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Reallocation worries
Old 07-13-2009, 02:52 PM   #1
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Reallocation worries

We FIREd in 2004 with a pretty conservative 40/40/20 equity/fixed/cash allocation (it is now 30/50/20 due to market declines and only partial rebalancing - more about that later). Our withdrawal rate exceeded our dividends and interest income by a little bit, but I didn't worry about it too much because equities were appreciating so fast that our net worth was rising at a comfortable pace.

Of course everything changed last year. Our portfolio value is down about 16% from its peak, but worse, our dividend and interest income has collapsed. We have dramatically cut back on expenses, but our withdrawals this year might still exceed our interest and dividend income.

Now I am beginning to think that we need to re-allocate to produce more dividend and interest income. Our cash holdings are entirely in money market funds, so they are earning almost nothing. I am content with 30% equities and would be happy with as little as 5% in cash, but the question is how to deploy that last 15% of our available capital?

Some details.

I am 55 and my partner is 50. A pension from mega-corp. provides about 30% of our current living expenses. We have tightened our belts so that a 3% withdrawal rate is sufficient for the rest. We own no real estate and have no debt. (Actually mega-corp. isn't so mega anymore and might go paws-up, taking our health insurance and pension with it, but that is a worry for another post.)

Our cash is in money market funds and the rest is almost all in index funds: basically total bond market and total stock market Index. (About 20% of our equities are in an international index fund and there is a little bit of BWX too, but let's keep things as simple as possible.) About 1/3 of our portfolio is in IRAs. The IRAs are entirely invested in target retirement funds and have been automatically rebalancing. The remaining 2/3 is in taxable accounts. I have been afflicted by investor paralysis and haven't rebalanced since January 2008.

Investor paralysis is pretty much par for the course for me. The reason we had so much cash in 2004 was from the sale of our house and I could never bring myself to put it into the market, despite the advice of financial planners. Meh. Stocks seemed over valued, I was worried about inflation, and money market funds were paying a pretty good return, so a lot of cash seemed acceptable if not optimal. Now, maybe not so much. We are spending principle now, and I don't like it.

What to do? I am considering a TIPS fund, but the current yield is low and its longish duration concerns me. Individual TIPS? CD ladder?
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Old 07-13-2009, 04:48 PM   #2
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A combination of CD ladder and Vanguards GNMA fund VFIIX might be something to consider. The fund's NAV is currently at its historical high though.
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Old 07-13-2009, 05:01 PM   #3
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Note you don't necessarily need to strictly live off dividends and interest if you are taking a "total return" approach, which is what safe withdrawal rates are based on. That said, nobody wants to sell their damaged equities right now, and it is very comforting to conservative investors to see those regular dividends come in. They are also a nice insurance policy if the stock market does not grow for years.

For what it's worth, I just spent several days researching all my options for new money and decided on Vanguard Wellesley Income (VWINX) -- where I already have a substantial position. Expenses are low. It's yielding 4.66% right now, and has some inflation protection built-in by virtue of a 40% allocation to equities. Whether we see slow growth, fast growth, no growth, inflation, or deflation, it is likely to do OK, or better than many other choices.
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Old 07-13-2009, 05:42 PM   #4
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Based on this statement:

Quote:
Now I am beginning to think that we need to re-allocate to produce more dividend and interest income. Our cash holdings are entirely in money market funds, so they are earning almost nothing. I am content with 30% equities and would be happy with as little as 5% in cash, but the question is how to deploy that last 15% of our available capital?
You have "set" your equity allocation to 30% as your new comfort zone and don't want to leave more then 5% in cash. That leaves 65% in bonds. Move the 15% into total bond market index, or split it up between TBM & TIP's if you feel you want a TIPS allocation for inflation hedging. Trying to time the bond market is even harder then stocks, just stay diversified and don't try to "guess" where we are heading in terms of deflation, inflation, stagnation or even worse try to chase yield.

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Old 07-13-2009, 06:25 PM   #5
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For personal portfolio advice such as what you are requesting, the best place on the web is found here: Bogleheads :: View Forum - Investing - Help with Personal Investments
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Old 07-13-2009, 06:26 PM   #6
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Originally Posted by IndependentlyPoor View Post
...(snip)...
What to do? I am considering a TIPS fund, but the current yield is low and its longish duration concerns me. Individual TIPS? CD ladder?
Timing bonds is a tough game. The long term TIPS (around 20 years out) now are about at historic average real rates but the 10 year TIPS are below average. What to do? You could maybe define a plan that invests what you want over a moderate time frame, like 6mo to 1 year. Then buy either the a TIPS fund or individual bonds that suit your need for the money. The duration of the TIPS fund should probably only be a concern if you will need the money shortly. At 55 you should have a pretty long investment horizon.

You might want to check out the TIPS chapter in Larry Swedroe's new Alternative Investments book.

