Pre-FIRE Asset Mgmt question. Be Gentle. It's my first time....

[Doc Holiday]

Hi ER community. Truly awesome website! I have been forsaking my NYT sub to read this nightly!

My current situation:
Age 52. Married, DW not working, DS in University, DD in HS. Live in Oregon.
Want to retire at 55 (DD graduates HS)

3.6 million in invested assets, 60/40 taxable/401k.
$550k in home equity
$200k in rental home equity (rent at 20k/year)

Investments in retirement accounts are 100% equities currently with the idea that I probably won't touch it until 70.

Here's the rub: my taxable account is about 40% total US, 15% foreign, 5% munis, the rest is in cash (40%). This high cash position is a result of some sales and cashing my own life insurance (still insured at work for $2 M).

My question is a) what do you think the best use for the cash would be/what percentage in bonds and b) the timing of said purchase? The current low rate of return and rising interest rates methinks makes this not the greatest of times to go all in. But I defer to your collective wisdom.

Our budget is currently 50k fixed, 70k fluff. (My DW would say that 70K for Whole Foods is fixed. Jk) 529s for each kid at about 200k.

Goal would be to downsize at FIRE, put equity from main home in market, travel and rent in a variety of outdoorsy locations for a few years until the Ouija board points to yes, settle in one spot. Looking at Washington state for final landing due to no state income tax (and we love the NW), although with primarily capital gains early on, that's less important now.

Both of us planning SS at 67, she has a small pension (7K/y COLA), and we will likely get a sizable inheritance from her parents, but I hate to count those chickens. Rental income as above.

My second, much less concerning question if I haven't tl;dr'd you is: although I will be RE, if I keep my disability going with the (fake) plan of going back to work, will it still pay if I'm injured or do I have to be employed at the time of injury? What do sabbatical people do?


Your cogitation on the above is appreciated in advance. I'm sure I have left out some key info, but will be happy to supply! This is my first post to a FIRE board!

[gcgang]

If you don't need the cash, invest it in equities while selling a like amount in your retirement acct. Use that retirement cash to ladder CDs or another lower risk bond fund.

[Foodie]

What is up Doc?

Let's do some math:

Retirement account
40% of 3.6M is 1,440,000 - all equities

Taxable account
2,160,000 allocated as
864,000 in US equities
324,000 in foreign equities
108,000 in munis
864,000 in cash

Overall your allocation is: (73% equities, 3% munis and 24% cash)

a) what do you think the best use for the cash would be/what percentage in bonds?

The exact numbers will vary, but at first sight 24% cash is way too high and bonds are way too low. Even an an aggressive asset allocation would be 70 equities/30 bonds. So, at the very least I would use ALL that cash to buy bonds. This would give you a 73 equities / 27% bonds.

Bonds are better in retirement accounts. So I echo the advice of gcgang: use the cash to buy equities in taxable account and move a percentage of your equities in the 401K to bonds.

You might even go 60 equities / 40 bonds. When and if the chickens come (sizable inheritance) use those $ to be more aggressive (70/30) if you are inclined to do so.

b) the timing of said purchase?

Easy question. Do it now. Don't time the market. As long as you buy a diversified bond portfolio of moderate interest rate sensitivity you should be fine. Stay the course.

The questions about disability, I do not know the answer.

Other comments:

Did you include health insurance in your $120K/year expenses? (I assume so)

Your expenses, including the fluff are $120k / year. You have $20K/ year rental income. Let's be conservative and not count your SS nor your wife's small pension. Even so, you need $100K/ year.

$100K corresponds to less than a 2.8% withdrawal rate of 3.6 millions. You are golden.... even without the chickens.

[DrRoy]

Foodie had good advice. Your overall AA is fine. You could put the cash into local munis for return without added tax.

[Doc Holiday]

Some sage advice, esp re: the AA! Thanks Foodie....

I am in the 39% bracket for the next 3 years. With respect to DrRoy's point, I would think that either I would buy munis now in the taxable acct and then switch to corporate when I retire or I could do what gcgang suggests and buy now in 401k to tax shelter interest. Would the plan be to again reshuffle at retirement so that I have bonds back in taxable account so that they are accessible in a market downturn?

You guys are great!

[USGrant1962]

I would go with munis in the taxable account, especially in your current tax bracket. That will provide a big benefit - it will give you the option of living off "principle" and paying zero taxes for number of years (8 or more!). So then you can meter out your capital gains to stay in the zero percent CG bracket. If the stock market corrects, most of that exposure remains in your retirement accounts and so will have time to recover (essentially a bucket system).

Further, you will be able to do Roth conversions at an extremely low tax rate, if your 401(k) has Roth. Or you could roll the 401(k) to an IRA and do the conversions.

Having a big stash of cash and/or munis in your taxable account provides huge flexibility in the E phase of ER. I actually over-did the proportion in retirement accounts (about 75%) and am a little constrained that way.

[street]

I like your way of thinking and also have a larger then normal cash stash. Mine is 14% of total portfolio but that was my plan to just live off of cash in some CD ladder accounts. My plan is to just let my investments grow and I won't have to touch them in my life time if I don't want to. Your cash reserves were done with some thought I'm sure. You can always turn that cash into stocks/bonds etc.

