Considering AA change from x-age to x years of cash+bonds

[RunningBum]

Since retirement, I've been doing some form of an age based AA, with fewer equities as I've been getting older. X has varied as I've reassessed my risk tolerance, but it's currently 120-age, and has always been > 100. I'm strongly considering changing that to a range of years worth of withdrawals (expenses) in non-equities. Perhaps 10-15 years, based on my view of market conditions.

A poll I started a couple years ago (http://www.early-retirement.org/forums/f28/age-based-aa-poll-88258.html) opened my eyes that many of you smart people are not using an age based AA, so this has been stewing for awhile. I don't mind bucking the norm if I'm comfortable with my reason for doing it. Then in the recent thread http://www.early-retirement.org/forums/f28/asset-allocation-100830.html (end of page 1, start of page 2), age based AA was basically said to be too simplistic and probably not right for most people. I asked why it was wrong, and the question was astutely turned around to me, "why are you using age based AA?"

Well, that kind of stumped me. The stock answer is that as you get older, you have less time to recover from a downturn, thus you should take less risk, but does that really make sense in a case like mine, where I will almost certainly not run out of money, have heirs to leave money to, and fewer years of my life I need to fund? I don't think so. What I really want is to be able to ride out an extended downturn without having to liquidate depressed stocks. Age is not really a factor for that. I'm no longer comfortable with x-age.

Another thing that bugged me about both x-age and a set AA is that in a downturn, how do you avoid selling stocks but stick to your AA plan?

What I'm consider is, in times like these where we've had a bull market, to keep 15 years of bonds+cash. In a downturn I'd let it go as low as 10 years. So in a bad year, I'd spend a year's worth out of the bonds+cash, and at the end of the year I'd drop my requirement to holding 14 years of bonds+cash. Depending on how the next year went, I could drop it another year with another bad market year, hold it at 14 if things were pretty steady, or go back to 15 years if the market had recovered. In a really bad year I could drop my cash/bond requirement by more than one year at a time, but to no lower than 10 years.

If we had an extended downturn as I get older, that 10-15 years of cash+bonds could turn into a significant % of my holdings, but if things matched most historical runs, I would keep a pretty high % of stocks, and still be safe with 10-15 years of cash+bonds to fall back on. Both seem acceptable and reasonable to me.

I'm not sure if 10-15 years is the right range, but 15 years happens to put me at pretty close the AA mix I have right now, so it wouldn't be an adjustment. I don't know if I want to go much lower than 10 years just in case of a market drop that takes a really long time to recover. I could always revisit the plan if I have to.

One further detail, right now I have assigned NPVs for SS and my small pension, add them to my investment portfolio value, and treat that like cash. (I actually use 75% of SS.) Once I start collecting on them, I will take them out of my portfolio value, but the benefit will also reduce the withdrawal needed each year, so I think it'll be a pretty seamless transition. I could use a side fund instead, but I like the idea of leaving the start of SS flexible. I plan to wait until 70, but might take it earlier if we have a big market downturn.

Anyone still reading? Did I explain it well enough? Please shoot holes where you see issues. Does the plan in general make sense? Is 10-15 years a reasonable range? I'm 58 if that matters.

 

[W2R]

I am no guru about this stuff, so I'll let others tackle it instead of me. But I *DO* have the answer to this question:

Another thing that bugged me about both x-age and a set AA is that in a downturn, how do you avoid selling stocks but stick to your AA plan?

During a downturn, such as 2008-2009, stocks went down more than bonds or cash. So, basically when you rebalance to get back to your asset allocation at times like that, you are selling bonds/cash and buying stocks, not the reverse. You are buying low.

It takes guts to do this! But this is how some of us came out of the Great Recession better off than previously.

I am in the process of slowly moving from a fixed AA to 110-age. For me, the simpler the better so this is about as complicated as I would ever want to try.

 

[RunningBum]

I am no guru about this stuff, so I'll let others tackle it instead of me. But I *DO* have the answer to this question:
During a downturn, such as 2008-2009, stocks went down more than bonds or cash. So, basically when you rebalance to get back to your asset allocation at times like that, you are selling bonds/cash and buying stocks, not the reverse. You are buying low.

It takes guts to do this! But this is how some of us came out of the Great Recession better off than previously.

