Is it LMP/RP, is it Buckets, is it rising equity AA, is it mental accounting, or is it just MLA? (Myopic loss aversion)?

[PaulF]

Dear Bogleheads,

I am a long-time reader (back to M* days), but post infrequently.

Thanks to you all, and some good fortune, I am approaching an early retirement in a couple of years at age ~57. I am trying to position myself for a secure future, and wanted to bounce some thoughts off of you. I am contemplating transitioning my viewpoint to a LMP/RP (liability matching portfolio/risk portfolio) outlook.

The short story: I am 55, my wife is 53, no kids. Current assets are ~$1.6M in a very Bogleheadish portfolio. A key factor is that we both will have nice pensions to provide much of the income stream needed in retirement. (We also have health insurance covered, and our house will be paid off well before retirement.)

I am targeting ~$110k in annual spending (which is more than we spend now, ~$90k). Our pensions will be ~$58k, and roughly COLA’ed. Therefore, for the period between retirement and SS (hopefully at 70), I estimate we will need to draw about $52k from our portfolio, which is a WR of ~3.25%. After starting SS, pension+SS should more than meet our needs. So it seems to me that just about any withdrawal tactic I use will work. (Yes, we are fortunate.)

With that in mind, I have been contemplating subscribing to the Bobcat2/Bill Bernstein/Zwecher/Bodie/Paula Hogan approach, namely, purchase safe assets to provide an income floor for peace of mind. In my case, I believe that I would only have to cover to age 70, letting the pension and SS be the floor from 70 onwards. A TIPS ladder providing the flooring to age 70 would cost about $900k, leaving about $700k for the Risk Portfolio (RP), which could be invested more aggressively. The RP could be used for lumpy spending.

This appeals to me, but it seems one could look at this from a multitude of perspectives. I have always been a “total return guy,” trying to choose my AA during accumulation to bear what I felt was the appropriate amount of risk. (I am at about 60/40 now, and have been targeting 58/42 as the “permanent” AA during decumulation.)

One could look at this proposed move as a “bucket strategy”: spend first from the TIPS bucket, while “preserving” the RP bucket. This kind of reasoning has always seemed like “mental accounting” to me, in a pejorative sense. I must admit, however, that I have come to see that “mental accounting” is not inherently wrong; it can be a useful heuristic.

Or, you could say that if I were to purchase $900k of TIPS, then keep the RP at a reasonably aggressive AA (say 80/20), then my effective AA at retirement would be 30/70. As I spent down the TIPS, my AA would revert back to 80/20 by age 70. From this perspective, this smells more like a Pfau/Kitces/Early Retirement Now scheme of raising one’s equity share during retirement. The notion is that this would help insulate me from a poor sequence of returns early in retirement, but allow for some upside over a longer time period with the RP. (I.e., Kitces’s “bond tent.”) I am aware that Kitces has pointed out the similarity of “bond tent” and “buckets.”

Or, I can look at this from a Total Return perspective; here, a 30/70 AA seems too conservative, especially since we seem to have the ability (if not the need) to bear more risk. Am I guilty of myopic loss aversion (MLA)? Could we not simply sally forth with a 60/40 AA and 3.25% WR, and suffer through any poor market period, while confident that eventual returns would more than make up for the shortfall?

I am leaning towards splitting the difference: dedicating enough funds (~$600k) to provide a flooring of ~$90k/year, and leaving a larger RP, and live with a little more volatility. (This would give an effective AA at retirement of about 45/55.) Maybe use VPW for the RP?

Actionable questions:
-Do you see any flaws in my thinking?
-Hell, do you have any advice for me?
-Whatever split I eventually decide on, would it be prudent to ramp up my bond purchases over the next 2 years to make my AA at retirement match my eventual LMP/RP split?


Thanks!
PaulF

[David Jay]

I have been very influenced by the Bond Tent.

I am retiring in 2019 at age 62 and I have prepared by taking my AA down to 50/50 (I was 100% equities just 5 years ago). As I spend my short term bonds in the years between retirement and start of SS it appears that my AA will drift back up to around 65% stocks.

[edit] of course this also looks like 2 buckets: money to get to SS and a Risk Portfolio for long term needs and legacy.

