33 days to wait it out until all the background paperwork is done. Our AA was/is about 65/25/10 and I count my preferred stocks as bonds/fixed income.
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Old 07-13-2018, 07:50 AM   #5
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We have 2 pensions and some rental income that cover 65% of spend. We withdraw from the portfolio as needed to cover the gap. Dividends from the taxable account take care of most of it. But we do sell equities when needed. No particular schedule. We usually pull from the 3% cash allocation and rebalance opportunistically to replenish cash.

In theory, we could go 2 to 2.5 years without selling by burning through the 3% cash. In reality, we could go significantly longer with a little discretionary budget trimming. We're both 57, so SS is still a ways off... probably 62-65 for her and 65-70 for me. Probably won't touch tax-deferred until RMDs except for Roth conversions between now and then.

I just try to keep things simple, pragmatic, and flexible. As situations change and various income streams come and go, I'll adapt with whatever approach seems sensible at that time.
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Old 07-13-2018, 09:02 AM   #6
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Thoughts:

1) There are those here who will argue convincingly that thinking about buckets and thinking about AA are basically the same thing. I disagree. With buckets, the AA is a consequence of the plan. It is not the plan.

2) Thinking about a simple two-bucket strategy, the conservatism of the plan is in the expected duration of the first bucket. Two years seems very short to me. IIRC market downturns since WWII have typically lasted 5 years or less. So 5 years is a more conservative bucket size and, yes, its consequence will be a more conservative AA.

3) The other thing to remember when thinking about buckets is that during a recovery from a market downturn, equity values are rising. So even if a nominally five year bucket ran dry a little early, refilling it from the equity tranche will not hurt as much as it would to be selling at the bottom.

4) AA percentages get thrown around here like confetti, but in fact one size does not fit all. An example I have used before is two identical widows age 70 from long lived stock. The standard formulas would give both of them the same AA. But now consider that one has assets of $200K and other other has assets of $10M. Should they have the same AA? Almost certainly not.
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Old 07-13-2018, 03:15 PM   #7
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Thoughts:
...
2) Thinking about a simple two-bucket strategy, the conservatism of the plan is in the expected duration of the first bucket. Two years seems very short to me. IIRC market downturns since WWII have typically lasted 5 years or less. So 5 years is a more conservative bucket size ...
I just don't see it. What is a "5 year bucket"? Is it 5 years of expenses? Why?

As I've pointed out before, a typical portfolio will kick off ~ 2.5% in divs. A conservative investor will probably be planning on a 3.0% ~ 3.5% WR, maybe less. So that is a 15% ~ 17.5% bucket.

In a downturn, a conservative investor would only need an added 0.5% ~1.0% draw-down of their account, and to rebalance, this would come from the fixed side. No selling of equities for a very long time, decades?

Why tie up money in a 'bucket'? Or is the bucket all you have in fixed income? I just fail to see how thinking in terms of buckets clarifies anything. All the discussions get complicated - when to fill, how much, multiple buckets, and on and on.

AA is simple. Buckets obfuscate. That's my opinion.


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...

4) AA percentages get thrown around here like confetti, but in fact one size does not fit all. An example I have used before is two identical widows age 70 from long lived stock. The standard formulas would give both of them the same AA. But now consider that one has assets of $200K and other other has assets of $10M. Should they have the same AA? Almost certainly not.
If they have the same time period and same WR, then I see no difference. Obviously, an early retiree with $200K has other sources of income, and/or an extremely low COL. That also assumes we keep an "emergency fund" out of the portfolio, as it isn't really invest-able. Though the person with $10M probably wouldn't need any emergency fund, they could liquidate the portfolio. Outside of that, I see it the same.

I do appreciate that you said "almost".

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Old 07-13-2018, 03:46 PM   #8
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AA is simple. Buckets obfuscate. That's my opinion.
Sorry you are having so much trouble with the concept. It is really quite simple but I have no appetite to deal with all your numbers and confusion.

