Is this idea irrational?

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gabe1955
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Is this idea irrational?

Post by gabe1955 » Thu Feb 14, 2019 10:11 am

I am 62, retired, living on investments, a pension, and social security. My long term plan for solvency requires that I have an annual average return of no less than 5% over the next 30 years. My current AA is 60-40 stocks and bonds--all index fund ETF.s Already, this year, my return has been 7.5%. Tax considerations aside, would it be irrational, at this point, to liquidate my stocks and go t0 0-100 bonds, more or less locking in my 7.5% gain, and next year, on Jan 1, once again returning to a 60-40 AA? My gut tells me this is an irrational idea. But I am not sure why.

onourway
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Re: Is this idea irrational?

Post by onourway » Thu Feb 14, 2019 10:16 am

Others will surely mention this and you probably already know, but 5% long-term is an exceptionally aggressive number, especially from a 60/40 AA. You would be advised to adjust this - either by producing more income while you can or aggressively reducing expenses.

The reason your idea won't work is that you don't know what will happen in the future. If you 'lock' in your gains now, and the market then rises another 20% this year, you will have lost out on a huge proportion of that growth that you are depending on when forced to buy back in at prices 20% higher than your exit. If you have any chance of hitting your goal, it will be by staying as hands-off as possible from your investments and simply riding market up and down, only withdrawing exactly what you need.

Jimmie
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Re: Is this idea irrational?

Post by Jimmie » Thu Feb 14, 2019 10:17 am

How does this scenario work for you?

After you have locked in and sold all your stocks, the market keeps going up, up, up to a 20% gain this year. January 1st, you buy back in and the market tanks in 2020.

a) You lost potential gains
b) You bought high (and probably will need to sell low if you need the money)

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gabe1955
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Re: Is this idea irrational?

Post by gabe1955 » Thu Feb 14, 2019 10:21 am

Thank you, onourway. If you see 5% as an exceptionally aggressive forecasted return for a 60-40 portfolio, what do you believe is the expected long term average return of such a portfolio? The past is not a guide to the future, but Vanguard reports the long term return of 60-40 form 1926-2017 was 8.8%.

thanks in advance
Last edited by gabe1955 on Thu Feb 14, 2019 10:26 am, edited 1 time in total.

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NYCPete
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Re: Is this idea irrational?

Post by NYCPete » Thu Feb 14, 2019 10:25 am

The distribution of returns is not constant, and it doesn't stick to a calendar year schedule. Say you follow through and sell out and buy back in 60/40 January 1st 2020. What do you do if you're 7.5% down on February 14, 2020, instead of up? Sell out? If you're down 7.5% in February 2020 and your strategy would be to hold on, then ask yourself what's different about today? Why bother with the 60/40 allocation if you're going to market time based on returns.

Something tells me you need to ask yourself if your asset allocation is too aggressive for your comfort level.

Best,
Peter
To the extent that a fool knows his foolishness, | He may be deemed wise | A fool who considers himself wise | Is indeed a fool. | | Buddha

onourway
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Re: Is this idea irrational?

Post by onourway » Thu Feb 14, 2019 10:28 am

gabe1955 wrote:
Thu Feb 14, 2019 10:21 am
Thank you, onourway. If you see 5% as an exceptionally aggressive forecasted return for a 60-40 portfolio, what do you believe is the expected long term average return of such a portfolio? thanks in advance
I should clarify first whether we are talking Nominal or Real return? That is, before inflation is accounted for or after? 5% Nominal is reasonable. 5% real would not be.

It's generally easier to work in Real numbers because that allows us to assume that a dollar today is worth the same as a dollar in the future. It makes things much simpler to understand.

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SpringMan
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Re: Is this idea irrational?

Post by SpringMan » Thu Feb 14, 2019 10:32 am

Selling all stocks and going to 100% bonds may not be a good idea in a taxable account. It could put your income higher to the point of higher Medicare premiums kicking in (IRMAA). Being 62 likely you are not on Medicare yet. I still don't think it is a good idea to make such drastic changes in your asset allocation.
Best Wishes, SpringMan

dbr
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Re: Is this idea irrational?

