How to calculate home/pension in asset allocation?

[tuixiu]

Comrades,

Assuming our current pot of gold consists of:

400k liquid
200k paid off house
100k pension value (including employer matching funds)

Now we're definitely going to sell this house in 5-6 years when we retire, as we live near this big city because of work and plan on doing a good bit of rambling both overseas and in the US.

The pension will be cashed out as wife would have to work until 55 to get it and we're still in our 30s should be retired early 40s. Overall it's a great deal since they match 100% of her contributions and give a set rate of return currently 8%.

So... in your opinion does that portfolio inherently contain 43% (relatively) stable investments so the other 400k should be invested more aggressively or should the 400k be looked at as the portfolio and done 70/30?

Replies appreciated, thanks in advance.

 

[W2R]

Comrades,

Assuming our current pot of gold consists of:

400k liquid
200k paid off house
100k pension value (including employer matching funds)

Now we're definitely going to sell this house in 5-6 years when we retire, as we live near this big city because of work and plan on doing a good bit of rambling both overseas and in the US.

The pension will be cashed out as wife would have to work until 55 to get it and we're still in our 30s should be retired early 40s. Overall it's a great deal since they match 100% of her contributions and give a set rate of return currently 8%.

So... in your opinion does that portfolio inherently contain 43% (relatively) stable investments so the other 400k should be invested more aggressively or should the 400k be looked at as the portfolio and done 70/30?

Replies appreciated, thanks in advance.

I notice this is your first post. Welcome to the ER Forum!!

As for asset allocation what does your gut tell you? Asset allocation is such a personal decision. We all want profit, but you need to feel you can sleep at night and not do something foolish the next time the market takes a dive. Your time horizon is also a consideration. A good book on the topic of asset allocation is Richard A. Ferri's All About Asset Allocation, and there are many other similar books.

Don't forget that the maximum amount that your house can add to your portfolio, will be your present home's value, minus your future home's value or equivalent lump sum used to generate rent, moving expenses, realtor, and so on. Since the value of your home is just $200K (same as mine), I would not consider that to be much of an addition to your "pot of gold" at the end of the rainbow. Personally I am not considering the value of my home at all in asset allocation, even though I am planning to move to an area with cheaper homes for ER, because the move and other costs will eat up any profit I might make from the difference in home costs.

I am wondering if you will be able to afford to travel and ramble overseas and the US for the rest of your life in the style you might desire, on less than 4% of your assets before taxes. I would tend to buy a $100K home someplace with a low cost of living and with low taxes. That would leave you with about $550K after moving expenses and closing costs and such, which would generate about $15K - $20K (after taxes) for your expenses and medical insurance.

I hope you have thought hard about cashing in her pension. That is usually an irrevocable decision, and sometime (though tempting) it can be a very bad deal if instead she could get a COLA'd pension later on in life. It all depends on what is offered, I suppose.

 

[tuixiu]

I notice this is your first post. Welcome to the ER Forum!!

Thanks, I appreciate your time and wisdom in response. I've lurked awhile and I think I posted a few years back under another name but I'm not sure if this is same forum and have no clue what my password is if it is. Either way thanks for the welcome.

As for asset allocation what does your gut tell you? Asset allocation is such a personal decision. We all want profit, but you need to feel you can sleep at night and not do something foolish the next time the market takes a dive. Your time horizon is also a consideration. A good book on the topic of asset allocation is Richard A. Ferri's All About Asset Allocation, and there are many other similar books.

My gut tends to change every time I read a different article, hence coming here to get feedback from the real experts.

Don't forget that the maximum amount that your house can add to your portfolio, will be your present home's value, minus your future home's value or equivalent lump sum used to generate rent, moving expenses, realtor, and so on. Since the value of your home is just $200K (same as mine), I would not consider that to be much of an addition to your "pot of gold" at the end of the rainbow. Personally I am not considering the value of my home at all in asset allocation, even though I am planning to move to an area with cheaper homes for ER, because the move and other costs will eat up any profit I might make from the difference in home costs.

I just go back and forth on whether if my goal is to increase net worth with a certain level of risk and the home is part of net worth that's low volatility (funny time to be making that claim I know) then should I count it. Arggh I guess no easy answer.

I am wondering if you will be able to afford to travel and ramble overseas and the US for the rest of your life in the style you might desire, on less than 4% of your assets before taxes. I would tend to buy a $100K home someplace with a low cost of living and with low taxes. That would leave you with about $550K after moving expenses and closing costs and such, which would generate about $15K - $20K (after taxes) for your expenses and medical insurance.

We're planning on about 5-6 years more work, and are really on a roll since no student loans etc. left we should be socking away close to 100k per year, currently living on probably 30k.

I hope you have thought hard about cashing in her pension. That is usually an irrevocable decision, and sometime (though tempting) it can be a very bad deal if instead she could get a COLA'd pension later on in life. It all depends on what is offered, I suppose.

Well when I said cashing in I assume we'll hold it in the account for as long as possible given the fairly generous set rate or return and state government backing it. An extra 12+ years of work seems like a long time to get that pension.

