Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
The limitations (and strength ?) of balanced funds...
Old 10-27-2008, 07:48 PM   #1
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,044
The limitations (and strength ?) of balanced funds...

Well it happened, MIL called, the DOW is down another 200 points, she is freaking out. But at least she understand that she shouldn't sell everything and run for the hills, but she feels very insecure about the current situation.

Right now, all of her retirement money (in her only IRA) is invested in Vanguard Target Retirement 2015. This fund has lost almost 29% YTD.

When she purchased the fund last year, she wasn't supposed to need the money until 2017, so the 2015 fund made sense for her. But her income has unexpectedly dried up this year (and it might remain that way for a few years), so she is currently living on her taxable savings and maturing CDs. Her CD ladder and savings will take her to the end of 2009, but after that she'll have to start taking money out of her IRA.

Now, a balanced fund, like TR2015, automatically sells bonds to buy more stocks when the stock market drops (i.e. it rebalances automatically and it's is supposed to be a good thing). The problem she is facing is that the amount of money invested in safer bonds keeps going down as the stock market goes down.

When she started with $200K in the TR2015 fund in 2007, she had about $80K in bonds. Now that the fund is down 30%, she has just about $56K left in bonds.

Right now, between her CDs and the bond portion of TR2015, she could cover 5 years worth of expenses. So she wants to secure the $56K worth of bonds in TR2015 to make sure the money will be there no matter what the market does. She is willing to leave the rest ride the market and get a chance to recoup her losses.

So here is my plan:

VG TR2015 is pretty much allocated as follows:
38% VG total bond market
50% VG total stock market
12% international (close to VG total international)

I want to advise her to sell her shares of VG TR2015, and purchase the individual VG total bond market, VG total stock market and VG total international funds keeping an AA similar to TR2015. This maneuver will not immediately impact her AA but it will do 2 things: 1) if the stock market recovers, she still participate in the recovery and 2) if the market keeps going down, only the stock portion of her portfolio will be impacted and the bond portion will remain safe (no more continuous rebalancing on the way down).

This solution would ease her mind because her income for the next 5 years would be more secure. She might then stop watching CNBC all day and go back to living her life.

Do you think that plan make sense? Is there any pitfall I didn't think of?
__________________

__________________
FIREd is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 10-27-2008, 08:10 PM   #2
Administrator
W2R's Avatar
 
Join Date: Jan 2007
Location: New Orleans
Posts: 38,934
I sure can sympathize with her. With only $200K in her retirement nestegg, this must be hitting her pretty hard.

Your plan sounds OK to me, but maybe others will have more to add.

A couple of thoughts/musings:

I think rebalancing works better in building wealth if you rebalance at bottoms as well as at peaks in the market.

What will you do to calm her if her VG total bond market starts dropping? I suppose maybe some of that could go to more CD's, temporarily, but then that money would just sit there. She might feel more secure about it, though.

Maybe she needs a bigger bond/cash allocation than this fund provides, in order to sleep at night, so to speak.

This is a tough problem.
__________________

__________________
Already we are boldly launched upon the deep; but soon we shall be lost in its unshored, harbourless immensities.

- - H. Melville, 1851
W2R is offline   Reply With Quote
Old 10-27-2008, 08:16 PM   #3
Recycles dryer sheets
 
Join Date: Feb 2008
Posts: 147
>> I think rebalancing works better in building wealth if you rebalance at bottoms as well as at peaks in the market. <<

Sure, but how do you identify those bottoms and peaks at the time?

I read (maybe here) about a study that showed many successful investors made most of their money from buying on the way down....
__________________
headingout is offline   Reply With Quote
Old 10-27-2008, 08:33 PM   #4
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,044
Quote:
Originally Posted by Want2retire View Post
I sure can sympathize with her. With only $200K in her retirement nestegg, this must be hitting her pretty hard.

Your plan sounds OK to me, but maybe others will have more to add.

A couple of thoughts/musings:

I think rebalancing works better in building wealth if you rebalance at bottoms as well as at peaks in the market.

What will you do to calm her if her VG total bond market starts dropping? I suppose maybe some of that could go to more CD's, temporarily, but then that money would just sit there. She might feel more secure about it, though.

Maybe she needs a bigger bond/cash allocation than this fund provides, in order to sleep at night, so to speak.

This is a tough problem.
It is a difficult time for her because she has been hit hard by both the loss of her income and the stock market declines.

VG total bond market has held up pretty well so far (-1% YTD). I think it suffered from the flight to quality we have seen lately but I expect that, as the government works on solving the credit crunch, it will go up again as people focus more on yield and less on safety once again. If I am wrong, then, as you pointed out, we could always buy more CDs. The important thing is to stop the endless rebalancing. At this point she is more worried about limiting the downside than missing any potential upside on her fixed income portfolio.

