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Questioning Age-Based Allocations
Old 01-07-2010, 01:40 PM   #1
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Questioning Age-Based Allocations

Reading on withdrawal approaches, I kept coming across the often-quoted guideline for using age to set stock allocation, traditionally "100% - Age" and more recently sometimes "120 - Age". I was curious how these age-based guidelines performed using historical data, so I ran some tests. IMO the results show age-based guidelines do not perform well in retirement. (On one Boglehead threat, a poster stated the age-based guidelines are only for the accumulation phase, not retirement, but I didn't see that caveat mentioned elsewhere.)

The tests use Shiller's data (i.e. S&P index and long interest rate from 1871 to present). All tests assume a 30-year retirement starting at age 60 with an inflation-adjusted annual withdraw amount and annual rebalancing. For the "100-Age" case, the stock allocation starts at 40% then decreases each year to end at 10%. For "120-Age", the stock allocation starts at 60% and ends at 30%. The below results compare the two age-based approaches to fixed allocations (for which either the equity percentage or the withdraw rate was varied to match the age-based success rate for a "break-even" comparison.) The "Success Rate" indicates the percentage of rolling 30-year periods when the portfolio did not run out of money....the same approach as FIRECalc.

4.00% Withdraw for 30 Years and 100-Age for Equities --- 88.99% Success Rate
4.00% Withdraw for 30 Years and Fixed 28% Equities --- 88.99% Success Rate
4.22% Withdraw for 30 Years and Fixed 40% Equities --- 88.99% Success Rate

4.00% Withdraw for 30 Years and 120-Age for Equities --- 94.50% Success Rate
4.00% Withdraw for 30 Years and Fixed 56% Equities --- 94.50% Success Rate
4.12% Withdraw for 30 Years and Fixed 60% Equities --- 94.50% Success Rate

5% Withdraw for 30 Years and 100-Age for Equities --- 44.95% Success Rate
5% Withdraw for 30 Years and Fixed 32% Equities --- 44.95% Success Rate
5.34% Withdraw for 30 Years and Fixed 40% Equities --- 44.95% Success Rate

5.00% Withdraw for 30 Years and 120-Age for Equities --- 60.55% Success Rate
5.00% Withdraw for 30 Years and Fixed 50.8% Equities --- 60.55% Success Rate
5.20% Withdraw for 30 Years and Fixed 60% Equities --- 60.55% Success Rate

For a higher-level view, the below diagram shows the maximum successful withdraw rate for each year using the two age-based guidelines compared to fixed allocations.

aged-based withdraws.pdf

Some thoughts....
-- Volatility risk is always reduced by lowering the equity ratio (assuming high-quality bonds), but the real risk we are concerned with is running out of money (although volatility can certainly contribute to running out of money). These different measures for risk seem to get blurred together and mixed up.
-- The age-based guidelines resemble a stocks-first harvesting strategy, which has been shown elsewhere to not perform well, so in this sense the results are not surprising.
-- I would not read too much into the results (although I find them interesting), just that if we lock in a withdrawal plan at the start of retirement, with blind adherence for the life, then a fixed stock/bond ratio performs better than an age-based ratio. In real life we don't blindly adhere to a plan, but reevaluate and adapt as we grow older.
-- We often should reduce equities as we age to lower retirement risk, but that decision should come from a broad-based reevaluation as circumstances change....and then only using guidelines with clear evidence to back them up. For example, there is evidence immediate annuities can reduce risk as we age. Another solid approach could be restarting/recalculating a withdrawal schedule at a later age using a shorter duration to derive a different stock/bond mix.
-- I doubt many here use an age-based formula, but not sure.

Thoughts....?
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Old 01-07-2010, 02:27 PM   #2
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I don't think the % bonds you have in a decumulation portfolio have as much influence on the outcome once you have 30% to 70% bonds. Other things have much more influence such as the sequencing of returns, your other income streams (SS, annuity, pension), your fraction of required expenses versus desirable expenses, cutting back expenses when times are tough, etc.

Basically, if you have big pile of money, you are gonna do OK.

This forum seems to cater to folks who are on some kind of cusp ... they want to retire as soon as they have the minimum amount required to retire. Many folks are not like folks on this forum: they just keep working until their pile of money is so big it doesn't matter, or keep working because their pile of money will never amount to much. Or they keep working to support their financial advisor. For folks here, working one more year or working part-time will have much, much more influence on the result than any stock:bond ratio they can dream up.

