How steep should the glide path be?

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FlyingMoose
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How steep should the glide path be?

Post by FlyingMoose » Mon Feb 06, 2017 7:09 pm

We're all familiar with the retirement glide path, but I want to look deeper into the reasoning behind it.

The ultimate reason for it seems to be to reduce sequence-of-returns risk at the beginning of retirement.

So then the question is, how far back from retirement should we go in order to reduce this risk?

For example, say we start with 100% stocks, and for the last 5 years before retirement, we reduce them 10% a year, so that we end up with 50/50 at time of retirement. This spreads the risk out over 5 years.

Or maybe we want to spread it out more, because sometimes the market has been down for 3-5 years at a time. So we reduce it 5% a year for 10 years.

One thing to keep in mind is that if the stock market is down substantially in a given year, we still may be buying stocks even though the allocation decreased, because the percentage of stock decreased even more by itself.

The other side of the argument is that if we start too soon, we're compromising our returns.

I don't understand the logic behind Vanguard's target retirement (and similar funds) that start many many years ahead and use a shallow glide path, and then steepen it near the end. Does this really help reduce the risk, and is it worth the loss of return?

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David Jay
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Re: How steep should the glide path be?

Post by David Jay » Mon Feb 06, 2017 7:22 pm

There is also a behavioral aspect - people get worried about their retirement. I think a fair amount of the TR glidepath is related to that.

I was 100% stocks into my mid-50s and I am planning to retire at age 62 (retirement AA: 60/40)
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Re: How steep should the glide path be?

Post by AlohaJoe » Mon Feb 06, 2017 7:26 pm

FlyingMoose wrote:The ultimate reason for it seems to be to reduce sequence-of-returns risk at the beginning of retirement.
This is basically totally wrong :)

It is based on the life cycle theory of consumption and investing from Zvi Bodie, Robert Merton, and Paul Samuelson and is about your declining human capital. It doesn't really have anything at all to do with sequence of returns.

Random Walker
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Re: How steep should the glide path be?

Post by Random Walker » Mon Feb 06, 2017 7:37 pm

How about personalizing the glide path? We can't control market returns, but we can react to our portfolio's past returns and future expected returns. Maybe after 7 or 8 better than expected years of returns take more off the table than a simple X% per year formula would dictate? As personal circumstances and market conditions change, ability, willingness, need change also and periodic changes to AA may well be reasonable. A fixed glide path is a good starting point, but it should be adaptable too.

Dave

cherijoh
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Re: How steep should the glide path be?

Post by cherijoh » Mon Feb 06, 2017 7:39 pm

FlyingMoose wrote:We're all familiar with the retirement glide path, but I want to look deeper into the reasoning behind it.

The ultimate reason for it seems to be to reduce sequence-of-returns risk at the beginning of retirement.

So then the question is, how far back from retirement should we go in order to reduce this risk?

For example, say we start with 100% stocks, and for the last 5 years before retirement, we reduce them 10% a year, so that we end up with 50/50 at time of retirement. This spreads the risk out over 5 years.

Or maybe we want to spread it out more, because sometimes the market has been down for 3-5 years at a time. So we reduce it 5% a year for 10 years.

One thing to keep in mind is that if the stock market is down substantially in a given year, we still may be buying stocks even though the allocation decreased, because the percentage of stock decreased even more by itself.

The other side of the argument is that if we start too soon, we're compromising our returns.

I don't understand the logic behind Vanguard's target retirement (and similar funds) that start many many years ahead and use a shallow glide path, and then steepen it near the end. Does this really help reduce the risk, and is it worth the loss of return?

I think part of the assumption is that when you first start investing, a drop in the stock market is simply an opportunity to buy more shares cheaply. In dollar terms, you haven't lost that much relative to any new contributions at the lower share price. Your account doesn't need to recover that much to pull ahead.

However, as your investing career progresses, your annual contribution gets dwarfed relative to your total account value. So most investors want to have less volatility. Hence the higher % in bonds. In addition they have less time to make it up if there is a 2008-09 like pullback in stocks.

For a point of reference, I can often see weekly changes in my aggregated retirement account balance that exceeds my annual contribution to my 401k. And I'm at a 60/40 stock to bond ratio. (When volatility is high it could be a daily change that big). No way would I want to play "Russian Roulette" by keeping a high percentage of stocks until the last minute.
Last edited by cherijoh on Mon Feb 06, 2017 7:43 pm, edited 1 time in total.

The Wizard
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Re: How steep should the glide path be?