Being retired, one has to watch out for inflation. But TIPS react to unexpected inflation so it will be futile to try to time them unless you are better then the market at predicting this stuff.

Just some thoughts, hope they help.
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Old 07-13-2009, 07:18 PM   #7
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Another approach is to supplement your remaining dividend and interest income with withdrawals from your cash pool. With 20% cash, even if you took the entire 4% SWR from your cash pool, it would take nearly 5 years to deplete it, assuming your cash earns 0.2% and you increase the withdrawal by 3% per year for inflation. Since you still have remaining dividends and interest, your withdrawal from your cash pool will be considerably less than 4% (or whatever withdrawal rate you choose to use), thereby stretching out its lifetime. This is the main reason for having cash in the portfolio in the first place. As the stock market recovers you can replenish your cash pool by selling some stock at that time.
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Old 07-13-2009, 08:21 PM   #8
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There really is no need for 5 years of cash when short-term bond funds paying 4+% will do nicely for years 2-5.
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Old 07-14-2009, 09:19 AM   #9
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There really is no need for 5 years of cash when short-term bond funds paying 4+% will do nicely for years 2-5.
Tell me about this, because I currently have 27% of my portfolio in cash that's only earning 1.7%. The rest is in equities and rental property, and I currently have a withdrawl rate of 2.4%.

I built up the cash back when I realized I was going to ER and when the sh*t was hitting the fan because I wanted to have enough cash to live for quite a few years if the sky really was falling. At my current spending, I have over 10 years of cash now.

I thought I would find lots of bargins in the form of additional equities post meltdown, but once I quit working I have found that I'm just not as interested in investing as I was (lazy?), and definitely way more conservative. I am in "thumb sucking" mode right, and really unsure about what I should do (which is why I'm doinig nothing I guess!).

So, I think I should be doing "something" with all that excess cash, but I don't want to risk it, so I'm just not sure what to do at this point.

I'm 45, married with two young boys, wife is working now, I may start working again but just part time and just for some additional pocket change (something fun and that the boys can help me with). We were considering moving out of the country recently but found that too clunky with the kids, and where visited for a month was not cheap enough to put up with all the expat type struggles IMO.

Any ideas for the cash, or whatever, are appreciated.
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Old 07-15-2009, 07:28 PM   #10
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....
Any ideas for the cash, or whatever, are appreciated.
This question gets asked a lot, but most of the people asking it, do not actually need the safety of cash. They can usually take on more risk. Let me give you an example.

A. Emergency fund. Nobody spends all of their 10-month emergency fund in 30 minutes notice on Friday afternoon. They might spend a little bit of that, but there are ways to buffer the actual need of cash-quick. We often write about losing your job. So if you put your emergency fund in something like Vanguard short-term bond index, or short-term investment grade, or GNMA you may be better off. Yes, these bond funds can lose 10% of their value, but so what? If you had a 10-month emergency fund, just change it to a 12-month emergency fund and you can lose 2-months of principal and be just fine.

B. Down payment for house, boat, car. Usually the timing of the purchase is not set in stone. You don't need to buy a house in 2 years plus or minus 3 days. You could buy the house in 2.5 years or 3 years or whenever. So you don't need to put your down payment savings in a 0.5% FDIC-insured account. You can put it the same short-term bond funds or even a balanced fund or a stock fund. If the market goes up, you buy a bigger house, make a larger down payment or buy earlier. If the market goes down, you buy a smaller house, make a smaller down payment or wait to buy.

C. Five years of retirement expenses. Same story as above. You don't need 5 years in cash, but you do need to think carefully about your asset allocation and the split between equities and fixed income. At the proverbial 4% suggested withdrawal rate, 5 years is 20% of your portfolio. You should have at least 20% in short-term fixed income for sure, but that doesn't mean the 0.1% cash sweep account at your broker or bank

Full disclosure: Among other investments, we own the Vanguard short-term investment grade bond fund and the Vanguard GNMA bond fund. In the last 2 years they have both dropped in value, but have also recovered in value. We can stand the volatility without even thinking about it. For that we have been rewarded 1- and 3-year returns of 2.1% and 4.3% for investment grade and for GNMA 8.4% and 7.3%. Yes, there were dates when we were underwater in these funds and there will probably be dates in the future where we will be underwater as well. But that's a chance I am happy to take.

Bottom line: Think hard about whether you really need the safety of cash.
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Old 07-18-2009, 03:13 PM   #11
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Originally Posted by FIRE'd@51 View Post
Another approach is to supplement your remaining dividend and interest income with withdrawals from your cash pool. With 20% cash, even if you took the entire 4% SWR from your cash pool, it would take nearly 5 years to deplete it, assuming your cash earns 0.2% and you increase the withdrawal by 3% per year for inflation. Since you still have remaining dividends and interest, your withdrawal from your cash pool will be considerably less than 4% (or whatever withdrawal rate you choose to use), thereby stretching out its lifetime. This is the main reason for having cash in the portfolio in the first place. As the stock market recovers you can replenish your cash pool by selling some stock at that time.
This was my initial reaction

consider I am not retired, but if something in an allocation has to give, it would be cash short term and equities over longer term.

