Asset Allocation for someone 6-10 years from ER?

[ESRBob]

One of my old friends and his wife are very keen on ER and have been asking me what is the right asset allocation for them during the 6-10 years leading up to ER. They are 48 now, living frugally, doing all the stuff they are supposed to be doing. (Even read my book!) Now they want to fire the financial planner and do it themselves, and and I am trying to help them. (Having urged them to leave the planner, I am suddenly realizing why Financial Planners get their fees, I guess!)

Other details in case they are relevant: both in good health, only son entering college next year with college savings already 'covered' outside the ER budget, own an appreciated home with 10 years of mortgage left, Dad works now -- safe, comfortable job paying in the 125k range. No other debt. Financial assets now in the 500k range plus in the background, a share of the family vacation home that is expected to be sold around the time of pulling the ER plug.

Anybody got any advice on asset allocation for a couple in this stage of the landing pattern?

Thx

 

[Cut-Throat]

Bob,

I think it doesn't matter so much if you are retired or not, but how long you have to live. I use the (110- Age = Percent you should be in Stocks)

If you invested in total Stock market and Total Bond Market to this formula it would probably work.

Otherwise you can read Berstein Books, get into Slice and Dice with International, Small Cap value, Large value etc. etc.

 

[Nords]

Anybody got any advice on asset allocation for a couple  in this stage of the landing pattern?

One of the best things about Bernstein's "Four Pillars" is the AAs of individual investors discussed in the back of the book. They can get a better idea of their volatility tolerance by comparing their emotional reactions to those investor profiles. I think that's a much better guide than the typical "risk tolerance" questionnaire.

Part of the AA question is how they want to treat pensions (if any) & SS. They could consider them as the bond/Treasury portion of their ER package and end up with their ER portfolio having a very high allocation to stocks. OTOH they could ignore their pension/SS income (set it against living expenses) and focus on a balanced AA (like Coffeehouse) to just pay their unfunded expenses.

If that $125K job is secure and they're comfortable with frugality, they might be socking away $5-6K/month. If they feel strongly about holding bonds then perhaps they'd want to consider paying off the mortgage before building a bond portfolio (but that would depend on their mortgage interest rate and their "sleep-at-night" comfort). Otherwise I'd be putting the rest of it into small-cap value & international stocks!

There's a poster on M*'s Hands-On board, SamBro, who maintains a 100% stock mutual fund portfolio at age 93. He pretty much lives off the distributions with an occasional small liquidation for a larger capital expense. It's definitely not for everyone but he sailed through 2000-2003 with no worries and has stopped fretting about the future.

 

[yakers]

I am sure you are aware of the site ( http://www.diehards.org/), that is the perfect place to post an AA question. Here people seem to have a interesting range of income flows and willingness to live frugal, if necessary.
Does you friend anticipate a pension? I expect one so my 401k/Roths are heavily in stocks. I am avoiding conventional bonds right now. And I wish I had bought REITs earlier but I am not buying them now. But its easy for me to reply with something like 60% stocks (half foreign) 20% total bonds, 10% REITs, 5% TIPS and 5% cash. Easy since its not my money and I'm not actually doing that. The idea of 50/50 equities/FI or 60/40 is a good place to start.
From reading your book you know a lot about these possibilities so IMHO where you can really help your friend is to put one together that is compatible with his peronal comfort risk level. One that he will stay with over 20+ years even if the market tanks for a while. Of course that is what good FAs are paid to do. Any good AA will probably do if you stay with it. Bailing at the wrong time is the killer.

 

[TromboneAl]

it doesn't matter so much if you are retired or not

I'm not sure of that.  When you're still in accumulation mode, you're able to add more money when the market is down.  Therefore volatility is more damaging when you are in the distribution phase of your life.

Of course, as you near retirement, the amount you are adding is small compared with the amount you've already saved.

 

[Cb]

This is what we're heading toward as we roll out of our 401K's (thanks in large part to many of Chinwhisker's "Know Nothing Portfolio" posts on the Vanguard Diehards board):

US Equities:
Large Growth     9%
Large Value       9%
Small Value       9%
REITS               9%

International Equities:
Europe                9%
Far East              9%
Emerging          9%
Int’l Value         9%

Comm Fut Index     9%

ST Bond Index       9% (gradually increasing as we age)
TIPS                     9% (gradually increasing as we age)

Old Guitar Amps     1%

Our pension & (SSI x .75) ought to cover >50% of our budget after 60-62, so I'm comfortable with the high equity allocation. 

