Directing asset allocation for early retirement

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jjunk
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Directing asset allocation for early retirement

Post by jjunk »

I'm currently reading 'How to retire early' by Robert Charlton and in it he mentions that when he and his wife retired at 43, their taxable account held a mix of equities and taxable bonds because they were well ahead of the time when they'd be able to touch their deferred accounts. I'm 40 and considering early retirement. I was wondering how others who've retired from full time work have targeted their asset allocations where your taxable account will act as your sole source of living expenses for 10+yrs. Currently my portfolio is 70/30 with my taxable being all equities and my deferred being all fixed income.

Does it make sense to reallocate my positions and make taxable 40/30 (E to FI) and 30% equities in my 401k?
livesoft
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Re: Directing asset allocation for early retirement

Post by livesoft »

Our taxable account is all equities. Fixed income is kept in tax-advantaged accounts. Asset allocation is about 35% fixed income.

It does not make sense to me to put fixed income in taxable, but our taxable account is large enough to probably fund our retirement for 20 years or more, so even if the stock market tanked, there would be plenty. I suppose folks might be worried about having to tap into tax-advantaged accounts if the taxable ran out. This is not a concern because one can tap into tax-advantaged accounts without paying penalty if one cares to learn the rules that are not widely known.

Related to this is how to keep cash needs in tax-advantaged accounts: http://www.bogleheads.org/wiki/Placing_ ... ed_account

But I can see some folks who want to retire early with little in the way of taxable accounts. It is possible, but they will be doing 72(t) SEPP withdrawal plans anyways and have very low expenses. To communicate with folks who early retire with minimal assets and who do the 72(t) thing, check out the Early Retirement forum:
http://www.early-retirement.org/forums/f21/
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bloom2708
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Re: Directing asset allocation for early retirement

Post by bloom2708 »

At 43 I've been thinking about this as well. With an early retirement, your taxable monies are your "near to nearer" term dollars. In this case wouldn't it make sense to have a more conservative AA in taxable? Your long term monies could be slightly more agressive.

Let's say I wanted a 70/30 overall AA. I could set up our tax sheltered to be 75/25 and then taxable to be 55/45 or whatever AA that brings you overall to 70/30.

Most have more in tax sheltered than taxable, but that is a generalization. Currently I use this overall we are at 60/40, but taxable is 52/48 and tax sheltered are at 65/35. I use new taxable contributions to re-balance. If Tax sheltered gets too far out of whack, then I will sell/purchase to rebalance within.
bulldog1
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Re: Directing asset allocation for early retirement

Post by bulldog1 »

My goal is to retire early with just my taxable account available. My retirement accounts are 70/30 and my taxable account is 50/50. I am not following the rules of including my taxable account into my whole portfolio. My taxable account will be strictly for early retirement.
livesoft
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Re: Directing asset allocation for early retirement

Post by livesoft »

Here's something else to consider. Generally, a higher fraction of fixed income in an account will reduce its expected performance. If one needs that taxable account to grow lots, then one probably should try to have lots of equities in that account. In other words, by having a high fraction of fixed income in the taxable account, one is practically assuring that the taxable account will have lower value than it could have when one really wanted it to have a higher value.

Of course, the risk is that the equities will drop lots just when you need them. Recent past history probably won't be repeated, but stocks did recover quickly. I prefer my taxable account growing big and fat because the risk of it tanking is easy to accept since my backstop is my tax-advantaged accounts and doing the 72(t) SEPP thing. And money is money, so I am happy to spend it out of my taxable or tax-advantaged accounts when I need to.

A lot of this is behavioral economics playing tricks on one's mind. One tends to fear losses more than necessary and appreciate gains less than reality. I think I've gotten past that kind of thinking and have been rewarded for doing so.
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Whatyear?
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Re: Directing asset allocation for early retirement

Post by Whatyear? »

My taxable account is about 70/30 Equity/Bonds and my 401K is about 50/50. I'm gradually managing them both to about 60/60 (or maybe 50/50 - we'll see) as I get closer to retirement (I'm 54 hoping to retire no later than 62, quite possibly at 60). I "get" that I really shouldn't have bonds in the taxable account, but like others who've posted, it's my "early retirement account" so I'll need it a lot sooner than my 401K.
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jjunk
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Re: Directing asset allocation for early retirement

