Rebalancing as allocations are exceeded

[ejman]

Like a lot of people, I'm starting to get uncomfortably close to a rebalance point as equities exceed my 55/45 comfort zone. Given the lousy returns/prospects for bond funds I had a brain fart - what if I reallocated the rebalance amounts from equities to a fixed annuity? A couple of questions then:

1)How would I calculate my AA then? how is a FA calculated into the overall AA?

2) Does it make any sense at all to do this sort of thing now?

 

[Alan]

My annuities (aka pensions) are not a part of my AA calculation. There have been recent threads discussing the pros and cons of different AA's when people have annuities or pensions covering a big chunk of their annual expenses.

 

[Alan]

Here are 3 similar discussions on pensions and AA

http://www.early-retirement.org/for...e-home-pension-in-asset-allocation-33516.html

http://www.early-retirement.org/forums/f28/can-you-comment-on-my-asset-allocation-58339.html

http://www.early-retirement.org/forums/f28/yet-another-ss-question-62506.html

 

[REWahoo]

2) Does it make any sense at all to do this sort of thing now?

With current interest rates at historic lows, I'd say no.

 

[ejman]

Here are 3 similar discussions on pensions and AA

http://www.early-retirement.org/for...e-home-pension-in-asset-allocation-33516.html

http://www.early-retirement.org/forums/f28/can-you-comment-on-my-asset-allocation-58339.html

http://www.early-retirement.org/forums/f28/yet-another-ss-question-62506.html

Alan, thank you for these links. From these threads I get mostly a sense of no, you don't count the income from pensions/SS etc into your asset allocation. Somehow this conclusion doesn't seem right at a gut level. I mean after all, if one is deriving a certain income from a bond portfolio, one would include such bonds as part of the AA. If income mysteriously appears in one's checkbook wouldn't the source matter in the AA?

 

[ejman]

With current interest rates at historic lows, I'd say no.

And I'd tend to agree with you. But what to do then? go ahead and rebalance into bonds knowing full well that either bonds go nowhere from now on for the next 10-20 years (ala Japan) or else they dive if inflation (ala the Chairman's wishes) gets reestarted?

Or else, do nothing and up the Brewester's prescription? (aka let equities ride and up consumption of strong tranks as required)

 

[REWahoo]

From these threads I get mostly a sense of no, you don't count the income from pensions/SS etc into your asset allocation. Somehow this conclusion doesn't seem right at a gut level.

In my view it has a lot to do with an individual's tolerance for risk. Those who have a higher threshold of risk tolerance will include it and have a corresponding higher allocation to equities. The less risk tolerant will exclude it and have a more conservative AA.

 

[ejman]

My annuities (aka pensions) are not a part of my AA calculation. There have been recent threads discussing the pros and cons of different AA's when people have annuities or pensions covering a big chunk of their annual expenses.

Alan, I forgot to say, I'm not talking about annuities or pensions covering a big chunk of annual expenses - just the rebalancing amounts.

 

[REWahoo]

And I'd tend to agree with you. But what to do then? go ahead and rebalance into bonds knowing full well that either bonds go nowhere from now on for the next 10-20 years (ala Japan) or else they dive if inflation (ala the Chairman's wishes) gets reestarted?

Or else, do nothing and up the Brewester's prescription? (aka let equities ride and up consumption of strong tranks as required)

Either way "you pays your money and you takes your chances".

I lean towards short to intermediate duration bonds and focus more on the long term and dividends rather than allow the potential for a dip in price to wag the dog.

 

[ejman]

Either way "you pays your money and you takes your chances".

I lean towards short to intermediate duration bonds and focus more on the long term and dividends rather than allow the potential for a dip in price to wag the dog.

And that's a fair answer. I dunno, I may rebalance into VFSUX, go to sleep for a few years and then take a lookisee again.

 

[Alan]

Alan, I forgot to say, I'm not talking about annuities or pensions covering a big chunk of annual expenses - just the rebalancing amounts.

If you wish to count annuities as bonds then why not buy bonds. Once you have purchased an annuity and are receiving an income stream, then for me it doesn't behave as if I had a load of bonds or bond funds because I can't cash them in or pass them on when I die etc.

Brewer has a good thread on how to "roll your own annuity" rather than buy one from an insurance company with all the associated fees.

http://www.early-retirement.org/forums/f28/how-to-replicate-an-equity-indexed-annuity-eia-34656.html

 

[pb4uski]

And I'd tend to agree with you. But what to do then? go ahead and rebalance into bonds knowing full well that either bonds go nowhere from now on for the next 10-20 years (ala Japan) or else they dive if inflation (ala the Chairman's wishes) gets reestarted?

