Asset allocation when approaching FIRE

[Pagw]

Hello - I was wondering has any work been done on the best strategy to transition from a high-stocks portfolio to one that is more conservative as the FIRE point becomes 5-10 years away? (This is assuming that the post-retirement portfolio will include a substantial proportion of more conservative assets.)

My current thought is to work out the time to FIRE, work out how much to save in shares such that they will have grown to the target amount for FIRE (say, 60% of the FIRE amount) by that time assuming a particular growth rate in future, and once that point is reached start putting all savings into the less risky assets (bonds etc.). This way, you don't expect to have to convert shares to bonds at any point (unless shares grow more than expected, which is a win), whilst having your target FIRE amount in shares in the market for the longest possible time and benefiting from the high expected return, so it seems efficient. And your holdings tend smoothly towards becoming more conservative as FIRE is approached. Also, if shares go down, the strategy would make you buy more, so you would still tend to top these up when valuations are lower. But I thought someone might have worked out a better way e.g. to better avoid setbacks caused by stock market crashes on the way. Also, maybe it's better to hold a higher proportion of shares for a while to benefit from their higher expected return?

Thanks for any thoughts you can share.

 

[Animorph]

Sounds as good as anything else.

My plan was to stay pretty much all stocks and retire when the portfolio was large enough, rather than pick a firm date. I chickened out, retiring in 2007, and converted about a third of the portfolio into bonds/cash/bear market investments that year. So that worked out better than it might have, but I didn't really follow the plan.

By the time the recession was over I was back to 100% equities. Now I'm working towards 75% equities. Our tax advantaged accounts have the new AA, but the taxable accounts are still 100% equities to avoid capitol gains taxes while we Roth convert.

I don't think there can be a simple answer to this question unless you know the future. Something like 100% equities can grow very fast initially in retirement and buffer any downturns after that. But an early market drop could be exciting. Moving to something very conservative would be safe through an early market drop, but would not grow fast enough to buffer any future drops. One is vulnerable early and one late.

A gradual transition from an accumulation portfolio to a retirement income portfolio might give a bit more certainty to the retirement date and be ready for the long haul.

 

[OldShooter]

One size fits none. If you will retire with $100,000 a reasonable AA will be different than if you retire with $10M. If you have well-tested understanding of your risk tolerance, that is a factor too. Finally, what is your objective? Do you want your last check to bounce or do you want to leave an estate?

We were 90/10 until we neared retirement. 15 years later we are 75/25. This is what suits our situation.

Incidentally, to plan to "work out how much to save in shares such that they will have grown to the target amount for FIRE" is naive. I'd suggest that you start by reading the The Bogleheads' Guide To Investing and Bill Schultheis' "The Coffeehouse Investor." (Alternatively, if you can really do that calculation with certainty please PM me your secret.)

 

[pb4uski]

I did what the OP described but wasn't as scientific about it... in my mid/late-40's I started investing new money in fixed income and just monitored as I drifted from 100/0 to 60/40.

 

[Retiredmajor]

We are 70/30 and plan to stay that way. Planning for about 30 years of retirement and feel comfortable with some swings. Of course, nothing is etched in granite and I reserve the right to adjust in the future.

 

[OldShooter]

I did what the OP described but wasn't as scientific about it... in my mid/late-40's I started investing new money in fixed income and just monitored as I drifted from 100/0 to 60/40.

Dispassionate hindsight is a little difficult now that you have seen the cards, but do you thing this was too conservative or about right? I doubt you'd say it was too aggressive.

 

[ejman]

I predict that preferred allocations at this time of market highs and exuberance will look markedly different from preferred allocations next time the market has a crash similar to 2008. If memory serves at that time lots of folks sold at the bottom to 100% cash because the end of the world was near. The shock was so severe that some market gurus changed their bed rock philosophy as a result. Its easy to say when the stock market is kind "I would never do that" but when the news are unrelentingly bad month after month after month ( and year after year in the Great Depression) it's a lot harder to resist.

 

[pb4uski]

Dispassionate hindsight is a little difficult now that you have seen the cards, but do you thing this was too conservative or about right? I doubt you'd say it was too aggressive.

Not sure what you are asking. Are you asking if I wish I had started to blend in fixed income earlier or later? If so, I dunno. It wasn't a very calculated decision... just a realization that I was getting old enough that I should have some fixed income.

 

[The Cosmic Avenger]

I predict that preferred allocations at this time of market highs and exuberance will look markedly different from preferred allocations next time the market has a crash similar to 2008. If memory serves at that time lots of folks sold at the bottom to 100% cash because the end of the world was near. The shock was so severe that some market gurus changed their bed rock philosophy as a result. Its easy to say when the stock market is kind "I would never do that" but when the news are unrelentingly bad month after month after month ( and year after year in the Great Depression) it's a lot harder to resist.

