BabyApe's Portfolio

[BabyApe]

xxxxx

 

[brewer12345]

Not enough info. Which accounts (taxable vs. non) contain which assets? How close are you to ER at 4%? Are you adding more dough to this portfolio? What are your inflation expectations and risk tolerances?

Personally, I think you are way, way too heavy on bonds, but I don't really have enough info to comment. Other than that, you have so little in certain assets (2%?) that its not worth the confusion to maintain all of that.

 

[Bob_Smith]

I agree - more info is needed. In the meantime it's my impression that a 20% stock exposure is too low to stick with over the long term for a ~45 year old. Are you holding out for lower prices? I'm 52 and my stock target is around 40%, although I'm a little below that now due to drift. Since you're so heavily invested in bonds and cash, inflation could be a problem for you. I'd suggest that you look at TIPS if you haven't. Real returns are at almost 2.5% at the moment. Whether they advance much higher is anyone's guess. I believe three who post on this board have been buying in the 2.5% range - I'm one of the three. Can I do better by waiting until rates rise, or by investing in traditional bonds? Possibly. But the compound real return on bonds from 1946-1965 was (negative) -1.2%. 1966-1981 was even worse -4.2%, and stocks returned almost zero real return during that period. Although the last 20+ years was an incredibly good time for bonds, I'm not too enthusiastic going forward. So I bought LT TIPS and plan to hold until maturity.

 

[Cut-Throat]

I would agree with the other posters. You should have at a bare minimum 35% stocks preferably 40%.

I am in similar situation and am comfortable with 60% stocks 40% fixed.

 

[brewer12345]

I guess that we still don't know perhaps the most important part. Are you ER yet? If not, how close are you in terms of assets and years?

 

[brewer12345]

In that case, I would say that you probably are considerably underweighted in equities. Remember, the SWR study assumed that you had an optimized portfolio for the length of time you planned on withdrawing. For someone your age, we are probably talking about 75% or more equities. The study indicated that if you had a less than optimal portfolio, you couldn't withdraw as much.

If I were in your shoes, I would probably shoot for at least 50% equities. With a well diversified portfolio of domestic and international equity, and annual rebalancing, it would probably be pretty hard to get a 20% or larger drop in your portfolio. Take a look at Burns' couch potato portfolio artticles to see what kind of drops this type of portfolio would have sustained even in bear markets. IIRC, it was nowhere near 20% in a year.

One other thought: you might make an effort to futher diversify away from just stocks and bonds, especially if you are leery of equities. There are lots of other things out there that don't act like either asset class, and a modest amount (10% or less) might add some good diversification. Commodities, royalty trusts, certain types of partnerships (pipelines, etc.), and commercial real estate all move very differently thatn stocks or bonds.

 

[cute fuzzy bunny]

I may be nearing the land of John Galt...I'm only about 45% stock and if you omit my IRA that I wont be into for another 20 years, I'm probably close to Babyapes 20% stock. Maybe closer to 25 or 30%.

As far as it being unlikely for a well allocated equity portfolio to drop more than 20%...didnt that just happen four years ago? And a ~16% drop ten years ago? And a 40-something% drop 18 years ago?

Fortunately they bounced back. I just wouldnt feel comfortable with suggesting someone push their equity holdings upward into the face of these valuations.

I do think that an *overall* weighting of less than 40% mixed equities is throwing out the baby (cough) with the bathwater, but I'd be weighting my equities into longer term investments like an IRA/401k...

In this case with babyapes IRA being all bonds and all the equity holdings in the taxable account...I did it the other way around. Given the long horizon until withdrawal and the fact that we're about the same age, I'd adopt more of a 'shoot the moon' strategy with the ira and stay conservative with the taxable/today money.

 

[Cut-Throat]

As far as it being unlikely for a well allocated equity portfolio to drop more than 20%...didnt that just happen four years ago?

I don't think so TH, A 50/50 stock bond portfolio would have to have about a 40% drop in stocks to lose 20% of its value. This may have happened if you were heavy into techs, but not if you were diversified better. But if you were indexed to the overall market, you would have suffered around 30% loss on the stock end, but would have made some up on the bond side. - My guess is that the loss would have been no more than 10%.