Or else, do nothing and up the Brewester's prescription? (aka let equities ride and up consumption of strong tranks as required)

I sort of faced this when I rolled over my 401k to an IRA (was all bonds). I am concerned about interest rate risk and lack of yields of bonds generally. What I ultimately decided was to go ~74% intermediate term investment grade corporate bonds, ~16% high yield corporate bonds and 10% GNMAs. At the time the weighted yield was 3.75%, a lot better than 2.17% of the total bond fund, and the weighted average duration was slightly lower as well. So far so good, but only time will tell if it was the right decision.

My hope is that if the economy improves, that while my bonds will decline as interest rates rise that stocks will improve and will more than offset any interest rate loss on the bonds. In the meantime, I'm getting a pretty reasonable yield given the low interest rate environment. Better than treasuries anyway, even after considering potential credit losses.

 

[ejman]

I sort of faced this when I rolled over my 401k to an IRA (was all bonds). I am concerned about interest rate risk and lack of yields of bonds generally. What I ultimately decided was to go ~74% intermediate term investment grade corporate bonds, ~16% high yield corporate bonds and 10% GNMAs. At the time the weighted yield was 3.75%, a lot better than 2.17% of the total bond fund, and the weighted average duration was slightly lower as well. So far so good, but only time will tell if it was the right decision.

My hope is that if the economy improves, that while my bonds will decline as interest rates rise that stocks will improve and will more than offset any interest rate loss on the bonds. In the meantime, I'm getting a pretty reasonable yield given the low interest rate environment. Better than treasuries anyway, even after considering potential credit losses.

Sounds reasonable. What methodology did you use to split the bond allocation among the separate classes?

 

[ejman]

If you wish to count annuities as bonds then why not buy bonds. Once you have purchased an annuity and are receiving an income stream, then for me it doesn't behave as if I had a load of bonds or bond funds because I can't cash them in or pass them on when I die etc.

Brewer has a good thread on how to "roll your own annuity" rather than buy one from an insurance company with all the associated fees.

http://www.early-retirement.org/forums/f28/how-to-replicate-an-equity-indexed-annuity-eia-34656.html

Interesting. Has anyone actually done what he proposes? I wonder what the "gotchas" might be. If there is one thing I've learned over my 62 years is that I don't know what I don't know

 

[audreyh1]

And I'd tend to agree with you. But what to do then? go ahead and rebalance into bonds knowing full well that either bonds go nowhere from now on for the next 10-20 years (ala Japan) or else they dive if inflation (ala the Chairman's wishes) gets reestarted?

If we go into "Japan mode" owning bonds now will be a good thing. The longer duration bonds would even likely continue to appreciate because longer term interest rates would probably continue to drop, even though that seems so hard to believe.

If inflation increases because the economy recovers, then bonds will be hurt some, but will eventually recover. Expecting bond funds to "dive" is exaggerating the likely outcome.

The point of having an AA portfolio is to have exposure to a group of poorly correlated assets so that when one decreases due to changes in economy/global outlook, another increases. This would be an "all weather" portfolio. You can't worry about every zig and zag along the way.

For me - if we end up in a Japan type scenario, I'll probably be spending down my appreciated bond funds while waiting for equities to eventually recover. If the economy recovers soon instead, leading to higher interest rates, I'll be spending down from equities and adding to the bonds until interest rates flatten again.

Audrey

 

[Alan]

Interesting. Has anyone actually done what he proposes? I wonder what the "gotchas" might be. If there is one thing I've learned over my 62 years is that I don't know what I don't know

I don't know. For myself I use Wellesley as an income stream to supplement my pension and let the management team buy the appropriate bonds and dividend producing equities, and keep it in an AA of around 35/65. You can see the how it is currently divided up from the link below. It is currently yielding only 2.6% but overall performance if dividends were reinvested is much higher.

Wellesley Allocation

Snap shot of overall performance

 

[ejman]

Thank you Audrey and Alan. This board is helping me immensely to get pass the temporary insanity that paying too much attention to headlines engenders. Audrey's comments on uncorrelated assets is right on and the prescription on what do do depending on the scenario development sounds reasonable. As to Wellesley, I already have about 1/3 of my liquid assets there and am happy with that investment but reluctant to add to it.

 

[pb4uski]

Sounds reasonable. What methodology did you use to split the bond allocation among the separate classes?

I just played around with percentages that seemed to provide a sensible balance of the three funds that had a better yield than the total bond fund and a shorter duration.