But...that defeats the whole purpose of having an AA strategy, if you deviate from it due to market conditions rather than a change in strategy (like becoming more conservative as you get older). From what I've heard here, most of us got through 2008 just fine because we stayed the course, not just month after month, but year after year as it took into 2011 or 2012 for the markets to fully recover to pre-2008 levels.

As I tell my partner, we're prepared for everything except the complete collapse of the world economy, in which case we're financially screwed no matter what our asset allocation or investing strategy!

 

[ejman]

But...that defeats the whole purpose of having an AA strategy, if you deviate from it due to market conditions rather than a change in strategy (like becoming more conservative as you get older). From what I've heard here, most of us got through 2008 just fine because we stayed the course, not just month after month, but year after year as it took into 2011 or 2012 for the markets to fully recover to pre-2008 levels.

As I tell my partner, we're prepared for everything except the complete collapse of the world economy, in which case we're financially screwed no matter what our asset allocation or investing strategy!

I completely agree with you that maintaining one's asset allocation strategy is the best approach ( and as you point out many of the posters @ this board do just that) yet it seems to be human nature to bail out and many succumb to fear when the markets turn ugly for a long time.

 

[sengsational]

Seems like ratcheting down the equity portion a little at a time is a good idea. Say your fixed income stash would last you 1 year at your current allocation. You draw a line from there to a number of years you're comfortable with, whatever...7, and step through an allocation adjustment every year so when you arrive, you have the cushion you're comfortable with.

 

[Telly]

About a year or so ago, there was an article by a reasonably-respected financial person (sorry, I don't remember who or where I read it!) that outlined a different approach than I had seen before. The gist of it was to reduce your percentage of equities over some years as you approach your retirement date. Then, after a few years of retirement, start to ramp it up again. So a glide slope down to retirement, then hold steady at a value, then a glide slope back up to a final long-term allocation.

As I Early-ER'd quite a few years ago and had no knowledge of any of that then, I have been holding at 60/40 the whole time retired. I remember the killer inflation years, and I think that affected me more in thought than the worry of declining equities in a down market. As far as worrying about the interval BEFORE retirement, I didn't then, as my early-early retirement came upon me completely unexpected.

 

[W2R]

I did what the OP described but wasn't as scientific about it... in my mid/late-40's I started investing new money in fixed income and just monitored as I drifted from 100/0 to 60/40.

Sounds reasonable.

Like most here, my retirement AA (45:55) was more conservative than my AA while in the accumulation phase (100:0).

When doing my original retirement planning, I read in one of the books on the Boglehead's book list that it was good to move investments to the planned retirement AA during the last three years of working. So, that is what I did and when I did it, myself.

Now that I am long retired and over 70 (a.k.a. "Older than Methuselah"), I am slowly shifting to an even more conservative AA, 110-age. Every year after withdrawing that year's spending money, I rebalance, and that is when I make that year's shift to a slightly more conservative AA.

 

[USGrant1962]

About a year or so ago, there was an article by a reasonably-respected financial person (sorry, I don't remember who or where I read it!) that outlined a different approach than I had seen before. The gist of it was to reduce your percentage of equities over some years as you approach your retirement date. Then, after a few years of retirement, start to ramp it up again. So a glide slope down to retirement, then hold steady at a value, then a glide slope back up to a final long-term allocation.

That is the bond tent approach described by Kitces here: https://www.kitces.com/blog/managing-portfolio-size-effect-with-bond-tent-in-retirement-red-zone/

In particular he notes that the years leading up to and soon after the retirement date are a "red zone" where sequence of returns risk is highest.

I'm following a version of bond tent - was my lowest equity ever at 55% when I retired at 55 years old. Using age in stocks from there.

 

[Pagw]

Thanks very much for all the replies. Yes I recall now coming across the bond tent or equity glide path ideas before, which seem relevant - I haven't found the analysis behind Kitces' illustration in USGrant1962's link where he treats the 10 years leading up to the retirement date as special (as opposed to 5 years or 15 years), and I don't know if that's meant to be taken literally - it would be interesting to know what would actually have worked best given historical asset returns (as imperfect a guide though that is). At least using 10 years as a time span in which to shift assets over seems like it might be reasonable.

The bond tent idea looks to be based on the analysis in this article: https://www.onefpa.org/journal/Pages/Reducing Retirement Risk with a Rising Equity Glide Path.aspx . The impact on portfolio performance made by the tent looks very subtle according to their statistics, though, so it seems unclear that has a good chance of actually working better in future (particularly when bond interest rates are currently so low), so I don't feel inclined to follow that approach at present.

 

[Which Roger]

Since I became a boglehead-style investor about 15 years ago, I've maintained an asset allocation of age-10 in bonds. I rebalance annually, and since I'm a year older each time, add 1% to my target allocation of bonds. So at age 45, I was 65/35 stocks/bonds, at age 46 I was 64/36, then 55/45 at age 55, and so on.