Post by The Wizard » Mon Feb 06, 2017 7:43 pm

AlohaJoe wrote:
FlyingMoose wrote:The ultimate reason for it seems to be to reduce sequence-of-returns risk at the beginning of retirement.
This is basically totally wrong :)

It is based on the life cycle theory of consumption and investing from Zvi Bodie, Robert Merton, and Paul Samuelson and is about your declining human capital. It doesn't really have anything at all to do with sequence of returns.
Joe is right.
Sequence of returns after retiring is a separate issue, though your percentage of stocks definitely affects it...
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Re: How steep should the glide path be?

Post by pkcrafter » Mon Feb 06, 2017 11:00 pm

The Wizard wrote:
AlohaJoe wrote:
FlyingMoose wrote:The ultimate reason for it seems to be to reduce sequence-of-returns risk at the beginning of retirement.
This is basically totally wrong :)

It is based on the life cycle theory of consumption and investing from Zvi Bodie, Robert Merton, and Paul Samuelson and is about your declining human capital. It doesn't really have anything at all to do with sequence of returns.
Joe is right.
Sequence of returns after retiring is a separate issue, though your percentage of stocks definitely affects it...
Why is it a separate issue? A bad sequence of events can throw off any retirement plan, whether it's life-cycle investing or any other strategy.

FlyingMoose, I think it's prudent to cut back on equity risk at 10 years from retirement. Of course, like every decision, it does depend on the risk exposure you have, the need and ability to take risk, etc. But if you are coming in hot, say 80% equity or higher, it's just prudent to cut back. I don't think a gradual decline in equity allocation is necessary because if you allow 10 years you have time to recover most losses. Instead of a long slide, I think of it as an abrupt step down in AA, and maybe two steps depending on personal situation. Bottom line is we do not want to get derailed by an unforeseeable calamity in our retirement savings.

Paul
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Re: How steep should the glide path be?

Post by KlangFool » Mon Feb 06, 2017 11:08 pm

OP,

1) It is wrong to go with 100/0 at any time. The right number is between 75/25 and 25/75.

2) Your glide path should be based on your portfolio size:

A) As a multiple of your annual expense -> Aka, how close you are to retirement.

B) As a multiple of your annual savings -> Do you have time to recover your losses if the stock market drop by 50%? If your portfolio size is 20 times your annual savings and you probably could work for another 5 years, then you could not lose more than 5 years. Your AA should be 50/50.

KlangFool

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Re: How steep should the glide path be?

Post by dbr » Mon Feb 06, 2017 11:26 pm

pkcrafter wrote:
The Wizard wrote: Joe is right.
Sequence of returns after retiring is a separate issue, though your percentage of stocks definitely affects it...
Why is it a separate issue? A bad sequence of events can throw off any retirement plan, whether it's life-cycle investing or any other strategy.
A bad sequence of returns throws the outcome to the downside of possible scenarios. That we would agree with. That a bad sequence of returns can be neutralized or mitigated by steering as far as possible to bonds is a possible but unproven hypothesis that would have to be supported before we presume it would work. Remember that steering excessively to bonds is in and of itself a self inflicted bad sequence of returns. I think that in many historical cases bad sequence of returns really means poor returns for an extended period rather than a market crash. That is one of the reasons a more subtle idea is proposed by some people, namely cutting stocks just before and just after retirement and then taking a reverse glidepath to more stocks. I think this issue is trickier than presumed. Or ... in general I think messing with asset allocation may have less to do with the outcome than people might presume.

dos palomas
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Re: How steep should the glide path be?

Post by dos palomas » Mon Feb 06, 2017 11:31 pm

KlangFool wrote:It is wrong to go with 100/0 at any time. The right number is between 75/25 and 25/75.
...for you.

I have arrived at a portfolio at 100% equities. Young physician, can work for 20-30 years if desired, good disability insurance, income exceeds expenses by several multiples. Will increase bonds when I am winding down career, but don't see the point at this time.

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Re: How steep should the glide path be?

Post by pkcrafter » Mon Feb 06, 2017 11:49 pm

dbr wrote:
pkcrafter wrote:
The Wizard wrote: Joe is right.
Sequence of returns after retiring is a separate issue, though your percentage of stocks definitely affects it...
Why is it a separate issue? A bad sequence of events can throw off any retirement plan, whether it's life-cycle investing or any other strategy.
A bad sequence of returns throws the outcome to the downside of possible scenarios. That we would agree with. That a bad sequence of returns can be neutralized or mitigated by steering as far as possible to bonds is a possible but unproven hypothesis that would have to be supported before we presume it would work. Remember that steering excessively to bonds is in and of itself a self inflicted bad sequence of returns. I think that in many historical cases bad sequence of returns really means poor returns for an extended period rather than a market crash. That is one of the reasons a more subtle idea is proposed by some people, namely cutting stocks just before and just after retirement and then taking a reverse glidepath to more stocks. I think this issue is trickier than presumed. Or ... in general I think messing with asset allocation may have less to do with the outcome than people might presume.
dbr, you are right, of course, and I tried to address some of those issues in my post a few replies back.

