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Re: Welcome Young Dreamers!
Old 04-05-2004, 09:21 AM   #41
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Re: Welcome Young Dreamers!

Chris,

Thanks for the reply. Just so I get started off right here, I have been using my expected rate of return (example 10%) for predicting my 401k balance in the future. I know that that figure has to be adjusted of inflation. Are most people using a "real rate of return" figure (example 6%) for their predictions? I find this confusing because any calculations I do I know are in todays dollars. Keeping everything in todays dollars seems easier to me than adjusting now for inflation. My pension estimates from my employer are in todays dollars. My SSA estimates from the SSA are in todays dollars.

Mark
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Re: Welcome Young Dreamers!
Old 04-05-2004, 09:36 AM   #42
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Re: Welcome Young Dreamers!

Quote:
For now, I agree with you, but to check us both I'll pick at it a bit: Is your asset allocation advice the same for someone who's withdrawing and someone who's 15+ years from withdrawals? You say don't increase risk to get an extra half percent, but if we're not taking withdrawals then where's the risk? And a half point annual return compounded over 15+ years adds up to something, although I'm too lazy to calculate what it adds up to.
How about a qualified "maybe"? The maybe depends on the persons stomach for risk, and thats usually different when its a piece of paper you look at quarterly vs the source of your daily bread.

That having been said, I would recommend a stock portion of no less than 60 or more than 65 for a pre-withdrawal type, and something in the 50-60% range for a withdrawing type.

The way I have things allocated divides the asset classes up into taxable and IRA in a way that separates the riskier classes away from my "daily bread". My taxable account has large cap value, short to intermediate bond, and foreign indexes. My IRA has small cap, international small cap, REIT, TIPS and emerging market indexes.

The stuff I'm drawing from today and for the next 18 or so years is fairly stable income producing and more or less tax friendly; the stuff I'll be drawing from later is somewhat less so.

My allocation (as of today) is about 55% stock. In my taxable account its about 45%. About 90% in my IRA.
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Re: Welcome Young Dreamers!
Old 04-05-2004, 09:41 AM   #43
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Re: Welcome Young Dreamers!

Quote:
Chris,

Thanks for the reply. Just so I get started off right here, I have been using my expected rate of return (example 10%) for predicting my 401k balance in the future. I know that that figure has to be adjusted of inflation. Are most people using a "real rate of return" figure (example 6%) for their predictions? I find this confusing because any calculations I do I know are in todays dollars. Keeping everything in todays dollars seems easier to me than adjusting now for inflation. My pension estimates from my employer are in todays dollars. My SSA estimates from the SSA are in todays dollars.

Mark
Inflation affects your returns TODAY. If this years inflation rate is 2.5% and your returns are 10%, your real rate of return is 7.5%. As for far flung future estimates, working exclusively in todays dollars is a good idea, but you still need to apply inflation adjustments to your current annual returns.

I'm presuming 8-9% for my IRA allocation (pre inflation) and 6-8% for my taxable allocation (pre inflation).

That (hopefully) means my taxable piece gives me 4% SWR (which I can live well on), plus enough to accomodate inflation and keep me from eating my principal, while my IRA portion can bounce all to hell and back but (again hopefully) becomes a substantial piece of principal for me to start working with when I'm of curmudgeonly age.
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Re: Welcome Young Dreamers!
Old 04-05-2004, 09:49 AM   #44
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Re: Welcome Young Dreamers!

BMJ - Occurs to me I may not have completely answered your question with regards to risk and withdrawal.

As an aside, which probably has huge bearing, I dont consider some stock investments like REITS and emerging markets as a pure "stock" class, even though they are stocks. I consider REITS as a real estate asset class, and emerging markets as a speculative one.

I think the fair answer to your question is that during long time periods, the volatility (aka risk) factors of a 100% stock (or even 100% high risk stock) portfolio are mitigated. However if your withdrawal hits at the end of a period of high downside volatility, that might hurt. Coupled with Bernsteins allegation that stocks and bonds may have similar returns going forward...

But then again, you should consider my thinking with a grain of salt as I ate a tofu hot dog for breakfast...although I did put mustard, onions and sauerkraut on it. Heyyy...does that make me a cybersauer?
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Re: Welcome Young Dreamers!
Old 04-05-2004, 10:07 AM   #45
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Re: Welcome Young Dreamers!