So your numbers are nice, but do they really mean a thing? I think that's the same conclusion that you came to.
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Old 01-07-2010, 02:28 PM   #3
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Here's some numbers...
I started out with the "100 - age" rule when I FIREd at age 48 in 2007 under Retirement Plan B.
I was supposed to do an early out at age 50 according to Retirement Plan A, so I used that as my "age".
So I set my AA to 50/50 as an experiment for year 1 of FIRE.
Then 2008 happened. I lost almost 25% of my portfolio value by 4Q08. I knew right then, i.e. via real live experience, that my self-assessed risk comfort level had been exceeded. A valuable lesson in reality versus formulas and rules set forth by the industry.
So in Jan 2009, at age 51, I reset my target AA to 40/60, allowing for a 10% drift back to 50/50, but not ever going to 30/70.
Call me crazy, but I do sleep really well at night.
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Old 01-07-2010, 03:11 PM   #4
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Originally Posted by freebird5825 View Post
Here's some numbers...
I started out with the "100 - age" rule when I FIREd at age 48 in 2007 under Retirement Plan B.
I was supposed to do an early out at age 50 according to Retirement Plan A, so I used that as my "age".
So I set my AA to 50/50 as an experiment for year 1 of FIRE.
Then 2008 happened. I lost almost 25% of my portfolio value by 4Q08. I knew right then, i.e. via real live experience, that my self-assessed risk comfort level had been exceeded. A valuable lesson in reality versus formulas and rules set forth by the industry.
So in Jan 2009, at age 51, I reset my target AA to 40/60, allowing for a 10% drift back to 50/50, but not ever going to 30/70.
Call me crazy, but I do sleep really well at night.
2008 had one thing going for it - - it was a WONDERFUL test of comfort with one's asset allocation, and each of us had an unforgettable experience. It prepared us for any worse disasters in the future. In retrospect, it worked out beautifully for me. I found that with my AA I was was in no danger of selling low, even when I honestly thought we were in the middle of a total financial collapse (thank goodness I was wrong!), and then, just as though nothing had happened, the market went back up and my portfolio recovered completely just in time for ER.

Quote:
Originally Posted by LOL!
Basically, if you have big pile of money, you are gonna do OK.
Oh good! Then all's right with the world. (Great summary.)
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Old 01-07-2010, 03:51 PM   #5
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I had been going with the 100-age rule for sometime. When I FIRE'd a couple years ago, the CFP recommended an allocation even a bit more than 100-age. During the market turmoil and freefalling, I discovered the recommended allocation was too much for my sleeping point, do now I'm back to 100-age and I sleep better at night.
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Old 01-07-2010, 03:56 PM   #6
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If you don't want a lot of risk in your retirement, don't retire until you can live on a 3% SWR. Or as LOL said, "until you have a big pile of money".
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Old 01-07-2010, 05:27 PM   #7
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Originally Posted by LOL! View Post
I don't think the % bonds you have in a decumulation portfolio have as much influence on the outcome once you have 30% to 70% bonds. Other things have much more influence such as the sequencing of returns, your other income streams (SS, annuity, pension), your fraction of required expenses versus desirable expenses, cutting back expenses when times are tough, etc.

Basically, if you have big pile of money, you are gonna do OK.

This forum seems to cater to folks who are on some kind of cusp ... they want to retire as soon as they have the minimum amount required to retire. Many folks are not like folks on this forum: they just keep working until their pile of money is so big it doesn't matter, or keep working because their pile of money will never amount to much. Or they keep working to support their financial advisor. For folks here, working one more year or working part-time will have much, much more influence on the result than any stock:bond ratio they can dream up.

So your numbers are nice, but do they really mean a thing? I think that's the same conclusion that you came to.
I think you are correct. I had a very good margin, then I got divorced and I now have an " I hope it's ok margin."

Most of what uses up the most airtime around here, other than weighty topics such as who will be in fashion ads going forward, is really just polishing rocks. Other than doing really out-there things like putting everything in a beaten down stock, or spending with almost no regard for resources, circumstances and the way the future unfolds will dominate. And by far the best bulwark agains untoward events is having more than enough money before you start, or having secure employment, even part-time. There is really nothing quite like earned income, or a government pension.

I expect as this decade unfolds we will undergo more than one test of our skills, and of the adequacy of our resources. I know one thing- I would not be waiting until there is a market run-up and dividing by 25 and saying, "Wow! Some folks around here eat on $2.97 a day, this should be enough income, let's jump before something changes."