[AlohaJoe]

Actionable questions:
-Do you see any flaws in my thinking?

I'm not totally clear on what question you are asking here. LMP, buckets, and rising equity glidepaths all have similarities but now they are not exactly the same. In particular, they all have different characteristics during the withdrawal phase. Buckets refill. LMP doesn't. Buckets & LMP don't care about your asset allocation -- there's no rebalancing -- so you could end up at 90% bonds and 10% equity....or vice versa. Glidepaths rebalance to a fixed asset allocation (even if that fixed asset allocation changes every year or five years or whatever the glidepath is doing).

All of the those differences add up to the different outcomes and different results in various scenarios.

-Hell, do you have any advice for me?

Since you have more than enough money, anything you do will work, so it doesn't matter. Just pick something and do that.

-Whatever split I eventually decide on, would it be prudent to ramp up my bond purchases over the next 2 years to make my AA at retirement match my eventual LMP/RP split?

I guess? Sure? That'll work. I don't really understand what alternative you're considering? Buy all at once the day you retire? Buy all at once on the day you submit your resignation notice? Again, since you have so much money, any option will work out fine in the end. But most people would probably experience a lot of regret if markets crashed 3 months before their planned retirement and they hadn't already finished setting up their LMP/buckets/AA/whatever.

[The Wizard]

I'm not a big fan of TIPS.
I retired at 63, so only half the time to age 70, seven years instead of the 15 for the OP.

I had/have several thousand dollars per month income from annuities rather than pension and also withdraw $3000 per month in lieu of SS from my remaining portfolio, in the 3-4% SWR range. I actually changed part of that $3000 to be a Roth conversion a while back, so my real withdrawal rate is even less.
My withdrawals have been "pro rata" across my portfolio, leaving my AA unchanged.

I kept my portfolio AA at 50% stocks the first few years of retirement but am letting it drift upward to 60% stocks nowadays with just 18 months to go until age 70.

I had a Plan B of claiming SS earlier than age 70 in the event of a major stock market crash but it looks like that won't be needed.
OP has seven years of retirement prior to age 62, so will need a different Plan B for that timeframe...

[TomatoTomahto]

We are doing a LMP/RP kind of thing. DW is still working, and excess goes to RP.

The best part of this strategy is that I don’t have to think about AA. Our funds will be “sufficient.”

[grayfox]

Dear Bogleheads,

I am a long-time reader (back to M* days), but post infrequently.

Thanks to you all, and some good fortune, I am approaching an early retirement in a couple of years at age ~57. I am trying to position myself for a secure future, and wanted to bounce some thoughts off of you. I am contemplating transitioning my viewpoint to a LMP/RP (liability matching portfolio/risk portfolio) outlook.

The short story: I am 55, my wife is 53, no kids. Current assets are ~$1.6M in a very Bogleheadish portfolio. A key factor is that we both will have nice pensions to provide much of the income stream needed in retirement. (We also have health insurance covered, and our house will be paid off well before retirement.)

I am targeting ~$110k in annual spending (which is more than we spend now, ~$90k). Our pensions will be ~$58k, and roughly COLA’ed. Therefore, for the period between retirement and SS (hopefully at 70), I estimate we will need to draw about $52k from our portfolio, which is a WR of ~3.25%. After starting SS, pension+SS should more than meet our needs. So it seems to me that just about any withdrawal tactic I use will work. (Yes, we are fortunate.)

...

Floor + Upside

Determine a floor, i.e. the minimum amount of income you need to survive. This is bare bones: roof over head (rent or PITI, utilities), food (at home), transportation (public, if available, or cheap car), medical (insurance + out of pocket), no travel, vacations, toys or other activities. For the sake of argument, let's say that is $80,000 per year. (if you are currently spending $90,000 per year, surely $10,000 of that is above the survival floor.)

You already have $58,000 in guaranteed income (pensions). That only means you need to cover an additional $22,000 per year with guaranteed income, like TIPS ladder or annuity. A 30-year TIPS ladder paying $22,000 per year costs about $600,000. A 15-year ladder is somewhere around $400,000. That should leave well over $1M left over for RP.

