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entering glide path - how to determine proper AA?
Old 07-24-2013, 04:34 PM   #1
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entering glide path - how to determine proper AA?

Hi folks.

Wife and I are both 47. Firecalc tells me that if I had to, I could retire today (100% success rate). However, I still enjoy my job and want more of a cushion before pulling the plug. I would say that the chances of me retiring in the next 5 years are quite high.

Our current AA is 75/25. It seems to me that your AA should not just depend on your age and expected lifetime, but also whether you are accumulating or withdrawing. Possibly other factors as well.

So, my question is - how do you determine your AA when you (semi-)retire early? I can provide financial info if that would help.

Thanks.
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Old 07-24-2013, 07:29 PM   #2
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If you explore you will find lots of threads on AA. i agree that your AA can be more aggressive when you have other sources of income (wages, or pension or SS).

However, in the extreme if comes down to two schools of thought. One is if you have much more than you need (a really low WR or a pension/SS that is high in relation to what you need to live) is that since you don't really need that money or the income that there is no need to take any risk and you should be totally in FDIC insured CDs. The other extreme is that if you don't need that money to survive that you can swing for the fences and be 100% in aggressive equities.

The reality then becomes what AA allows you to sleep best at night. I think most of our members have equity allocations of 40-70% depending on their appetite for risk and stomach for volatility.
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Old 07-24-2013, 08:25 PM   #3
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If you explore you will find lots of threads on AA. i agree that your AA can be more aggressive when you have other sources of income (wages, or pension or SS).

However, in the extreme if comes down to two schools of thought. One is if you have much more than you need (a really low WR or a pension/SS that is high in relation to what you need to live) is that since you don't really need that money or the income that there is no need to take any risk and you should be totally in FDIC insured CDs. The other extreme is that if you don't need that money to survive that you can swing for the fences and be 100% in aggressive equities.

The reality then becomes what AA allows you to sleep best at night. I think most of our members have equity allocations of 40-70% depending on their appetite for risk and stomach for volatility.
Thanks for the response.

I understand the answer to my question is probably very personal and not formulaic, so let me rephrase the question: do most of you early retirees have an AA that is similar to an accumulator of similar age, or is it fundamentally different?
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Old 07-24-2013, 08:52 PM   #4
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Thanks for the response.

I understand the answer to my question is probably very personal and not formulaic, so let me rephrase the question: do most of you early retirees have an AA that is similar to an accumulator of similar age, or is it fundamentally different?
You might consider reading the book "Spend 'till the end", which says that a roller coaster (two hump graph) allocation is optimal. But the traditional approach is a continual decrease in volitility with age. There's a fairly sophisticated AA plan, by age, in the 'gone fishin' article, linked on this post: Income for Life Buckets vs Lazy Portfolio Withdrawals
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Old 07-24-2013, 09:05 PM   #5
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Here's a new article that touches on the subject.

Retirement Researcher Blog: Decomposing SPIAs: Rising Equity Glidepaths vs. Mortality Credits

"As it turns out, having a rising stock allocation (a rising equity glidepath) during retirement can actually support lower failure rates and better retirement outcomes than any fixed stock allocations. Essentially, target date funds would have a declining equity glidepath over the accumulation phase (which they currently do) and then an increasing equity glidepath over the retirement phase (which they currently do not). The intuition for this is that you want to have the lowest stock allocation when you are most vulnerable, which tends to be at around your retirement date when you are the most exposed to sequence of returns risk."

Be conservative just after you retire. If your retirement timing is flexible, I'd stay aggressive right up until I retired. If the market sets you back, you may work an extra year. If things go well you could retire earlier.

Just after retirement you are probably taking your largest withdrawals as a percentage of your portfolio. That's when market dips will do the most damage. Later in retirement your portfolio most likely will have grown and other sources of income (pension, SS, deferred annuities, ...) will have come online. That might allow you to raise your equity allocation safely if you would like.
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Old 07-24-2013, 09:42 PM   #6
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Originally Posted by mrfeh View Post
Thanks for the response.