Cb

 

[Cut-Throat]

There's a poster on M*'s Hands-On board, SamBro, who maintains a 100% stock mutual fund portfolio at age 93. He pretty much lives off the distributions with an occasional small liquidation for a larger capital expense. It's definitely not for everyone but he sailed through 2000-2003 with no worries and has stopped fretting about the future.

I wouldn't worry about the future much at his age either! - He doesn't have much of one!

 

[justin]

I'm sort of in the same 6-10 years out predicament. Right now I'm almost 100% equities. I want to get the highest returns possible now. I don't mind spending a few extra years working if the market tanks in the meantime. The portfolio is very diversified with respect to active/passive, size, domestic/international, etc.

Probably once my portfolio gets to 70-90% of where I want it to be to support my SWR, I'll start gradually shifting into bonds. Any sooner and I'll forgo the higher returns of equities.

 

[grumpy]

If they can figure out what their likely withdrawals will need to be in retirement (living expenses minus pensions & other stable income sources) I would have them put 5 X that amount into laddered bonds or CD's now and put the rest 100% in equity mutual funds. So if they figure they need to withdraw $20K per year in retirement then they would put $100K in the ladder and all the rest in equities. The allocation within the equities can be as aggressive as will let them sleep well at night. They would roll over the CD's as they mature to capture any rising interest rates between now and ER. Once the are retired they would replenish the ladder from sale of equities unless market conditions dicatate that they wait for a better time to sell. They would have 5 years to ride out any substantial market drop.

This is pretty much the scheme I follow and it works well for me.

Grumpy

 

[ats5g]

Hey Bob,

Here's an article from Rick Ferri on The Asset Allocation Question. You could probably whip something up for them in 10 minutes.

- Alec

 

[Cut-Throat]

Hey Bob,

Here's an article from Rick Ferri on The Asset Allocation Question. You could probably whip something up for them in 10 minutes.

- Alec

But, if he doesn't do the proper homework, like reading the Four Pillars and a few other Investment books, if the market takes a turn south, he's likely to panic and not stay the course.

He's got to understand the history of the stock market! - Even those who use an investment advisor usually will panic and demand the advisor pull all of their investments out the market, despite protests of the investment advisor. It happens every at every bear market. This is the real danger of using an investment advisor. He can't stop you from panic that a Bear Market will surely inflict!

 

[ats5g]

But, if he doesn't do the proper homework, like reading the Four Pillars and a few other Investment books, if the market takes a turn south, he's likely to panic and not stay the course.

He's got to understand the history of the stock market! - Even those who use an investment advisor usually will panic and demand the advisor pull all of their investments out the market, despite protests of the investment advisor. It happens every at every bear market. This is the real danger of using an investment advisor. He can't stop you from panic that a Bear Market will surely inflict!

exactly. that's why the article talks about reinacting the 73-74 bear market, or the most recent one.

- Alec

 

[Mysto]

Hey Grumpy

I'd love to know more about your rules for when to replenish the fixed income ladder and anything else you wish to share about your model. I have been discovering the same method and I just started reading asset dedication (same basic idea - a fixed income draw as your fixed portion and the rest in equities)

Thanks

 

[Ed_The_Gypsy]

ESRBob,

If they are 6 years out, they could start setting up Galeno's CD ladder.

From his post of Nov 20, 2002:

Yes I am following the same mechanical withdrawal plan. In short, it goes like this:

FI = 25%
2y living expenses in MMF
2y living expenses in 2y CD (maturing in 1y)
2y living expenses in 2y CD (maturing in 2y)

Stocks = 75%

At the end of the year I sell 4% of the value of my stock portfolio and buy a 2y CD. I let half of the maturing 2y CDs go to MMF and I buy another 2y CD with the other half. I then divide the entire FI balance by 72 and that's my monthly draw for the year. At year end, I repeat the process.

Even with this three year bear market, my monthly FIRE income fluctuates very little thanks to my FI buffer. It's a similar approach to intercst's inflation adjusted withdrawals but slightly different in that I let the long term growth of my stock portfolio indirectly take care of any inflation or deflation in the economy.

Ed

 

[ESRBob]

Thanks all for great advice and links/resources. I've sent him a lengthy email and he is honing in on something around 80% equities, 20% FI and REIT. I suppose when I had a job with steady income, I was up in that range, too.