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Equity/Bond Allocations using Ability, Willingness and Need!
Old 08-05-2011, 08:25 PM   #1
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Equity/Bond Allocations using Ability, Willingness and Need!

I am reading The Only Guide to a Winning Investment Strategy You'll Ever Need by Larry Swedroe and it appears to bring clarity on how one should make an asset allocation. In the current tumultuous market, it may not be the right time to revaluate one’s allocation, but then again it may be the best time. For those of you who are familiar with this approach, I would really appreciate you reading this and given me some insight into my allocation between equities and fixed income using the three pronged approach of 1) Ability to take risk, 2) Willingness to take risk and lastly 3) Need to take risk. The following is a discussion of applying each of these criteria to my situation.


I am retired since December, 2007 and am currently 48 years of age. I am married with 3 Children (ages 18, 15, 13). My home is paid for and I have no debt. My kids are just beginning the college phase of life and I have promised to pay for a college of their choice if I am able. First one chose a private liberal arts college (very pricey). PS. Never promise your kids anything! My only source of income is from investments.

Ability to take Risk

My investment horizon is 42 years to age 90 (Currently 48). I used the Horizon vs. % Max equity allocation table (Swedroe) and applied yearly outlays against the table. This weighted average approach yielded an estimated 66% equities allocation. Swedroe also talks about stability of earned income. I am not considerring this in my allocation decision given that I am retired and also since my labor capital in a “Plan B” scenario of going back to work is low compared to my net worth. In terms of liquidity I have approximately 9 months of cash on reserve. Lastly, Swedroe discusses what the availability of “Plan B” options one has (i.e. Worst Case Action Plans). For me the following could be done in order of priority:

1) Living expenses cut in half to 1 ½% of portfolio
2) Refocus undergrad to instate schools so yearly outlay reduced to $50k per year for all three kids
3) Get a job or start a business conservatively estimated at $60k income given skill set
4) Graduate schools paid for by kids with student loans

Conclusion: In isolation, the allocation to equities considering the “Ability to Take Risk” considering both the quantitative and subjective factors above is IMO 60% equities.

Willingness to Take Risk

I am the type of person who plans for the storms of life. As a result I always think about the “worst case scenarios” and thus this kind of thinking keeps me up at night. My Maximum tolerable loss is based on the level which I find myself needing sleeping pills and becoming just too irritable to be considered a nice person. The being said, using Swedroe’s Table as a suggested guideline, my Maximum Tolerable Loss is 15% and thus my Maximum Equity Exposure should be 40%.

Need to take Risk

My understanding here is that that if the need to take risk is low, a lower allocation to stocks is prudent. Another words, the marginal benefit of making more money is just not worth it. In my situation, I can maintain my current standard of living, remain retired and send my kids through college with an average 4% Required Withdrawal Rate over the next 10 years and then reduced to a 2% thereafter. I have no desire to increase my personal standard of living. My approach here, (I and do not know if this is right or not because I just made it up) was to run Firecalc using a constant rate of assumptions but I kept lowering my equity % allocation as low as it could go without the success rate falling below 100%. My constant assumptions were as follows:

- Spending starts at 4% of starting portfolio
- Model Using "Reality Retirement Plan" as described by Ty Bernicke, withdrawals after age 55 are reduced by 2-3% per year until age 76.
- 42 Year Time Horizon (to age 90)
- No Income other than from Investments (No SS considered)
- 3% (default) inflation adjustments to historical data
- .18% Expense Ratio

Conclusion: In isolation, the allocation to equities considering the “Need to Take Risk” using the above approach yielded a minimum 30% equities allocation before success fell below 100%.

Overall Conclusion

Under Swedroe’s methodology your allocation to equities should be the lower of the willingness, ability and need tests.

60% Ability to Take Risk
40% Willingness to take risk
30% Need to take risk

Therefore, my current equity allocation of 38% is too high and should be no more than 30%.

Am I approaching this correctly? Feedback please!

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Old 08-05-2011, 09:15 PM   #2
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Join Date: Aug 2007
Posts: 1,224
I think your approach is fine. It looks like you have a very conservative plan that should meet your needs. I wouldn't spend much time agonizing over 30 vs 38%, there isn't that much precision in these estimates. In your shoes I would likely say OK 35% is probably a reasonable equity allocation and then rebalance when it gets off by 5% either way and call it done.

At 54% of FIRE target
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