Paul
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Re: How steep should the glide path be?

Post by The Wizard » Tue Feb 07, 2017 3:44 am

The point about glide paths and sequence of returns is: during your accumulating years you FULLY EXPECT to have a few down market periods. Some people even pretend to enjoy those down periods since they are buying more shares of stock funds at bargain prices.
So when your Human Capital is flourishing, fluctuations in the stock market are not a bad thing. Your retirement date is not cast in stone typically and during latter working years, more new money is being saved/invested than ever before.

Once you retire, your Human Capital goes into hibernation and may be more or less difficult to resurrect later if the now important Sequence of Returns blows a hole in your finances...
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Re: How steep should the glide path be?

Post by AtlasShrugged? » Tue Feb 07, 2017 6:45 am

Flying Moose....To answer your question. I can only tell you my glide path. It is for you to ultimately decide what glide path works for you.

Currently, I am age 50 with an overall split of 83/17 [equity/bond]. The glide path I have chosen is to subtract roughly 2% from equities each year and move it to bonds for the next 12 years. The goal is to get to a 60/40 split by the time I am 62. The question in my mind is what to do between 62 and my FRA of 67...do I move to 50/50 to mitigate sequence of return risk, or leave the portfolio at 60/40? Fortunately, I have some time to figure that out.

The method I am doing the glide path is redirecting contributions over the course of each year. I only rebalance when the positive variance is >3% across my investment types. That happened two times in 2016. I check my investments weekly, and monitor the variance. Takes 10 minutes.

Hope this helps.
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Re: How steep should the glide path be?

Post by Dottie57 » Tue Feb 07, 2017 7:14 am

The Wizard wrote:The point about glide paths and sequence of returns is: during your accumulating years you FULLY EXPECT to have a few down market periods. Some people even pretend to enjoy those down periods since they are buying more shares of stock funds at bargain prices.
So when your Human Capital is flourishing, fluctuations in the stock market are not a bad thing. Your retirement date is not cast in stone typically and during latter working years, more new money is being saved/invested than ever before.

Once you retire, your Human Capital goes into hibernation and may be more or less difficult to resurrect later if the now important Sequence of Returns blows a hole in your finances...

This is me at a 50/50 split. When I was young I didn't care about losses. The ability to buy more for less was great.

Now I don't want to lose what I have accumulated. I am at 50/50 split. I know potential gains are reduced. So are losses. I am much happier at this allocation at this point in life. I am 5 years from retirement.

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Re: How steep should the glide path be?

Post by rkhusky » Tue Feb 07, 2017 8:06 am

FlyingMoose wrote: I don't understand the logic behind Vanguard's target retirement (and similar funds) that start many many years ahead and use a shallow glide path, and then steepen it near the end. Does this really help reduce the risk, and is it worth the loss of return?
Having more stocks does not guarantee higher return. Having less stocks does not guarantee a lower return. Based on past performance, there is the expectation that more stocks will result in higher return, but there is a non-zero probability that the return will be lower.

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Re: How steep should the glide path be?

Post by KlangFool » Tue Feb 07, 2017 8:53 am

dos palomas wrote:
KlangFool wrote:It is wrong to go with 100/0 at any time. The right number is between 75/25 and 25/75.
...for you.

I have arrived at a portfolio at 100% equities. Young physician, can work for 20-30 years if desired, good disability insurance, income exceeds expenses by several multiples. Will increase bonds when I am winding down career, but don't see the point at this time.
dos palomas,

How does 100/0 make any sense for you?

A) <<income exceeds expenses by several multiples. >>

If this is true, you will reach financial independence in less than 10 years. Why would you want to take extra risk? You could get there even with 60/10 in 40 years. In fact, you could get there with 0% real return. Why take the risk when you do not have to?

B) <<can work for 20-30 years if desired,>>

Which has nothing to do with you if (A) is correct? You do not need to work for 20 to 30 years. So, why do you base your AA on that assumption?

Your AA should be designed assuming that you can retire in 10 years. You can choose to work longer but it is not necessary. You will have that option in 10 years.

Whether you want to wind down your career in 10 years is an independent decision from your AA. Having an AA to allow you to retire in 10 years give you the option if you want to.

KlangFool
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Re: How steep should the glide path be?

