Changing asset allocation in the years approaching retirement

[Antares]

Following up on the "Is this stupid?-Timing the market" thread:

 

I agree that selling now in anticipation of a major drop is unlikely to be a successful strategy. No one knows what will happen, and as I once was prone to doing stuff like that, I can testify to the fact that not knowing when to get back in, especially when the feared scenario fails to materialize, leads to huge missed gains compared to just sitting tight and doing nothing.

But the advice in the over thread was given to someone with decades to go until retirement. I have to admit I've been questioning my longstanding allocation of 65% equities recently. Partly, I admit is fear of the long bull market and of the political risk I see. But I wouldn't base it just on those things. It makes me wonder whether with 7 years to go, it's a time to forgo possible gains in exchange for greater certainty of getting to the end line, albeit with a little less. I need to maintain my current savings of 140K per year and 6% earnings to be where I want to be at 65. Otherwise I'll have to work longer or scale back my retirement wishes. At 2% growth, I'm a million short.

Any thoughts?

[VagabondMD]

Antares wrote:

Following up on the “Is this stupid?-Timing the market” thread:

 

I agree that selling now in anticipation of a major drop is unlikely to be a successful strategy. No one knows what will happen, and as I once was prone to doing stuff like that, I can testify to the fact that not knowing when to get back in, especially when the feared scenario fails to materialize, leads to huge missed gains compared to just sitting tight and doing nothing.

But the advice in the over thread was given to someone with decades to go until retirement. I have to admit I’ve been questioning my longstanding allocation of 65% equities recently. Partly, I admit is fear of the long bull market and of the political risk I see. But I wouldn’t base it just on those things. It makes me wonder whether with 7 years to go, it’s a time to forgo possible gains in exchange for greater certainty of getting to the end line, albeit with a little less. I need to maintain my current savings of 140K per year and 6% earnings to be where I want to be at 65. Otherwise I’ll have to work longer or scale back my retirement wishes. At 2% growth, I’m a million short.

Any thoughts?

Click to expand...

Yes, I have been ratcheting down my allocation to equities, as I approach part time (2018) and likely "early" retirement (2020, at age 55).

In 2007, I was 80:20; in 2011, I went to 70:30, and more recently, I am pegged around 60:40, inching toward 55:45. I am at the point where I have enough to retire, and the requirement for capital appreciation is balanced, if not surpassed, by the need for capital preservation. If I lose 50% in the next year, I would not likely be able to retire from the clinical job in 2020. If I lose 25% in the next year, I could still probably pull it off (or do locums for a year or two until delayed retirement). The latter scenario is tolerable; working another 5-7 years because I was too aggressively positioned is not tolerable (former scenario).

I will openly state that the fact that valuations are high by historical standards contribute to my desire to be less aggressive.

[Faithful Steward]

One strategy, that allows you to make sure you can fund your income needs upon retirement, yet maintain a long-term equity portfolio is to use a retirement income strategy called liability matching.

It's a bit of a complex strategy to explain, but relies upon elegant simplicity, once you understand it.

It has the potential to prevent you from having to sell shares from your portfolio during market downturns. Instead, your the income you need from your portfolio each year will come from bond interest payments and return of principal on maturing bonds.

It also can help avoid the damages that reverse-dollar-cost-averaging can do to your portfolio if you use a systematic withdrawal strategy to generate your retirement income. Instead of selling shares of your investments at set interims, the income portion of your portfolio is normally set to cover your next 3-7 years of retirement income; affording you time to intelligently navigate your portfolio. This is in stark contrast to systematic withdrawal plans that actually reinforce poor investment discipline; dictating that you sell fewer shares at high prices and more shares at low prices.

Finally, it also can help protect you from loss of principal in your fixed income holdings due to rising interest rates, as you will be holding your bonds until maturity - thereby eliminating the duration effect.

If you'd like to learn more, I'd suggest watching the three videos in this playlist link: https://www.youtube.com/playlist?list=PLvIlbbBY5l50ePbJoCq8BW_qkblpJAxB9

[Donnie]

Antares wrote:

Following up on the “Is this stupid?-Timing the market” thread:

 

I agree that selling now in anticipation of a major drop is unlikely to be a successful strategy. No one knows what will happen, and as I once was prone to doing stuff like that, I can testify to the fact that not knowing when to get back in, especially when the feared scenario fails to materialize, leads to huge missed gains compared to just sitting tight and doing nothing.

But the advice in the over thread was given to someone with decades to go until retirement. I have to admit I’ve been questioning my longstanding allocation of 65% equities recently. Partly, I admit is fear of the long bull market and of the political risk I see. But I wouldn’t base it just on those things. It makes me wonder whether with 7 years to go, it’s a time to forgo possible gains in exchange for greater certainty of getting to the end line, albeit with a little less. I need to maintain my current savings of 140K per year and 6% earnings to be where I want to be at 65. Otherwise I’ll have to work longer or scale back my retirement wishes. At 2% growth, I’m a million short.