I am in the process of slowly moving from a fixed AA to 110-age. For me, the simpler the better so this is about as complicated as I would ever want to try.

Yep, you're right, at least in a decent sized downturn. This shows that I need to model some different scenarios in a spreadsheet to make sure I really understand how this would work and that I'm ok with it. Thanks.

 

[davebarnes]

We (ages 71/62) are at 7 years of cash and [short-term] bonds.
Assuming average market returns, we will increase this over the next decade.
But, for us, stocks, baby, stocks.
According to various retirement models, we will leave our daughter somewhere between $30K and $13M.

 

[audreyh1]

Yep, you're right, at least in a decent sized downturn. This shows that I need to model some different scenarios in a spreadsheet to make sure I really understand how this would work and that I'm ok with it. Thanks.

I have a minimum number of years of post-tax spending in fixed income that I won’t go below when rebalancing.

I actually hit that limit in 2008. Knowing that I had that minimum threshold made it psychologically possible to rebalance during a very scary time.

But I’m usually way above that as I’m currently targeting 50% fixed income.

So the minimum threshold is only there to keep fixed income from going too low during bad equity market times, when I am drawing it down to buy stocks. You if keep fixed income low all the time you might not have enough to buy stocks when they go on sale.

 

[GR111]

Hi RunningBum and all,

Have you looked at the bucket strategy? Morningstar has a great description of it, but the executive summary is to keep 5-7 years worth of money you will need in fixed income/cash, and every thing else in equities. The idea is that in a down market you never need to sell your equities, even if it takes 5-7 years for the market to rebound. Your income stream comes from the fixed income bucket. That’s the strategy we use though we are a bit cash heavy this late in the market cycle. Good luck!

 

[RunningBum]

I have a minimum number of years of post-tax spending in fixed income that I won’t go below when rebalancing.

I actually hit that limit in 2008. Knowing that I had that minimum threshold made it psychologically possible to rebalance during a very scary time.

But I’m usually way above that as I’m currently targeting 50% fixed income.

So the minimum threshold is only there to keep fixed income from going too low during bad equity market times, when I am drawing it down to buy stocks. You if keep fixed income low all the time you might not have enough to buy stocks when they go on sale.

Hmm, more reason to do some modeling. Am I better off staying highly invested in equities, or to leave more room to buy more stocks when they are low? With the strategy I was thinking, I shouldn't need to sell equities when low, but I probably wouldn't be buying either, in most cases. Maybe I need a larger range and more adjustment in down times, or maybe it just doesn't work well.

 

[RunningBum]

Hi RunningBum and all,

Have you looked at the bucket strategy? Morningstar has a great description of it, but the executive summary is to keep 5-7 years worth of money you will need in fixed income/cash, and every thing else in equities. The idea is that in a down market you never need to sell your equities, even if it takes 5-7 years for the market to rebound. Your income stream comes from the fixed income bucket. That’s the strategy we use though we are a bit cash heavy this late in the market cycle. Good luck!

I'll take a look, thanks. 5-7 years probably handles most cases, but maybe not a worst reasonable case situation. Also, I don't think I'd want to be 100% equities in 7 years. Might have some large irregular expenses pop up at the worst time, and be forced to sell stocks low.

 

[GR111]

Here is a link that provides more info on bucket strategy if interested:

https://www.morningstar.com/articles/920390/3-retirement-bucket-portfolios-for-minimalists

 

[VanWinkle]

We (ages 71/62) are at 7 years of cash and [short-term] bonds.
Assuming average market returns, we will increase this over the next decade.
But, for us, stocks, baby, stocks.
According to various retirement models, we will leave our daughter somewhere between $30K and $13M.

That's a pretty big spread from 30K to 13M, but life happens. I laughed out loud when I read that. Thanks for the humor as it is appreciated.

VW

 

[nancyfrank232]

You leave the money to your daughter, or her spouse lol

 

[GravitySucks]

I like your thinking.
80/20 and 70/30 in 2015 but it spooked me. At 60/40 since 2016 and barely noticed 12/2018.
Now I'm looking more at years expenses in high quality bonds. 9 more years until SS, and I could live decently on SS, so having 10 years of bonds works nice. It also lines up with my current AA. I'm keeping the expenses in bonds till SS even if I have to miss out on the next buying opportunity.
At SS and near SS I might let the AA rise a bit, but never drop below 6 years of expenses minus SS. If it goes to 10 years expenses minus SS it'll be a nice way to have cash for buying equities.
It could be a fun balancing act to stay at a comfortable AA vs. years expenses.