Post by dbr » Thu Feb 14, 2019 10:33 am

So you left your front door unlocked and nobody walked in uninvited, but they might have. Now for a week you are going to lock your door secure that no one will walk in uninvited. Then you are going to start leaving your door unlocked again. So how exactly did locking your door for a week affect what is going to happen next?

IPS&IPA
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Re: Is this idea irrational?

Post by IPS&IPA » Thu Feb 14, 2019 10:35 am

Absolutely you should see about a 5% average return over the long haul.
The key is the 'long haul' and one way to screw it up is to market time.
Believe me, I know from personal experience that it will not work to lock in a gain and think you can beat the market.
The 'stay the course' path is easier in the accumulation phase than in the retirement phase.
Future years will determine what the average return will be so 5% might not happen.
If you can't live with that possibility then maybe find other options such as lowering expenses or supplement income if possible.
Elwood: It's 106 miles to Chicago, we got a full tank of gas, half a pack of cigarettes, it's dark... and we're wearing sunglasses. Jake: Hit it.

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cheese_breath
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Re: Is this idea irrational?

Post by cheese_breath » Thu Feb 14, 2019 10:36 am

In addition to what others have already said, 100% in bonds will not lock in your gains. Bonds can lose value too. I suppose if you wanted to 'lock in' your gains you could to go to FDIC insured savings or CDs, but you pay for this security in the form of lower interest rates.
The surest way to know the future is when it becomes the past.

RNJ
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Re: Is this idea irrational?

Post by RNJ » Thu Feb 14, 2019 10:38 am

Yes, it's irrational.

You might want to take a look at the video in this thread: viewtopic.php?f=10&t=272899&p=4380997#p4380997

Admiral
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Re: Is this idea irrational?

Post by Admiral » Thu Feb 14, 2019 10:39 am

gabe1955 wrote:
Thu Feb 14, 2019 10:11 am
I am 62, retired, living on investments, a pension, and social security. My long term plan for solvency requires that I have an annual average return of no less than 5% over the next 30 years. My current AA is 60-40 stocks and bonds--all index fund ETF.s Already, this year, my return has been 7.5%. Tax considerations aside, would it be irrational, at this point, to liquidate my stocks and go t0 0-100 bonds, more or less locking in my 7.5% gain, and next year, on Jan 1, once again returning to a 60-40 AA? My gut tells me this is an irrational idea. But I am not sure why.
This is the problem that needs your attention, not all this market timing which won't work anyway for all the reasons others have stated.

5% after inflation for expected 30 years with a 60-40 portfolio (what about taxes??) is a red flag. Have you used iORP or another online tool to model your portfolio, income streams, and expenses? That should be your first step.

cherijoh
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Re: Is this idea irrational?

Post by cherijoh » Thu Feb 14, 2019 10:43 am

gabe1955 wrote:
Thu Feb 14, 2019 10:21 am
Thank you, onourway. If you see 5% as an exceptionally aggressive forecasted return for a 60-40 portfolio, what do you believe is the expected long term average return of such a portfolio? thanks in advance
IMO 5% nominal return is doable.

The issue is the real inflation-adjusted return which is what you need for the long term survivability of your portfolio. I would assume 0% real return on the bond portion and 4-5% real return on the stock portion. (If we weren't at this point in the economic cycle, you could probably expect a better stock return). This gives you a 2.4 - 3% real return on the overall portfolio. In order to have a 5% real return on the entire portfolio you would need to have 8.33% real return on stocks with a 0% real return on bonds. Again that seems high for where we are in the business cycle.

The reason I am assuming 0% real return on the bonds is because we are still at historically low interest rates, so returning will not be juiced the same way they are in a falling-interest rate environment.

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HomerJ
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Re: Is this idea irrational?