Any thoughts?

Click to expand...

In order to provide much feedback, we need to know a bit more about your current retirement savings and your goal.  If the $980k you plan to save over the next 7 years is a large portion of your total retirement goal, then you should stay aggressive on your allocation.  If it is a smaller % of your total goal, and you already have a large amount of retirement savings, you should be less aggressive.

[Antares]

Thanks Faithful Steward, I will check out those links!

[Antares]

Thanks Donnie. Ok, so I am looking for 5M. I have 2.5M now. With saving 140,000 per year for 7 years and earning 6% I'm at slightly over 5 M. Saving and earning 2% leaves me at just under 4M. How does that affect your thoughts?

[Donnie]

I might think about it as shown in the attached if I were you.  I would think about a minimum level of retirement funds that I could retire on in a worst case scenario.  Maybe that is $2.5M, resulting in $100k of withdrawals per year using the 4% rule.  At 65% allocation to stocks, $2.5M of savings, and $1M of future savings, you will still have covered your minimum retirement goal of $2.5M, even in a stress case of a -50% stock return and -10% bond return.  Since that is still above your downside case minimum retirement goal, I would be OK with that allocation.

Now if you look at your expected case, you expect to have $4.5M in 7 years assuming 6% stock and 2% bond return and no return on your future savings.  That puts you reasonably on target for your $5M goal.  Therefore, my advice would be to stick with your current allocation.  This analysis will change as your future savings decline, you have more current retirement, and a stress case would hurt you more.

[VagabondMD]

The irony of following the the 4% rule, without consideration of market conditions, is the following:

Let's say I need $1M to retire, and I am allocated 80:20, and intend to withdraw 4% per annum ($40k) to meet my spending needs, and I have a 95+% chance of long term success. Based on the 4% rule dogma, this is well-accepted and advisable. Or so it seems.

Now, let's say that instead of retiring, I am offered an incentive to stay. I work an additional six months, and I receive a cash payment of $200k (net of taxes) on the last day of the 6 month period. However, in the last month of that six month period, the market drops 50%. I now have $800,000. (50:50), and the 4% rule says that I cannot retire because 4% of $800,000 is $32k, and I am now not able to meet my required $40k per annum withdrawal.

So, I would have been okay to retire 6 months ago, but I worked longer and saved more money, but now I cannot afford to retire.

[Donnie]

Vagabond MD wrote:

The irony of following the the 4% rule is the following:

Let’s say I need $1M to retire, and I am allocated 80:20, and intend to withdraw 4% per annum ($40k) to meet my spending needs, and I have a 95+% chance of long term success. Based on the 4% rule dogma, this is well-accepted and advisable. Or so it seems.

Now, let’s say that instead of retiring, I am offered an incentive to stay. I work an additional six months, and I receive a cash payment of $200k (net of taxes) on the last day of the 6 month period. However, in the last month of that six month period, the market drops 50%. I now have $800,000. (50:50), and the 4% rule says that I cannot retire because 4% of $800,000 is $32k, and I am now not able to meet my required $40k per annum withdrawal.

So, I would have been okay to retire 6 months ago, but I worked longer and saved more money, but now I cannot afford to retire.

Click to expand...

I imagine a 50% drop the year after you retire is one of those 5% of times that result in failure.  You should probably continue working in that scenario.

[Faithful Steward]

Vagabond MD wrote:

The irony of following the the 4% rule, without consideration of market conditions, is the following: Let’s say I need $1M to retire, and I am allocated 80:20, and intend to withdraw 4% per annum ($40k) to meet my spending needs, and I have a 95+% chance of long term success. Based on the 4% rule dogma, this is well-accepted and advisable. Or so it seems. Now, let’s say that instead of retiring, I am offered an incentive to stay. I work an additional six months, and I receive a cash payment of $200k (net of taxes) on the last day of the 6 month period. However, in the last month of that six month period, the market drops 50%. I now have $800,000. (50:50), and the 4% rule says that I cannot retire because 4% of $800,000 is $32k, and I am now not able to meet my required $40k per annum withdrawal. So, I would have been okay to retire 6 months ago, but I worked longer and saved more money, but now I cannot afford to retire.

Click to expand...

This is the classic "sequence of returns" problem that causes many people problems with their retirement planning. You're going to get bad returns at some point in retirement. Better to get them in the later years, when your balance is smaller, than in the early years when you have the largest portfolio values.

However, strategies that avoid having to sell shares during the bad return years (liability matching or living off dividends and bond interest payments) prevent investors from having to sell shares of their investments during those market downturns; thereby limiting it to a loss on paper (albeit, nobody likes seeing the values on their account statement going down) and giving your portfolio time to return.

For instance, if you had the bad luck of retiring in August of 2008 and had created a 5-year income bridge, using laddered bonds to provide your income needs from August 2008 through August 2013, the remainder of your portfolio would have been able to ride out the market downturn and then participate in the market rebound.

