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Revisiting my asset allocation
Old 02-11-2018, 11:19 PM   #1
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Revisiting my asset allocation

I'll admit the 10% correction was abit of an eye opener for me in terms of real $ loss. The best way proper A/A has been described is to determine your maximum tolerable loss and then work backwards from there.

So for me I have 1.2M in invested assets (well more like 1.13 after the correction). I have a 70/30 allocation. So on a 50% equity pullback, I would suffer a real $ loss of $420,000. Although that would royally suck; I have then asked myself, how much would that push back my retirement age range? For me I clear about 100K per year at work so my age of retirement would go from my proposed 50 (aiming for $2Mil) to 54. I then ask myself, can i live with that? The answer is yes and hence how I come up with a 70/30 split. Does this line of thinking make sense?

Now this assumes I can retain the same level of employment between ages of 50 and 54. It also assumes that future expected returns are not impacted by the pullback. I'm still wrapping my head around that one. I believe the market is essentially a giant discounted cash flow mechanism so that if we get a pullback that should mean returns on the morning of that pullback should be higher over my expected lifetime then at the peak of that pullback. I assume 5% nominal return for equities in my calculations. If we had a massive pullback like that presumably I could use a higher expected rate of return going forward which would reduce the 4 years calculated above??
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Old 02-12-2018, 04:20 AM   #2
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If a 10% correction was an eye opener, how long have you been investing? We have just come off of one of the least volatile periods in stock market history. That does not make it the norm. Over very long periods, a 10% drop occurs about once a year, a 20% drop once every 3 years, and a >40% drop every decade or two. I did not like the correction either, but I was not surprised in any way.
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Old 02-12-2018, 04:34 AM   #3
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... I believe the market is essentially a giant discounted cash flow mechanism so that if we get a pullback that should mean returns on the morning of that pullback should be higher over my expected lifetime then at the peak of that pullback. I assume 5% nominal return for equities in my calculations. If we had a massive pullback like that presumably I could use a higher expected rate of return going forward which would reduce the 4 years calculated above??
Market return can and did stay above or below par for a long time, meaning a decade or more. An economic cycle can be that long. The cash flow spigot is turned off, and the stock market reflects that.

However, the economy is still doing great. World economy is going more gunho than it has been for the last several years. Outside the US, the mood is very upbeat, such as in Europe. Of course when everything is working great the danger is higher, but nobody talks about any immediate decline yet. I am always on the lookout for that.
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Old 02-12-2018, 05:21 AM   #4
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I only have 2% of my NW in stocks and have cold feet with that, it’s yielding me $500 a month in dividends but I’m not liking the risk/reward, I’m getting out of it this week and gonna put it back into gold.
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Old 02-12-2018, 05:37 AM   #5
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My liquid investments are 95% equities. Even with the 10% correction, I am much further up than if I would have been in any other allocation.

I am staying the course.
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Old 02-12-2018, 06:23 AM   #6
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Originally Posted by accountingsucks View Post
I'll admit the 10% correction was abit of an eye opener for me in terms of real $ loss. The best way proper A/A has been described is to determine your maximum tolerable loss and then work backwards from there.

So for me I have 1.2M in invested assets (well more like 1.13 after the correction). I have a 70/30 allocation. So on a 50% equity pullback, I would suffer a real $ loss of $420,000. Although that would royally suck; I have then asked myself, how much would that push back my retirement age range? For me I clear about 100K per year at work so my age of retirement would go from my proposed 50 (aiming for $2Mil) to 54. I then ask myself, can i live with that? The answer is yes and hence how I come up with a 70/30 split. Does this line of thinking make sense?

Now this assumes I can retain the same level of employment between ages of 50 and 54. It also assumes that future expected returns are not impacted by the pullback. I'm still wrapping my head around that one. I believe the market is essentially a giant discounted cash flow mechanism so that if we get a pullback that should mean returns on the morning of that pullback should be higher over my expected lifetime then at the peak of that pullback. I assume 5% nominal return for equities in my calculations. If we had a massive pullback like that presumably I could use a higher expected rate of return going forward which would reduce the 4 years calculated above??
I think you need to find your target asset allocation and stick with it. This does not mean never change it, it just means aligning it with your goals and time horizon. The big question for me is whether you have sufficient "safe" assets to ride out an extended downturn without selling equities? If so, then over time a higher allocation to equities will generate higher total returns, generally speaking. You have to be able to stomach the risk, of course.

If you have tuned your asset allocation per the above, then hopefully you can ignore interim market moves and stick to your strategy.

