Otar vs. Total Return

[Flying Dutchman]

I am very close to FIRE. Otar suggests an AA of 5% cash, 10% ST bonds, 25% IT bonds and 60% stocks as optimum if the withdrawal rate is about 3%. Optimum in the sense of minimizing reverse dollar cost averaging. In this case stocks refill cash, ST bonds and then IT bonds or IT bonds refill cash, ST bonds and then stocks depending on the situation. Vanguard and the Bogleheads on the other hand would tend to suggest a total return AA of 1 year of expenses in cash, 40% IT bonds and 60% stocks (if one was 60/40). In the total return case, dividends and interest are sent to a MM account and for the next year a small amount of stocks or bonds, depending on what is doing better, are sold to provide the 3%.

I am trying to decide which approach to take and hoping that those who have been retired for some time can provide guidance.

 

[Spanky]

Both methods are quite similar -- AA of 60/40 (equity/fixed-income). A cash bucket to fund one year of expenses seems reasonable. Thus, the Bogglehead approach is fine.

 

[pb4uski]

I guess that I somewhat split the difference. I started off with a 2 year cash bucket (based on a 3% WR) and investment bucket but decided I preferred to just have my cash/ST bonds be a portion of my 40% of fixed income. Simpler for me.

I have income from taxable investments sent to my checking account rather than reinvested to simplify my taxes. I have a 60/34/6 AA of stocks/bonds/cash & ST investments rather than the 60/40/0 I had prior to retirement so my cash bucket is now just implicit in my fixed income allocation.

 

[Flying Dutchman]

I guess that I somewhat split the difference. I started off with a 2 year cash bucket (based on a 3% WR) and investment bucket but decided I preferred to just have my cash/ST bonds be a portion of my 40% of fixed income. Simpler for me.

I have income from taxable investments sent to my checking account rather than reinvested to simplify my taxes. I have a 60/34/6 AA of stocks/bonds/cash & ST investments rather than the 60/40/0 I had prior to retirement so my cash bucket is now just implicit in my fixed income allocation.

Do you keep the 34% as IT bonds? I am also wondering how retirees rebalance if there is a major drop in the market (like 2008), if all the bonds are IT.

 

[Flying Dutchman]

Both methods are quite similar -- AA of 60/40 (equity/fixed-income). A cash bucket to fund one year of expenses seems reasonable. Thus, the Bogglehead approach is fine.

Yes I agree they are similar. The biggest difference is the lack of ST bonds in the Total Return approach and I wonder how retirees rebalance and if there are downsides to not having ST bonds.

 

[Spanky]

Yes I agree they are similar. The biggest difference is the lack of ST bonds in the Total Return approach and I wonder how retirees rebalance and if there are downsides to not having ST bonds.

Some experts suggest all fixed-income should be in ST bonds.

 

[Flying Dutchman]

Some experts suggest all fixed-income should be in ST bonds.

Bernstein suggests that I know. The Vanguard papers on Total Return all use the TBM as the bond holding.

 

[pb4uski]

Do you keep the 34% as IT bonds? I am also wondering how retirees rebalance if there is a major drop in the market (like 2008), if all the bonds are IT.

The 34% is short/intermediate term.

About 9% is in Vanguard Intermediate Term Corporate fund, 12% is in Guggenheim 2019 and 2020 Corporate Bulletshares, 7% is in Vanguard International Bond Index Fund, 5% is in Guggenheim 2017 and 2018 High Yield Bulletshares and the remaining 1% is a whole life insurance policy.

I view the Bulletshares as a substitute for a CD since I intend to hold them to maturity/liquidation. I'm thinking about transitioning the remainder of my Intermediate Term Corporate to Bulletshares later this year because I'm no keen on the interest rate risk of the Intermediate Term Corporate shares.

Not sure I understand your second question, but if there is a major drop in the market I would sell some bonds and buy equities to rebalance.

 

[jebmke]

Yes I agree they are similar. The biggest difference is the lack of ST bonds in the Total Return approach and I wonder how retirees rebalance and if there are downsides to not having ST bonds.

Transfer funds from bond fund to equity fund. It is no more complicated than if you had cash.

I rebalance to food this way every month.

 

[Lsbcal]

My portfolio looks somewhat like Otar's. But right now because of low rates, cash is only a few months of spending. With equities moving up I rebalance into bonds and cash. I see no problem readjusting allocations at any time. To me the important thing is to have a full helping of equities and IT.

My 2 cents.

 

[Flying Dutchman]

Transfer funds from bond fund to equity fund. It is no more complicated than if you had cash.

I rebalance to food this way every month.

True. What it interest rates rose from the current low rates? IT bonds and stocks may well both fall. Now you are rebalancing to stocks and food from a falling asset.

 

[Flying Dutchman]

The 34% is short/intermediate term.

About 9% is in Vanguard Intermediate Term Corporate fund, 12% is in Guggenheim 2019 and 2020 Corporate Bulletshares, 7% is in Vanguard International Bond Index Fund, 5% is in Guggenheim 2017 and 2018 High Yield Bulletshares and the remaining 1% is a whole life insurance policy.

I view the Bulletshares as a substitute for a CD since I intend to hold them to maturity/liquidation. I'm thinking about transitioning the remainder of my Intermediate Term Corporate to Bulletshares later this year because I'm no keen on the interest rate risk of the Intermediate Term Corporate shares.