Post by jhfenton » Tue Feb 07, 2017 9:00 am

KlangFool wrote:OP,

1) It is wrong to go with 100/0 at any time. The right number is between 75/25 and 25/75.
Um…we'll just have to disagree. I was happily 100% equities until age 45. I would have been greatly uncomfortable "wasting" 25% of my portfolio in bonds when it represented such a small portion of my lifetime earnings. I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.
KlangFool wrote:2) Your glide path should be based on your portfolio size:

A) As a multiple of your annual expense -> Aka, how close you are to retirement.

B) As a multiple of your annual savings -> Do you have time to recover your losses if the stock market drop by 50%? If your portfolio size is 20 times your annual savings and you probably could work for another 5 years, then you could not lose more than 5 years. Your AA should be 50/50.
I agree with (A) as a general principal, but (B) is again too conservative. It would lead to a 0/100 portfolio at retirement, when no one should be ever more conservative than 30/70. And I don't expect to ever be less than 50/50 or 60/40

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Re: How steep should the glide path be?

Post by Svensk Anga » Tue Feb 07, 2017 9:13 am

I like Bernstein's advice that if fate hands you a bull market late in your career, start bailing on stocks big time. He means substantially steeper than a 1% per year glide path. The bull market likely means that there is mean reversion and poor if not negative equity returns in your future.

For me, this was going from 95% stocks in October 2008 to 58% stocks in October 2015, or a slope of 5.26% per year. This was at age 49 to 56 and with retirement at 57. It helped that we had a very high savings rate these last years. The mortgage was done. Kids finished school early in the period. We were earning the highest salaries of our careers. A lot of the AA shift was just directing new funds to fixed income, but we did sell some stock funds.

The trick is when that bull market happens to show up relative to your intended retirement date. Maybe you have to bail at a younger age than you may have considered ideal. Maybe it doesn't show up until retirement eve, in which case you have to play a game of chicken. Which will arrive first, your "number" or the next bear? That might be okay if you are shooting for early retirement and are willing to work longer if things don't pan out. If that bull is late in coming is perhaps the case where a gradual glide path makes more sense.

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Re: How steep should the glide path be?

Post by KlangFool » Tue Feb 07, 2017 9:13 am

jhfenton wrote:
KlangFool wrote:OP,

1) It is wrong to go with 100/0 at any time. The right number is between 75/25 and 25/75.
Um…we'll just have to disagree. I was happily 100% equities until age 45. I would have been greatly uncomfortable "wasting" 25% of my portfolio in bonds when it represented such a small portion of my lifetime earnings. I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.
KlangFool wrote:2) Your glide path should be based on your portfolio size:

A) As a multiple of your annual expense -> Aka, how close you are to retirement.

B) As a multiple of your annual savings -> Do you have time to recover your losses if the stock market drop by 50%? If your portfolio size is 20 times your annual savings and you probably could work for another 5 years, then you could not lose more than 5 years. Your AA should be 50/50.
I agree with (A) as a general principal, but (B) is again too conservative. It would lead to a 0/100 portfolio at retirement, when no one should be ever more conservative than 30/70. And I don't expect to ever be less than 50/50 or 60/40
jhfenton,

<<It would lead to a 0/100 portfolio at retirement, >>

Just a point of clarification, (B) does not apply when you are retired. You do not plan to save further. You are in a spend-down mode. So, (B) applies before retirement. Aka, accumulation phase.

KlangFool

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Svensk Anga
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Re: How steep should the glide path be?

Post by Svensk Anga » Tue Feb 07, 2017 9:32 am

jhfenton wrote: I would have been greatly uncomfortable "wasting" 25% of my portfolio in bonds when it represented such a small portion of my lifetime earnings.
Well, in hindsight, "wasting 25% of one's portfolio space on bonds" worked out pretty well over the last three decades. In other decades, perhaps including the next couple, bond allocation has indeed been a waste. YMMV. TIPS may bail you out in situations where nominal bonds were a poor deal in the past.

Reading "The Great Depression: A Diary" by Benjamin Roth has given me a greater appreciation for the value of bonds. During the 1930's, about the only folks who had funds available were those who held bonds, preferably Treasuries. Even bank savings accounts were at terrible risk. FDIC/NCUA insurance makes that less of a risk now, but how tiny are allocations to those low-yielding assets? Thinking that your rental real estate portfolio will carry you through? Guess again. It is awfully hard to collect rent when nobody has cash, but your mortgage and property tax obligations continue.

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Re: How steep should the glide path be?

Post by cherijoh » Tue Feb 07, 2017 9:36 am

jhfenton wrote: Um…we'll just have to disagree. I was happily 100% equities until age 45. I would have been greatly uncomfortable "wasting" 25% of my portfolio in bonds when it represented such a small portion of my lifetime earnings. I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.
Huh? Your asset allocation is based on what you have now - "expected future savings" has absolutely nothing to do with it. Not to mention the issue of counting chickens before they have hatched.
jhfenton wrote:
KlangFool wrote:2) Your glide path should be based on your portfolio size:

A) As a multiple of your annual expense -> Aka, how close you are to retirement.