 

[Navigator]

When I was thinking of retiring, I modeled the 100-age in bonds strategy that so many financial advisors recommend. For a 30 year retirement, it turned out to be the single worst strategy I looked at. Why? It guarantees low returns because of low stock allocations over a long period of time. Moreover, it exposes you fully to Sequence of Returns Risk at the beginning of retirement, but doesn’t allow you to make up for early losses with gains later in retirement (since stock allocations go down with time).

The 15 years cash and bonds strategy is another variation of the 100-age strategy in that stock allocation percentages usually go down with time. The problem with holding large cash holdings to hedge against market downturns is that it creates a ‘cash drag’ on portfolio performance when times are good, and the good times in the market greatly outnumber the bad years.

Since 1928, a person could withdraw at least 4.5% per year in good years and bad for 30 years with a 60/40 allocation and not run out of money. IMHO, the reason to look at hedging and market timing strategies is if you need to withdraw more than this per year.

 

[RunningBum]

The 15 years cash and bonds strategy is another variation of the 100-age strategy in that stock allocation percentages usually go down with time. The problem with holding large cash holdings to hedge against market downturns is that it creates a ‘cash drag’ on portfolio performance when times are good, and the good times in the market greatly outnumber the bad years.

I've put together a spreadsheet and am running it against historical stock and bond returns. I'm finding this to be true, 15 years cash+bonds is running me completely or nearly out of stocks eventually.

I have a minimum number of years of post-tax spending in fixed income that I won’t go below when rebalancing.

I actually hit that limit in 2008. Knowing that I had that minimum threshold made it psychologically possible to rebalance during a very scary time.

But I’m usually way above that as I’m currently targeting 50% fixed income.

So the minimum threshold is only there to keep fixed income from going too low during bad equity market times, when I am drawing it down to buy stocks. You if keep fixed income low all the time you might not have enough to buy stocks when they go on sale.

I played with the opposite of this, a range of 5-12% cash+bonds, but a minimum of 50% stocks. I think your way probably makes better sense though. I'll try that next. Maybe I'll try a combo--at least 5 years cash+bonds, and if I've satisfied that, at least 50% stocks.

Or maybe I'm overthinking all of this and should just go 60/40!

It is an interesting exercise to play with though, even if I don't implement it.

 

[audreyh1]

I generally rebalance to a ~50/50 target AA. The X year after-tax expenses in fixed income rule is simply a limit applied when rebalancing to buy more stocks after a bad equity market year. Depending on how badly things have been whacked, it might temporarily prevent me from getting all the way back to 50/50.

 

[RunningBum]

I think I'm going to give up on this idea. I've run a few different historical scenarios, and it's usually lagged 60/40 just a little bit, but sometimes a lot more. The scenarios I'm most concerned with are the bad ones. I could live with a little less return on the high side if it handled the low side better. I tried the last 29 years of the Nikkei, and my formula did a lot worse. I suppose I could figure out how to tweak it to make it come closer or maybe even better, but forcing a formula to fix past data isn't likely to work well for uncertain future data.

A revised thread title might be "Considering AA change from x-age to 60/40" but that seems kind of boring.

60/40 very rarely puts me at less than 5 years of bonds+cash. The Nikkei example didn't run enough years. 40 years starting in 1929 puts me at slightly under at age 95, in year 37, and still 4.5 years at the end of my run at 97. I can live with that.

 

[GenXguy]

Once I closed in within about 2 years of FIRE in my 50's, I moved from 80% to 60% equities, and then to 42% equities after another 6 months, making these changes when my investments were at record highs.

That shift out of equities was mostly in my work retirement plan because the fund expenses and plan admin fees together are over 1 1/2%, plus I can rebalance without incurring capital gains and resulting taxes, so I went with a 3% fixed income fund (stable value fund) in my retirement fund. No expenses or admin fees apply to that fund.

Through today, I've probably missed out on $30,000 in gains over the last year and a half by going more conservative, but I had already hit my target number, and I sleep better at night.