Post by HomerJ » Thu Feb 14, 2019 10:43 am

gabe1955 wrote:
Thu Feb 14, 2019 10:11 am
I am 62, retired, living on investments, a pension, and social security. My long term plan for solvency requires that I have an annual average return of no less than 5% over the next 30 years. My current AA is 60-40 stocks and bonds--all index fund ETF.s Already, this year, my return has been 7.5%. Tax considerations aside, would it be irrational, at this point, to liquidate my stocks and go t0 0-100 bonds, more or less locking in my 7.5% gain, and next year, on Jan 1, once again returning to a 60-40 AA? My gut tells me this is an irrational idea. But I am not sure why.
The problem is that you get 5% average only by averaging over the entire time. The market goes up and down in weird cycles.

You lock in 7.5%, and miss another 10% rise, then next year the market drops 8%. Someone who "stayed the course" got close to their 5% average over the two years. You ended up down over the two years.

But of course, the opposite could happen, you stay in, the market drops 10% from here, and you lose all the gains we already got. But then maybe next year, it goes up 15%, and you're back to getting 5% average over the two years.

No one knows.

Bouncing in and out may make you more. But it also may make you less.

Staying the course in index funds will get you the market return. Of course, the market return might be poor or even negative for a while, but you'll get whatever it returns, guaranteed.

Selling and buying, you're more likely to do worse than the market return.
The J stands for Jay

livesoft
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Re: Is this idea irrational?

Post by livesoft » Thu Feb 14, 2019 10:46 am

gabe1955 wrote:
Thu Feb 14, 2019 10:11 am
I am 62, retired, living on investments, a pension, and social security. My long term plan for solvency requires that I have an annual average return of no less than 5% over the next 30 years. My current AA is 60-40 stocks and bonds--all index fund ETF.s Already, this year, my return has been 7.5%. Tax considerations aside, would it be irrational, at this point, to liquidate my stocks and go t0 0-100 bonds, more or less locking in my 7.5% gain, and next year, on Jan 1, once again returning to a 60-40 AA? My gut tells me this is an irrational idea. But I am not sure why.
No, it would not be rational. First, you have to consider that in 2018 your portfolio fell behind your required 5% return, so you have to play catch-up :twisted:

You might wish to watch the 4 videos on "Managing Expections" linked in this thread from 2016:
viewtopic.php?t=205911
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Topic Author
gabe1955
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Re: Is this idea irrational?

Post by gabe1955 » Thu Feb 14, 2019 10:59 am

Thanks everyone. I'm persuaded. I will just stay the course. And, yes, in assuming 5% average annual returns, I am using current dollars and taking inflation (estimated long term at 2.5%) and taxes into account. With those assumptions, a long-term planning tool gives me 98% certainty of meeting my objectives.

Valuethinker
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Re: Is this idea irrational?

Post by Valuethinker » Thu Feb 14, 2019 11:00 am

gabe1955 wrote:
Thu Feb 14, 2019 10:11 am
I am 62, retired, living on investments, a pension, and social security. My long term plan for solvency requires that I have an annual average return of no less than 5% over the next 30 years. My current AA is 60-40 stocks and bonds--all index fund ETF.s Already, this year, my return has been 7.5%. Tax considerations aside, would it be irrational, at this point, to liquidate my stocks and go t0 0-100 bonds, more or less locking in my 7.5% gain, and next year, on Jan 1, once again returning to a 60-40 AA? My gut tells me this is an irrational idea. But I am not sure why.
Individual year returns have a huge dispersion.

Some years minus, some years double digit plus.

So you can only "lock in" with money that you know will only give you 2-3% (US Treasury bonds) that you do not need a higher return.

If you rebalance regularly (ie more than once a year) you "lock in" gains in any case when you sell equities and buy bonds (although if it's a bear market, going down, you are buying into that, too).

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tadamsmar
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Re: Is this idea irrational?

Post by tadamsmar » Thu Feb 14, 2019 11:14 am

gabe1955 wrote:
Thu Feb 14, 2019 10:59 am
Thanks everyone. I'm persuaded. I will just stay the course. And, yes, in assuming 5% average annual returns, I am using current dollars and taking inflation (estimated long term at 2.5%) and taxes into account. With those assumptions, a long-term planning tool gives me 98% certainty of meeting my objectives.
I find this confusing. 5% is a fixed value. If your spending rate estimate is, I assume, a fixed value. No randomness in that. So how are you coming up with 98%?