As far as her bond / cash allocation goes, she is the one who wants to keep a pretty aggressive portfolio (last year she was 90-95% foreign stocks before I convinced her to come to the light and become more conservative with her money). She wants to have a chance to recoup her losses and to (hopefully) continue growing her money enough to retire in relative comfort.
__________________
FIREd is offline   Reply With Quote
Old 10-27-2008, 08:34 PM   #5
Thinks s/he gets paid by the post
Bikerdude's Avatar
 
Join Date: Jul 2006
Posts: 1,901
Quote:
Originally Posted by FIREdreamer View Post


Do you think that plan make sense? Is there any pitfall I didn't think of?
Just the possible market fluctuations when you try to do the sell/buy transactions. You know sell low buy high.
__________________
“I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said” Alan Greenspan
Bikerdude is offline   Reply With Quote
Old 10-27-2008, 08:39 PM   #6
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,044
Quote:
Originally Posted by Bikerdude View Post
Just the possible market fluctuations when you try to do the sell/buy transactions. You know sell low buy high.
I was thinking about doing an overnight exchange:

Sell TR2015 and simultaneously buy 38% VG total bond, 50% VG total market and 12% VG international (same proportions as in TR2015). I figure that it should take care of the problem, no?
__________________
FIREd is offline   Reply With Quote
Old 10-27-2008, 08:42 PM   #7
Administrator
W2R's Avatar
 
Join Date: Jan 2007
Location: New Orleans
Posts: 38,934
Quote:
Originally Posted by FIREdreamer View Post
I was thinking about doing an overnight exchange:

Sell TR2015 and simultaneously buy 38% VG total bond, 50% VG total market and 12% VG international (same proportions as in TR2015). I figure that it should take care of the problem, no?
If you do it in Vanguard, you can do it as an exchange and it will be simultaneous. That is probably what you meant! Never mind.
__________________
Already we are boldly launched upon the deep; but soon we shall be lost in its unshored, harbourless immensities.

- - H. Melville, 1851
W2R is offline   Reply With Quote
Old 10-27-2008, 08:48 PM   #8
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,044
Quote:
Originally Posted by Want2retire View Post
If you do it in Vanguard, you can do it as an exchange and it will be simultaneous. That is probably what you meant! Never mind.
Yes that's what I meant!
__________________
FIREd is offline   Reply With Quote
Old 10-27-2008, 09:19 PM   #9
Thinks s/he gets paid by the post
DblDoc's Avatar
 
Join Date: Aug 2007
Posts: 1,224
Quote:
Originally Posted by headingout View Post
>> I think rebalancing works better in building wealth if you rebalance at bottoms as well as at peaks in the market. <<

Sure, but how do you identify those bottoms and peaks at the time?

I read (maybe here) about a study that showed many successful investors made most of their money from buying on the way down....
A couple of thoughts:

First - rebalancing is a risk management tool not a wealth building tool. If you look at the studies comparing different time intervals or bands the gain (or loss) in the hypothetical portfolios is very small and pales in comparison to your AA decision.

Second - rebalancing should be done mechanically. Either based on a time interval (annually, every 2 years etc) or bands and not based on some prediction of where the market is going.

Third - I hope your right cause I've been buyin alot on the way down...

DD
__________________
DblDoc is offline   Reply With Quote
Old 10-27-2008, 09:33 PM   #10
Administrator
W2R's Avatar
 
Join Date: Jan 2007
Location: New Orleans
Posts: 38,934
From Swedroe (2005), p. 201:
Quote:
Rebalancing - - Buy Low and Sell High
In addition to providing the all-important benefit of avoiding style drift, rebalancing can also add to portfolio returns. [...] Rebalancing over time will likely produce a bonus--the portfolio's annualized return will exceed the weighted average of the annualized returns of the component asset classes.
That is what I meant by wealth building. Perhaps I was embellishing a little, unintentionally.

Rebalancing in bands, while ignoring the bottom of the band, will hamper the increases in annual returns. Both the top and the bottom of the band need to trigger rebalancing for better results. Many of us rebalance when our AA has wanded by 5% one way or another, for example. I rebalanced last week because I was over 5% off of my AA, but I don't claim last week to be "the" market bottom.
__________________
Already we are boldly launched upon the deep; but soon we shall be lost in its unshored, harbourless immensities.