B) As a multiple of your annual savings -> Do you have time to recover your losses if the stock market drop by 50%? If your portfolio size is 20 times your annual savings and you probably could work for another 5 years, then you could not lose more than 5 years. Your AA should be 50/50.
I agree with (A) as a general principal, but (B) is again too conservative. It would lead to a 0/100 portfolio at retirement, when no one should be ever more conservative than 30/70. And I don't expect to ever be less than 50/50 or 60/40
Where did you get that out of KlangFool's post? No one mentioned an all bond 0/100 portfolio. The lowest stock allocation he mentioned was 50/50.

In the end everyone has to choose their own AA, but if you decide to defend your choice you should at least try and come up with a logical argument. Yours doesn't even make sense IMO.

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Re: How steep should the glide path be?

Post by KlangFool » Tue Feb 07, 2017 9:57 am

Folks,

IMHO, the steepness of the glide path should be dependent on the grow-rate the portfolio in relation to

A) multiple of annual expense

B) multiple of annual savings.

This makes the most sense to me. So, a person should adjust his AA when his portfolio hit certain threshold dependent on (A) or (B) or both.

KlangFool

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Re: How steep should the glide path be?

Post by jhfenton » Tue Feb 07, 2017 10:01 am

cherijoh wrote:
jhfenton wrote: Um…we'll just have to disagree. I was happily 100% equities until age 45. I would have been greatly uncomfortable "wasting" 25% of my portfolio in bonds when it represented such a small portion of my lifetime earnings. I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.
Huh? Your asset allocation is based on what you have now - "expected future savings" has absolutely nothing to do with it. Not to mention the issue of counting chickens before they have hatched.
Absolutely, positively "expected future savings" should be considered. Some folks call it human capital. It's why a 25-year-old with a tiny portfolio, assuming his psychology permits, should be more aggressive than an about-to-retire 65 year old.

And it's not about counting unhatched chickens. It's about planning for likely outcomes. A CPA and an attorney are likely to be able to continue earning a decent income. If something happens, that's what we have insurance for. Putting blinders on and ignoring the future makes no sense.
cherijoh wrote:
jhfenton wrote:
KlangFool wrote:2) Your glide path should be based on your portfolio size:

A) As a multiple of your annual expense -> Aka, how close you are to retirement.

B) As a multiple of your annual savings -> Do you have time to recover your losses if the stock market drop by 50%? If your portfolio size is 20 times your annual savings and you probably could work for another 5 years, then you could not lose more than 5 years. Your AA should be 50/50.
I agree with (A) as a general principal, but (B) is again too conservative. It would lead to a 0/100 portfolio at retirement, when no one should be ever more conservative than 30/70. And I don't expect to ever be less than 50/50 or 60/40
Where did you get that out of KlangFool's post? No one mentioned an all bond 0/100 portfolio. The lowest stock allocation he mentioned was 50/50.

In the end everyone has to choose their own AA, but if you decide to defend your choice you should at least try and come up with a logical argument. Yours doesn't even make sense IMO.
I can extrapolate, based on his description of the principle. He came up with 50/50 based on working 5 more years, contributing 5% per year, so needing to limit maximum losses on a 50% equity drawdown to 25% (5 x 5%). Following his math, someone planning to work 3 more years, should be 30/70. because he would need to limit his losses to 15%. In the just-about-to-retire-case, rule (B) would result in a 0/100 portfolio.

But KlangFool clarified that (B) doesn't apply in retirement. So at some point close to retirement, you stop applying rule (B) and switch to rule (A).

Are you having a rough morning? I hope it improves. :beer

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Re: How steep should the glide path be?

Post by Random Walker » Tue Feb 07, 2017 10:17 am

Svensk anga,
Totally agree with you. Bernstein's advice from Ages of Investor: Critical Look at Life Cycle Investing makes total sense to me. I'm 54 now. In 2008 I was 80/20 (60US/40Int), in 2015 went to 70/30, and have now taken some profits, paid tax, and am 47% equities (50US/50Int) /35%bonds / 18% uncorrelated stuff with equity like expected returns. Given current valuations, the potential dispersion of returns for equities doesn't look worth the risk to me when retirement age is within sight.

Dave

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Re: How steep should the glide path be?

Post by rkhusky » Tue Feb 07, 2017 10:31 am

When considering my glide path, my operating principal is that the stock market can lose 50% and not come back for 20 years.

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Re: How steep should the glide path be?

