For Target date fund owners in retirement

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Cody
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For Target date fund owners in retirement

Post by Cody »

I am seriously considering moving all my funds (mostly they are IRA's and Roths) to a Target date fund.

For those of you who use them in retirement help me make a good descsion.

My first concern is this: in a down market we will need to continue to take money out (3% withdrawal rate or so).

√ How do you deal with the idea that in a Target fund you will be selling equity in that down market. (Normally I would sell from the fixed part of my portfolio.)

Could we focus just on this question first and move on to my next concern. I'd rather not make this about the overall reasons people use Target Dated funds.

Thanks,
cody
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arcticpineapplecorp.
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Re: For Target date fund owners in retirement

Post by arcticpineapplecorp. »

Two portfolios $100,000 in each:
1. target date let's say allocation is 50/50 ($100,000 in one fund) vs.
2. 50% stocks 50% bonds ($50,000 in one stock fund, $50,000 in one bond fund)

Overall it's the same whether they're in one fund or separated into two funds.

Say the stock part goes down by 50% and for simplicity's sake bond's do nothing. Now you have:

1. $75,000 (target date fund. The $50,000 (stocks) lost 50% which leaves $25,000 in stocks and still $50,000 in bonds = $75,000 overall in one fund) vs.
2. $25,000 in stock fund, $50,000 in bond fund = $75,000 total (same as in target date, #1 above).

You need to withdraw 3%. What happens?

1. $75,000 - $2250 (that's 3% of $75,000) = $72,750 vs.
2. leave $25,000 stocks alone, but still need to take out 3% overall so have to take it ($2250) out of bonds. What happens:
$25,000 in stocks, $50,000 - $2250 in bonds = $47,750 in bonds.
Combined new amounts = $25,000 (stocks) + $47,750 (bonds) = $72,750.

Same in either case right?

edit: by the way, you'd then have to rebalance your two funds to be 50/50 again which would mean you'd have to sell $11,375 of bonds and buy stocks with that to bring each up (or down in the case of bonds) to $36,375. $35,375 in stocks +$36,375 in bonds = $72,750 overall. This also happens in the target date retirement fund...but automatically (that's what you're paying extra for, why the expense ratio is higher). When you reduce your target date fund to $72,750 overall, if it's a 50/50 fund then half would be in stocks and half in bonds. Same in either case.
Last edited by arcticpineapplecorp. on Sat Jan 21, 2017 11:29 am, edited 2 times in total.
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RadAudit
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Re: For Target date fund owners in retirement

Post by RadAudit »

Cody wrote:My first concern is this: in a down market we will need to continue to take money out (3% withdrawal rate or so).√ How do you deal with the idea that in a Target fund you will be selling equity in that down market. (Normally I would sell from the fixed part of my portfolio.)
My wife is retired and is invested in a target date fund. I'm thinking about moving my funds to either a target date fund or a life strategy fund.

The first concern I'd look at is does your withdrawal rate (3%) and expected portfolio return give you a reasonable chance of meeting your investing goals? Mine is to not die poor. If you have an acceptable chance of meeting your goals (portfolio has a 95% chance to last 30 or 40 years and your age is 65), then I'd trust the withdrawal rate. (As some wag opined, you'll probably die before you run out of money, anyway. So, no worries.) If I became really concerned, I'd try to trim back on the rate of withdrawals for a while.

I've set my RMDs to be taken from the bond side of my portfolio; however, according to my IPS, I also rebalance the portfolio upon occasions - annually and / or when the portfolio varies by 5% from the targets. I don't really see any substantial difference in outcome between my approach and just taking the money out of a target date fund - except I wouldn't have to go through the exercise of rebalancing.

How do I deal with the uncertainty? Pepto. I'm a natural worrier, which is a real waste of time. I have never found a really good way to handle the uncertainty of investing - other than getting the portfolio asset allocation to a point where I ought to be able to handle the variation and where the expected return looks good enough to handle the withdrawal rate - and hope for the best. The trick is to accept the uncertainty.
Last edited by RadAudit on Sat Jan 21, 2017 10:27 am, edited 1 time in total.
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Watty
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Re: For Target date fund owners in retirement

Post by Watty »

Cody wrote:How do you deal with the idea that in a Target fund you will be selling equity in that down market. (Normally I would sell from the fixed part of my portfolio.)
I'm retired and mainly using Target date funds but most of my funds are in retirement accounts where taxes are not an issue.

I think that the statement about normally selling from the fixed part of your portfolio is incorrect. If you have multiple funds then when you needed to sell you would first sell whichever asset class is above your desired asset allocation.