Post by jjunk »

livesoft wrote:Here's something else to consider. Generally, a higher fraction of fixed income in an account will reduce its expected performance. If one needs that taxable account to grow lots, then one probably should try to have lots of equities in that account. In other words, by having a high fraction of fixed income in the taxable account, one is practically assuring that the taxable account will have lower value than it could have when one really wanted it to have a higher value.
Thanks livesoft, this is a very good point. The counter argument that I was also considering was survivability of the taxable account. If I were to pull the plug now at 40, I would be ~15-20yrs away from being able to touch my other retirement assets. The hope would be that my large equity positions would cover me for that period of time (and I'm fairly certain they would) but in reading their book, it seems like they were "lucky" to have fixed income because they retired right into the 08 meltdown. Bonds would save you a little there.

I'm glad to hear everyone's opinions here. It's nice to know that there is variability here with how folks expect to handle this. The way I'm looking at it is this, if I have a hypothetical 1mil portfolio and need 48k/yr to live, if I had a 70/30 portfolio like I do now I could possibly work part time somewhere and make 10-15k and then use 30k/yr from taxable to pay my living expenses. My taxes should be close to $0 so long as the gains are long term and I'd have a solid chance the equities portion would cover that 30k without a need to touch principal. Does that sound plausible?
livesoft
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Re: Directing asset allocation for early retirement

Post by livesoft »

As I re-read what I wrote, I had an additional thought.

We see all the time on the forum that folks want to put 100% equities in their Roth IRAs because equities will achieve the most growth in these future tax-free accounts, so folks want them to grow the fastest and the mostest. They even like to put riskier equities in Roths such as REITs and emerging markets.

If these are the same folks who say taxable accounts need to have fixed income in them in case of potential losses, then there is some inconsistent thinking going on here.

One could turn the equities-in-Roth argument around: One needs to have a mix of equities and fixed income in the Roth in case equities go down. One doesn't want to lose that money in precious future tax-free space, so one should adjust the asset allocation in that account in order to preserve capital.

Clearly, some behavioral aspects to all this, but I think one should be self-consistent about all this.
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jjunk
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Re: Directing asset allocation for early retirement

Post by jjunk »

Fair point :happy
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midareff
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Re: Directing asset allocation for early retirement

Post by midareff »

livesoft wrote:As I re-read what I wrote, I had an additional thought.

We see all the time on the forum that folks want to put 100% equities in their Roth IRAs because equities will achieve the most growth in these future tax-free accounts, so folks want them to grow the fastest and the mostest. They even like to put riskier equities in Roths such as REITs and emerging markets.

If these are the same folks who say taxable accounts need to have fixed income in them in case of potential losses, then there is some inconsistent thinking going on here.

One could turn the equities-in-Roth argument around: One needs to have a mix of equities and fixed income in the Roth in case equities go down. One doesn't want to lose that money in precious future tax-free space, so one should adjust the asset allocation in that account in order to preserve capital.

Clearly, some behavioral aspects to all this, but I think one should be self-consistent about all this.

You make a valid point and I am one who is 100% equities in my Roth. On the other hand my retirement funding was directed to my deferred compensation account for most of the years. Only when there was surplus dollars, and double up (def comp) tried to put that on hold for three years, so being Roth serious was difficult. Now it's a play money account.. very un-Bogelish but it is what it is for me. It's under 3% of portfolio so .. really, dilligas. It only got there by very lucky sector selection, just a hot hand, lucky picks and good fortune. No chance of repeating, and it is what it is.
bhsince87
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Re: Directing asset allocation for early retirement

Post by bhsince87 »

I'm planning to retire in 3-5 years around age 53-55. I don't plan to worry much about percentages in my taxable account, but instead focus on $ amounts there. I want to have at least 4 years worth of expected expenses in Prime/CD's/short term bonds in my taxable at all times, while keeping my overall mix at 60/40.

I'm currently about 50% t401k, 50% taxable (0 Roth).

Taxable is 80% equity 20% Prime & Short Term Bonds. The 401k is bond heavy. Probably 40/60 (target overall is 60/40, but I'm too tired to do the math...)

I've got huge capital gains in taxable (some over 20 years) that I want to capture at 0 or possibly 15%. I'll also possibly convert some t401k to Roth. Too early to tell which would make the most sense.

