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Asset allocation idea/question
Old 05-13-2007, 10:45 AM   #1
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Asset allocation idea/question

Hi all,
I have been early retired now for 1 year ( 59 ), the first 6 months was strange but now I could never go back.

The question I have is asset allocation. The story goes that anything between 100% stocks to 60/40 stock/bonds 50/50 etc. is a good allocation. Aparently the bond portion is for income.
Well my idea of looking at it is as follows, say you want 50/50 ( just for example ) you have a small pension of say $30,000 a year. At 5% interest that would require $600,000 capital. If you had capital of $600,000 and placed it ALL in index funds ( divesified of course.) That would be the eqivalent of 50/50 stock /bond allocation.
In other words the pension becomes the bond part of the portfolio.
Am I missing something.

Regards Brit.
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Re: Asset allocation idea/question
Old 05-13-2007, 10:52 AM   #2
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Re: Asset allocation idea/question

pensions should be kept out of the equation the same as we keep our salarys out of it.. you cant re-balance a pension, or use your future pension to buy stocks in a downturn.
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Re: Asset allocation idea/question
Old 05-13-2007, 11:07 AM   #3
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Re: Asset allocation idea/question

Some look at it that way.

I believe you can view the annuity as an income stream. But having an asset allocation across bonds and a variety of equity classes and a cash reserve pool enables one to rebalance and capture some of the gains into an asset that has a lower correlation that may be down or regrouping for the next advance.

In other words. Look at the annuity (pension) as part of an income stream not as the portfolio.

Look at the portfolio as a mechanism to capture gains and buffer volatility (rebalancing between equity, bonds, and cash pool). Essentially you buy less volatility at the expense of reduced gains. The resulting benefit is cash when you need it with less chance of damaging the portfolio. That cash when you need it is the other part of your income stream that the pension does not provide.

If your $30k/year is all of the income you need... then 100% stock is not a big problem since you can wait out stock market down cycles. Even if thaqt is the case, I would pool some money into a cash (money market or short term bond) fund for consumption purposes... because it is difficult to judge the equity markets and corrections.
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Re: Asset allocation idea/question
Old 05-13-2007, 02:24 PM   #4
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Re: Asset allocation idea/question

Quote:
Originally Posted by Brit
If you had capital of $600,000 and placed it ALL in index funds ( divesified of course.) That would be the eqivalent of 50/50 stock /bond allocation.
In other words the pension becomes the bond part of the portfolio.
Am I missing something.

Regards Brit.
This has been discussed before. You might want to search for it. I agree with you and count my pension as bonds. I therefore have all my capital in non-bond funds.
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Re: Asset allocation idea/question
Old 05-13-2007, 03:56 PM   #5
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Re: Asset allocation idea/question

Quote:
Originally Posted by Brit
Am I missing something.

Regards Brit.
Yes.

The bond portion is NOT for income. It's to balance out the stock portion and to lower the overall volatility of the portfolio. When stocks go down, you sell some of the bonds and use it to buy stocks, thus rebalancing the portfolio. When stock go up, you sell some of the stocks and buy bonds. That way, as your portfolio (hopefully) grows over time you are reducing the risk back to your original allocation, constantly harvesting from the higher performing assets.

You don't worry about the yield of your investment portfolio. The yield is not to generate income. When you extract your annual withdrawal from the portfolio, you sell whatever has increased in value the most over the year and rebalance the portfolio.

Audrey
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Re: Asset allocation idea/question
Old 05-13-2007, 08:12 PM   #6
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Re: Asset allocation idea/question

(3) Pension or annuity: If the payments are fixed for life, multiply the after-tax annual value of your payments times your current age divided by 100. So, if you were getting a $30,000 fixed pension each year, a 20% tax would be 0.20 x $30,000 = $6,000 and the after-tax amount would be $30,000 - $6,000 tax = $24,000. The amount you could afford to spend this year at age 70 would be $24,000 x 70 / 100 = $16,800. That leaves $24,000 - $16,800 = $7,200 to be reinvested to compensate for future inflation.

A Practical Note: Rather than save a certain amount from each Social Security and pension check, it’s usually more practical to spend the entire after-tax amount and reduce the amount that you would otherwise draw from investments by a comparable amount. In this example case the amount you would subtract from the amount you can draw from investments would be $2,700 (if you used the Social Security refinement) as well as $7,200 for a year’s pension withdrawals. Next we’ll calculate how much you project you can afford to draw from investments before such reductions.

From Analyzenow.com "Simplest Retireemnt Plan" article
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Re: Asset allocation idea/question
Old 05-13-2007, 09:48 PM   #7
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Re: Asset allocation idea/question

I don't count my pensions and SS as part of my portfolio. I look at the delta I need to maintain my expected expenses and have an AA that matches that need and my risk tolerance. Having said that, even if my pensions covered all my needs I would never go greater than an AA of 80/20. I just am more comfortable having at least a 20% bond/fixed income portion to reduce some of the volatility.
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