TH, sounds good enough to me. Up until recently my thought was to stay nearly 100% stock to maximize returns and make it to ER as soon as possible, then move to a more mellow, less volatile portfolio to make it through retirement. I was pleased that I took the dramatic 40-50% drop in value after 2000 without panic. But two main points these days are making me want to have a bond mix now.

One point is market timing. How will I know when the right time to move my funds from 100% stocks to a balanced allocation? If my retirment year is like 2001 was I would've felt good up until a few months before retirement then panicked. If I adjust my mix now there's no timing issue; I'll keep largely the same allocation from now through retirement through death.

The other point is that I may need to make an unanticipated withdrawal, and that would be more likely to happen during a downturn in stocks. I resisted the temptation to use my pretax funds to pay off my debt, but late last year I had the threat of a layoff and probably would have wanted/needed to withrdaw some funds after that. If I balance my allocation now my portfolio will always be ready for an emergency withdrawal.

Additionally, my outlook on finances is evolving. My path to eliminating debt was determination and (somewhat) strict budgeting. Once the debt is gone, my path to ER doesn't need to be as strict; after all the point of wanting to RE is to have more freedom and enjoy life more, but I can get some of that between now and ER; so as an example perhaps I can quit a job if it becomes too annoying, take a few months off and then go back to work. It will put off ER, but then it's like taking a bit of ER now instead of later. The point of all this is that a balanced allocation during accumulation will help this situation, too.

EDIT: I cross-posted with your post immediately preceeding this one. Wow, and Bob_Smith just posted while I'm editing; I can't keep up with you guys. Anyway, you mention the market timing issue and make a good point about stock/bond returns. Whether or not one agrees about future returns, there is certainly no guarantee that either stocks or bonds will outperform the other, so that seems to support a balanced portfolio, too. And I think you do your best stuff after wine and eating.
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Re: Welcome Young Dreamers!
Old 04-05-2004, 10:07 AM   #46
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Re: Welcome Young Dreamers!

Quote:
For now, I agree with you, but to check us both I'll pick at it a bit: Is your asset allocation advice the same for someone who's withdrawing and someone who's 15+ years from withdrawals? You say don't increase risk to get an extra half percent, but if we're not taking withdrawals then where's the risk?
Hi BMJ. I know this was directed to TH, but I'll throw in my two cents.

Zbwmy said he might retire in 8 years, and I think what he may find is that his tolerance for work at age 47 will be much lower than it is now at age 39. If he's sitting on a phenomenal benefit package plus $750,000 or so at age 47, he may very well want to pull the trigger then.

Also, one advantage to allocating between stocks and bonds is re-balancing. It would force him to buy stocks when they are down, and lighten up when they are high. If he's 100% in stocks, he can't do that.
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Re: Welcome Young Dreamers!
Old 04-05-2004, 10:19 AM   #47
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Re: Welcome Young Dreamers!

Bob_Smith, go right ahead! Great points about rebalancing and the decreasing tolerance for work.

8 months ago I was over 95% stocks. Today I'm about 20% bonds and getting closer and closer to deciding to adjust to 35-40% bonds from this year forward.
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Re: Welcome Young Dreamers!
Old 04-05-2004, 12:56 PM   #48
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Re: Welcome Young Dreamers!

Hello Mark,

Hmm, I think we have a disconnect so let's make sure. I'm pretty sure I have these terms right - someone please correct me if I'm wrong. The "actual" rate is what the market actually returned. The historical actual rate of return for the market is generally accepted to be about 10-11%. "Real" means "actual" rate of return minus the inflation correction. The historical real rate of return for the market is generally accepted to be about 7-8%. It depends on what historical periods you use for the calculations of both actual returns and inflation rates... Anyway. The real rate of return will give current year dollars for ball park projection calculations. The actual rate of return will give future year dollars for ball park projection calculations because it is not corrected for inflation. Most people like to think in terms of current year dollars and that means handicapping your actual expected rate of return by your expected inflation rate meaning the real rate of return. Yes, you are right the SSA and the pension plans report to you in current year dollars. So unless you expect to see 10% as a real return rate (more like 13-14% before inflation), you will need to adjust for inflation to see the results in today's (current year) dollars.