If/when I build up excess cash in taxable, I will either buy more bonds or repurchase equities (at a new basis), with the goal of keeping my overall balance at 60/40. At least until I hit 59 1/2, when another set of options becomes available....
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Re: Directing asset allocation for early retirement

Post by placeholder »

I'm 100% equities (mostly REIT) in Roth because that makes the most sense for tax efficient placement as I can't hold REIT in the 401k and I don't want it in taxable although I could take out the smaller amounts of value funds to taxable and put some bonds in Roth but I don't see the point.
scrabbler1
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Re: Directing asset allocation for early retirement

Post by scrabbler1 »

Jjunk, I am 51 and retired nearly 6 years ago. I have different AAs for my taxable portfolio (the one I living off now) and my tax-deferred portfolio (my IRA) which I won't be touching until I turn ~59. I am about 63/37 in favor of bonds in the taxable account because I have set up a monthly dividend income stream to cover my expenses. In my IRA I am 50/50 (down from 55/45 stocks due to aging). Two different investment goals, two different AAs. It has worked out well in the last 6 years. I have a frozen company pension and Social Security awaiting me when get later into my 60s, the rest of my "reinforcements."
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kramer
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Re: Directing asset allocation for early retirement

Post by kramer »

I retired at age 41 and I think my taxable was about 2/3 of my net worth. And my overall asset allocation for all my accounts was about 65% equities and 35% fixed income. Anyway, I did not compromise too much and so, on average, over 90% of my taxable has been in equities.

I do track both my SWR from my overall net worth and my SWR from taxable account alone. I think you must pay more attention to this issue of taxable asset allocation if your SWR from taxable account alone is high and you are still far away from age 59.5. For me, even my SWR from just my taxable account is well under 4% so I feel I don't have to worry about that as much. I have opted to not hold too much fixed income in taxable since I know that 72(t) withdrawals from my IRA are a backup. Also, I am trying to use this taxable space for other valuable things discussed below.

One thing to help the taxable asset allocation is to use the low 0% tax space for interest income, in addition to non-qualified dividends. If you are single, let's say that 4,000 of your dividends are non-qualified. Then you have $6,000 of interest income possible that will be taxed at 0%. You can put your safest and shortest term bonds in taxable and that could be a quarter of a million dollars at today's low rates. Also, it is easier to chase good CD rates in your taxable account.

Each year I do tax gain selling up to the top of the 15% bracket, so I maximize my capital gains in the 0% bracket. Starting this year, I am doing IRA to ROTH conversions to fill up the 0% bracket and 10% brackets and then I will tax gain sell my equities up to the top of the 15% bracket.

Some subtleties to consider:

* When you are paying zero taxes you can't take advantage of foreign taxes paid. So if you do some IRA to ROTH conversions or earn some taxable interest income, your effective tax rate will not be the full tax rate since you will be able to take advantage of the foreign tax credit to reduce that rate.

* In your first full year of early retirement, when you may owe zero taxes, don't forget to apply your foreign tax credit to the previous year when you were earning a lot of money working. I got a four figure refund on my foreign taxes paid when I did this on my 2008 taxes (I retired in mid-2007 -- I carried back my foreign taxes paid in 2008 to my high earning 2007 year). I think many folks don't realize they can do this.

* Your income is also taxed at the State level and your overall income may affect your Obamacare subsidies. So it is important to consider all these things.
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Re: Directing asset allocation for early retirement

Post by abuss368 »

There are two strategies in terms of portfolio construction:

1) Equal Location - the same funds in each account (with possibly minor differences such as taxable and tax exempt bonds).
2) Asset Location - different funds in different accounts.

We have tried both strategies and follow the "Equal Location" strategy. This strategy is also recommended by Rick Ferri and his firm Portfolio Solutions. There are several advantages and disadvantages to both strategies. The important part is to determine which strategy works best for you as there is no one right answer.

The difference in strategies has grown more intense in recent years so much that the Bogleheads wiki had to be updated. You will hear and read arguments for both strategies.

Here is an excellent article titled "Does Asset Location Make Sense?" by Rick Ferri from his website. You may find this helpful.

http://www.rickferri.com/blog/strategy/ ... ake-sense/

Best.
John C. Bogle: “Simplicity is the master key to financial success."
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