The main idea is that you don't have to cover all your spending (floor + aspirational) with guaranteed income sources, only the survival floor. Aspirational spending would be covered by RP.

You can also adjust your lifestyle to reduce the floor, e.g. move from HCOL area to LCOL, and downsize. I would try to lower my floor to below $58,000 so that it's completely covered by pensions. Then the entire $1.6 million would be for aspirational spending / upside.

[Dottie57]

Asset allocation 50/50. Accumulating CDs this year for next 8 years of barebone expenses. Extras will come from retirement accounts. SS will provide most of my needs at 70.

[Svensk Anga]

The Bill Bernstein formulation of the LMP does cover only basic needs as per Grayfox's post. See Bernstein's pamphlet, "Ages of the Investor". That said, I decided that our retirement would be disappointing if we could not cover all anticipated spending, so I sized my LMP for everything. We do live somewhat frugally, so there is not a lot of difference between basics and everything. Bernstein thinks that half of your equity dividends can count as safe money for covering basic needs. Since you appear to be very well funded, you could still have substantial equities throwing off a useful amount of dividends. This would shrink the pile of TIPS you need.

Bernstein also suggests moving quickly to fund your LMP should a bull market swell your portfolio ahead of your retirement date. I think the last nine years have done that, so you should seriously consider moving quickly toward the LMP, however large you decide to make it. Since you are already 40% bonds, that might mean just exchanging funds for a TIPS ladder now and adding a few more rungs over the next two years.

It appears that you could fund a LMP and still be 65/35:
$110,000 desired spending, less
$58,000 pension, less
$9,400 dividend, leaves
$42,600 to be funded for 13 years until SS.

$42,600 x 13 = $553,800 LMP
$1.6 MM -$0.554 MM = $1.046 MM potentially in stocks.
@ 1.80% total stock market dividend yield = $18,800/year dividends (or more with some international allocation)
x only half of dividends to be relied upon = $9,400/year.

The RP need not be 100% equities of course. Do whatever you are comfortable with. I hold a lump sum against unforseen expenses, medical emergencies and/or long term care. Bear in mind that absent a severe recession, you will have the other half of the dividend stream typically available.

All the safe withdrawal rate research assumes that the future looks like the past in terms of returns and inflation and their covariance. It need not necessarily be so. We have the tools now to bypass the inflation risk, though it is arguably expensive. You have the means to secure your retirement and apparently no bequest motive, so it looks prudent to me for you to lock it in rather than subject yourselves to market risk.

[Tub84]

With your solid pensions and sizable nestegg, you appear to be an ideal candidate for the Variable Percentage Withdrawal (VPW) [and especially the VPW-Advanced].

VPW should work nicely with your LMP/RP desires as well.

VPW-Advanced: viewtopic.php?t=250391

[PaulF]

I'm not totally clear on what question you are asking here. LMP, buckets, and rising equity glidepaths all have similarities but now they are not exactly the same.

Well, you have indeed exposed at least one flaw in my thinking. I thought I understood what a bucket strategy was, and it appears I did not fully get it!

I guess? Sure? That'll work. I don't really understand what alternative you're considering? Buy all at once the day you retire? Buy all at once on the day you submit your resignation notice? Again, since you have so much money, any option will work out fine in the end. But most people would probably experience a lot of regret if markets crashed 3 months before their planned retirement and they hadn't already finished setting up their LMP/buckets/AA/whatever.

Yup, that was the alternative, and yup, you have identified my fear.

Thank you.

[PaulF]

To some of the others:

David Jay: thanks for your story. Bond tent does seem compelling to me, too, if you can afford not to take the risk (as I am fortunate enough to forgo).

Wizard, thanks for the thoughts. In particular, I hadn't thought of your Plan B. As you say, it does not help me for 5 years or so, but it had never occurred to me.

Grayfox: (I have an Excel file on my computer titled "Grayfox's actual spending." Thanks for sharing your pattern a while ago!)
Yes, you are right. LMP doesn't have to cover anything beyond the basics. I will take a harder look at basics vs. aspirational, and see if that makes me feel more comfortable to NOT be tying up so much in flooring (i.e., TIPS, for example).