Unless you are going try to time the market by changing you asset allocation depending on if you feel the markets are "up or down" then using a target date fund or multiple index fund is more about tax efficiency than performance.

The target date funds work best in retirement accounts where taxes are not an issue so if you are investing in taxable accounts a three fund portfolio is likely a better choice.
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Cody
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Re: For Target date fund owners in retirement

Post by Cody »

I think that the statement about normally selling from the fixed part of your portfolio is incorrect. If you have multiple funds then when you needed to sell you would first sell whichever asset class is above your desired asset allocation.
I was just saying if stocks fell in a 50-50 portfolio to 40% fixed (in this senerio) moves up to say 60% - I'd rebalance.

Cody
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David Jay
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Re: For Target date fund owners in retirement

Post by David Jay »

My plan is to move from individual funds LifeStrategy funds because they maintain the AA I select. I Want to hold a constant AA in retirement.
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Topic Author
Cody
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Re: For Target date fund owners in retirement

Post by Cody »

Two portfolios $100,000 in each:
1. target date let's say allocation is 50/50 ($100,000 in one fund) vs.
2. 50% stocks 50% bonds ($50,000 in one stock fund, $50,000 in one bond fund)

Overall it's the same whether they're in one fund or separated into two funds.

Say the stock part goes down by 50% and for simplicity's sake bond's do nothing. Now you have:

1. $75,000 (target date fund. The $50,000 (stocks) lost 50% which leaves $25,000 in stocks and still $50,000 in bonds = $75,000 overall in one fund) vs.
2. $25,000 in stock fund, $50,000 in bond fund = $75,000 total (same as in target date, #1 above).

You need to withdraw 3%. What happens?

1. $75,000 - $2250 (that's 3% of $75,000) = $72,750 vs.
2. leave $25,000 stocks alone, but still need to take out 3% overall so have to take it ($2250) out of bonds. What happens:
$25,000 in stocks, $50,000 - $2250 in bonds = $47,750 in bonds.
Combined new amounts = $25,000 (stocks) + $47,750 (bonds) = $72,750.

Same in either case right?

edit: by the way, you'd then have to rebalance your two funds to be 50/50 again which would mean you'd have to sell $11,375 of bonds and buy stocks with that to bring each up (or down in the case of bonds) to $36,375. $35,375 in stocks +$36,375 in bonds = $72,750 overall. This also happens in the target date retirement fund...but automatically (that's what you're paying extra for, why the expense ratio is higher). When you reduce your target date fund to $72,750 overall, if it's a 50/50 fund then half would be in stocks and half in bonds. Same in either case.
I feel very much like my mind is in Zeno's Paradox and basically my thinking is sideways.

Is not the slice and dice strategy more effect because you, in the end, are using all 3%, in rebalancing, to buy "cheaper' equity in this case?

In your example above the end totals are the same but in slice and dice you are gaining the added benefit of buying 3% of the lower performer. So even though the numbers are the same you own more cheap equity in S&D. It just seems more beneficial, but is it significant? Or relevant?

Most importantly then do you lose much if the fund rebalances themselves vs.traditional slice and dice set up. Remember in this senerio you have to take the 3%, realizing you might adjust that depending on good or bad markets.

Straighten me out.
cody
RetiredinKaty
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Re: For Target date fund owners in retirement

Post by RetiredinKaty »

Cody,

Perhaps a real world example will help. Consider the Vanguard Balanced Index fund, which has been a 60/40 stock / bond fund since inception. The stocks in the fund resemble the total US stock market, and the bonds resemble the total US bond market. Rebalancing strategy is proprietary to Vanguard. However, efficient management of the fund's investor purchases and redemptions means the fund is effectively rebalanced daily. Information on the Vanguard website shows me that the fund's compounded annual return for the last 15 years (2002 through 2016) has been 6.50%. An additional retiree making modest withdrawals would obviously not affect fund performance.

Now consider a two fund portfolio consisting of 60% total stock market fund VTSAX and 40% total bond market VBTLX. The Portfolio Visualizer backtest tool shows that with annual rebalancing this portfolio would have returned a compounded annual 6.67% from 2002 through 2016. However, if we make an annual withdrawal of 3% initially and then increase future withdrawal amounts for inflation, the portfolio performance falls to 6.45%.

Conclusion: all withdrawals hurt performance in a down market regardless of which asset you sell. This is because a $100 spent on food is a $100 that a younger investor would have put into the down stock market, and there is no way to avoid this except to not eat.

I think there is an illusion related to the efficacy of market timing. Some people believe they can defy poor markets with a large cash bucket, because it is so obvious when looking at historical data to know when to refill the bucket and when to spend cash. The catch is that is is not at all obvious in real time.
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