Not sure I understand your second question, but if there is a major drop in the market I would sell some bonds and buy equities to rebalance.

The second question is how do you rebalance if interest rates rise and you are now rebalancing from IT bonds that have fallen to stocks which may have dropped more.

 

[Flying Dutchman]

My portfolio looks somewhat like Otar's. But right now because of low rates, cash is only a few months of spending. With equities moving up I rebalance into bonds and cash. I see no problem readjusting allocations at any time. To me the important thing is to have a full helping of equities and IT.

My 2 cents.

Even if you have reduced cash do you keep the ST bonds like Otar suggests to help with rebalancing? Especially in the case of retiring or being retired in a market where interest rates are likely to rise and keep rising.

 

[jebmke]

True. What it interest rates rose from the current low rates? IT bonds and stocks may well both fall. Now you are rebalancing to stocks and food from a falling asset.

That's why they call it risk. Over the long haul, avoiding cash has paid off for me. I have stayed in bonds throughout, although my average duration is a bit lower than IT. When I need money, I sell whatever is out of balance.

 

[Lsbcal]

Even if you have reduced cash do you keep the ST bonds like Otar suggests to help with rebalancing? Especially in the case of retiring or being retired in a market where interest rates are likely to rise and keep rising.

In the last year the only rebalancing for us was from stocks -> bonds as stocks went up nicely. I pumped up stocks to the max in recent years (as I expected bonds to have a somewhat low real return going forward) and only rebalance when they are 1% above that allocation. The ST bonds are in there as a comfort factor and to sell for cash if nothing else has done well over recent months. If rates go up I don't expect that returns will be too negative on IT bonds over any 12 month stretch.

Historically you would have done better having the max stock allocation rather then just letting them ride going up and agonizing over when to "rebalance". For example, I'd rather have 65% equities and rebalance at 66% then have 60% equities and rebalance when they hit 66% or when it "feels" too high. But we have to realize their are an infinite number of these types of schemes.

In 2008 there was a major rebalancing decision and I completely changed the way I thought about this stuff. My investment approach is not the usual type. I try to have a plan and then follow through on it.

 

[Flying Dutchman]

In the last year the only rebalancing for us was from stocks -> bonds as stocks went up nicely. I pumped up stocks to the max in recent years (as I expected bonds to have a somewhat low real return going forward) and only rebalance when they are 1% above that allocation. The ST bonds are in there as a comfort factor and to sell for cash if nothing else has done well over recent months. If rates go up I don't expect that returns will be too negative on IT bonds over any 12 month stretch.

Historically you would have done better having the max stock allocation rather then just letting them ride going up and agonizing over when to "rebalance". For example, I'd rather have 65% equities and rebalance at 66% then have 60% equities and rebalance when they hit 66% or when it "feels" too high. But we have to realize their are an infinite number of these types of schemes.

In 2008 there was a major rebalancing decision and I completely changed the way I thought about this stuff. My investment approach is not the usual type. I try to have a plan and then follow through on it.

That's a very good point that " I don't expect that returns will be too negative on IT bonds over any 12 month stretch." I think I'll keep my ST bonds for the same reason - comfort.

I'm not sure what you mean by pumping up stocks and having the maximum stock allocation? Why not have 60% stock and use 5/25 rebalancing bands? If you rebalance at 66% do you also rebalance at 64%? Doesn't this result in a lot of buy/sell activity?

What did you do in 2008? I'm sure we'll have to deal with another 2008 at some point.

Thanks for the ideas.

 

[Lsbcal]

That's a very good point that " I don't expect that returns will be too negative on IT bonds over any 12 month stretch." I think I'll keep my ST bonds for the same reason - comfort.

I'm not sure what you mean by pumping up stocks and having the maximum stock allocation? Why not have 60% stock and use 5/25 rebalancing bands? If you rebalance at 66% do you also rebalance at 64%? Doesn't this result in a lot of buy/sell activity?

First, my tax profile is unusual so I don't have to worry about shifting asset classes and/or frequent rebalancing. But most of the time I don't do much rebalancing in a year. I do not rebalance into stocks. If they go down I just hold on (most of the time anyway).

What do I mean by having a max stock allocation? You could indeed have a 60% stock allocation and rebalance as you said. The would be fine. My guess is that in most historical periods a 65% rebalanced frequently would beat a 60% with 5/25 rebalance bands. But this is quibbling and the important thing is to have a plan and stick with it.

What did you do in 2008? I'm sure we'll have to deal with another 2008 at some point. ...

I'm hoping we will have a normal bear market the next time around and we'll not see another 2008 in my lifetime . In 2008 I just held positions and managed adjustments to get the best tax efficiency ... and worried a lot. In July 2009 I rebalanced to get equities back up. I just am not going to try to catch a falling knife when I'm retired. Just my way of coping.

Also I have a very thoroughly researched timing plan which would be described as buy and mostly hold. It is not a simple moving average type of plan. Developed this over recent years but haven't had to do any selling except to rebalance (from 66% equities to 65%). The purpose of my rebalancing and potentially selling all equites is not to beat the market but to reduce extreme risks. But note I would be a buy-holder should we have another 1987 sharp, cliff like type sell off.

Most individuals would be better serviced by just straight buy-hold which is close to what I do.