All this simply highlights that retirement income planning is not a one-time event; it's an ongoing process.

[Antares]

Vagabond MD wrote:

The irony of following the the 4% rule, without consideration of market conditions, is the following:

Let’s say I need $1M to retire, and I am allocated 80:20, and intend to withdraw 4% per annum ($40k) to meet my spending needs, and I have a 95+% chance of long term success. Based on the 4% rule dogma, this is well-accepted and advisable. Or so it seems.

Now, let’s say that instead of retiring, I am offered an incentive to stay. I work an additional six months, and I receive a cash payment of $200k (net of taxes) on the last day of the 6 month period. However, in the last month of that six month period, the market drops 50%. I now have $800,000. (50:50), and the 4% rule says that I cannot retire because 4% of $800,000 is $32k, and I am now not able to meet my required $40k per annum withdrawal.

So, I would have been okay to retire 6 months ago, but I worked longer and saved more money, but now I cannot afford to retire.

Click to expand...

You would have been in an even worse position had you not worked the extra six months and not received the $200k, unless you significantly altered your asset allocation after retirement.

[Antares]

Donnie wrote:

I might think about it as shown in the attached if I were you.  I would think about a minimum level of retirement funds that I could retire on in a worst case scenario.  Maybe that is $2.5M, resulting in $100k of withdrawals per year using the 4% rule.  At 65% allocation to stocks, $2.5M of savings, and $1M of future savings, you will still have covered your minimum retirement goal of $2.5M, even in a stress case of a -50% stock return and -10% bond return.  Since that is still above your downside case minimum retirement goal, I would be OK with that allocation.

Now if you look at your expected case, you expect to have $4.5M in 7 years assuming 6% stock and 2% bond return and no return on your future savings.  That puts you reasonably on target for your $5M goal.  Therefore, my advice would be to stick with your current allocation.  This analysis will change as your future savings decline, you have more current retirement, and a stress case would hurt you more.

Click to expand...

Thank you for that analysis, Donnie. Certainly gives me food for thought.

[VagabondMD]

Faithful Steward wrote:

Vagabond MD wrote:

The irony of following the the 4% rule, without consideration of market conditions, is the following: Let’s say I need $1M to retire, and I am allocated 80:20, and intend to withdraw 4% per annum ($40k) to meet my spending needs, and I have a 95+% chance of long term success. Based on the 4% rule dogma, this is well-accepted and advisable. Or so it seems. Now, let’s say that instead of retiring, I am offered an incentive to stay. I work an additional six months, and I receive a cash payment of $200k (net of taxes) on the last day of the 6 month period. However, in the last month of that six month period, the market drops 50%. I now have $800,000. (50:50), and the 4% rule says that I cannot retire because 4% of $800,000 is $32k, and I am now not able to meet my required $40k per annum withdrawal. So, I would have been okay to retire 6 months ago, but I worked longer and saved more money, but now I cannot afford to retire. 

Click to expand…

This is the classic “sequence of returns” problem that causes many people problems with their retirement planning. You’re going to get bad returns at some point in retirement. Better to get them in the later years, when your balance is smaller, than in the early years when you have the largest portfolio values.

However, strategies that avoid having to sell shares during the bad return years (liability matching or living off dividends and bond interest payments) prevent investors from having to sell shares of their investments during those market downturns; thereby limiting it to a loss on paper (albeit, nobody likes seeing the values on their account statement going down) and giving your portfolio time to return.

For instance, if you had the bad luck of retiring in August of 2008 and had created a 5-year income bridge, using laddered bonds to provide your income needs from August 2008 through August 2013, the remainder of your portfolio would have been able to ride out the market downturn and then participate in the market rebound.

All this simply highlights that retirement income planning is not a one-time event; it’s an ongoing process.

Click to expand...

Understood. That said, deciding to retire is a cousin of market timing. More people are likely to make the decision to retire (especially retire early), when the coffers are flush. I know quite a few docs who retired around 1999/2000, 2006/2007, and we have had a flurry of retirements recently. People were not bailing out in 2002 and 2009 to the same degree.

While there are many factors that contribute to the decision for a doc to retire beyond simply grinding to financial independence (including age, health, family, windfalls, burnout, loss of interest, new interests, etc.), one of the conditions to absolute retirement is that you need to be able to sustain yourself on your nest egg. This is more likely to be found at the perceived market tops than bottoms.

Any sequence of return beating strategy is going to be less aggressive than 100% stocks, short of having an eight figure nest egg and living relatively frugally from the dividends. Liability matching is similar to the "three bucket" strategy that allows one to mentally allocate short, intermediate and long term assets, to help weather market volatility (mainly drawdowns) that are inevitable during a lengthy (30+ year) retirement. By necessity, these strategies are going to be considerably less aggressive.