I understand the answer to my question is probably very personal and not formulaic, so let me rephrase the question: do most of you early retirees have an AA that is similar to an accumulator of similar age, or is it fundamentally different?
My AA was predominately stocks until I was in my early/mid 40s, at which time I started diverting new money (contributions) to fixed income and gradually got to 60/40 just prior to retiring which is the same AA I use today.

The only difference for me in retirement is that I have 6% of my 405 fixed income allocation in cash and short term investments rather than intermediate term bonds.

YMMV.
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Old 07-25-2013, 07:36 AM   #7
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Here's a new article that touches on the subject.

Retirement Researcher Blog: Decomposing SPIAs: Rising Equity Glidepaths vs. Mortality Credits

"As it turns out, having a rising stock allocation (a rising equity glidepath) during retirement can actually support lower failure rates and better retirement outcomes than any fixed stock allocations. Essentially, target date funds would have a declining equity glidepath over the accumulation phase (which they currently do) and then an increasing equity glidepath over the retirement phase (which they currently do not). The intuition for this is that you want to have the lowest stock allocation when you are most vulnerable, which tends to be at around your retirement date when you are the most exposed to sequence of returns risk."

Be conservative just after you retire. If your retirement timing is flexible, I'd stay aggressive right up until I retired. If the market sets you back, you may work an extra year. If things go well you could retire earlier.

Just after retirement you are probably taking your largest withdrawals as a percentage of your portfolio. That's when market dips will do the most damage. Later in retirement your portfolio most likely will have grown and other sources of income (pension, SS, deferred annuities, ...) will have come online. That might allow you to raise your equity allocation safely if you would like.
Thank you very much - this summarizes my primary concern, which is being fairly heavy in equities right at retirement and thus being vulnerable to a serious market drop.

This leads to another question - if I were to take this route (fairly aggressive right before retirement and then somewhat conservative immediately after retiring), doesn't that imply a sudden and large change in asset allocation? If so, does it not also imply a large sale of equities (to buy fixed income), resulting in a large tax event?
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Old 07-25-2013, 08:02 AM   #8
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Good answers so far, mostly focused on risk tolerance, a large determinant indeed. You probably already know, but there are plenty of online quizzes to test risk tolerance, Vanguard https://personal.vanguard.com/us/FundsInvQuestionnaire among others. But there are other factors that may be important such as:
  • Residual plan, leaving a large $ legacy at one extreme, and dying broke at the other.
  • Life expectancy. Some people know their lives may be shorter or longer than average based on family history and/or known health issues.
  • Floor income. As pb4uski mentioned. The larger your Soc Sec/pension/annuity income relative to your projected spending, the more risk you can take with your portfolio AA.
  • Nest egg vs spending. The larger your portfolio relative to projected spending, the more conservative (or risky) your AA can be despite your risk tolerance. For example, if your risk tolerance suggests at AA of 75/25, that might be appropriate if your nest egg is 25x first year annual spending. If however your next egg is 50x spending, you might invest half at 75/25 and be more or less conservative with the balance.
  • Sleep. All the above is governed by what allows you to sleep at night. Some people retire at a 70% success rate while others aren't comfortable unless they reach 200% (a nest egg twice the 100% number).
  • Withdrawal method.
It's not as simple as bond allocation = retiree age or similar, though that's not too far afield and might serve well enough for many. You could star there and tweak based on the above considerations.

No one size fits all answer that I know of. My age, AA, WR below, though not a recommendation by any means. Any equity allocation from 20% to 70% is defensible for a retiree under 90 from what I've read, I'd be wary of any recommendations outside that range though (there are a few members here).
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Old 07-25-2013, 08:11 AM   #9
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Quote:
Originally Posted by mrfeh View Post
I understand the answer to my question is probably very personal and not formulaic, so let me rephrase the question: do most of you early retirees have an AA that is similar to an accumulator of similar age, or is it fundamentally different?

We ER'ed at age 55 with non-COLA'ed pensions covering ~70% of desired income. We had, and still have at age 58.5, 40% in equities.