[Doc Holiday]

Great ideas Grant. Love me some zero taxes. After years of paying nearly 50% tax rates (Oregon is 9.9%), it's an almost devilishly delicious thought of paying next to zero.
I plan to use my newfound tax space wisely and convert my 401K to personal IRA and then convert to Roth up to headroom in the 15% bracket.

I may be wrong, but isn't 25% tax bracket where munis make more sense? So once I retire and living in the Elysian Fields of low taxes, wouldn't I sell the munis and get corporate?

[Mod Edit]

[Doc Holiday]

Street,
Cash is obviously a nice comforter, only slightly thinner than bonds currently (but more flexible).
Certainly the omens and signs, e.g., CAPE10, would suggest that we need to be prepared for a storm, and cash will help as we hunker down. But good lord, it's hard to not see these as different times than previous eras. My simplistic idea is that the low interest rate and market rebound lead to a shift from bonds to equities, pumping the P/E. Indexes may have done similar. How long this will play out is unclear to my myopic financial vision. Taking that first step to FIRE will be a doozy for me.

[USGrant1962]

Quote:

Originally Posted by Doc Holiday I may be wrong, but isn't 25% tax bracket where munis make more sense? So once I retire and living in the Elysian Fields of low taxes, wouldn't I sell the munis and get corporate?

Yes, once you ER you could move to short-to-mid term government or corporate. Though with that much in taxable bonds ($900K+) you are going to be generating taxable interest that you'll need to manage along with your conversions and cap gains.

[bingybear]

Quote:

Originally Posted by Doc Holiday Great ideas Grant. Love me some zero taxes. After years of paying nearly 50% tax rates (Oregon is 9.9%), it's an almost devilishly delicious thought of paying next to zero. I plan to use my newfound tax space wisely and convert my 401K to personal IRA and then convert to Roth up to headroom in the 15% bracket. I may be wrong, but isn't 25% tax bracket where munis make more sense? So once I retire and living in the Elysian Fields of low taxes, wouldn't I sell the munis and get corporate? [Mod Edit]

I use my taxable accounts for equities with a value tilt expecting mostly qualified dividends. I then roth convert to the top of the 15% bracket. This way the qualified dividends are taxed at 0% (fed not state for me). This allows more conversions with lower tax than I think corporate bonds.

I only have some government bonds (owned for over a decade) in my taxable accounts. These will not be taxable for more than a decade when they mature or are sold.
If you want income, take the dividends in cash, if not, then reinvest them.

[OldShooter]

Assuming you are going to buy high grade bonds (govvies, agencies, high grade corporates) there is no reason to use a bond fund. All it gets you is fees and some wild rides when interest rates change. Just buy individual bonds and hold them to maturity. Then you are guaranteed to get exactly what you signed up for, with no angst.

You have easily enough money to diversify your corporate bond tranche and you don't have to diversify government securities. Also, I would consider buying long TIPS with a significant fraction of the investment. Returns are not quite as good as straight govvies but a big risk for all of us in retirement is high inflation. TIPS are wonderful insurance against what is maybe a low probability event but what is certainly a high impact event.

Setting this up shouldn't take more than a few hours of strategizing and consultation with your brokerage firm's bond specialists. I use Schwab, where the bond guys are not on commission and are quite experienced. I understand the same thing is available from FIDO. From that point it is an hour or two a year to roll over maturing bonds to extend the ladder.

Buying bonds is not difficult and does not require witches and priests to assist unless you want to get into junk or non-US. But IMO the point of bonds is stability and safety, not gambling. So why walk out onto the thin ice?

[Doc Holiday]

Bingybear: good thoughts re: value stocks and using dividends for income. My concern would be in the event of a downturn or black swan. There might not be a dividend and I'd have to hit capital for expenses. How would you manage those events with your current approach?

[Doc Holiday]

Oldshooter: I can really tell that you have thought about this for a while and it works for you. I'm with Fido and was a hair's breadth away from getting a 5 year muni ladder recently. Based on the relatively low amount invested (under 5 M!), others warned me of fees of the secondary market as well as decreased liquidity if cash was needed.
To my beginner eyes, a fund's advantage is the number of bonds within it, making changes of (hopefully) increasing returns more even, less stepwise. And a distant second would be the smaller impact if any bond defaulted.
I'm sure you can set me straight. What are your ladder time rungs? 6 months? 1 year? Length of ladder currently...5 years?

I was thinking of doing a muni bond fund until I retire in 3 years and then either getting a ladder or going with a bond index of corporates.

TIPS sound good, but are you paying taxes on the yearly inflation adjustment?

Truly appreciate your input!

[bingybear]

Quote:

Originally Posted by Doc Holiday Bingybear: good thoughts re: value stocks and using dividends for income. My concern would be in the event of a downturn or black swan. There might not be a dividend and I'd have to hit capital for expenses. How would you manage those events with your current approach?