- - H. Melville, 1851
W2R is offline   Reply With Quote
Old 10-27-2008, 09:39 PM   #11
Moderator Emeritus
Rich_by_the_Bay's Avatar
 
Join Date: Feb 2006
Location: San Francisco
Posts: 8,827
One disadvantage of target funds and other balanced products is the loss of your ability to selectively sell shares of just one of its components. Same trait makes them very convenient during accumulation but inflexible during withdrawal.

If it were me, I'd hold off as long as I could for markets to rebound a little, then split it up. Tough situation - hang in.
__________________
Rich
San Francisco Area
ESR'd March 2010. FIRE'd January 2011.

As if you didn't know..If the above message contains medical content, it's NOT intended as advice, and may not be accurate, applicable or sufficient. Don't rely on it for any purpose. Consult your own doctor for all medical advice.
Rich_by_the_Bay is offline   Reply With Quote
Old 10-27-2008, 09:44 PM   #12
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: May 2004
Posts: 11,615
Just an echo of W2R's comments. If your MIL needs money within the next few years, would it not be more prudent to build a CD ladder for her? FDIC insured (things could get worse, and this will be some comfort to her) and not subject to the interst rate/default risk bonds can have.

Other than that, dividing up the $$ into separate funds (rather than allowing the continual rebalancing) will probably meet your short term objective of stabilizing her account. When the market turns around, though, she'll obviously have less growth potential than f she'd continued to buy equities on the way down.

Providing hands-on investment advice to your MIL? What, were all the "fun" jobs on the bomb squad already filled?
__________________
"Freedom begins when you tell Mrs. Grundy to go fly a kite." - R. Heinlein
samclem is offline   Reply With Quote
Old 10-27-2008, 11:02 PM   #13
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,044
Quote:
Originally Posted by samclem View Post
Just an echo of W2R's comments. If your MIL needs money within the next few years, would it not be more prudent to build a CD ladder for her? FDIC insured (things could get worse, and this will be some comfort to her) and not subject to the interst rate/default risk bonds can have.

Other than that, dividing up the $$ into separate funds (rather than allowing the continual rebalancing) will probably meet your short term objective of stabilizing her account. When the market turns around, though, she'll obviously have less growth potential than f she'd continued to buy equities on the way down.

Providing hands-on investment advice to your MIL? What, were all the "fun" jobs on the bomb squad already filled?
I understand that splitting the balanced fund is not a perfect solution, but I am thinking that it might be the least damaging solution given the situation (at least she gets to keep some money in the market and -hopefully- recoup some of her losses). MIL did not seem to want more CDs (because the money is "locked up"), but I will carefully present the pros and cons of both bond funds and CDs and let her decide which one she prefers.

I wish I didn't have to provide her with investment advice. But, she is clueless when it comes to her finances (she is not stupid, she is just not very good with numbers and money). She even has trouble balancing her own checkbook sometimes (last week I got a worried phone call because her checkbook register showed a -$10,000 balance)... So I (or someone else) have to help her. Her brother-in-law (who is a financial adviser in one of those wall street firms) proposed to help her with her retirement portfolio for a... fee and commissions that she couldn't afford (he wouldn't even give her a discount).

The truth is that I have a vested interest in her financial success. If her retirement plan fails, guess who's going to have to support her financially or worse, guess in whose guest bedroom she (and her pets) will end up crashing...
__________________
FIREd is offline   Reply With Quote
Old 10-27-2008, 11:14 PM   #14
Moderator Emeritus
 
Join Date: May 2007
Posts: 11,044
Quote:
Originally Posted by Rich_in_Tampa View Post
One disadvantage of target funds and other balanced products is the loss of your ability to selectively sell shares of just one of its components. Same trait makes them very convenient during accumulation but inflexible during withdrawal.

If it were me, I'd hold off as long as I could for markets to rebound a little, then split it up. Tough situation - hang in.
Thanks for your encouragements Rich.

I keep hearing that we should expect a bear market rally anytime soon and I had told her that we should take advantage of that rally to do some selling. The problem is where is that darn rally! At this point, her patience is running thin...

I have heard this argument many times about that disadvantage of balanced funds which you pointed out and I must say that I had a hard time understanding it. But now that I look at it from the withdrawal perspective, I think I get it.
__________________

__________________
FIREd is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Balanced/Target Funds mike hall FIRE and Money 8 10-17-2008 08:43 PM
What do you think of these balanced funds? rec7 FIRE and Money 34 05-09-2008 12:17 PM
Balanced Funds Only? Maneiac FIRE and Money 15 05-22-2006 09:14 PM
Balanced funds in taxable? fire5soon FIRE and Money 9 08-31-2004 07:56 PM
Index Funds or Balanced Funds ? renferme FIRE and Money 5 04-20-2004 05:21 PM

 

 
All times are GMT -6. The time now is 10:15 AM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.