Biggest decision - asset allocation

[firewhen]

We will all ultimately retire, and most on the earlier side. While that is a big decision, I see a bigger one, and ultimately a lifelong one, of how to allocate one's nest egg. I have read here and elsewhere, that there are 2 major choices:

equities - higher returns with more risks
bonds/money market - lower returns with more safety

Up until now, I have always gone with equities (about 90%), and it has rewarded us well. Of course, it is always just paper gains/losses while you have a paycheck and do not rely on it for living expenses.

Even as I get closer to RE, it is not a major concern, but it is a leap of faith to live off a pile of money that will shrink/grow depending on the markets. We will have no pension other than SS which is a ways off. That makes it even more difficult.

Fortunately, we have saved a bit, and can live off an estimated 2.5% withdrawal, which is essentially the dividend yield currently. So even with a prolonged bear market, if dividends were not cut much, we would not have to sell into it to live.

The other option is to move more into fixed income, but that goes against my nature. Call it greed and habit. Although I am starting to come around to the thought of giving up some potential return for portfolio stability. Some market watchers see future returns in the 7-8% range, which is closer to bonds.

More than anything else I do, this can make or break our future. If the markets do give 8% over the next 30 years, we will wind up with millions and I will have happy kids (since we could never spend that much anyway). I see this as the more likely scenario, but the Japanese market is an indication that things can go wrong.

Long winded, but how are others handling their allocations?

 

[Animorph]

I'm pretty much all stocks. With the market looking overextended starting 1-2 years ago, I started moving a bit to cash. I had enough for about 3 years of full retirement when RE'd last November. DW decided not to retire yet, so we have a big cushion there as well. I plan to spend the cash down first rather than leaving it as a permanent allocation. I hope to do something similar in the future, selling equities for cash when the market exceeds expectations and hopefully using that cash in the dips, either spending it as needed or returning it to the market. With the market down 20%, I've already returned about 40% of the cash back to equities.

Only a year into a so far partial retirement, but that's the plan.

 

[2B]

I'm a reformed equity junkie myself. I used to be 90% equities but after reading various books and articles I decided to go to a more conservative 60% equities and 40% fixed income. It works out to about 5 to 15 years of living expenses in fixed income depending on what budget mode I am into. A small market decline wouldn't impact my spending but if 1929 returned I'd definitely go to the highly frugal spending plan.

I suggest you read Bernstein's Four Pillars. It will repeatedly put you to sleep but it's a great discussion of asset allocation. Scott Burns' articles on Couch Potato investing are easier reads. The forum has a recommended reading list that you can find in a search.

High equity exposures usually provide better long term returns. The operative word is "usually." A repeat of any one of our real market meltdowns (ala 1929, 1973 and others) will make the wisdom of owning bonds sink in but then it will be too late for you.

I personally am all in laddered CDs right now. I advocate holding individual issues of either CDs or bonds. I considering buying TIPS but I'll only get the actual bond. I do this rather than buying a mutual fund because I want to know that I really will get 100% of my principle back on a specific date. That isn't the case with bond mutual funds.

 

[Bikerdude]

I have a 50/50 bond/stock portfolio. Over time it should return 85% of a 100% equity portfolio at 50% of the risk. However, if you can live off of the dividend yield of a 100% equity portfolio I say go for it. But for me, I like to sleep at night.

 

[Alan]

I have a 40/50/10 mix with a target withdrawal of 3%. But I have plenty of fat in the budget and could easily manage on 2% withdrawal rate.

 

[W2R]

Like Alan, I could easily live on 2% which is more than my present budget while working. I might withdraw about 3-4% except in years when the market is down. I have some adjusting to do and do not know if I can spend money like that.

My planned asset allocation when retired is 45% equities, 55% fixed. I will get it in place and not mess with it, or at least I won't mess with it often.

My asset allocation up to 3 years before ER was 100% equities. That is risk-taking behavior, and my luck held as it paid off with good increases in the bull market environment of 2002-2006. I was diversified within equities, with much of it in small business and international.

During the crummy market just prior to those years, I was 33% equities and 66% bonds. In retrospect, probably I should have allocated a greater percentage to equities.

 

[unclemick]

Hmmm - I have this vague idea that 60/40 is the benchmark pension or Bogle's 'policy portfolio'.

First ten years of ER was handgrenade 60/40ish with 3% as my 'floor' portfolio yield and VG Lifestrategy moderate as my lead sled dog(nod to Fleckenstein). In jan 2006 sort of consolidated my outliers and went Target 2015 a lifecyle fund. Note that a small pension kicked in at +5 yrs and early SS at +10 yrs into ER - up to 40% of income if I throttle back SWR which I varied between 2.5 to 7% over the last 15 years.

7% the year after Katrina for house plus remodeling plus travel. 5% variable 2007 and maybe 4% this year cause I am not getting any younger.

