Asset Allocation Help

[TedMunson]

Hi All-

I am not sure if this is the right place to post this question as I am new to the forum. If it should be place elsewhere please let me know.

DW and I were just talking about getting serious about ER, my intro is in the Hi I am... section, and it made me think that maybe we should review where are retirement assets are currently. The company that I work for does not offer a retirement plan, but I am working deligently to change that. So that just leaves my Roth IRA, which is invested in a life cycle fund with Vangaurd (Target Retirement 2045). My wife has a 403b and 457 plan. The 457 plan has a small cap fund in it, which accounts for a pretty small amount of our portfolio. The 403b has a bond fund (12%), a reit fund (9%), target retirement 2045(67%) and emerging markets (12%). My wife also has a Roth IRA with the 100% in the Star Fund. I chose this fund because at the time it had the lowest initial amount needed to open an account.

Now to my question. I think that we have too many bonds in our portfolio and I am thinking about exchanging the Star Fund for a stock fund. I am just not sure which one. Most of our money is in index funds, but I am not opposed to actively managed Vanguard funds. I was initially thinking that we should exchange the Star Fund for either the Mid Cap Index or the Small Cap Index fund. Do any of you have any suggestions?

I should also add that our portfolio is not very big, but it is starting to grow a little bit at a time

Ted

 

[jIMOh]

You need to step back. Don't look at each fund. Look at sum of all the parts.

I might suggest doing a morningstar x-ray. It will tell you what your allocation is.

Allocation in simplistic terms:

%equity/%bonds/%cash

Allocation is mild terms:
% domestic equity/% foreign equity/ % bonds/% cash

Allocation in detailed terms
domestic (large cap value, large cap growth, midcap value, mid cap growth, small cap value, small cap growth), foreign (large cap...)

Before doing the detailed allocation, look at the simple allocation.

Then look at retirement goal (money goal)- will overall allocation get you there?

Then put a time on it. Will amount be reached based on time table you want?

If current allocation gets you there by age 60, and you want to retire at 55... it's possible lifestyle changes could make up for 5 years without adjusting allocation.

My answers to above (for me):
99% equity, 1 % bond
74% domestic equity, 25% foreign equity, 1% bond

I shoot for
44% domestic large cap, 15% domestic mid cap, 15% domestic small cap, 15% international large cap and 10% international small cap. 1% bonds.

I sell 1% of portfolio every 6 months to raise bond allocation.

I need ~$1.5 M to retire at age 60. If I pay off house earlier, I can reduce the $1.5 M goal to around $1 M. With what I have invested now, I can hit $1.5 M by age 60 with a 9% return (I have close to $125k invested now, and am 34 yo).

 

[wildcat]

Ted, do you mind disclosing your age and risk tolerance?

Do you and your wife intend to combine your asset allocation or do you intend to keep it separate in order to match each individual's risk tolerance? Together I assume.

 

[LOL!]

Best place on the web for free, serious, and personalized asset allocation advice is Bogleheads :: View Forum - Investing and Personal Finance
Be sure to read the 'instructions' at the top. Also it is helpful to know a bit beforehand by reading All About Asset Allocation and/or The Four Pillars of Investing.

 

[Spanky]

What does "too much" bond mean? What is your desired bond allocation? What is your desired asset allocation (AA)?

Adjust your fund holding based on your desired AA -- it's very simple.

 

[TedMunson]

Asset Allocation

Wow, thank you all for your questions and comments.

jIMOh, you have outlined exactly what I am attempting to do. However, you have done it with much more clarity, thank you. I am still working on this but here is how our assets breakdown for both DW and myself.

DW 403b, Roth IRA and 457:
Overall - 74.9% Stock/25.1% Bond

73% US
27% International

65% Large Cap (LC)
27% Mid Cap (MC)
8% Small Cap (SC)

My Roth IRA
Overall - 90% Stock/10% Bond

80% US
20% International

63% LC
28% MC
9% SC

I am still working on looking at both of our portfolios as one portfolio. But I think that based on what we have right now we need to reduce our bond allocation with more stocks, in the hope for higher returns, to reach our retirement goals. The retirement number is also something that I am struggling with. Being atleast 20 years out I am not sure what that number will be. If I had to guess, maybe $2M with a paid off house, but that is really just a guess. BTW, I like that you have a stronger slant toward small caps.

I should also mention that both DW and I have about the same amount in our respective accounts, small but growing.