Again, thanks for the reply I do appreciate it.

 

[walkinwood]

As the OP said, asset allocation is very personal, so I'll share what I'm doing and have done - it may not apply to you.

I do not count the value of my house in my 'portfolio' and hence do not consider it in my asset allocation. It is my insurance policy for the future. I may reconsider down the line, but at the (almost) beginning of ER, that's how I look at it.

If I understand it correctly, your wife's pension acts as a high-yielding CD for as long as you hold on to it. Why not treat it as such in your AA?

I had a 80/20 equity/bond allocation till the past couple of years when I've moved to 70/30 and am drifting towards 65/35 as I start ER.

The high equity portion (large, small, international) helped me reach my ER goals, and the 20% mainly short-term bonds helped cushion the swings a bit - but as I've said before, AA is very personal and dependent on your (and your wife's) ability to stomach the churn.

Welcome.

 

[rayvt]

I ignore my house in figuring my net worth or asset allocation. You have to live somewhere, so I consider the house to be something to be consumed rather than something that is invested.

 

[ats5g]

Comrades,

Assuming our current pot of gold consists of:

400k liquid
200k paid off house
100k pension value (including employer matching funds)

Now we're definitely going to sell this house in 5-6 years when we retire, as we live near this big city because of work and plan on doing a good bit of rambling both overseas and in the US.

The pension will be cashed out as wife would have to work until 55 to get it and we're still in our 30s should be retired early 40s. Overall it's a great deal since they match 100% of her contributions and give a set rate of return currently 8%.

Could you explain more about how does the pension plan work? A link to the state's website would be helpful. Is the pension plan a cash balance pension plan or some kind of hybrid defined benefit plan? Or is it a defined contribution plan?

So... in your opinion does that portfolio inherently contain 43% (relatively) stable investments so the other 400k should be invested more aggressively or should the 400k be looked at as the portfolio and done 70/30?

That depends on what kind of return you need to acheive to reach your goal. Here's a page with a lot of links on Asset Allocation, including Rick Ferri's The Asset Allocation Question. Since your wife has a pension, you certainly could invest the 400K more aggressively, but if your saving 100K per year, and you only need 1-2% real returns, then taking a whole lot of risk may not make that much sense.

Here's a quote from chapter 1 of Zvi Bodie's Worry-Free Investing:

1. Set goals.
Make a list of the specific goals you want to achieve through your saving and investment plan. For example, “I want to continue to live at my customary standard of living after I retire,” or “I want to pay for my children’s college tuition at Harvard.”

2. Specify targets.
Determine the amount of money you will need to achieve each goal. These amounts become the targets of your plan. The very definition of risky or safe investing will depend on the target. TIPS and I Bonds have substantially lowered risk if the goal is retirement, but for college saving, special tuition-linked accounts are safer.

3. Compute your required no-risk saving rate.
Figure out how much you need to save as a fraction of your earnings on the assumption that you take no investment risk. For many people, it is appropriate to count your house as a retirement asset.

4. Determine your tolerance for risk.
Using as your benchmark the lowered-risk plan you have created in Steps 1–3, evaluate how much risk you are willing to take. Your capacity to tolerate investment risk should be related to the riskiness of your projected future earnings and your ability and willingness to postpone retirement if necessary. The safer your job and your future earnings, the greater your tolerance for risk in your investments. The more willing you are to postpone retirement if your risky investments perform badly, the greater your tolerance for risk.

5. Choose your risky asset portfolio.
After deciding how much of your wealth you are willing to put at risk, choose a form for taking the risk that gives you the greatest expected gain in welfare.

6. Minimize taxes and transaction costs.
Make sure that you are not paying any more in taxes, fees, or other investment costs than is necessary.

I bolded/italicized the relevant text about whether you should invest heavily [or not] in risky asset [like stocks].

- Alec

 

[tuixiu]

Could you explain more about how does the pension plan work? A link to the state's website would be helpful. Is the pension plan a cash balance pension plan or some kind of hybrid defined benefit plan? Or is it a defined contribution plan?

It's a pension plan, but they track a value of your contributions + the match which is vested over 10 years, and give you a published interest rate on it. If you get the required points of age+service you can retire as true defined benefit plan, but if you leave service short of retirement you can simply take out the cash balance + match to roll into IRA etc.

The wife will probably retire at 42-43 years old, far short of the age/service she would need to get lifetime pension , so we just consider it a pretax savings vehicle containing the contributions + vested match.

The point in the article you so kindly included is huge IMO, about how flexible you are timing impacts risk tolerance. We have nothing set in stone and are surely guessing a date on projected net worth as opposed to a certain age. That probably leans me a little more towards an aggressive portfolio.

 

[Midpack]

I include my home and other property in my net worth, but not at all in my asset allocation. I expect I will always own a home, so those funds are tied up forever IMO. Unless you have a very expensive house and plan to buy something much less expensive, I wouldn't even consider it with AA. And if you did, it's pretty much like cash as over the long term it will probably increase in value pretty much in line with inflation.