Not saying that is right or wrong but meets our personal sleep-at-night factor.
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Old 07-25-2013, 10:39 AM   #10
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I've been using age-10 in bonds since I started paying attention to things like asset allocation about 9 years ago. I plan to continue that during ER, although if my nest egg increases to a point where I don't feel I need to take much risk, I may become much more conservative. Or if my nest egg increases greatly, to the point where I can roll the dice and take on more risk, I might also consider that.
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Old 07-25-2013, 12:38 PM   #11
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Thank you very much - this summarizes my primary concern, which is being fairly heavy in equities right at retirement and thus being vulnerable to a serious market drop.

This leads to another question - if I were to take this route (fairly aggressive right before retirement and then somewhat conservative immediately after retiring), doesn't that imply a sudden and large change in asset allocation? If so, does it not also imply a large sale of equities (to buy fixed income), resulting in a large tax event?
The initial sales may not be bad if you can sell higher priced shares first. I don't remember having a giant tax bill. Capital gains are not too bad usually, unless they knock you out of the 0% capital gains tax bracket or cause some marginal tax rate problem (like the ACA subsidy income limit). Otherwise it's just 15% no matter how much you sell. Take your own tax situation into account, and that may lead to spreading changes across a few years, but don't let the tax tail wag the dog.
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Old 07-25-2013, 01:35 PM   #12
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Thank you very much - this summarizes my primary concern, which is being fairly heavy in equities right at retirement and thus being vulnerable to a serious market drop.

This leads to another question - if I were to take this route (fairly aggressive right before retirement and then somewhat conservative immediately after retiring), doesn't that imply a sudden and large change in asset allocation? If so, does it not also imply a large sale of equities (to buy fixed income), resulting in a large tax event?
A lot depends on your personal circumstances. I knew that I was going to receive a significant (2.5+ years of living expenses) distribution from a Megacorp bonus plan that I had to take in cash (yes, and pay the taxes), and DH was already retired and drawing his pension. In my mind this covered the market risk so we stuck with our 70-30 allocation.

What we had done back when DH retired in preparation for my retirement was to convert all of our taxable accounts from reinvested dividends and capital gains into taking them in cash. We used this method to move from 75-25 to 70-30 by the effect of ending the reinvestments.

As in all things financial, you have lots of options, and YMMV. Happy planning!
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Old 07-25-2013, 02:22 PM   #13
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The initial sales may not be bad if you can sell higher priced shares first. I don't remember having a giant tax bill. Capital gains are not too bad usually, unless they knock you out of the 0% capital gains tax bracket or cause some marginal tax rate problem (like the ACA subsidy income limit). Otherwise it's just 15% no matter how much you sell. Take your own tax situation into account, and that may lead to spreading changes across a few years, but don't let the tax tail wag the dog.
Huh? This year in the US I am paying 23.8% long term capital gains tax. The extra 3.8% is obamacare so I believe even lower capital gains brackets pay it.

Without the 3.8% I'm at 20% base long term capital gains tax.
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Old 07-25-2013, 03:46 PM   #14
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Huh? This year in the US I am paying 23.8% long term capital gains tax. The extra 3.8% is obamacare so I believe even lower capital gains brackets pay it.

Without the 3.8% I'm at 20% base long term capital gains tax.
Congratulations on being in the top tax bracket.
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Old 07-25-2013, 09:02 PM   #15
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Huh? This year in the US I am paying 23.8% long term capital gains tax. The extra 3.8% is obamacare so I believe even lower capital gains brackets pay it.

Without the 3.8% I'm at 20% base long term capital gains tax.
Your capital gains tax is like old people's underwear: Depends

People in the low tax brackets may not pay capital gains tax at all.
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Old 07-25-2013, 09:25 PM   #16
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Huh? This year in the US I am paying 23.8% long term capital gains tax. The extra 3.8% is obamacare so I believe even lower capital gains brackets pay it.

Without the 3.8% I'm at 20% base long term capital gains tax.
New for 2013 when in the new $450k+/$400k tax bracket. I've been there in the early 2000's when the normal rate was 20% and exemptions and deduction rollbacks increased the marginal rate.

3.8% hits at 250k/200k of investment income (or AGI if smaller).

https://www.fidelity.com/viewpoints/...axpayers-guide
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