Post by KlangFool » Tue Feb 07, 2017 11:27 am

jhfenton wrote:
cherijoh wrote:
jhfenton wrote: Um…we'll just have to disagree. I was happily 100% equities until age 45. I would have been greatly uncomfortable "wasting" 25% of my portfolio in bonds when it represented such a small portion of my lifetime earnings. I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.
Huh? Your asset allocation is based on what you have now - "expected future savings" has absolutely nothing to do with it. Not to mention the issue of counting chickens before they have hatched.
Absolutely, positively "expected future savings" should be considered. Some folks call it human capital. It's why a 25-year-old with a tiny portfolio, assuming his psychology permits, should be more aggressive than an about-to-retire 65 year old.

And it's not about counting unhatched chickens. It's about planning for likely outcomes. A CPA and an attorney are likely to be able to continue earning a decent income. If something happens, that's what we have insurance for. Putting blinders on and ignoring the future makes no sense.
jhfenton,

<< I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.>>

Just to complete the discussion. In your case, you are at 88/12 at the age of 47. You are assuming how many years of expected future savings?

A) 20 years

B) 10 years

C) 5 years

KlangFool

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Re: How steep should the glide path be?

Post by BigJohn » Tue Feb 07, 2017 11:52 am

My two cents.... I think there are two issues at work here. First is the traditional glide path to increase bonds and decrease risks as you get older. Conceptually this is driven by decreasing human capital and increasing portfolio size so there is less need/ability to take higher risk with stocks. Details on what %, when and how fast to change are very person dependent and go back to the big three questions (willingness, need, ability). My suggestion would be to read a variety of view points on this and then decide what feels best for your situation.

The second issue is sequence of return risk. I'm with Svenska Anga and Random Walker in my belief that Dr Bernstein has the right approach and would recommend reading his short book "The Ages of the Investor". I think this article by Kitces is along the same lines and a good summary of the risk and how it can be managed with an overlay on the traditional glide path approach https://www.kitces.com/blog/managing-po ... -red-zone/

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Re: How steep should the glide path be?

Post by HomerJ » Tue Feb 07, 2017 12:21 pm

AlohaJoe wrote:
FlyingMoose wrote:The ultimate reason for it seems to be to reduce sequence-of-returns risk at the beginning of retirement.
This is basically totally wrong :)

It is based on the life cycle theory of consumption and investing from Zvi Bodie, Robert Merton, and Paul Samuelson and is about your declining human capital. It doesn't really have anything at all to do with sequence of returns.
You'll have to explain that better. Sequence of returns risk is what I'm worried about. My human capital will be zero the day I retire.

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Re: How steep should the glide path be?

Post by jhfenton » Tue Feb 07, 2017 12:55 pm

KlangFool wrote:
jhfenton wrote:
cherijoh wrote:
jhfenton wrote: Um…we'll just have to disagree. I was happily 100% equities until age 45. I would have been greatly uncomfortable "wasting" 25% of my portfolio in bonds when it represented such a small portion of my lifetime earnings. I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.
Huh? Your asset allocation is based on what you have now - "expected future savings" has absolutely nothing to do with it. Not to mention the issue of counting chickens before they have hatched.
Absolutely, positively "expected future savings" should be considered. Some folks call it human capital. It's why a 25-year-old with a tiny portfolio, assuming his psychology permits, should be more aggressive than an about-to-retire 65 year old.

And it's not about counting unhatched chickens. It's about planning for likely outcomes. A CPA and an attorney are likely to be able to continue earning a decent income. If something happens, that's what we have insurance for. Putting blinders on and ignoring the future makes no sense.
jhfenton,

<< I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.>>

Just to complete the discussion. In your case, you are at 88/12 at the age of 47. You are assuming how many years of expected future savings?

A) 20 years

B) 10 years

C) 5 years

KlangFool
13 - 15 years. Our kids are only 12 and 14 (7th and 8th grades), so retirement won't even cross our minds until the younger is out of college in 10 years. Our current portfolio is in the mid-to-high six figures and our savings rate is such that we'll add about 9% this year. I had significant student loans to pay off after college and law school. My wife went back for a second degree. And then I got a masters in tax. So our savings rate in our 20's was limited. I also worked for a non-profit legal services group for a while, so my income was much lower than it is now. (Working in-house, my income is still not what it would be working for big law, but I also work 7-4:30 most days.)

My glide path, since that's what we were discussing, is 2% per year. At that rate, we'll hit 60/40 the year we turn 60.

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Re: How steep should the glide path be?

