How would you rebalance when your fixed income investments are not liquid?

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rca1824
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How would you rebalance when your fixed income investments are not liquid?

Post by rca1824 »

I plan on retiring with an annuity, whole life insurance cash value, and social security. The first two assets because you can get higher yields than on bonds. However unlike a traditional 3-fund portfolio, how do I rebalance if I don't own any liquid bonds? If equities fall in value I might be able to scrape up cash from my emergency fund or take a loan on my whole life insurance policy, but it would be difficult to follow a proper rebalancing strategy. And how do you even count assets that aren't tradeable and just have an income stream like annuities and social security? Do you take the current bond yield and extrapolate back a net worth figure and rebalance according to that? I don't see much on the wiki on rebalancing between equities and fixed income with illiquid fixed income assets so was wondering if anyone has figured this problem out yet.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
Sidney
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by Sidney »

rca1824 wrote:And how do you even count assets that aren't tradeable and just have an income stream like annuities and social security?
You don't. Count them as offsets to spending stream.

I don't have these annuities but I do have investment real estate and I don't count that either.

It sounds like you are 100% equity. The term "re-balance" doesn't apply to you.
I always wanted to be a procrastinator.
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rca1824
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by rca1824 »

Sidney wrote: You don't. Count them as offsets to spending stream.
Can you explain the implication of this and how it affects your portfolio? Do you do something like figure out your net spending stream (total spending - fixed income streams), then work backwards to determine an equity/bond allocation that can "guarantee" that stream? e.g. Spend $50000/year, get $30000/year from annuities + SS, so only need $20000/year from investments. If net worth is $1M, this is a mere 2% drawdown meaning I can afford a high equity portfolio like 75/25... ?
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
dbr
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by dbr »

Sidney is right. That is one of the reasons the logic behind counting income as a bond breaks down.

Having said that, the income situation may justify having all the liquid assets in equities, or it may not.
Keiser2015
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by Keiser2015 »

I wouldn't worry about rebalancing. You have cash flow with annuity and SS. You have equities for growth potential and possible inflation protection. You also have cash for emergencies or to somewhat counter deflation. Rebalancing does not guarantee a better return, it just keeps your risks constant.
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rca1824
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by rca1824 »

Keiser2015 wrote:I wouldn't worry about rebalancing. You have cash flow with annuity and SS. You have equities for growth potential and possible inflation protection. You also have cash for emergencies or to somewhat counter deflation. Rebalancing does not guarantee a better return, it just keeps your risks constant.
But when equities fall in value isn't it beneficial to be able to rebalance into them to buy them cheap? I know it's not "guaranteed" but holding 10-20% in bonds and rebalancing seems to greatly smooth returns. 100% equity can take several decades to "win" and in retirement I might not want that much volatility.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
Sidney
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by Sidney »

rca1824 wrote:But when equities fall in value isn't it beneficial to be able to rebalance into them to buy them cheap? I know it's not "guaranteed" but holding 10-20% in bonds and rebalancing seems to greatly smooth returns. 100% equity can take several decades to "win" and in retirement I might not want that much volatility.
You can choose any allocation you are comfortable with. I am 40/60 in retirement -- could probably go lower in equity but it would require taking capital gains which I don't need on my 1040 right now.

The point we are making is that the annuity streams are not assets and should not be viewed as assets.
I always wanted to be a procrastinator.
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BL
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by BL »

It sounds like you want to sell 10-20% of your equities and buy bonds so you have some bonds for buying equities when they are a bargain. Go for it!
JW-Retired
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by JW-Retired »

rca1824 wrote: But when equities fall in value isn't it beneficial to be able to rebalance into them to buy them cheap? I know it's not "guaranteed" but holding 10-20% in bonds and rebalancing seems to greatly smooth returns. 100% equity can take several decades to "win" and in retirement I might not want that much volatility.
The benefit of rebalancing into them when equities fall is pretty much cancelled out by rebalancing out of them when equities are rising. Which brings up the question of why you haven't been doing that? Stocks are riding a 4 year bull market and you still have a portfolio of 100% equities?

What am I missing?
JW
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pkcrafter
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by pkcrafter »

We need to know the answer to this question: Does the income stream cover all your spending needs? If true, then the equity is all discretionary money. Having said that, I'm not a fan of substituting an income stream for all your non-equity allocation. If you want to do that, there is no way to buy equities at low prices, but you also don't want to sell them during that time. If your annuity and whole life cover basic spending needs (floor) you can still manage real investment assets with 60-70% in stock and the remainder in bonds/cash.
I plan on retiring with an annuity, whole life insurance cash value, and social security. The first two assets because you can get higher yields than on bonds.
That's a very expensive way to buy yield. Is the annuity a SPIA? Also, perhaps recency bias in thinking bond yields will remain where they are now forever.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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rca1824
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by rca1824 »

JW Nearly Retired wrote:
rca1824 wrote: But when equities fall in value isn't it beneficial to be able to rebalance into them to buy them cheap? I know it's not "guaranteed" but holding 10-20% in bonds and rebalancing seems to greatly smooth returns. 100% equity can take several decades to "win" and in retirement I might not want that much volatility.
The benefit of rebalancing into them when equities fall is pretty much cancelled out by rebalancing out of them when equities are rising. Which brings up the question of why you haven't been doing that? Stocks are riding a 4 year bull market and you still have a portfolio of 100% equities?