Wildcat, I don't mind disclosing my age at all. I am 30 and DW is 29. I would say that our risk tolerance is pretty high. We aren't interested in day trading or betting on penny stocks (no offense to anyone who has been successful at either of these) and we do invest primarily with index funds, but we are of the mindset that we can handle a market downturn because we have a long time horizon. In fact, from what I have been reading it looks like we should welcome a market downturn while we are in our accumulation stage. My job is pretty stable and DW job is very very stable. Also, she will have in addition to the above accounts a pension. Lastly, we do plan on combining our portfolios to mimic one account. In that sense we have the same risk tolerance.

LOL!, thanks for the heads up on the Bogleheads. I have been to their site many times and think I have learned a lot on that forum. I have also read the Bogleheads book, which is a really great read, in my opinion, for just about anyone.

Spanky, I think that too much bond means that I would like to lower our bond allocation to about 10% in the hopes of attaining a higher return. I think that my desired allocation would be 90% stock/10% bond. I guess my real question is should I re-allocate the Star Fund, which holds about 25% bonds and 12.5% short term reserves, into a more agressive stock fund like the Mid Cap Index, Small Cap Index or other stock fund. You are right, the allocation (90/10) part is very simple, but how to split up the allocation between LC, MC, and SC is what has me a little bit confused.

Thanks again for all of you responses. Please let me know if I haven't answered your questions correctly, I'm still learning

Ted

 

[jIMOh]

Wow, thank you all for your questions and comments.

jIMOh, you have outlined exactly what I am attempting to do. However, you have done it with much more clarity, thank you. I am still working on this but here is how our assets breakdown for both DW and myself.

DW 403b, Roth IRA and 457:
Overall - 74.9% Stock/25.1% Bond

73% US
27% International

65% Large Cap (LC)
27% Mid Cap (MC)
8% Small Cap (SC)

My Roth IRA
Overall - 90% Stock/10% Bond

80% US
20% International

63% LC
28% MC
9% SC

I am still working on looking at both of our portfolios as one portfolio. But I think that based on what we have right now we need to reduce our bond allocation with more stocks, in the hope for higher returns, to reach our retirement goals. The retirement number is also something that I am struggling with. Being atleast 20 years out I am not sure what that number will be. If I had to guess, maybe $2M with a paid off house, but that is really just a guess. BTW, I like that you have a stronger slant toward small caps.

I should also mention that both DW and I have about the same amount in our respective accounts, small but growing.

Wildcat, I don't mind disclosing my age at all. I am 30 and DW is 29. I would say that our risk tolerance is pretty high. We aren't interested in day trading or betting on penny stocks (no offense to anyone who has been successful at either of these) and we do invest primarily with index funds, but we are of the mindset that we can handle a market downturn because we have a long time horizon. In fact, from what I have been reading it looks like we should welcome a market downturn while we are in our accumulation stage. My job is pretty stable and DW job is very very stable. Also, she will have in addition to the above accounts a pension. Lastly, we do plan on combining our portfolios to mimic one account. In that sense we have the same risk tolerance.

LOL!, thanks for the heads up on the Bogleheads. I have been to their site many times and think I have learned a lot on that forum. I have also read the Bogleheads book, which is a really great read, in my opinion, for just about anyone.

Spanky, I think that too much bond means that I would like to lower our bond allocation to about 10% in the hopes of attaining a higher return. I think that my desired allocation would be 90% stock/10% bond. I guess my real question is should I re-allocate the Star Fund, which holds about 25% bonds and 12.5% short term reserves, into a more agressive stock fund like the Mid Cap Index, Small Cap Index or other stock fund. You are right, the allocation (90/10) part is very simple, but how to split up the allocation between LC, MC, and SC is what has me a little bit confused.

Thanks again for all of you responses. Please let me know if I haven't answered your questions correctly, I'm still learning

Ted

The info you gave is good.

Being age 30, I might suggest a two or three tiered retirement plan. Creating a plan without a goal or milestones (to track progress) will lead to where you are now. Step back from the asset allocation issue and set some goals.

Here's the ones I use:

current take home income/.04=$aving$ goal. If I take home $48,000 each year, the goal is 48,000/.04=$1.2 M.

In my case I buffer the 48,000 with a 25% increase (taxes, raises, increased spending). As I approach retirement, I reduce the buffer. So my goal is $1.5 M (48,000+25%/.04=$1.5 M).

Next step is to create milestones.

1.5 M is the age 60 goal. I want half of this by age 52. I keep subtracting 8 years and dividing need by half.

$1.5 M age 60
$750,000 age 52
$375,000 age 44
$187,500 age 36
$93,750 age 28

I am 34... and have close to $150k saved thus far. If I hit the age 36 goal (it will be close), that means my current savings gives me a retirement date of age 60 (assuming a 9% return). Anything I contribute after this point is for early retirement. The ER goal is hit the next $$ amount by the age which is 8 years younger (like $750k by age 44). My goal has already been reduced from age 68 retirement.