 

[unclemick]

My big dog - quasi 60/40 Vanguard Lifestrategy mod was down -10.3% for 2002 and at one point had yr to date -16.56% - hardly a big deal.

The fun test is when stocks go south AND interest rates rise at a rapid rate - together. That's when I'll be looking at the SEC yield to stay calm.

 

[brewer12345]

My big dog - quasi 60/40 Vanguard Lifestrategy mod was down -10.3% for 2002 and at one point had yr to date -16.56% - hardly a big deal.

The fun test is when stocks go south AND interest rates rise at a rapid rate - together. That's when I'll be looking at the SEC yield to stay calm.

That's why I was suggesting a 10% allocation to something that is not correlated with stocks and bonds. Since what you describe is probably a stagflation scenario, some sort of hard asset probably would work, say real estate, or commodities, or something related to extraction.

 

[unclemick]

Yep

That's why I've been reading at lot of raddr' et al commodity data on the nuts and bolts of commodity investment at his forum. Leaning strongly, but not there yet.

 

[cute fuzzy bunny]

I don't think so TH, A 50/50 stock bond portfolio would have to have about a 40% drop in stocks to lose 20% of its value.

Perhaps I misunderstood the statement made, which wasnt about a stock/bond mixed port, it was:

"With a well diversified portfolio of domestic and international equity, and annual rebalancing, it would probably be pretty hard to get a 20% or larger drop in your portfolio."

If Brewer meant "...a well diversified portfolio of domestic and international equity mixed with bonds..." then thats something else.

On the other hand, most folks are warning of a 10%+ drop in intermediate term bonds due to expected interest rate increases. Couple that with an RTM on stocks and you've got a problem.

Of course, while thats hardly 'worst case', its 'fairly possible case'.

On the other hand, vanguards 60/40 managed 'wellington' fund, which has a very long viewable track record (1929-2004+), its had many drops over 20%, some sustained.

 

[cute fuzzy bunny]

The tax implications are something you'll have to determine for your particular scenario.

In general, things that throw off lots of taxable events without creating income are usually best kept in the tax deferred area. TIPS, REITS, high turnover stock funds and commodities funds create lots of low predictability taxable events...in the case of TIPS you dont even get the income until the bonds mature.

Low turnover index funds (one does not automatically mean the other...there are high turnover indexes) sit well in the taxable portfolio.

But heres the part YOU have to do...somewhere along the line you have to drain off the money you're going to live on. If those are long term capital gains from stocks and stock funds, that will be ok to have in your taxable port. If its short term gains, those could get to be rather expensive. If you have a lot of trailing capital losses to offset gains, a wild and crazy set of stocks and funds in your taxable port might be just great. Dividend and interest income from bonds, MM's and CD's are taxed at your nominal rate.

For my situation, I have no debt whatsoever, and complete control over my withdrawal rate. I live very nicely on ~30k a year but could live comfortably on half that. My taxable portfolio throws off enough dividends to cover most of that and I'm hauling along ~$110k in short and long term capital losses from a few years ago to offset any capital gains. The low withdrawal amount coupled with good deductibles and my carryover losses means I havent paid taxes in a while and wont for some time. My taxable portfolio is very conservative, somewhat like your overall port is. Its conservative because with a low withdrawal rate, I dont have to take any risks and if theres no need, why keep yourself awake at night? On the other hand, since I wont be tapping my IRA for 20+ years, I put emerging market stocks, reits, healthcare, energy and other volatile rocketships that do well over long periods of time in that area. In a perfect world, I ride through the next 20 years with my primary taxable portfolio largely intact, having lived off mostly interest/dividend throwoffs, and my IRA will have appreciated significantly, assuring me of a very comfortable 'real' retirement should I live a long time...and thats what I plan to do!

But without a comprehensive view into your financial situation, neither I nor anyone can give you any exacting suggestions or advice.

The real keys for you are controlling expenses and withdrawals, the right tax strategy for the long haul, and exactly how much risk you're willing to take in this endeavor over the next 40 years.

My last suggestion is if you're single, go marry a nice woman with a job!