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If they have the same time period and same WR, then I see no difference. Obviously, an early retiree with $200K has other sources of income, and/or an extremely low COL. That also assumes we keep an "emergency fund" out of the portfolio, as it isn't really invest-able. Though the person with $10M probably wouldn't need any emergency fund, they could liquidate the portfolio. Outside of that, I see it the same.
Well if you add a bunch of assumptions you can certainly reach whatever conclusion you like. For purposes of my simple illustration, there are no unstated facts and certainly none of the ones you propose.

Widow with $200K is in probably very tough shape and cannot stand any risk. Widow with $10M may take the view that she is investing for the beneficiaries of her estate, possibly testamentary trusts, and may take a long view with a very high equity percentage. Or she may not. Point being that she has lots of AA freedom, none of which is contemplated by some brain-dead arithmetic based solely on her age. The arithmetic is similarly brain-dead for advising the widow with inadequate assets.
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Old 07-13-2018, 06:43 PM   #9
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But if my AA is 60/35/5 and my WR is 3%, even if I use an AA approach then essentially I have 1-2 years in a cash bucket and ~10+ years in a bond bucket (recognizing that withdrawals will increase each year for inflation) and the remainder in equities.

If the SHTF, I can chose to just spend from cash/bonds and let equities ride.... or I can chose to rebalance.

I'm thinking an interesting strategy to deal with sequence of return risks might be to only rebalance where equities exceed target, and if equities are less than target then just replenish cash from bonds until equities recover above target. I'm thinking that a decision rule along those lines simply adds a bucket tilt to a traditional AA approach... a good middle ground that is easy to administer.
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Old 07-13-2018, 06:48 PM   #10
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But if my AA is 60/35/5 and my WR is 3%, even if I use an AA approach then essentially I have 1-2 years in a cash bucket and ~10+ years in a bond bucket (recognizing that withdrawals will increase each year for inflation) and the remainder in equities.

If the SHTF, I can chose to just spend from cash/bonds and let equities ride.... or rebalance.

I'm thinking an interesting strategy to deal with sequence of return risks might be to only rebalance where equities exceed target, and if equities are less than target then just replenish cash from bonds until equities recover above target. I'm thinking that a decision rule along those lines simply adds a bucket tilt to a traditional AA approach... a good middle ground that is easy to administer.
You miss out on some nice gains if you do this. In 2008/9 as painful as it was to buy stocks and rebalance, we were rewarded big time. The models count on rebalancing when stocks are down as well as up.

If you are worried about depleting your fixed income too much from rebalancing then set a threshold, which is what I did during the worst of it. Of course the models don’t do this either. I’m not sure historically fixed income has ever been drawn down so much it leaves you with too little.
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Old 07-13-2018, 07:10 PM   #11
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You miss out on some nice gains if you do this. In 2008/9 as painful as it was to buy stocks and rebalance, we were rewarded big time. The models count on rebalancing when stocks are down as well as up. ...
And those same models will show that during the BIG BULL market of the 90's, you'd be rebalancing out of equities and into fixed, and therefore not enjoying all the gains.

The studies I've seen show rebalancing to be kind of a meh thing. I'm lazy, so I don't do any rebalancing unless I feel I'm way out of whack, and even that is probably not helping, but I guess it's good to have a road map of sorts.

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Old 07-13-2018, 07:16 PM   #12
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And those same models will show that during the BIG BULL market of the 90's, you'd be rebalancing out of equities and into fixed, and therefore not enjoying all the gains.

The studies I've seen show rebalancing to be kind of a meh thing. I'm lazy, so I don't do any rebalancing unless I feel I'm way out of whack, and even that is probably not helping, but I guess it's good to have a road map of sorts.

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Sure - itís about improving the risk/reward results (efficient frontier) and maintaining a target risk profile. You may give up a little during up markets, but you also gain a little during down markets, for reduced volatility overall.
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Old 07-13-2018, 07:22 PM   #13
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Sorry you are having so much trouble with the concept. It is really quite simple but I have no appetite to deal with all your numbers and confusion. ...
I have no trouble with the concept, I just don't see the point. And it seems that even "Mr Buckets" didn't have any clear cut definitions on refilling the various buckets.