What am I missing?
JW
I'm still 20-30 years from retirement so I am 100% equities and bond yield are low right now but I think in retirement I may add 10-20% bonds for stability and rebalancing. Although I have run simulations in cfiresim.com and using historical data it says that 100% equities has higher median, average, max, and (almost) min ending portfolio values than 80/20 or 90/10, and all have a 100% success rate with a 2% drawdown rule. I don't know all the assumptions they use but my gut tells me not to trust this because of the mantra "bonds for safety" but it looks like from the data all bonds do is bleed the portfolio dry.

I do want to rebalance into bonds when equities become overvalued and bonds become undervalued like during 2000. So that year taught me that a static 100% equity portfolio is far from optimal.
pkcrafter wrote:That's a very expensive way to buy yield. Is the annuity a SPIA? Also, perhaps recency bias in thinking bond yields will remain where they are now forever.
If bond yields are higher when I retire then I might keep bonds but if a SPIA can give me 6-7% yield and bonds are 2-4% then I will probably purchase a SPIA. I will evaluate whatever has the highest yield at the time, but historically I don't know if bonds have ever yielded more than a SPIA. It must be difficult for bonds to do so because SPIA subsidize the yield by using the capital of dead people, giving the maximum sustainable steady income while alive. Although I know they take out a fee to provide this service, the net yield is still higher so it seems advantageous. Without a SPIA, it seems one runs the risk of having an inefficient retirement by leaving too much money in their estate. I would rather have equities for the estate.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
Keiser2015
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by Keiser2015 »

"But when equities fall in value isn't it beneficial to be able to rebalance into them to buy them cheap? I know it's not "guaranteed" but holding 10-20% in bonds and rebalancing seems to greatly smooth returns. 100% equity can take several decades to "win" and in retirement I might not want that much volatility."

Just because equities fall in value does not mean they are cheap. The equities could fall further before rebounding. Holding 10-20% bonds will not greatly reduce volatility. If you want to grow your wealth pick equities. If you have enough assets (or won the game) then you have options. You can go for the growth for possibly a larger inheritance or you can hunker down with a larger percentage of fixed assets (bonds, CD, etc.). What exactly are your goals (growth, comfort, or something in the middle)?
Topic Author
rca1824
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by rca1824 »

Keiser2015 wrote:"But when equities fall in value isn't it beneficial to be able to rebalance into them to buy them cheap? I know it's not "guaranteed" but holding 10-20% in bonds and rebalancing seems to greatly smooth returns. 100% equity can take several decades to "win" and in retirement I might not want that much volatility."

Just because equities fall in value does not mean they are cheap. The equities could fall further before rebounding. Holding 10-20% bonds will not greatly reduce volatility. If you want to grow your wealth pick equities. If you have enough assets (or won the game) then you have options. You can go for the growth for possibly a larger inheritance or you can hunker down with a larger percentage of fixed assets (bonds, CD, etc.). What exactly are your goals (growth, comfort, or something in the middle)?
It will depend on my situation at the time (planning 20-30 years in advance here) but I think my goal will be to have a very small drawdown rate 1-2% and then focus on growing my portfolio to leave to my estate. I want to leave something behind for my immediate and extended family to remember me by. So whatever gives the most growth. I know the data says 100% equity is optimal but I just don't see how this can be optimal when in 2000 equities were trading at PE10 of 45 and 10 year treasuries were yielding 7%. Seems like a nobrainer to switch to treasuries in that event. So I think there is a strong argument for either a static allocation of 10-25% bonds or a tactical allocation that overweights the asset with higher yield. I need to figure out how to download historical data so I can run some simulations with this strategy but even then historical data doesn't prove future results so I also want a strong theoretical justification for a strategy that will be robust in the future.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
rkhusky
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by rkhusky »

rca1824 wrote: I do want to rebalance into bonds when equities become overvalued and bonds become undervalued like during 2000. So that year taught me that a static 100% equity portfolio is far from optimal.
Problem is, it is really hard to pinpoint this in time, except in hindsight.
pkcrafter
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by pkcrafter »

rca, your post is a bit misleading, or I misunderstood. Apparently you don't have a whole like policy or an annuity. You are 20 years from retirement with 100% stocks and you are worried about how to rebalance in retirement with no bonds? Don't you face the same problem right now?
I know the data says 100% equity is optimal but I just don't see how this can be optimal when in 2000 equities were trading at PE10 of 45 and 10 year treasuries were yielding 7%.
Who says 100% equity is optimal? You don't know the answers as to what is optimal, only what was optimal, so the best approach is to be diversified. You are over thinking this.
I need to figure out how to download historical data so I can run some simulations with this strategy but even then historical data doesn't prove future results so...
Whoops, stop right there. Hold that thought.
I also want a strong theoretical justification for a strategy that will be robust in the future.
What you want is the baseball defense. Baseball teams don't know exactly where the ball will be hit, so they place the fielders in positions where most of the balls have been hit. They get that from historical data. With assets you create a diversified portfolio that considers risk and potential return because you don't know where the ball is going to be hit. You use historical data as a general guideline, but you can't catch all the balls.


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
dhodson
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Re: How would you rebalance when your fixed income investments are not liquid?

Post by dhodson »

you also dont necessarily get higher yield on those non liquid assets then bonds. Sure at the moment the return on an older insurance product you have had for a long time looks good compared to buying bonds today but over the entire time one needs to hold these assets (entire life for the insurance), the return is on the lower "bond side". One has to remember these companies are primarily buying bonds and have high costs/fees/drags etc so you should realize bond like returns are not guaranteed. Dividends continue to fall at this point since they lag the interest rate environment.
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