Cheers!
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Old 02-12-2018, 06:50 AM   #7
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I have developed a portfolio allocated between equity funds (domestic and foreign) and bond funds and some REIT funds, but I'm no longer certain that it really matters all that much. I remember learning long ago about the efficient frontier and the virtues of diversification, but 2008-09 taught me that in a real panic all correlations run to 1.0. IIRC, by March 2009, everything but cash had crashed and burned. I'm not prepared to sell everything and stay in cash, but it is difficult for me to get to excited about whether I should be at 70/30 or 6/40 or 50/50 or any other combination.
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Old 02-12-2018, 09:12 AM   #8
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(I'll answer based on the notion that 100 years or so of market history has some predictive value for the future. Inductive reasoning has its pitfalls --- Google "Taleb's Turkey" -- but it is really all that we have.)

@accountingsucks, youir second paragraph is based on a false premise: That money "lost" in a downturn is lost forever. Not so. The market (historically) has always come back. So the only way that money is "lost" is if you sell out your position instead of sitting tight. That's why as you approach retirement you'll be moving some of your investments out of equities. It's those non-equity investments that you can sell when equity prices are down. Google "sequence of returns risk" and read until your eyes glaze over.

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Originally Posted by accountingsucks View Post
... If we had a massive pullback like that presumably I could use a higher expected rate of return going forward which would reduce the 4 years calculated above??
Of course! Assuming the market average is not changing, every period of below-average performance is balanced by a period of above-average performance. That's just arithmetic. The fancy term is "regression to the mean."

So what is a "period?" Well, looking at history shows that the down periods are usually short and exciting and the "up" periods that follow are usually measured in years. Except for the great depression, which took WWII to recover, numbers like 1-5 years are what we see. And, remember, during that recovery, returns are above average. It is just that asset values have not yet reached where they were at the beginning of the "down" period. So if you need to sell during a recovery you will net more than you would have at the bottom. The longer you wait, the smaller the hit.
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Old 02-12-2018, 09:26 AM   #9
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Still a paper loss until sold.

I remember the 2008 meltdown. Was disheartening to see investments go down month after month despite rebalancing. But I didn't panic sell and once things turned around all the extra shares bought during the downturn paid off good.

When in a downturn, I think shares and not dollars .
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Old 02-12-2018, 09:43 AM   #10
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I paper lost more than a 2017 BMW M760i Xdrive as I was / am 95% equities. However I am not as resolved as Senator. Will be away from screen from 2/25-3/11 so setting a conditional sell off of SCHA @ 73 (previous high), the proverbial canary in the coal mine. That would put me @ 85% equities. But I have an aversion to bonds so if it goes, I'll be looking for a place to put it. All models state I'm overloaded in large caps & large cap ETF so
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Old 02-12-2018, 09:48 AM   #11
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WADR, if this minor correction has the OP rattled, then perhaps 70/30 is to strong of a AA for him/her.
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Old 02-12-2018, 09:51 AM   #12
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I did not want to have the traditional 60/40 retirement portfolio.
We retired in June 2017 at ae 57, I decided to keep 13 years of living expenses (we plan to take ss at ae 70) and invested the balance in a 70/30 portfolio.
My portfolio ended up being 60/40 after all this exercise. !
I know I can live with it after the sudden 10% correction and will be able to weather a bear market upto 30% decline if need be.
I am happy to have found my sweet spot.....hope you can too!
Cheers.
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Old 02-12-2018, 10:01 AM   #13
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AccountingSucks, SPY set its low of $258.70 on February 6, above the 200-day simple moving average $253.31, which is the downside risk to complete the correction. A 10% drop usually happens over 4 months and takes 4 months to recover, drops of 20%+ are rarer and take up to 22 months to recover. In that most of us will spend decades in retirement that's a blimp on the radar.
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Old 02-12-2018, 02:11 PM   #14
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I only have 2% of my NW in stocks and have cold feet with that, itís yielding me $500 a month in dividends but Iím not liking the risk/reward, Iím getting out of it this week and gonna put it back into gold.
If 2% of your NW generates $500/month in dividends, then 100% NW in stocks would generate $25,000/month or $300K/year in dividends.

If I had that kind of money, I would leave it all in the market. I would still sleep very well as my expenses are not as high as that, and leave me plenty of safety margin.
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Old 02-12-2018, 02:24 PM   #15
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I'll admit the 10% correction was abit of an eye opener for me in terms of real $ loss. The best way proper A/A has been described is to determine your maximum tolerable loss and then work backwards from there.