Post by KlangFool » Tue Feb 07, 2017 2:34 pm

jhfenton wrote: 13 - 15 years. Our kids are only 12 and 14 (7th and 8th grades), so retirement won't even cross our minds until the younger is out of college in 10 years. Our current portfolio is in the mid-to-high six figures and our savings rate is such that we'll add about 9% this year. I had significant student loans to pay off after college and law school. My wife went back for a second degree. And then I got a masters in tax. So our savings rate in our 20's was limited. I also worked for a non-profit legal services group for a while, so my income was much lower than it is now. (Working in-house, my income is still not what it would be working for big law, but I also work 7-4:30 most days.)

My glide path, since that's what we were discussing, is 2% per year. At that rate, we'll hit 60/40 the year we turn 60.
jhfenton,

Just another data point for comparison.

I am at 64/36. I am close to 20 times my annual expense. I am gliding towards 60/40 in 5 years which is my retirement AA. I have zero annual savings over the next 3 to 5 years since I "cash flow" my children's college education. Aka, all my annual savings go towards the college education. But, for the tax purposes, I spend from my taxable account while maxed up Trad. 401Ks and Roth IRAs. I am hoping for 5% nominal return over the next 5 years to reach my targeted number.

I will adjust my AA to 62/38 when my portfolio is in between 20 to 25 times my annual expense.

KlangFool

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Re: How steep should the glide path be?

Post by HomerJ » Tue Feb 07, 2017 2:43 pm

rkhusky wrote:When considering my glide path, my operating principal is that the stock market can lose 50% and not come back for 20 years.
This is how I do it too... I plan for a 50% drop that could take 5-10 years to recover.

So that's why I'm at 50/50 stocks/bonds 7 years away from retirement.

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Re: How steep should the glide path be?

Post by Grogs » Tue Feb 07, 2017 3:08 pm

The problem with waiting until 5-10 years until retirement is that you don't know when you're going to retire. You might know when you think you'll be able to retire, or when you hope to retire, but it's not the same thing. I know two or three people who 'retired' in their early 50s. They got laid off and we're never able to find another job making close to what they were before, so they finally gave up. If that was coupled with a stock market crash and a high equity allocation, it could be devastating.

For my glide path, I follow a version of what Klang is advocating. I use 80% equities, minus 1% for every year of basic living expenses in my portfolio. My goal is to hit 30X expenses at a 50/50 AA. Once I reach that point, I can retire, or continue to work if I want to.

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Company "glide-paths" ?

Post by Taylor Larimore » Tue Feb 07, 2017 3:25 pm

FlyingMoose:

A target fund's "glide path" based on age is better than nothing but it falls short of being ideal.

Our stock/bond allocation should be based on 1) our goals, 2) our time-frame, 3) our risk-tolerance and 4) our personal financial situation--not just age.

I'll use myself as an example. I am 93. I have a 65% stock/35% bond allocation unlike any company "glide path." My 35% bond allocation is what I cannot afford to lose. The rest is in stocks with higher expected return.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: How steep should the glide path be?

Post by jhfenton » Tue Feb 07, 2017 3:29 pm

KlangFool wrote: jhfenton,

Just another data point for comparison.

I am at 64/36. I am close to 20 times my annual expense. I am gliding towards 60/40 in 5 years which is my retirement AA. I have zero annual savings over the next 3 to 5 years since I "cash flow" my children's college education. Aka, all my annual savings go towards the college education. But, for the tax purposes, I spend from my taxable account while maxed up Trad. 401Ks and Roth IRAs. I am hoping for 5% nominal return over the next 5 years to reach my targeted number.

I will adjust my AA to 62/38 when my portfolio is in between 20 to 25 times my annual expense.
I've read your plan before. It sounds eminently logical.

I have trouble thinking that way because I haven't the slightest clue what our expenses will be in retirement. Our assets will largely determine our expenses. We plan to move out west when we retire, if not sooner. Where is a variable. We would like to travel, but where and on what budget is a variable. Pretty much everything except being debt-free is a variable.

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Re: How steep should the glide path be?

Post by KlangFool » Tue Feb 07, 2017 3:36 pm

jhfenton wrote:
KlangFool wrote: jhfenton,

Just another data point for comparison.

I am at 64/36. I am close to 20 times my annual expense. I am gliding towards 60/40 in 5 years which is my retirement AA. I have zero annual savings over the next 3 to 5 years since I "cash flow" my children's college education. Aka, all my annual savings go towards the college education. But, for the tax purposes, I spend from my taxable account while maxed up Trad. 401Ks and Roth IRAs. I am hoping for 5% nominal return over the next 5 years to reach my targeted number.

I will adjust my AA to 62/38 when my portfolio is in between 20 to 25 times my annual expense.
I've read your plan before. It sounds eminently logical.