Granted, the AA people will debate about when, and how often to re-balance. But the reality is it doesn't matter much, if at all, in the long run. You won't empty a bucket, no matter what. Just rebalance, or not.


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...
Well if you add a bunch of assumptions you can certainly reach whatever conclusion you like. For purposes of my simple illustration, there are no unstated facts and certainly none of the ones you propose.

Widow with $200K is in probably very tough shape and cannot stand any risk. Widow with $10M may take the view that she is investing for the beneficiaries of her estate, possibly testamentary trusts, and may take a long view with a very high equity percentage. Or she may not. Point being that she has lots of AA freedom, none of which is contemplated by some brain-dead arithmetic based solely on her age. The arithmetic is similarly brain-dead for advising the widow with inadequate assets.
Who is adding assumptions? What does it matter if it was a bachelor, spinster, widow, or widower?

It makes no difference if one can "withstand risk" or not. If I enter $200K or $10M into FIRECalc, a 40 year portfolio will only survive at an X.XX% WR. You need to accept risk (volatility, actually), in order for your portfolio to support X.XX% for 40 years. Regardless the amount. The 'market' doesn't care about your risk level, it will do whatever it does.

Sure, someone with $10M can take a big hit and still have plenty to live a comfortable lifestyle. But not what they were accustom to. But if the other person was getting by on a $200K portfolio, they surely had other income/support. Regardless, being too conservative only means the odds of them running to zero is higher.

There's no free lunch. If they can't accept the risk that their 75/25 portfolio drops 50%, how can they accept the higher risk that their conservative portfolio drops to zero in their lifetime? FIRECalc shows quite clearly that a 'too conservative' portfolio has a higher risk of going to zero.

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Old 07-13-2018, 10:10 PM   #14
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I have read some of the threads debating bucket vs hybrid bucket/AA vs AA and tend to agree that AA with rebalancing will be my choice once I start SoSec.
Ed B,
As you've already done some background reading, you may have already read this article by Kitces. If not, I highly recommend it, it clarified a lot of things for me. I found that the comments and answers after the main article were also worth reading. Your question in the OP, as I read it, is how best to use buckets to address sequence of returns risk in your first years of retirement, and this is exactly what Kitces covers in the linked article.

Bottom line (and slight generalization): If you are in the withdrawal phase and plan to set an asset allocation and rebalance to it on a regular basis (which is a very good idea), then common bucket strategies have zero impact. It may have some psychological benefit, but it does not reduce risk in comparison to simple rebalancing without the artifice of "buckets."
If you don't plan to automatically rebalance your portfolio across asset classes when they get out of whack (buckets or no buckets), then that's worth a separate discussion, and the topic will be "the sad and sordid history of market timers."
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Old 07-14-2018, 06:37 AM   #15
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My SORRs risk aversion, and how I became a believer in buckets. http://www.aaii.com/journal/article/...in-the-details

After last year’s 24.5% run up in the 401k, realized that I could retire in two years at 59 instead of waiting until 60 – which is certainly not RE by many on this forum. (We are FI now but wanting to feather the nest a bit.) Original plan was to stay 100% invested until 2019, and then crawl into the bond tent to minimize SORR. See Kitces ARTICLE https://www.kitces.com/blog/managing...ment-red-zone/

However, a corresponding 24.5% drop in an all equities 401k this year would be a real setback on the eve of FIRE causing me to work past 60. DW said do what makes you comfortable. So, in early April I pulled all of the EuroPac and ExUSA funds out and parked them in a MM account. This amount equaled projected SS gap income until FRA. As soon as I hit the ‘confirm’ for this transaction an unexpected wave of relief washed over me. Selected EuroPac and ExUSA because the dollar was gaining momentum (Lucky DMT that I am). Selected a MM account because the bond funds offered by my 401k are all in decline while the Fed normalizes rates. Went from looking at Fidelity once a day to once a week. Thought it was fun to watch the account grow – but apparently there was also a bit of unrecognized stress from risk taking.