So for me I have 1.2M in invested assets (well more like 1.13 after the correction). I have a 70/30 allocation. So on a 50% equity pullback, I would suffer a real $ loss of $420,000. Although that would royally suck; I have then asked myself, how much would that push back my retirement age range? For me I clear about 100K per year at work so my age of retirement would go from my proposed 50 (aiming for $2Mil) to 54. I then ask myself, can i live with that? The answer is yes and hence how I come up with a 70/30 split. Does this line of thinking make sense?

Now this assumes I can retain the same level of employment between ages of 50 and 54. It also assumes that future expected returns are not impacted by the pullback. I'm still wrapping my head around that one. I believe the market is essentially a giant discounted cash flow mechanism so that if we get a pullback that should mean returns on the morning of that pullback should be higher over my expected lifetime then at the peak of that pullback. I assume 5% nominal return for equities in my calculations. If we had a massive pullback like that presumably I could use a higher expected rate of return going forward which would reduce the 4 years calculated above??

You say your hoping to retire at 50, but realistically might push that back to 54. But how old are you now?
IMO, the number of years you have before you are compelled to start pulling from the nest egg, has an influence on how you might set your AA.

Also, I am curious about the time frame since you started your savings and investing life. If you didn't suffer a reduction in your portfolio with the debacle of '07-'08, and all you know is how much fun a big run-up is, than you likely don't really know your risk tolerance.

Those of us who experienced the last crash, and stuck it out were handsomely rewarded with a relatively quick and protracted Bull. In 1999 that wasn't the case. I was fortunate in that I wasn't planning on retiring for another 15-17 years so I had a decade or so to buy equities before the return of the Bull.
Are you prepared for something like that? It could happen.
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Old 02-12-2018, 04:30 PM   #16
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I think your reasoning in the 2nd paragraph is sound and a good way to arrive at your AA. I would also look at how uncomfortable a 50% drop in equities would make you feel. If you felt a 10% drop was an "eye opener", I think you need to look at this more critically. Like DrRoy said, expect this to happen about once a year.

If you're within 5 years of your planned ER, consider moving the AA slowly to the desired post-ER AA.
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Old 02-12-2018, 04:41 PM   #17
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If 2% of your NW generates $500/month in dividends, then 100% NW in stocks would generate $25,000/month or $300K/year in dividends.

If I had that kind of money, I would leave it all in the market. I would still sleep very well as my expenses are not as high as that, and leave me plenty of safety margin.
I would have a slightly modified version of this. Put enough in cash and equivalents to have something if the market really tanked, and the let rest ride.
Assuming a 5% dividend rate, this is a $6 Mil asset base. Stick $1-$1.5 in short term or inflation adjusted fixed so that you can "guarantee" that it isn't wiped out, no matter what happens in the market.
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Old 02-12-2018, 05:27 PM   #18
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I have developed a portfolio allocated between equity funds (domestic and foreign) and bond funds and some REIT funds, but I'm no longer certain that it really matters all that much. I remember learning long ago about the efficient frontier and the virtues of diversification, but 2008-09 taught me that in a real panic all correlations run to 1.0. IIRC, by March 2009, everything but cash had crashed and burned. I'm not prepared to sell everything and stay in cash, but it is difficult for me to get to excited about whether I should be at 70/30 or 6/40 or 50/50 or any other combination.
This is not true. High quality bond funds appreciated during the route - some quite a bit. And even if many equity asset classes behave similarly during a big selloff, the rest of the time they are less correlated and so the diversification still pays. And even the corporate bond funds that sold off during the rout recovered more quickly.

I think looking at how things actually performed in 2008 is a good lesson in diversification best practices. Donít be seduced by riskier bond funds that offer poor diversification against stocks.
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Old 02-12-2018, 05:30 PM   #19
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AccountingSucks, SPY set its low of $258.70 on February 6, above the 200-day simple moving average $253.31, which is the downside risk to complete the correction. A 10% drop usually happens over 4 months and takes 4 months to recover, drops of 20%+ are rarer and take up to 22 months to recover. In that most of us will spend decades in retirement that's a blimp on the radar.
I hope itís a blip on the radar - I donít want a blimp!
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Old 02-12-2018, 05:41 PM   #20
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... I think looking at how things actually performed in 2008 is a good lesson in diversification best practices. ...
Be a little careful with this. The jump in bond values in 2008 was due to central banks' dropping interest rates to zero. Our 2026/2% TIPS went up by 50%! I don't think you can confidently project that kind of central bank action for future periods of excitement.
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