How long can the cash tide you over without dividends/interest?
If factoring in the dividends and interest, how long can the cash last?

IMO if you can come up with a 7 year plan where you only reallocate in up years, you will probably find success.

**Most of my planning right now is trying to have "a 7 year plan" for market doing a 2008 to us when we retire around 2030- meaning have enough in cash that if market drops, we sell no equities until market recovers**
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Old 07-18-2009, 03:24 PM   #12
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This question gets asked a lot, but most of the people asking it, do not actually need the safety of cash. They can usually take on more risk. Let me give you an example.

A. Emergency fund. Nobody spends all of their 10-month emergency fund in 30 minutes notice on Friday afternoon. They might spend a little bit of that, but there are ways to buffer the actual need of cash-quick. We often write about losing your job. So if you put your emergency fund in something like Vanguard short-term bond index, or short-term investment grade, or GNMA you may be better off. Yes, these bond funds can lose 10% of their value, but so what? If you had a 10-month emergency fund, just change it to a 12-month emergency fund and you can lose 2-months of principal and be just fine.

B. Down payment for house, boat, car. Usually the timing of the purchase is not set in stone. You don't need to buy a house in 2 years plus or minus 3 days. You could buy the house in 2.5 years or 3 years or whenever. So you don't need to put your down payment savings in a 0.5% FDIC-insured account. You can put it the same short-term bond funds or even a balanced fund or a stock fund. If the market goes up, you buy a bigger house, make a larger down payment or buy earlier. If the market goes down, you buy a smaller house, make a smaller down payment or wait to buy.

C. Five years of retirement expenses. Same story as above. You don't need 5 years in cash, but you do need to think carefully about your asset allocation and the split between equities and fixed income. At the proverbial 4% suggested withdrawal rate, 5 years is 20% of your portfolio. You should have at least 20% in short-term fixed income for sure, but that doesn't mean the 0.1% cash sweep account at your broker or bank

Full disclosure: Among other investments, we own the Vanguard short-term investment grade bond fund and the Vanguard GNMA bond fund. In the last 2 years they have both dropped in value, but have also recovered in value. We can stand the volatility without even thinking about it. For that we have been rewarded 1- and 3-year returns of 2.1% and 4.3% for investment grade and for GNMA 8.4% and 7.3%. Yes, there were dates when we were underwater in these funds and there will probably be dates in the future where we will be underwater as well. But that's a chance I am happy to take.

Bottom line: Think hard about whether you really need the safety of cash.
I think the above is EXCELLENT advice. I think this advice might need some more discussion... but the very basics of "leave 12 months expenses in CASH or "what is a cash investment and how much should the investment be" are all valid discussion points.

I would modify the above advice slightly:

1) Keep 3 months expenses in CASH at all times. Could be a 91 day CD ladder (this is what I do- I have 3 91 day CDs maturing 30 days apart, each with 1 months expenses in them), could be money market fund, could be something else. Returns are not the issue here, focus on safety (FDIC).

2) Have X months expenses in safe investments (in a taxable account). While working, this would depend on occupation, kids, family situation, life situation and many other factors.

I recommend at least 6 months expenses in cash for everyone regardless of circumstance. 3 months is kept in cash at item #1, 3 months or more is kept in a conservative investment vehicle as was mentioned in the thread I quoted.

If you are self employed, 6 months expenses is not enough, 12 or 24 should be expected.
If you take lots of vacations, or spend large chunks of money on things, more than 6 months of expenses is suggested (for example if you do lots of house repairs, flip houses on the side, or have large irregular expenses because that is your life, keep more cash around).

--
For retirement, the only thing which changes (to me) is that instead of 3-12 months expenses in cash, the amount might triple or quadruple- keep 4-8 years expenses in cash.

For my calculations (I am not retired right now) I do not consider the cash part of the portfolio where I calculate SWR from. If market goes down, I am not going to rebalance to acquire more equity shares, so therefore the cash I keep around for emergencies is not part of my SWR portfolio.
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Old 07-18-2009, 03:35 PM   #13
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...
2) Have X months expenses in safe investments (in a taxable account). While working, this would depend on occupation, kids, family situation, life situation and many other factors.
...
I have learned from others that there is no need to keep your safe investments in a taxable account. Keep your safe investments in a tax-sheltered account if you have a taxable account.

Indeed, one should try to keep only tax-efficient stock index funds in a taxable account. This is described elsewhere in many places but also in this thread:
FIRE and tax-advantaged accounts

If your stock index fund loses money in your tax-sheltered account, there is not much you can do. If your stock index fund loses money in your taxable account, you can do tax-loss harvesting and get the IRS to pay some of your losses. There are other benefits as described in the link.
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