First week of June decided to fully implement preFIRE portfolio and go to a 60/0/40 mix after subtracting the SS gap fund. Because of all the trade talk, only kept the home boys fund of Russell2000. Sold all of the S&P500 and Russell3000 and stuffed that into the mattress. Immediately afterwards, both of those indices went up 2%, so that move did not feel as smart the previous. However, yesterday FIDO indicated the 401k was up over 5% YTD, so I am good with the current mix. Cash balance pension keeps chugging along at the 4% rate per annum.

This strategy (which evolves and refines thanks to this forum and bogleheads) means that we will spend down a sizeable chunk of the portfolio before FRA. For the particular situation of DW and I, taking SS at FRA makes the best sense (everyone is different). Additionally, I prefer the “safety first” strategy of taking the non-cola pension annuity joint 100% in the current interest rate environment. Pfau https://www.forbes.com/sites/wadepfa.../#4bbb8f943453 (Plus, it is a liability offset for my fixed mortgage P&I https://www.bogleheads.org/wiki/Matching_strategy). IOrp, FireCalc and FIDO indicate >90% success. We can cut back expenses if needed to make it 100%.

The other check that I am still seeking to understand is the “Funding Ratio” analysis, using a very low discount rate. https://www.ifa.com/articles/funded_ratio_actuarial_approach_retirement_spendin g/ I also like the idea of a late 70’s age SPIA and annuity hurdle for longevity risk to avoid having to save an overly large portfolio.

What this all boils down to is a bucket approach rising equity glidepath, with up front pension annuity to minimize SORR and a FRA SS coupled with a longevity SPIA to minimize longevity risk. For our situation to optimize retirement goals (everyone is different) I am tossing out the standard 60/40 portfolio and 3 to 4% SWR and SS at 70. This means that we will not leave an excess pile of money to DS and DD, but we will meet our retirement goals. (Sorry kids)

My approach to retirement has been unorthodox so far with the experts claiming to start a bond glidepath much earlier than this, instead of less than 2 years before retirement. (BTW – they are right and I am a lucky duck). I’m still doing a lot ‘wrong’ by carrying a mortgage into retirement and keeping my NextEra utility stock for capital gains NUA and a whole bunch stuffed into the MM mattress. Both of these carry their own risk, but I am comfortable with it.

Very unnatural for me to have anything outside of stocks after being all in equities for 32 years investing. Still, my risk tolerance has diminished as freedom approaches and have come to the realization that I don’t want the stomach churn of another tech bubble or financial crisis at this stage of life. I am also growing concerned with concurrent yield inversion, low unemployment/labor tightening, corporate stock buyback levels coupled with lower levels of investor money to stocks, neutral to tightening monetary policy upcoming shift by the Fed, huge US government budget shortfalls, trade war has started, negative interest rates in Europe, Chinese debt, Japan lugging along (still), and high large cap PE valuations. My magic 8 ball can’t predict the future, but my optimism for near term equity performance is diminished.

YMMV

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Old 07-14-2018, 07:24 AM   #16
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It's very scary to go into retirement with only your investments to support you. Not having the paycheck coming in every month to add to the bottom line is quite unsettling. It can be hard to even get yourself to spend at first.

We initially handled it by having extra funds up front to cover extra traveling right after retiring, plus others to cover a year of expenses. Was intimidated enough, and didn't want to be distracted by market movements and the impacts on our long-term invested retirement portfolio that had a healthy equity allocation.

Good thing too - as we retired in 1999!! And 2000, 2001, and 2002 were miserable market years!

But we still have a good chunk invested in equities. And we made it. I don't think we would be doing nearly so well today if we hadn't had a good equity exposure all those years in spite of two nasty bear markets. We've pulled back just a bit on equity exposure as we got older, but still above 50/50.
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Old 07-14-2018, 09:11 AM   #17
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But if my AA is 60/35/5 and my WR is 3%, even if I use an AA approach then essentially I have 1-2 years in a cash bucket and ~10+ years in a bond bucket (recognizing that withdrawals will increase each year for inflation) and the remainder in equities.