Probably 65/35 now not adjusting for pension or SS.

heh heh heh - Sort of match your wiggles and waggles over the years and use your handgenades to stay within the kill radius of 25 times expenses - portfolio wise - or until RMD makes you an offer you can't refuse.

 

[Alan]

Hmmm - I have this vague idea that 60/40 is the benchmark pension or Bogle's 'policy portfolio'.

I'm sure you are right, but according to VG's portfolio analyzer there is only a 1% difference between 60/40 (8.9% long term avg) and 40/60 (7.9% long term avg) so I confess that I am taking the chicken approach and going for the lower return and volatility. For me that means more zzzz's, less stress, better health, ....... I hope

 

[walkinwood]

The magic of a portfolio composed of uncorrelated asset classes is that you can have a higher overall return than the average of the separate asset classes. That is, adding an uncorrelated asset that has a lower return, could raise your portfolio return.

I recommend reading the William Bernstein books - Four Pillars and also Intelligent Asset Allocator.

My allocation is currently 65% equities (domestic, international and REITs) and 35% bond (mainly short-term high-quality short term). During my accumulation phase it was 80/20.

 

[charlie]

I would like to bring up a point that is not discussed very often. That is, you need to be careful to consider the long term when you are young because over time your taxable investments will accumulate capital
gains that will cost you a bundle if you switch horses in mid-stream.

If I were a long way from retirement, I would seriously consider using Vanguard's new FTSE All World fund as my primary vehicle in the taxable account. This fund seems to cover all bases ..... low cost index and market weighted diversification among domestic, international and emerging market stocks. You could augment this one fund approach with other "ideas" as the urge strikes..... and believe me, they will.

At 74, needing supplemental income from my taxable account, I am using Vanguard's Wellington with a dash of Tax Managed Small Cap and FTSE All World Ex US.

The point is, plan ahead as far as you can, choose wisely and "stay the course". If you have to play around, do it on the edges.

Cheers,

charlie

 

[unclemick]

I would like to bring up a point that is not discussed very often. That is, you need to be careful to consider the long term when you are young because over time your taxable investments will accumulate capital
gains that will cost you a bundle if you switch horses in mid-stream.

If I were a long way from retirement, I would seriously consider using Vanguard's new FTSE All World fund as my primary vehicle in the taxable account. This fund seems to cover all bases ..... low cost index and market weighted diversification among domestic, international and emerging market stocks. You could augment this one fund approach with other "ideas" as the urge strikes..... and believe me, they will.

At 74, needing supplemental income from my taxable account, I am using Vanguard's Wellington with a dash of Tax Managed Small Cap and FTSE All World Ex US.

The point is, plan ahead as far as you can, choose wisely and "stay the course". If you have to play around, do it on the edges.

Cheers,

charlie

Amen!

heh heh heh - I wish Vanguard would quit coming out with new stuff that I like! aka All World Fund.

 

[jIMOh]

I am 97% equity now and 3% bonds. Age 35, about 15-35 years from retiring.

My plan is to sell 1% of portfolio to bonds every 6 months until I am at 80-20. This June I did not need to sell, the market corrected this for me. Part of the plan is to sell 1% off top of everything I hold 2X per year as well, but the market of 2008 had other ideas thus far.

The earlier I retire, the more I would like my withdraws to be dividend and interest payments (as opposed to selling shares). I think a 30 year retirement allows for selling shares, where as early retirement suggests to just live off the dividends and interest to allow for close to 50 years of withdraw.

 

[sidney]

Ours is approximately 50/50 .. mainly because we don't need to take the risk with a lot of equity (expenses are .8% of the total + we get a DB pension that starts in about 10 years).

 

[Spanky]

Our allocation is 52/48 (equity/fixed income) -- 5 years from retirement.

 

[FANOFJESUS]

Any more than a 60/40 and I have trouble sleeping at night.

 

[bamsphd]

I think of it in terms of one year's "safe" withdrawals, which I currently approximate as 4% of my investments.

• I keep between $10,000 and one year in MM funds.
• I keep about one year in a short-term bond fund for sudden unplanned needs, and for float when manipulating my bond ladder.
• I am building a five year TIPs ladder with new issues. Each year I invest 4% of my then current total investment portfolio in a new rung.
• The remaining roughly 70% is in equities. If taxes were not an issue, and Admiral shares were available, I would probably put almost all my equity money into Vanguard's new all world fund. As it is, I have a mix of index funds and individual stocks that I am reluctant to move because I prefer to defer taxes. I also keep my international outside of IRA/401k/etc accounts so that i can capture the foreign tax credit.

I still have a salary, but will not have a pension, and expect to wait at least 15 years before SS starts. I might decrease the equities to around 60% as I get even closer to retirement. Perhaps by purchasing some 30 year TIPs for a rainy day. I currently find it hard to imagine intentionally going below 60% equities, though a bear market could easily take me there. If it did, based on past experience, I would probably not make any significant portfolio changes. Though if it reached depression or Japan levels I would start eating my ladder.