Maybe there wasn't a disconnect, but I feel better now. Yes, a lot of folks use the 6% real figure. Why? I think that folks do this for two reasons. The first is most folks don't ride 100% in the stock market. While diversification gives you a less volatile portfolio, it also provides you with a smaller return than 100% stocks (although some would argue this statement). The second reason is that if you can hit your mark with the lower rate of return, great. You might be pleasantly surprised by a higher return in the long run. Pleasant surprises are much more fun to deal with than disappointing surprises. Along this same thought line, some folks just don't think the market is going to perform quite as well in the near future. Belt and suspenders? However you want to think of it.

I can't "retire" until age 57, so I'll quit and then file for retirement at 60. It would be nice for me to be able to file the retirement paperwork at age 47...

Hope that helped.

Chris
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Re: Welcome Young Dreamers!
Old 04-05-2004, 01:37 PM   #49
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Re: Welcome Young Dreamers!

Quote:
While diversification gives you a less volatile portfolio, it also provides you with a smaller return than 100% stocks (although some would argue this statement).
I wont argue, but I'll disagree...

Several of the "asset allocation" guys point out that high diversification portfolios can enhance returns while concurrently reducing volatility.

But it clearly depends on what you're using for diversification classes, how much, and what periods you measure.

The three down years we just had were pretty good for bonds, so a 50/50 or 60/40 stock/bond mix would have done way better during that period than a pure stock portfolio. While reducing overall volatility.

REITS, emerging markets and small caps have done far better than the s&p500 over the last couple of years. Incorporating some of those would have improved your returns, again while reducing volatility.

Riskier and less risky classes besides US stocks CAN improve your returns while reducing portfolio volatility, providing you balance correctly, rebalance periodically (every 1-3 years), and choose classes that are not highly correlated with one another.

Here are some asset classes and correlation influences I incorporate into my asset allocation spreadsheet; this information comes from Gillette Edmunds book. Not as thorough as Bernsteins, but a one sitting read without as much brain burn:

- Emerging Markets, US Stocks and foreign on different "tracks".
- Small US and Large US stocks are on the same one.
- US and Foreign stocks on different ones.
- Emerging market and foreign are somewhat correlated.
- Real estate and oil/gas on similar ones.
- Bonds and stocks in the same country often track similar
- High inflation hurts stocks and bonds in the short term, then can improve stocks by higher product selling prices and bonds by accompanying higher interest rates.
- Declining inflation helps stocks and bonds in the short to medium term.
- Rising currency value helps both stocks and bonds in that country.
- Declining currency hurts both stocks and bonds in that country.
- Money markets, tbills and cash track similar to bonds.

From this, a smidgeon of foreign stocks (which can be further sub-split to small and large cap), some REIT's and/or oil and gas pumpers, a helping of domestic bonds, and perhaps a little foreign bonds and/or emerging market stocks. Then a precious metals cherry on top?

Its also worth it to note that with our current low inflation and rates, its likely both may rise and fall over our retirement period, inflicting benefit and damage on the US markets; these may have inverse relationships on foreign issues as those become more expensive or cheaper relative to US investment instruments.

Plus our low US dollar value right now will (again hopefully) reverse itself, sending a few ripples.

With these in mind, owning any long term bonds or a very heavy intermediate term bond (10+ years) may be a bad idea. Further, Bernstein showed that the risk/return profile of 10+ year bonds isnt very appealing most of the time.

Several "portfolio's for every season" have been posted here, but:

10% to foreign issues
3-5% emerging markets
5-15% reits
2-3% precious metals (perhaps)
3-5% high quality foreign bonds (perhaps)
10-20% small cap value
remainder of portfolio split 60/40 between s&p 500 or total stock market and short term corporate and/or TIPS

You may wish to use large cap value instead of s&p500 or TSM for your major US stock holding. Higher returns and dividends over long time periods.

Rebalance between winners and losers every couple of years. Rinse and repeat. Some will argue that rebalancing all the time or monthly/quarterly gets you something. Others note that some assets have performed great for many years straight and awful for many years, so frequently rebalancing to/from those would hurt. I think every year or two might do the trick.
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Re: Welcome Young Dreamers!
Old 04-05-2004, 04:27 PM   #50
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Re: Welcome Young Dreamers!

I am a wavering "lumper" having most of my IRA
in Vanguard's Target Retirement 2025. However,
I am becoming increasingly interested in being a
"splitter" for the IRA in my name and leave my
wife's IRA in the 2025 fund and put our after tax
fund in 2025 as well. In the "splitter" IRA I am considering using the "coffee house" formula" in all Vanguard funds:

10% in Large Cap Index
10% in Value Index
10% in Small Cap Index
10% in Small Cap Value Index
10% in REIT Index
10% in Total International Index
20% in Short Term Corporate
20% in TIPs fund.

