When more than 10 years from retirement your best chance is to be stock heavy. The investor could choose anything from 100/0 to 70/30 with 100/0 being least-risk. This assumes an appropriate emergency fund in addition to the portfolio so nobody will actually be at 100/0. This will match what you see from the professionals in target date funds with conservative plans at 70/30 and aggressive plans at 95/5 AA. The reason we don't particularly care about stock declines is that poor stock performance will cause a person with any portfolio with stocks (30/70, 50/50 or 90/10) to have to work longer. Working these extra years gives stocks plenty of time to recover and additions dampen any risk from volatility.In any analysis, starting assumptions are so important. I think this thread touches on something that is both critical and often overlooked and therefore provides service to the community.Can you provide more specifics as to the method mentioned above for derisking?In worst case stock outcomes you end up roughly the same as holding some fixed income after 30 years. In most cases you are way ahead.
The argument for holding a significant amount of bonds in accumulation is almost entirely behavioral. It would be fine for someone to say that they would panic sell and therefore hold bonds. They don't do that, they tell you that you are taking excessive risk despite their being no evidence of that risk over a career.
Make sure you think heavily on your risk tolerance. The ideal historical allocations are roughly
0-15x 100/0
20x 90/10
24x 80/20
25x 70/30
You should have an emergency fund appropriate for your situation in addition to the above portfolio.
You can go above these AA's (more stocks) if you want to take extra risk and you can go below these (more fixed income) if you want extra risk to manage fears of volatility.
Above 25x we don't have historical measures of risk because those always succeeded. I'm working on a thread to show portfolios with comparable risk. As an example 90/10 at 4% withdrawal had 25x the historical safety of a 20/80 AA. Many here would incorrectly consider the 20/80 AA "safer" because they think only in terms of volatility.
It is very possible to increase risk by trying to manage volatility. (too much fixed income)
It is very possible to increase risk by going only after expected returns. (too much stocks)
My general advice is to add fixed income a decade before your planned retirement. We typically jump from 15x to 24x pretty quickly so while the plan may be to add fixed income steadily, the optimal implementation often involves de-risking more rapidly as you achieve those multiples of expenses.
*Note that a lump sum has less safety than the accumulation portfolio. The ideal risk portfolio might add 10% fixed income to the above numbers if you are not accumulating.
Should the 25x 70/30 line read ≥25x 70/30? As in, stick to 70/30 at and above 25x?
I assume the glide from 15x 100/0 to 20x 90/10 to 24x 80/20 intended to be gradual, and one might even change the allocation at least partly with new contributions.
The change from 24x 80/20 to 25x 70/30 is more abrupt. Is there a reason for this? I assume this would have to happen through the selling of equities to purchase fixed income.
You mention adding 10% to fixed income relative to the above guidelines in decumulation (ideally at ≥25x and therefore 60/40). Would that transition also be abrupt?
Once you hit around 15x expenses you have enough stocks to drive growth and now it is time to start protecting that nest egg. Now you rapidly add fixed income to protect those stocks as they are still the driver of your success rate. If you have a 50% decline before you can buy that fixed income you are back to 7.5x expenses but you are probably going to work another decade to get to something like 25x expenses anyway. It doesn't really hurt you as compared to the alternatives and sitting at 7.5x expenses you are purchasing stocks rather than fixed income. Put another way it takes the same number of years for a 50/50 portfolio to recover as a 100/0 portfolio. You get no benefit in accumulation from dampening a decline unless stocks never recover before your retirement date.
My general findings are that beyond 25x expenses it doesn't matter if you add 100% fixed income or 100% stocks as the portfolio has equal risk of bad things happening to stocks and bad things happening to bonds. 15x stocks is enough to give good growth so up to 30x we prioritize fixed income a bit. From there adding 50% stocks and 50% fixed income will have a little bit less risk than adding all stocks or all bonds so the least risk recommendation would be:
Least-risk
25x expenses at 70/30 which is 17.5x expenses in stocks and 7.5 expenses in fixed income.
30x expenses at 63/37 which is 19.0x expenses in stocks and 11.0 expenses in fixed income.
35x expenses at 57/43 which is 20x expenses in stocks and 15 expenses in fixed income.
45x expenses at 56/44 which is 25x expenses in stocks and 20 expenses in fixed income.
The above is a little weird as it is not a simple rule around 25x expenses so I am also okay with starting at 15x in stocks and 10x in fixed income and just adding 50/50. Call this the conservative plan to handle risk - not quite optimum but maybe more comfortable if we don't like volatility.
Least-risk (modified)
25x expenses at 70/30 which is 15x expenses in stocks and 10x expenses in fixed income.
30x expenses at 63/37 which is 17.5x expenses in stocks and 12.5 expenses in fixed income.
35x expenses at 57/43 which is 20x expenses in stocks and 15 expenses in fixed income.
45x expenses at 56/44 which is 25x expenses in stocks and 20 expenses in fixed income.
None of this is exact so if you see slight differences any of them will be fine. We may also choose to ignore the least risk plan and have more fixed income or more stocks.
Most conservative accumulation portfolios will fail if stocks are not providing positive returns. It is really as simple as
EDIT: This thread makes me wonder what proportion of investors would not be able to reach their retirement goals without the growth provided by equities.
- start working at 22
- work until 62 years old with 4 years of lay-offs
- save 1x expense per year
If you invest only in fixed income you have 36x-4x = 32x expenses at age 62.
So if you are not saving almost 1x expenses per year you are dependent on stock returns. It gets worse if you invest in stocks and believe they can decline over your career. You invest at 30/70 AA and you need to save 1.3-1.4x expenses per year if you believe the stock portion can go to zero. These are unrealistic savings rates for most people and thus for most people our best chance is to try and capture any stock growth and eventually turn some of that into fixed income - assuming we can invest rationally and not based on fears.
Historically we only need a 10-20% savings rate if we choose stocks and we might need to work 30-40 years depending on our sequence.
Statistics: Posted by abc132 — Fri Sep 27, 2024 8:30 pm — Replies 267 — Views 37619