 

[thaidyed]

I also keep my international outside of IRA/401k/etc accounts so that i can capture the foreign tax credit.

VERY curious, as I recently was off playing nice with forms 2555 and 1116...

How do you get the foreign tax credit by keeping your international equity investments in a straight-up taxes paid account?

 

[Moemg]

Whatever allows you to sleep at night is the correct allocation . For me it is 75% stocks 25% bonds and a nice pension.

 

[hankster]

I'm sleeping well at 65/35 with about 9 years to ER. Planning to slowly transition to 50/50 by then.

 

[DblDoc]

VERY curious, as I recently was off playing nice with forms 2555 and 1116...

How do you get the foreign tax credit by keeping your international equity investments in a straight-up taxes paid account?

It comes to you documented on a 1099 form. You don't get the credit if your holdings are in a tax deferred acount, nor if your international holdings are a "fund of funds".

DD

 

[bamsphd]

It comes to you documented on a 1099 form. You don't get the credit if your holdings are in a tax deferred acount, nor if your international holdings are a "fund of funds".

DD

DD is correct based on my experience.

 

[mickeyd]

Ten years ago, when I was slaving away, but bringing home a nice piece of change, I had a mix of 90/10 because I had a long time horizon and two DB plans. After reading all of the relevant books and applying the info to me, I realized that retirement was not all that far away.

I then changes my AA to 70/30. I am now semi-retired and have activated one of my DB plans (the one left still grows), DW draws her small DB plan and we have not touched SS. My AA is now 60/40. I suspect that it will remain there for many years because of the two income streams that I have not tapped yet (DB and SS).

Gotta love that flexibility.

 

[huskerblue]

After being *alls out with 100% stocks {a fair amount international} except for the TIAA Traditional that DW brought into the marriage, I have finally settled on an allocation that feels right for these last 5+ years before ER {started this in December}. Coming from the world of non-profit endowment due to a recent career change, the smooth ride achieved by endowment-like investing appeals so we are working toward:

30% domestic equity {still a bit heavy}
20% international equity {still a bit heavy}
10% real estate {some int'l} {not quite fullly invested yet}
10% natural resources/commodities/energy {not quite fully invested yet}
15% GIC's
8% TIP's {some int'l} {not quite fully invested yet}
7% absolute return {mostly Hussman SG}

The ride so far has been remarkably smoothed versus what I was used to with all stocks. Most stock is now in total market indexes with some small stock managed both domestic and int'l {2%}. Some ETF's, mostly funds with about 8% in individual stocks in a taxable account that have a lot of gain built in so holding.

 

[headingout]

A few years from ER now, my target AA is 50/50 stocks/bonds. However I add the PV of my SS to my bond position per Bernstein (Four Pillars, p.278-279) and others. Without that adjustment, my target allocation would be about 65/35. I'm holding my nose and rebalancing toward stocks in this market, but generally sleeping OK.

 

[firewhen]

What now?

I wrote this in August 2008, just before stocks lost half their value and unemployment doubled. I have not even been here much as ER seemed like a now far off dream. As the economy and our net worth has recovered, the gleam is starting to come back. I did promise myself that if we got back, I would seriously relook at our asset allocation. Fortunately I have not sold, and have ridden the wave back up to the point where net worth is within 10% of 2007. Do I look at this rebound as the chance to take some money off the table, or of the resiliency of stocks and of their long-term strength? At any rate, it is nice to be back!

We will all ultimately retire, and most on the earlier side. While that is a big decision, I see a bigger one, and ultimately a lifelong one, of how to allocate one's nest egg. I have read here and elsewhere, that there are 2 major choices:

equities - higher returns with more risks
bonds/money market - lower returns with more safety

Up until now, I have always gone with equities (about 90%), and it has rewarded us well. Of course, it is always just paper gains/losses while you have a paycheck and do not rely on it for living expenses.

Even as I get closer to RE, it is not a major concern, but it is a leap of faith to live off a pile of money that will shrink/grow depending on the markets. We will have no pension other than SS which is a ways off. That makes it even more difficult.

Fortunately, we have saved a bit, and can live off an estimated 2.5% withdrawal, which is essentially the dividend yield currently. So even with a prolonged bear market, if dividends were not cut much, we would not have to sell into it to live.

The other option is to move more into fixed income, but that goes against my nature. Call it greed and habit. Although I am starting to come around to the thought of giving up some potential return for portfolio stability. Some market watchers see future returns in the 7-8% range, which is closer to bonds.

More than anything else I do, this can make or break our future. If the markets do give 8% over the next 30 years, we will wind up with millions and I will have happy kids (since we could never spend that much anyway). I see this as the more likely scenario, but the Japanese market is an indication that things can go wrong.

Long winded, but how are others handling their allocations?