Svensk, thanks for crunching those numbers. Hadn't thought about the dividend angle. I guess that sort of sets a truly minimum SWR? I will reread Bernstein et alii on this.

Tub84: I was blissfully ignorant of VPW Advanced (only knew of VPW). Obviously, I will look into this. But, yes, my thinking had been to just VPW it as a best practice. What changed was that I can see the precipice of human capital going to zero (by choice) from where I stand! Clearly, that has made me feel more nervous!

On that subject, note to all: It does feel odd. Yes, the numbers all say that I will be fine no matter what tactics I use. But, boy, it still makes me feel uncertain to chart this course (of not making money). I assume lots of us can relate to this feeling, right? I realize that there is nothing stopping me from going back to work in a few years if I want or need, but it does feel like a leap into the void! Thanks for listening and thanks everyone for the advice.

[FIREchief]

We are doing a LMP/RP kind of thing. DW is still working, and excess goes to RP.

The best part of this strategy is that I don’t have to think about AA. Our funds will be “sufficient.”

+1 With an LMP / RP strategy, I don't care what stocks are doing and I never have to rebalance or debate my AA. Both will reflect whatever the market gives us.

[Meg77]

I don't have anything substantial to add, but I just want to say thanks for this discussion. My mother turned her portfolio over to me this year upon retiring, and I'm struggling to sort out exactly how to manage her AA and withdrawals. It's one thing to debate theory, but quite another when forced to pick a theory and put it into practice.

[alec]

I don't have anything substantial to add, but I just want to say thanks for this discussion. My mother turned her portfolio over to me this year upon retiring, and I'm struggling to sort out exactly how to manage her AA and withdrawals. It's one thing to debate theory, but quite another when forced to pick a theory and put it into practice.

That’s why I’d go with the “do no harm first” method, which is usually the strategy that bobcat2 advocates.

[Peter G]

I see plenty of merit in your ideas.
Your 'TIPS ladder' should be a non-rolling ladder I think, which if I understand it means that you know exactly how much it will provide you and that it will address cost of living changes. Deflation reduces redemption values of TIPS, perhaps only as far as their issued face value (I don't know). But I'd be making sure I understood all that before building my own non-rolling TIPS ladder, because nominal bonds do well in a deflationary environment; not that I'm suggesting the latter is a better choice.

[PaulF]

I see plenty of merit in your ideas.
Your 'TIPS ladder' should be a non-rolling ladder I think, which if I understand it means that you know exactly how much it will provide you and that it will address cost of living changes. Deflation reduces redemption values of TIPS, perhaps only as far as their issued face value (I don't know). But I'd be making sure I understood all that before building my own non-rolling TIPS ladder, because nominal bonds do well in a deflationary environment; not that I'm suggesting the latter is a better choice.

All I can say is thank goodness for #Cruncher's TIPS spreadsheet! http://eyebonds.info/downloads/pages/TIPSLadder.html I wish there were a way to give him more props for this.

[cody69]

Congratulation Paul on attaining such a positive position.

I am also planning the "next step" and have been contemplating similar issues... LMP/RP vs total return portfolio.
- In my case, funding the LMP 100% felt overly expensive, as it would consume a significant portion of savings.
- my concern with the total return portfolio is committing to a fixed asset allocation, say 50/50. During a major market down-turn, I'm not sure I could be committed to re-balancing from bonds to stocks.

I'm reading Living Off Your Money, by Michael McClung, and find it extremely insightful to thinking through options. The section on income harvesting strategies provides great detail on the subject. Eg., the favored Prime Harvesting strategy has bond allocation based on a percentage of the total portfolio, withdrawals are always funded by bonds, bonds are replenished from stock only when market is up (which is determined by a comprehensive metric). For me, this helped to integrate the "bucket strategy" ala JB Quinn, Jim Otar... with Bernstein's LMP... with Bengen's traditional reblancing approach.

You can read this in a preview of the book that contains the first three chapters -- subject is covered in chapter 3 http://livingoffyourmoney.com/

[grok87]

some discussion here as to how to combine social security, pensions/tips-ladder, and a risk portfolio in a 3-legged stool approach...
viewtopic.php?f=10&t=245377
cheers,
grok