So goal 1 is normal retirement (age 60)
goal 2 is early retirement (age 52)
goal 3 is late retirement (age 68 if life happens).

One thing I have learned from this website is the goal I have set is high/aggressive. it is very possible I can retire earlier with less than I am planning.

Next step is the asset allocation to get 9% return. I think a 75-25 portofolio can yield an 8-9% return annually. No reason, IMO, to think you need to reduce bond exposure if you were in my situation (but if you were well short (40k+) of the 93k goal by age 28, I might change this advice.

In my case I manage the portfolio of each 401k differently.

My 401k is 74/25/1 (domestic equity-international equity-bond)
My wife's 401k is 75/25
Our Roth IRA is close to 75/25

I manage each one seperately. For example, I am on 401k #4 starting in January. 4 401ks in 11 years because my company keeps changing owners (was SDRC, then EDS, then UGS, now Siemens). Each owner has a new 401k... to manage changing funds in my IRA each time we get bought/sold is too much work.

My wife is on 401k #4 as well. She hasn't had stable employment until last 2 years... and has had 3 employers over the last 6 or 7. I allocate hers as 75/25 as well.

The advantage to this, is I can look within each account, see if it's out of whack (unbalanced) and reallocate without regard to other accounts. Takes some adjusting- my 401k is short on mid caps, so I have 30% in small caps... wife's 401k is short on small caps, so she has 30% in mid caps. Niether of us have a good international small cap fund, so it's just 25% international large caps in each 401k.

My Roth+ wifes Roth= portfolio core. This I pay lots of attention to, because the Roth will last longer than any of the 401ks. Our Roths are with T Rowe Price. My Roth is 10X the size of my wife's, but she'll catch up soon, because I plan to put some more aggressive choices in hers at 1/2 the amount of mine (so a 15% small cap allocation is 10% conservative in mine and 5% aggressive in hers).

Using some leveraged funds and concentrated funds to bridge the gap (and shoot for an early retirement).

 

[Dawg52]

I think your current allocation is fine. One guide some people use is the 100 rule. 100 - age = stock allocation. Some use 110 as the beginning factor. Looks like you fall right in the middle of the guide.

You might be glad you have some bonds next time we have a stock correction(crash).

 

[TedMunson]

Assest Allocation

jIMOh, thank you for sharing your retirement plan and goals. Maybe that is posted all over the internet somewhere and I just haven't seen it, but that is the best answer that I have seen for how to estimate a retirement number and then get to it with milestones. Now that I have the milestones the retirement number doesn't seem nearly as daunting. I think getting to my first milestone at 36 is going to be pretty tough, but from there on out I imagine it will get easier.

Now, if I could just figure out how much DW's pension will be worth at the time of retirement. I guess I'll probably have to talk directly to her employer about that one.

Dawg52, thanks for the suggestion.

Cheers,

Ted

 

[jIMOh]

jIMOh, thank you for sharing your retirement plan and goals. Maybe that is posted all over the internet somewhere and I just haven't seen it, but that is the best answer that I have seen for how to estimate a retirement number and then get to it with milestones. Now that I have the milestones the retirement number doesn't seem nearly as daunting. I think getting to my first milestone at 36 is going to be pretty tough, but from there on out I imagine it will get easier.

Now, if I could just figure out how much DW's pension will be worth at the time of retirement. I guess I'll probably have to talk directly to her employer about that one.

Dawg52, thanks for the suggestion.

Cheers,

Ted

Consider the pension closer to retirement, you don't need it for planning 30 years out.

Plan on saving the entire amount needed. It's just a number.

Once you hit a status check/milestone (like age 36), work on getting 8 years ahead of the plan. Somewhere in there factor the pension income.

I had a pension 8 years ago at EDS. They sold us off and I lost it. I have around 4k in a rollover IRA from it, though. That is not considered in my planning right now.

All of that which I posted above came from learning, asking questions and listening to others.

The asset allocation is mine- I figured out how much risk I could take myself.

For bonds, my calculator is "20-years to retirement=%bonds". If number is negative, no bonds... at year 19, 1%, at year 15, 5%... gradually increasing bonds over the final 20 years of working.

This assumes a long, early retirement. The year I retire I would be 80-20, and I assume I would add another 10 or 20% to bonds the year I retire (or add 10 or 20% cash in addition to 20% bonds).