I have a short term CD ladder/HY savings that should last at least 4 years. A 2008/9 event will bring down pretty much all bonds but the absolute best, at least for a while. I'm assuming that 3 to 5 years is enough to get through most events.

[OldShooter]

Quote:

Originally Posted by Doc Holiday ... Based on the relatively low amount invested (under 5 M!), others warned me of fees of the secondary market as well as

Well, undoubtedly SGOTI said this. Also, people selling bond funds will say this. Why don't you talk to the FIDO bond guys? They are buying millions in bonds every day and a dealer who is trying to rape their customers will not get a dime of that. Re their own inventory they are fiduciaries, so they cannot rape you that way either. They will have to accept the same kind of markup that the dealers are offering.

Quote:

Originally Posted by Doc Holiday decreased liquidity if cash was needed.

Well, first thing: I see bonds as long term things. I have a bucket of shorter term money in MM, T-bills, and even occasionally (gasp!) a short-term government fund. In the unlikely event you do have to sell a bond, it is presumably nothing weird because you have been conservative, so it should not be a big deal. Again, talk to the FIDO guys.

Quote:

Originally Posted by Doc Holiday To my beginner eyes, a fund's advantage is the number of bonds within it, making changes of (hopefully) increasing returns more even, less stepwise. And a distant second would be the smaller impact if any bond defaulted.

I'm not sure what you mean about "increasing returns." TANSTAAFL; you can buy the same bonds that a fund buys. The difference is that when rates rise, your ending cash will not be reduced -- which it may well be with a fund. Re diversification we do that to reduce risk. It's not needed on govvies and agencies. I have seen statisticians argue that 30-60 stocks is adequate diversification. I think (IOW, SGOTI) that there is less risk and hence less need for diversification with high-grade corporates. I would be comfortable with five or ten issues with no sector concentration. Ask the FIDO guys.

Quote:

Originally Posted by Doc Holiday What are your ladder time rungs? 6 months? 1 year? Length of ladder currently...5 years?

Actually I am not in a ladder right now. I have about $750K of 2026 TIPS that we bought about ten years ago. The rest is short term because of rate uncertainty and wanting to have some dry powder ready for a big correction; $200K MM, $450K in t-bills and about $500K in SAMBX. So, much too weird for a guy (like you, I think) looking for something simple. For you, speaking as SOGTI, I'd suggest a short term bucket holding 2-4 years of cash needs, and a ladder beginning 2 years out and going as far as you're willing to ride the bucking bronco of long-term rates.

Quote:

Originally Posted by Doc Holiday TIPS sound good, but are you paying taxes on the yearly inflation adjustment?

Yes, if held in a taxable account, but so what? You'd pay taxes on Treasury Bond interest anyway and you have enough liquidity that you don't need the actual cash from the TIPS to pay the taxes. And, ... if that inflation income gets big, you will be one of the happiest guys on the planet. Treasury will stop issuing TIPS to avoid pouring fuel on a fire and people panicking will bid them though the roof. You'll think it was a genius investment.

HTH, SOGTI

[Doc Holiday]

OldShooter: thanks for your enthusiastic reply. You bring light to the subject that I did not have.
Your TIPS argument seems to hold water. I will likely add those in a modest fashion.

I don't quite understand why you would get long term bonds in a low rate environment. I'm leaning to intermediate at most. Maybe you were saying that you would prefer non-bond emergency money on a downturn.

My "increasing returns" comment is based on my own concept. If a fund is constantly adding new funds at higher rates and dropping lower ones, the increase of yield would look like a diagonal line and not a stair step as in a ladder. I would think the area under the curve would be greater for that. I'm sure you can correct me on that!

Beam me up, SGOTI!

[OldShooter]

Quote:

Originally Posted by Doc Holiday ... I don't quite understand why you would get long term bonds in a low rate environment. I'm leaning to intermediate at most. Maybe you were saying that you would prefer non-bond emergency money on a downturn. ...

Sorry. I am guilty of sloppy rhetoric. When I said "I see bonds as long term things." I was using "long term" to mean that I think the only rational plan is to hold them to maturity. So "maturity" is "long term" in that sense. Re buying long bonds I agree with you completely.

To anticipate a question, I don't consider long TIPS to be the same as long bonds. Yield on long bonds reflects the buyer's and seller's (opposite) guesses on inflation. TIPS moot that discussion, so I don't mind buying long ones.

Quote:

Originally Posted by Doc Holiday My "increasing returns" comment is based on my own concept. If a fund is constantly adding new funds at higher rates and dropping lower ones, the increase of yield would look like a diagonal line and not a stair step as in a ladder. I would think the area under the curve would be greater for that. I'm sure you can correct me on that!

Well, yes. Yield will increase as you say, but don't forget that each time rates rise, the NAV of your bond fund goes down because the value of its holdings goes down. If you're not familiar with "duration" and are serious about funds, that is something to study carefully.

For me, worrying about duration just makes my head hurt. If I buy a bond, collect the interest, and get paid at maturity I don't have to worry about that stuff. I get exactly the dollars I was expecting. (Admittedly, glossing over callable bonds and credit risk here) With a bond fund I have no idea of what I will get at any point in time.