You are assuming something has a probability distribution. But you return figure is fixed, so what's the probability distribution? Your lifespan or something?

MotoTrojan
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Re: Is this idea irrational?

Post by MotoTrojan » Thu Feb 14, 2019 11:15 am

gabe1955 wrote:
Thu Feb 14, 2019 10:59 am
Thanks everyone. I'm persuaded. I will just stay the course. And, yes, in assuming 5% average annual returns, I am using current dollars and taking inflation (estimated long term at 2.5%) and taxes into account. With those assumptions, a long-term planning tool gives me 98% certainty of meeting my objectives.
What % pretax are you withdrawing annually?

Topic Author
gabe1955
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Re: Is this idea irrational?

Post by gabe1955 » Thu Feb 14, 2019 11:19 am

I am withdrawing 2.5% annually.

Admiral
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Re: Is this idea irrational?

Post by Admiral » Thu Feb 14, 2019 12:00 pm

gabe1955 wrote:
Thu Feb 14, 2019 11:19 am
I am withdrawing 2.5% annually.
Ah. There's the rub.

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Ben Mathew
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Re: Is this idea irrational?

Post by Ben Mathew » Thu Feb 14, 2019 12:48 pm

Sounds like you need 5% nominal, so about 3% real. That should be do-able with a 60/40 portfolio, if you think you can tolerate the volatility as you age.

But to answer your original question, locking in gains for a particular year is irrational. For one, if that made sense, why not lock in gains for the month, or the week? When you lock in gains for the year and exit the market, your money is not earning the expected return during the time you're out. Maximizing the time you're in the market gives you the highest return for the lowest risk. If you stay out of the market for some time, you will have to increase your stock allocation when you're in the market to compensate for it and get the same expected return. That means more risk, because you're missing out on time diversification. Returns across time are almost uncorrelated. For a given expected return, you minimize risk by spreading it out as much as possible over time. 50% stock over 12 months is lower risk than 100% stock in the first 6 months followed by 0% in next six.

ExitStageLeft
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Re: Is this idea irrational?

Post by ExitStageLeft » Thu Feb 14, 2019 1:14 pm

https://www.bogleheads.org/blog/boglehe ... he-course/

It's definitely time to develop or review the Investment Policy Statement. One that anticipates you asking yourself a similar question in the future and tells yourself what your rational, long-term plan is.

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Sandtrap
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Re: Is this idea irrational?

Post by Sandtrap » Thu Feb 14, 2019 1:20 pm

gabe1955 wrote:
Thu Feb 14, 2019 10:11 am
I am 62, retired, living on investments, a pension, and social security. My long term plan for solvency requires that I have an annual average return of no less than 5% over the next 30 years. My current AA is 60-40 stocks and bonds--all index fund ETF.s Already, this year, my return has been 7.5%. Tax considerations aside, would it be irrational, at this point, to liquidate my stocks and go t0 0-100 bonds, more or less locking in my 7.5% gain, and next year, on Jan 1, once again returning to a 60-40 AA? My gut tells me this is an irrational idea. But I am not sure why.
Your gut is correct.
Hesitant about that 5% figure.
How did you arrive at it?

Flipping around your allocation with the "anticipation" of returns is not sound.

Try some of these projection tools and see how your figures work out.
ONLINE FINANCIAL TOOLS
PORFOLIO VISUALIZERS, PROJECTIONS, AND ANALYSIS
https://www.portfoliovisualizer.com
Firecalc. Retirement. How long will your money last?
https://www.firecalc.com
Morningstar Instant Xray
http://www.morningstar.com/portfolio.ht ... Entry.aspx
Optimal Retirement Planner (I-ORP)
https://www.i-orp.com/paper/index.html
http://www.calculator.net/investment-calculator.html
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