 

[Bob_Smith]

As far as assigning stocks to taxable vs. tax deferred, I don't follow conventional wisdom. I keep my stock holdings in tax deferred accounts because:

--Stocks are what I expect to access last. I'm only 52 so I want to keep CDs and shorter term bonds where I can access them without going through the 72(t) process.
--I like the simplicity at tax time. I can reallocate/re-balance stocks without consideration of tax issues.
--I have been in a low tax bracket for some time due to aggressive use of retirement plans. Now that I'm ER'd, I expect my tax bill to be almost zero for the next few years. If I were in a higher bracket I'd probably have to rethink the matter.
--I have a daughter starting college in the fall. There's a weird wrinkle in the financial aid process. If I am eligible to file a 1040A or 1040EZ (as opposed to the 1040), then I'll qualify for the "Simplified Needs Test" which disregards assets when determining the expected family contribution. So, anything that triggers the use of a Schedule D will mean that I am not eligible to use a 1040A or 1040EZ, which would force me to disclose my assets. Otherwise it's under the radar. I believe the school can request more than the federal form requires, but many don't and it could mean the difference between getting need based financial aid, and not getting it.

 

[brewer12345]

As far as the allocation of assets between after tax and tax sheltered accounts goes, I think the best way to decide is to build a spreadsheet. That way you can vary the rates of return and tax rates on the different portions of the portfolio over time and come up with an answer that fits your exprectations of taxes and returns and your projected withdrawal pattern. However, based on the comments of many early retirees, I think you'l find that your income taxes will be quite minimal in ER compared to when you were in the accumulation phase. This is because your taxable income tneds to be relatively modest, keeping you in the "sweet spot" of the tax code. You also escape FICA and medicare taxes.

Royalty trusts are publicly traded entities that own some or all of the future cash flows associated with some asset, commonly an oil or other natural resource reserve. A good one to look at might be SJT, which spits out cash based on oil extracted from its San Juan basin reserves. Something that you'd have to study up on, but these things are chiefly hard asset plays that might offer some comfort in runaway inflation scenarios. Thay also tend to spit up a lot of tax-efficient investment income.

 

[ats5g]

Check out Retirement Investing for a number of papers on the subject.

Perhaps Jennifer Huang's paper, Taxable or Tax-Deferred Account? Portfolio Decision with Multiple Investment Goals, speaks directly to the early retirement problem of locating assets (stocks and bonds) in taxable or tax deferred account. If one has large liquidity needs (needs to withdrawal from portfolio before 59.5), then locating some bonds in the taxable account seems prudent.

As for how much to allocate to stocks vs. bonds, I think that's more of a personal decision than anything else. We can look at all the historical analysis, and monte carlo stuff to, but BabyApe has to be able to withstand the future market downturns (especially if all the risky investments tank at once). I would definitely take brewer's advice and diversify the risky investments into things like REITs, and perhaps commodities. Both should probably be held in your tax deferred accounts though, and you should understand all the risks of these investments - like liquidity and such - before using them.

If you (BabyApe) aren't comfortable with a very high equity/risky allocation, working and saving for another 2 years seems like a good plan to me to insure ER. I might be more inclined to argue for a higher equity allocation if I thought that the future expected risk premium for equities would is higher, but if we/you expect equity returns to be not much higher than bonds, I don't think it makes much sense to allocate a lot to equities (say over 50%) b/c the downside (horrible portfolio returns early in retirement) could force you back to work or lead to a lower standard of living.

- Alec

 

[Cut-Throat]

could force you back to work or lead to a lower standard of living.

What I have determined over the last 3 years is that going back to work is the lowest standard of living possible.

 

[db]

What would worry me about BabyApe's asset allocation is that he says he "needs" 4% and is working a little longer to achieve a "cushion." That suggests his asset base is close to the minimum he needs. Very low equitiy allocations might work and be comforting for those whose asset base is large relative to their proposed draw, but at his age I think future inflation is the greater risk. Just as most of us have witnessed drops in equity values for one of more periods, most of us have also witnessed periods of high inflation. I prefer the idea of keeping maybe 10 years worth of future draw in fixed income securities, and letting the remainder track inflation.

At 68, I allocate 40% TSM, 20% TISM, 10% REIT fund, remainder in short-term bond funds and cash -- all in low cost Vanguard funds. That allocation provides about 15 years of our future draw in FI.

db