If the SHTF, I can chose to just spend from cash/bonds and let equities ride.... or I can chose to rebalance.

I'm thinking an interesting strategy to deal with sequence of return risks might be to only rebalance where equities exceed target, and if equities are less than target then just replenish cash from bonds until equities recover above target. I'm thinking that a decision rule along those lines simply adds a bucket tilt to a traditional AA approach... a good middle ground that is easy to administer.
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You miss out on some nice gains if you do this. In 2008/9 as painful as it was to buy stocks and rebalance, we were rewarded big time. The models count on rebalancing when stocks are down as well as up.

If you are worried about depleting your fixed income too much from rebalancing then set a threshold, which is what I did during the worst of it. Of course the models don’t do this either. I’m not sure historically fixed income has ever been drawn down so much it leaves you with too little.
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And those same models will show that during the BIG BULL market of the 90's, you'd be rebalancing out of equities and into fixed, and therefore not enjoying all the gains.

The studies I've seen show rebalancing to be kind of a meh thing. I'm lazy, so I don't do any rebalancing unless I feel I'm way out of whack, and even that is probably not helping, but I guess it's good to have a road map of sorts.

-ERD50
While I concede that the approach that I described would ineitably miss out on some equity gains, the main purpose of the tilt is to sidestep/manage sequence of returns risk rather than optimize returns. I sort of did that in the 2008/2009 downturn.... I didn't have the courage to sell bonds and buy equities as I should have under an AA and rebalance approach, but I did stand pat with equities and benefitted from the recovery and then some.

While at the time I was still working and adding to both equities and bonds in the form of contributions, if I had been retired I would have been selling some bonds for living expenses.
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Old 07-14-2018, 09:19 AM   #18
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I could put 4 years distributions in stab LOL e value or cash-like funds to bridge to 62 but I don't want to put 7 (65) 9 (FRA) or 12 years (70) distributions in a cash-like fund up front thereby take it out of equities. I need the chance for that money to grow and outpace inflation.
Why do you "need" to have money in stocks to outpace 4, 7, 9, or 12 years of inflation?

In theory, laddered TIPS will stay even with inflation, why wouldn't that be good enough for this time period?
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Old 07-14-2018, 09:22 AM   #19
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While I concede that the approach that I described would ineitably miss out on some equity gains, the main purpose of the tilt is to sidestep/manage sequence of returns risk rather than optimize returns. I sort of did that in the 2008/2009 downturn.... I didn't have the courage to sell bonds and buy equities as I should have under an AA and rebalance approach, but I did stand pat with equities and benefitted from the recovery and then some.

While at the time I was still working and adding to both equities and bonds in the form of contributions, if I had been retired I would have been selling some bonds for living expenses.
I don't think you actually are managing sequence of returns risk if you do this. You already took the huge hit to the equity (so you already experienced the risk of negative outcome), but then you don't add to your equity when it is way down? You limited your ability to recover which is what the SWR models are based on.

Well - if you didn't do it in 2008/9, then never mind. Not buying more equity is way better than selling whatever equity you had left.

For me rebalancing my AA is not about optimizing returns, it's about managing risk and staying within a given AA which I have modeled with Firecalc and other models to choose a reasonable SWR for myself. If I wanted to increase long-term returns I would a) have a larger equity exposure and b) reinvest my unspent funds back into my retirement portfolio (which is basically using a lower withdrawal rate than I had initially picked).
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Old 07-14-2018, 09:25 AM   #20
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Originally Posted by Independent View Post
Why do you "need" to have money in stocks to outpace 4, 7, 9, or 12 years of inflation?

In theory, laddered TIPS will stay even with inflation, why wouldn't that be good enough for this time period?
Personally I believe I need equity to outpace inflation over a long time period.

TIPs haven't been around long enough to know their outcome, IMO. Plus they are long bonds which I avoid in my AA anyway.
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