I have already started "value averaging" into
Small Cap Value Index, the REIT Index and TIPS
at the rate of $5K per quarter. If the recent
down draft in REIT and TIPS continues, I will
get more aggressive. I will probably start the other
funds during the year.

This will give us an overall 60/40 split in the total
portfolio.

Currently our after tax account is 100% in TSM.
I know that the 2025 fund is less tax efficient,
but it is worth it to me to have the 60/40 mix
run on autopilot. However my male harmones,
still kicking at age 70, want to do the "splitter"
thingy for part of our portfolio.

Do you see any problems? Re-balancing the "splitter"
every year should not be a problem even for my
dear wife Lyn (whose eyes glaze over on this topic)
if I should have to take up residence in the old
folks home with drool cup in hand.

Cheers,

Charlie (aka Chuck-Lyn)
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Re: Welcome Young Dreamers!
Old 04-05-2004, 04:28 PM   #51
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Re: Welcome Young Dreamers!

I am a wavering "lumper" having most of my IRA
in Vanguard's Target Retirement 2025. However,
I am becoming increasingly interested in being a
"splitter" for the IRA in my name and leave my
wife's IRA in the 2025 fund and put our after tax
fund in 2025 as well. In the "splitter" IRA I am considering using the "coffee house" formula" in all Vanguard funds:

10% in Large Cap Index
10% in Value Index
10% in Small Cap Index
10% in Small Cap Value Index
10% in REIT Index
10% in Total International Index
20% in Short Term Corporate
20% in TIPs fund.

I have already started "value averaging" into
Small Cap Value Index, the REIT Index and TIPS
at the rate of $5K per quarter. If the recent
down draft in REIT and TIPS continues, I will
get more aggressive. I will probably start the other
funds during the year.

This will give us an overall 60/40 split in the total
portfolio.

Currently our after tax account is 100% in TSM.
I know that the 2025 fund is less tax efficient,
but it is worth it to me to have the 60/40 mix
run on autopilot. However my male harmones,
still kicking at age 70, want to do the "splitter"
thingy for part of our portfolio.

Do you see any problems? Re-balancing the "splitter"
every year should not be a problem even for my
dear wife Lyn (whose eyes glaze over on this topic)
if I should have to take up residence in the old
folks home with drool cup in hand.

Cheers,

Charlie (aka Chuck-Lyn)
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Re: Welcome Young Dreamers!
Old 04-05-2004, 04:35 PM   #52
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Re: Welcome Young Dreamers!

Sorry about the double post. Senility is creeping
in at an alarming rate.

Charlie
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Re: Welcome Young Dreamers!
Old 04-05-2004, 05:00 PM   #53
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Re: Welcome Young Dreamers!

I might pass on the small cap blend fund in favor of more of the small cap value. It beats up on the growth and blend funds with great regularity and pays a better dividend. Same with the large cap value, although large cap growth does occasionally have its day (like in the late 90's).

Total international is good, but it heavily underweights japan (3:1) and the emerging markets (9:1). Maybe I'm the only one seeing a recovery (finally) in japan, but I equal weighted europe and japan, and have a full 4% of my total port in emerging markets. In the total international index you'd have 1% net of your portfolio in emerging markets. Not that theres anything wrong with that; they're volatile and a little peaky right now.

Other than that, looks good, lump away.
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Re: Welcome Young Dreamers!
Old 04-05-2004, 05:50 PM   #54
 
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Re: Welcome Young Dreamers!

TH,

According to Bernstein. It is more important to stick with an Allocation of Asset Classes than trying to come up with the 'perfect' portfolio. IOW - Tweaking your portfoilo every couple of years has a negative effect.

Just a point to keep in mind. Once you get an Asset Allocation Plan, stick with it for the long haul. This is more important than anything else!
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Re: Welcome Young Dreamers!
Old 04-05-2004, 07:15 PM   #55
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Re: Welcome Young Dreamers!