 

[Doubledoc]

JimOh,

I like your approach and logic to work backwards from the goal. I also like that you have short-term milestones to drive the right investment decisions. I'm a little worried you aren't accounting for inflation. That $60k you need now will be $120K in 30 years and you'll end up with half of what you need - unless I'm missing something?

DD

 

[Spanky]

Spanky, I think that too much bond means that I would like to lower our bond allocation to about 10% in the hopes of attaining a higher return. I think that my desired allocation would be 90% stock/10% bond. I guess my real question is should I re-allocate the Star Fund, which holds about 25% bonds and 12.5% short term reserves, into a more agressive stock fund like the Mid Cap Index, Small Cap Index or other stock fund. You are right, the allocation (90/10) part is very simple, but how to split up the allocation between LC, MC, and SC is what has me a little bit confused.

For the equity (90%) portion, determine the allocation to overseas. For example, if it is 50%, then your allocation to US will be 50%.

For a very simple portfolio:
45% Vanguard Total International (or its ETF)
45% Vanguard Total Market (or its ETF)
10% Vanguard Total Bond Market


For a sliced and diced (S&D) portfolio, divide the US allocation evenly into LC and SC. Do the same for international if possible.

For a more complicated S&D portfolio, divide both US and international into LG, LV, SG, SV. It might be hard to find an index fund for international small cap growth and small cap value.

For an even more complicated one, add REIT, EM, commodities, energy and precious metal.

As you can see, allocation can be very simple or complex as more asset classes are added. Over a long-term (say 30 years), the return between a simple portfolio (i.e., 3 to 4 funds) and a S&D portfolio may be very similar albeit the S&D portfolio may exhibit lower volatility.

 

[jIMOh]

JimOh,

I like your approach and logic to work backwards from the goal. I also like that you have short-term milestones to drive the right investment decisions. I'm a little worried you aren't accounting for inflation. That $60k you need now will be $120K in 30 years and you'll end up with half of what you need - unless I'm missing something?

DD

You only spend what you have. Income drives spending and I will save based on my income and measure everything relative to take home income (which accounts for 100% of our spending).

I bumped up 25% to account for raises (which allow for increased spending) and I am comfortable with that... considering that house is paid off, and money needed might be 50% of what I need now. So the 60k now=120k later also means the 48k I need now goes down to 24k without my mortgage.

Also consider $800/month comes from my take home income and goes into my Roth and my wife's Roth. Again this is money I include in spending, but won't need in retirement.

We also have a rollover IRA for me not included in any calculations right now (it has 4k in it). My wife also plans to work much longer than me, and her 401k is not included either (meaning the 150k I have is my 401k plus my Roth).

Bottom line, assumptions need to be made for 30 year planning. For me to retire today the goal is 1.5 M. I could get a 25% raise and that number still holds true. If in 20 years I make more money, that whole goal shifts upwards... but there is no way of planning for a salary I may or may not have.

Live below our means to some extent, and see the hand life deals me.

 

[jIMOh]

For the equity (90%) portion, determine the allocation to overseas. For example, if it is 50%, then your allocation to US will be 50%.

For a very simple portfolio:
45% Vanguard Total International (or its ETF)
45% Vanguard Total Market (or its ETF)
10% Vanguard Total Bond Market


For a sliced and diced (S&D) portfolio, divide the US allocation evenly into LC and SC. Do the same for international if possible.

For a more complicated S&D portfolio, divide both US and international into LG, LV, SG, SV. It might be hard to find an index fund for international small cap growth and small cap value.

For an even more complicated one, add REIT, EM, commodities, energy and precious metal.

As you can see, allocation can be very simple or complex as more asset classes are added. Over a long-term (say 30 years), the return between a simple portfolio (i.e., 3 to 4 funds) and a S&D portfolio may be very similar albeit the S&D portfolio may exhibit lower volatility.

As a beginner I sliced and diced as stated above. 15% into large cap, 15% into mid cap, 15% into small cap really overexposes the risk (mid and small caps are much riskier than large caps).

Gain more experience and learn things like 45% large cap to 15% small cap.

for a $100,000 portfolio, 45% large cap is $45,000, probable 8% returns would yield $3600 each year.

for same $100,000 portfolio, 15% small cap is $15,000. If positioned to get 30% or 40% returns, the 30% on small caps is $4500.

Meaning a smaller position could equal the return of the large position on a dollar basis.

The likelihood small caps out perform by 20 basis points might be minimal, depends on how concentrated the position is.

While this is good theory, look at particular funds sectors. Emerging markets would need only a small position relative to core to gain same dollar return. Same with micro caps, International small caps (PRIDX is a good example).