Clarification of Asset Allocation in Retirement

[TheLastHylian]

Hi everyone

Please excuse my ignorance as i'm a fairly new investor (based in Australia) but I would love to get some clarification. I have read the wiki pages on the forum but can't seem to find a specific answer, hence my post here.

In some interviews with Mr Bogle I have noticed his comments regarding shifting asset allocation over the years to favour bonds to a greater extent the closer you get to retirement.

Is this because once retired; the predominant form of income will be from the interest/coupon of the bond?
(Due to decreased risk and more stable nature of the payout relative to stocks)

And if this is indeed the case, why would we need to have some equity remaining in stocks? Would we not get more benefit by having all of our investments in bonds to maximize our interest/coupons received?

[sailaway]

Bonds are used as ballast. They are unlikely to drop the 30-40% stocks do every decade or two.

Stocks are used for long term growth. They are more likely to keep up with, and even beat, inflation.

Your income can come from any combination of interest, distributions and selling off assets, although I am completely unfamiliar with your country's income tax rules as to why any particular strategy might be best.

[HMSVictory]

Vanguard advises using a total return approach to retirement income and not just the yield and or coupon.

Stocks have the best chances of beating inflation over long periods of time due to higher expected returns. Bonds are less volatile.

You need some allocation to stocks to maintain purchasing power in your retirement (which could last 30-40 years).

The lowest allocation to stocks I would suggest is 30% of the portfolio. I prefer to hold as little bonds as possible. YMMV.

[sycamore]

Please excuse my ignorance as i'm a fairly new investor (based in Australia) but I would love to get some clarification. I have read the wiki pages on the forum but can't seem to find a specific answer, hence my post here.

In some interviews with Mr Bogle I have noticed his comments regarding shifting asset allocation over the years to favour bonds to a greater extent the closer you get to retirement.

Is this because once retired; the predominant form of income will be from the interest/coupon of the bond?
(Due to decreased risk and more stable nature of the payout relative to stocks)

Welcome to the forum, TheLastHylian.

I can't speak to why Mr Bogle said what he said but I suspect it's related to a number of factors:
- the higher price volatility of stocks means you risk having to withdraw when stocks are down, thereby depleting your portfolio faster

- many investors have a preference for reduced volatility during retirement: after years of working hard and accumulating assets, they don't want to see their portfolio lose value during a crash

- some investors are susceptible to panic selling when they see stocks crash - better for such investors to have less in stocks to begin with.

And if this is indeed the case, why would we need to have some equity remaining in stocks? Would we not get more benefit by having all of our investments in bonds to maximize our interest/coupons received?

As noted by HMSVictory and sailaway, there's the question of inflation. There's no guarantee that stocks will keep up with inflation but the hope is that companies can raise prices and at least keep profits (and share prices) roughly in line with inflation.

Many bonds are nominal bonds -- the payout is not adjusted for inflation. I don't know if Australia issues something like US TIPS (Treasury Inflation Protection Securities) or UK inflation linked gilts. If they do, that kind of bond might be a better choice if you're worried about nominal bonds income keeping up with inflation.

Another thing to consider is that "most benefit" is partly matter of goals and personal preference. For example, people who invest not just for retirement but also (eventually) to pass on the assets to family or a charity. Over longer periods of time, there's a greater chance of stocks outperforming bonds, so for these investors "most benefit" can be achieved with some allocation to stocks.

If your only goal is to cover retirement spending needs with certain/less volatile assets, "most benefit" could very well mean owning only bonds.

In general, choosing a stock/bond allocation can be complicated; there's more to it than just "decrease stock allocation as you age." It's probably not the worst idea but there are better ways to think about it. In particular, I like the Bogleheads wiki article on Ability, willingness, and need to take risk.

[dbr]

Hi everyone

Please excuse my ignorance as i'm a fairly new investor (based in Australia) but I would love to get some clarification. I have read the wiki pages on the forum but can't seem to find a specific answer, hence my post here.

In some interviews with Mr Bogle I have noticed his comments regarding shifting asset allocation over the years to favour bonds to a greater extent the closer you get to retirement.

Is this because once retired; the predominant form of income will be from the interest/coupon of the bond?
(Due to decreased risk and more stable nature of the payout relative to stocks)

And if this is indeed the case, why would we need to have some equity remaining in stocks? Would we not get more benefit by having all of our investments in bonds to maximize our interest/coupons received?

You might want to peruse some of the withdrawal studies done over the years to look at the survivability of portfolios when supporting income. The landmark study would be Trinity https://en.wikipedia.org/wiki/Trinity_study The same methodology is embedded in planning tools such as www.firecalc.com and this one: https://engaging-data.com/visualizing-4-rule/

The gist of the results is that security of your withdrawal portolio depends strongly first of all on what year you retire, the effect of which is not known in advance, secondly on how much you withdraw, and lastly not much at all on your asset allocation unless you make the fatal mistake of not having any stocks. You can resurrect yourself from that death by limiting your withdrawal rate and then the effect of being all bonds is that your wealth at death will be the most predictable but also the least of all choices.

I find that the only approach to deciding an asset allocation that is meaningfully thoughtful is the need, ability, and willingness concept that Larry Swedroe writes about.