Quote:
Hello Mark,

Hmm, I think we have a disconnect so let's make sure. *I'm pretty sure I have these terms right - someone please correct me if I'm wrong. *The "actual" rate is what the market actually returned. *The historical actual rate of return for the market is generally accepted to be about 10-11%. *"Real" means "actual" rate of return minus the inflation correction. *The historical real rate of return for the market is generally accepted to be about 7-8%. *It depends on what historical periods you use for the calculations of both actual returns and inflation rates... *Anyway. The real rate of return will give current year dollars for ball park projection calculations. *The actual rate of return will give future year dollars for ball park projection calculations because it is not corrected for inflation. *Most people like to think in terms of current year dollars and that means handicapping your actual expected rate of return by your expected inflation rate meaning the real rate of return. *Yes, you are right the SSA and the pension plans report to you in current year dollars. * So unless you expect to see 10% as a real return rate (more like 13-14% before inflation), you will need to adjust for inflation to see the results in today's (current year) dollars. *

Maybe there wasn't a disconnect, but I feel better now. *Yes, a lot of folks use the 6% real figure. *Why? *I think that folks do this for two reasons. *The first is most folks don't ride 100% in the stock market. *While diversification gives you a less volatile portfolio, it also provides you with a smaller return than 100% stocks (although some would argue this statement). *The second reason is that if you can hit your mark with the lower rate of return, great. *You might be pleasantly surprised by a higher return in the long run. *Pleasant surprises are much more fun to deal with than disappointing surprises. *Along this same thought line, some folks just don't think the market is going to perform quite as well in the near future. *Belt and suspenders? *However you want to think of it. *

I can't "retire" until age 57, so I'll quit and then file for retirement at 60. *It would be nice for me to be able to file the retirement paperwork at age 47... *

Hope that helped.

Chris
Thanks Chris,

You cleared it up. Our retirement ages are inverse. I must retire by age 57, but can retire at age 47.
Mark
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Re: Welcome Young Dreamers!
Old 04-06-2004, 06:38 AM   #56
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Re: Welcome Young Dreamers!

TH,

Fine points, but that portfolio is not possible to recreate in zbwmy's retirement plan and my answer was aimed at his plan (although, I still believe that diversification handicaps the portfolio). The yearly re-jiggering would cause me heartburn. It's my personality, but the "losses" over the last couple of years from my S&P fund haven't caused me any heartburn or lost sleep. Just out of curiosity, have you seen any "model" diversified portfolios that consider the fund expenses. I suspect that with a small but growing portfolio this non-S&P (market) diversification split would be expensive wrt fund expenses. This could (further) handicap the diversified portfolio. I haven't seen any diversified models that I think are practical, then again, I haven't looked for them. Mostly, what I find in the magazines is the equivalent of hand waving, saying that this will be up when that's down and all is swell in the end.

If folks have a defined benefits pension and/or they believe that SS will be around for their retirement in some form, they have a built in diversification depending on how you look at it. Yes, there are pitfalls in this type of thought, but there are pitfalls to all investment choices.

I enjoyed your reply,

Kind Regards,

Chris
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Re: Welcome Young Dreamers!
Old 04-06-2004, 12:39 PM   #57
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Re: Welcome Young Dreamers!

The "rejiggering" is standard rebalancing. A typical balanced fund rebalances automatically. If you're buying multiple asset classes separately, you can do the rebalancing yourself. Or not. There are a lot of lines of thinking on this.

Me, I'm doing a couple of rebalances. If small or large cap value have a big run up over a couple of years, and the other is down or hasnt, I'll skim some off the winner and move it to the loser to re-establish my original percentages. If japan runs up and europe sputters (which has happened), I'll take some away from japan and give to europe. If my bond holdings run up and stocks drop, I'll take some away from bonds to feed the stocks.

Simple rebalancing, no more, no less.

As far as fund expenses, my aggregate expenses are exactly .25%. And believe it or not I may be able to reduce that to .20% with just a couple of changes in my small cap funds and/or by replacing a fund or two with cheaper ETF's. Still considering that.

True, this level of diversification isnt possible in zbwmy's available 401k choices but if they have a taxable account, one can spread their allocations between the two. I was more or less generically responding to the topic of overall asset allocation.

Other points:

- Dont read finance magazines.

- Read Edmunds "retire early and live well" or Bernsteins "Four pillars of investing". They'll explain the asset allocation theory and give you more real data and proof points than you're going to want to read. I did a "book report" in "investment strategies" on bernsteins book if you want to cut to the chase.
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