Ha
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Old 01-07-2010, 06:07 PM   #8
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Originally Posted by freebird5825 View Post
Then 2008 happened. I lost almost 25% of my portfolio value by 4Q08. I knew right then, i.e. via real live experience, that my self-assessed risk comfort level had been exceeded. A valuable lesson in reality versus formulas and rules set forth by the industry.
2008 really was a good real-live test of our individual risk tolerances, wasn't it? Like you, I had about 50% equities (we're about the same age, too). Although I didn't make any drastic changes during the worst part of the year, I literally felt sick to my stomach on many days. I rode it out, and even managed to do some buying before the run-up, but know now that I can't handle ever going through that again. It was quite a ride for my first year of ER!

I, too, have lowered my equity allocation slightly now. I'd like to be able to relax a little more in ER.
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Old 01-07-2010, 09:13 PM   #9
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We had just the opposite experience as a few of you. We're retired and have ^H^H^H^H had probably 80% stocks and the rest CDs and cash. The stock portfolio tracked the rest of the market down, down to about 35%-40% loss at the low point.

We mentally went thru my wife's checklist:
Can we afford to eat & pay all of our required bills?
Can we avoid having to sell any stocks for at least 1-2 years until the upturn?

I'm blessed with a wife who doesn't have the typical risk-adverse outlook that many women have, so we don't really have trouble with sleepless nights during a bear market.

However, lately I've been finding some great bargains in preferred stocks and "accdental high yielding" stocks, so I've been loading up on them. So for the next several years our fixed income portion will be throwing off a lot of money. So we have been shifting more toward lower stock portion by accident.
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Old 01-07-2010, 10:03 PM   #10
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For me a successful retirement outcome would have a portfolio value that is growing at least a little bit above inflation, on average, even with withdrawals. That's about what a 4% withdrawal rate gives you, on average.

That means that when you're 100, you most likely still have a portfolio value that could support you another 30-40 years worst case at the same withdrawal rate. Kind of pointless to be shifting into 100% bonds (or even 20%) at that point.

Given that longer-term view, and the fact that I have kids who will inherit the remainder and supposedly save it for retirement, I'm sticking with a fixed allocation that is light on bonds and cash.

I'm about 96% equities and 4% cash right now, excluding whatever cash my mutual funds are holding. During 2008 and 2009 I was adding to my equity allocation with the cash I had saved out for the first few years of retirement, just in case, and HELOC borrowed money so this fits my actual risk tolerance as well. Luckily DW doesn't watch me too closely (and decided she didn't want to retire yet, which stretched the cash).
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Old 01-07-2010, 10:15 PM   #11
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Originally Posted by haha View Post
I expect as this decade unfolds we will undergo more than one test of our skills, and of the adequacy of our resources. I know one thing- I would not be waiting until there is a market run-up and dividing by 25 and saying, "Wow! Some folks around here eat on $2.97 a day, this should be enough income, let's jump before something changes."

Ha
Oh no! Not another tough decade!!! I thought I already paid my dues with 2000-2002 and 2008-2009!!!

Audrey
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Old 01-07-2010, 10:32 PM   #12
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We've always been at 45% stock. Our age never mattered or what we were told we were 'supposed' to have.

Before the big drop, we were 45/35/20. Well our stock portion went out of whack, but we kept throwing money in DH's 401k with the same investment direction in 2008 and two months in 2009. Last year we took some profits and are presently at 32/51/17. This allocation along with a pension that pays 1/4 of our yearly expenses and only having to withdraw 3% from our portfolio seems to suit us just fine.

I'm 52 and DH is 55.
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Old 01-07-2010, 10:53 PM   #13
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...or keep working because their pile of money will never amount to much.
Too true.
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Old 01-07-2010, 10:54 PM   #14
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2008 really was a good real-live test of our individual risk tolerances, wasn't it?
Especially so in my case as I was unemployed for 5 months, too.
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Old 01-08-2010, 12:49 AM   #15
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Especially so in my case as I was unemployed for 5 months, too.
Congratulations, Ed, on getting back to work!

Ha
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Old 01-08-2010, 09:15 AM   #16
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I don't think the % bonds you have in a decumulation portfolio have as much influence on the outcome once you have 30% to 70% bonds. Other things have much more influence such as the sequencing of returns, your other income streams (SS, annuity, pension), your fraction of required expenses versus desirable expenses, cutting back expenses when times are tough, etc.
LOL, I wish the bond percentage in retirement was not so important for me, but I'm a guy that wants to squeeze out as much as I can with a higher withdrawal rate (too many kids and projects around the farm I want to fund). If you believe FIRECalc, at 5% for 40+ years it makes a big difference. You are right though, it makes little different for a 4% or less withdrawal rate for less than 30 years.

Sequencing of returns I can't control and other reliable income streams I classify as bonds. Right, the ability to cut back when times are tough is one of my insurance policies.