Is a reasonable assessment of fact that older investors tend to choose more conservative asset allocations up to a point, but I think enshrining that in actual advice to set bond allocation at years in age is simplistic and might not reflect what a person really wants to do with their money. I think in general it is a mistake to concentrate too much in only one set of risks. Your country's retirement structure is not quite the same as the US, but in general you would look ahead to a variety of resources such as social support, pensions, owning a home perhaps, and a not extreme mix of stocks and bonds.

[TheLastHylian]

Blimey, thank you so much for all the detailed answers! I truly appreciate it

I see, that makes much more sense now. I will absolutely look at the articles and websites you have provided therein to consolidate my knowledge.

[1moreyr]

Please read up on Sequence of returns risk (SORR). This is the item that I see cash/bonds really help, I just retired this year and if I wasn't prepared for this drop (just because i know my own luck to retire into a mess like this) I would be selling stocks to make ends meet in the worst time.

this supports the need for the ballast of bonds

[dbr]

Please read up on Sequence of returns risk (SORR). This is the item that I see cash/bonds really help, I just retired this year and if I wasn't prepared for this drop (just because i know my own luck to retire into a mess like this) I would be selling stocks to make ends meet in the worst time.

this supports the need for the ballast of bonds

The data analysis on the relationship between SORR and asset allocation is that there is a slight maximum in safe withdrawal rate around 60/40 for 30 year retirements and maybe a little more than that in stocks for longer retirements. Reducing volatility too much actually sabotages a retirement because loss of sufficient return that goes along with that overwhelms the reduction of volatility problems. 100% stock allocations are not hugely less sustaining of withdrawals than more conservative asset allocations but portfolios 100% in bonds do fall off the cliff of decent withdrawal rates.

The surest defense against sequence of return risk and also of retiring into a secular period of low returns is to reduce the withdrawal rate. Historically below maybe 3% the sustainability of a 30 year retirement has no dependence on asset allocation except maybe in the worst case of no stocks. In perspective, however, is that historically retirements have sustained more than 4% withdrawal rates in almost all cases and as low as only 4% in very few cases with only high bond portfolios doing badly.

In any case the volatility of portfolios requires as a nature of the beast that one takes withdrawals both from portfolios that are at dips and from portfolios that are at peaks. This has nothing to do as such with selling stocks at a bad time, something could happen from time to time but doesn't usually because one would be rebalancing into stocks. In any case the math applies to the portfolio as an entirety and not to the behavior of the different components in isolation.

For some time people have advanced different spending rules that adjust withdrawals to meet portfolio excursions as those operate the lever that has an actual effect, namely the amount of withdrawal.

[Beehave]

Here's a link to a brief video in which John Bogle explains his ideas for increasing the bond allocation relative to stocks as one ages. Hope it is helpful.

https://www.youtube.com/watch?v=BAqlll-vMjQ

Note that he advises considering pension or government retirement pay (or annuity) income in retirement as part of the bond allocation.

Best wishes.

[1moreyr]

Please read up on Sequence of returns risk (SORR). This is the item that I see cash/bonds really help, I just retired this year and if I wasn't prepared for this drop (just because i know my own luck to retire into a mess like this) I would be selling stocks to make ends meet in the worst time.

this supports the need for the ballast of bonds

The data analysis on the relationship between SORR and asset allocation is that there is a slight maximum in safe withdrawal rate around 60/40 for 30 year retirements and maybe a little more than that in stocks for longer retirements. Reducing volatility too much actually sabotages a retirement because loss of sufficient return that goes along with that overwhelms the reduction of volatility problems. 100% stock allocations are not hugely less sustaining of withdrawals than more conservative asset allocations but portfolios 100% in bonds do fall off the cliff of decent withdrawal rates.

The surest defense against sequence of return risk and also of retiring into a secular period of low returns is to reduce the withdrawal rate. Historically below maybe 3% the sustainability of a 30 year retirement has no dependence on asset allocation except maybe in the worst case of no stocks. In perspective, however, is that historically retirements have sustained more than 4% withdrawal rates in almost all cases and as low as only 4% in very few cases with only high bond portfolios doing badly.

In any case the volatility of portfolios requires as a nature of the beast that one takes withdrawals both from portfolios that are at dips and from portfolios that are at peaks. This has nothing to do as such with selling stocks at a bad time, something could happen from time to time but doesn't usually because one would be rebalancing into stocks. In any case the math applies to the portfolio as an entirety and not to the behavior of the different components in isolation.

For some time people have advanced different spending rules that adjust withdrawals to meet portfolio excursions as those operate the lever that has an actual effect, namely the amount of withdrawal.

Thanks DBR, to be clear, i was not advocating 100% bonds. I was trying to say having stable money or money that falls less than stocks holds up better and allows you to not be selling multiply more shares of stocks in a down market and diminishing the number of shares in return. I do look at allocations but in retirement, i am more looking in years of coverage. Do i have enough to weather this and give my stocks a chance to rebound?
my current target for WR is 2.75% and i am so far holding to that. Assets and frugal living are both enough to make it comfortable and doing what I want. this in conjunction with 40% or less in bonds gives me solid coverage for the future.