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So your numbers are nice, but do they really mean a thing? I think that's the same conclusion that you came to.
I believe the numbers show age-based guideline are weak. Given I live closer to the edge, I want firmer foundations underlying my portfolio planning. Historical data doesn't predict the future but it provides a reasonable test for the advice we are given.

I agree with your sentiment though....the other factors matter greatly. An extremely bad decade or two can make any portfolio plan meaningless. The odds are strongly in our favor though.
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Old 01-08-2010, 10:19 AM   #17
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I was curious how these age-based guidelines performed using historical data, so I ran some tests. IMO the results show age-based guidelines do not perform well in retirement.

4.00% Withdraw for 30 Years and 100-Age for Equities --- 88.99% Success Rate
4.00% Withdraw for 30 Years and Fixed 28% Equities --- 88.99% Success Rate
4.22% Withdraw for 30 Years and Fixed 40% Equities --- 88.99% Success Rate


Some thoughts....
-- Volatility risk is always reduced by lowering the equity ratio (assuming high-quality bonds), but the real risk we are concerned with is running out of money (although volatility can certainly contribute to running out of money). These different measures for risk seem to get blurred together and mixed up.

Thoughts....?
Those results look to be roughly inline with what I've seen with FIRECALC - too low an equity exposure (< ~ 40% equities) starts to hurt the long term success rates.

And I agree that many seem to get a bit mixed up over volatility and success rates. However, if the volatility means that you get scared and make changes during a downturn, then I guess that is somethnig to take into account at an individual level.

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We had just the opposite experience as a few of you. We're retired and have ^H^H^H^H had probably 80% stocks and the rest CDs and cash. The stock portfolio tracked the rest of the market down, down to about 35%-40% loss at the low point.

We mentally went thru my wife's checklist:
Can we afford to eat & pay all of our required bills?
Can we avoid having to sell any stocks for at least 1-2 years until the upturn?

I'm blessed with a wife who doesn't have the typical risk-adverse outlook that many women have, so we don't really have trouble with sleepless nights during a bear market.
That's closer to my story also. Although DW's risk aversion is probably more along the lines of "if I'm not worried, and I don't tell her to stop shopping, she figures she won't worry either". And we didn't have to sell stocks during the downturn (actually rebalanced and bought some). I might have to sell some in another year - but only small amount for cash flow to cover the difference between dividends and expenses. It would be a very small % of total portfolio.

Life is good. - ERD50
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Old 01-08-2010, 12:04 PM   #18
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At some point before I retire I'm going to have to purchase a few of these "bond" thingies.

I will admit that the recent downturn tested my risk tolerance. I thought that I would never need bonds, but I would have had a tough time dealing with the downturn if I hadn't been employed.
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Old 01-08-2010, 03:16 PM   #19
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One consideration is that a plan really isn't pass/fail. Unless your budget is really cut to the bone, a barely failing plan can still work. There's always something more you can cut, or if you're still able you could w*rk part-time to make ends meet. If your plan fails by $10, it's considered a failure, but I think you could scrape up $10 in change from fountains in a few weeks.

I would suspect the failures in the age-based allocation plan don't fail too badly. Staying high in equities the whole way through may fail less often, but I'm guessing there are some spectacular failures that you simply couldn't overcome.

I use an age-based allocation formula, but a pretty aggressive one, 120-age, and I include a cash value estimate of a small pension I'll be getting as a non-equities part of the total.
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Old 01-10-2010, 09:42 AM   #20
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I would suspect the failures in the age-based allocation plan don't fail too badly. Staying high in equities the whole way through may fail less often, but I'm guessing there are some spectacular failures that you simply couldn't overcome.
Good theory so I checked it out. Age-based allocations don't appear to last any longer to soften failures.

Here's what I observed.

Age-120/4%/30 Year: Average Year of Failure = 28.0; Worse Failure 26 Years
Age-100/4%/30 Year: Average Year of Failure = 28.2; Worse Failure 27 Years
60% Stock/4%/30 Year: Average Year of Failure = 28.0; Worse Failure 26 Years
40% Stock/4%/30 Year: Average Year of Failure = 29.2; Worse Failure 28 Years

Age-120/5%/30 Year: Average Year of Failure = 24.2; Worse Failure 18 Years
Age-100/5%/30 Year: Average Year of Failure = 23.7; Worse Failure 18 Years
60% Stock/5%/30 Year: Average Year of Failure = 23.7; Worse Failure 19 Years
40% Stock/5%/30 Year: Average Year of Failure = 24.1; Worse Failure 19 Years
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