I have trouble thinking that way because I haven't the slightest clue what our expenses will be in retirement. Our assets will largely determine our expenses. We plan to move out west when we retire, if not sooner. Where is a variable. We would like to travel, but where and on what budget is a variable. Pretty much everything except being debt-free is a variable.
jhfenton,

You are aiming for retirement. I am aiming for financial independence (FI). In term of FI, I just have to use my current annual expense for my planning purposes.

KlangFool

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Re: How steep should the glide path be?

Post by jhfenton » Tue Feb 07, 2017 3:50 pm

KlangFool wrote: jhfenton,

You are aiming for retirement. I am aiming for financial independence (FI). In term of FI, I just have to use my current annual expense for my planning purposes.

KlangFool
You can look at it that way. Because of the age of our kids, our retirement window is fairly narrow. We're not going to be debating whether we are financially independent at 55 because we'll have two kids still in college. If the second one graduates on schedule when we're 57, then we'll see where we are with work and our portfolio.

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Re: How steep should the glide path be?

Post by KlangFool » Tue Feb 07, 2017 4:05 pm

jhfenton wrote:
KlangFool wrote: jhfenton,

You are aiming for retirement. I am aiming for financial independence (FI). In term of FI, I just have to use my current annual expense for my planning purposes.

KlangFool
You can look at it that way. Because of the age of our kids, our retirement window is fairly narrow. We're not going to be debating whether we are financially independent at 55 because we'll have two kids still in college. If the second one graduates on schedule when we're 57, then we'll see where we are with work and our portfolio.
jhfenton,

My older brother retired at 49 years old when his kids went to college. I could retire when my kids go to college too if I did not gamble on stock and lost 50% of my savings in the process 10+ years ago.

KlangFool

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Re: How steep should the glide path be?

Post by jhfenton » Tue Feb 07, 2017 4:08 pm

KlangFool wrote:
jhfenton wrote:
KlangFool wrote: jhfenton,

You are aiming for retirement. I am aiming for financial independence (FI). In term of FI, I just have to use my current annual expense for my planning purposes.

KlangFool
You can look at it that way. Because of the age of our kids, our retirement window is fairly narrow. We're not going to be debating whether we are financially independent at 55 because we'll have two kids still in college. If the second one graduates on schedule when we're 57, then we'll see where we are with work and our portfolio.
jhfenton,

My older brother retired at 49 years old when his kids went to college. I could retire when my kids go to college too if I did not gamble on stock and lost 50% of my savings in the process 10+ years ago.

KlangFool
Good for him. We will not be ready to retire with the lifestyle we want at age 49.

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Re: How steep should the glide path be?

Post by Johnnie » Wed Feb 08, 2017 4:30 pm

rkhusky wrote:When considering my glide path, my operating principal is that the stock market can lose 50% and not come back for 20 years.
Knocked-down 50 percent and held there for 20 years? That's scary. Anything is possible but has such a thing ever happened in modern US markets? (Back to the 1920s.)
HomerJ wrote: This is how I do it too... I plan for a 50% drop that could take 5-10 years to recover. So that's why I'm at 50/50 stocks/bonds 7 years away from retirement.
That's scary too, but not outside the "stress tests" I apply my own situation. Down 50% and held there 5 years - ouch but I'll live. 10 years? Thankfully I can get by on just SS if I had to. (But would rather not!)

60/40 and 4 to 6 years out (if it's up to me).
"I know nothing."

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Re: How steep should the glide path be?

Post by rkhusky » Wed Feb 08, 2017 7:33 pm

Johnnie wrote:
rkhusky wrote:When considering my glide path, my operating principal is that the stock market can lose 50% and not come back for 20 years.
Knocked-down 50 percent and held there for 20 years? That's scary. Anything is possible but has such a thing ever happened in modern US markets? (Back to the 1920s.)
Or down 50% and takes 20 years to double. Just because it hasn't happened yet doesn't mean that it won't in the future. Search "black swan" on this site. It's why I'm not 100% stock 10 years from retirement.

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Re: How steep should the glide path be?

Post by whomever » Wed Feb 08, 2017 7:56 pm

It depends, among other things, on the riskiness of your career, as Grogs points out above.

Suppose you are absolutely sure you can maintain a nice income until you choose to retire (university professor, civil service, doctor, ...). You plan to retire at 60. If the market drops at 59, you can just keep working until 70 if needed. Reasonable people in this situation might elect to carry a high risk/high return portfolio until right before they formalize retirement plans.

OTOH, if you're in a field where there is a risk you might get downsized at age 55 (or have health probs or ...) and have difficulty maintaining the same income, reasonable people might want to start derisking as time goes on.

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Re: How steep should the glide path be?

Post by vitaflo » Wed Feb 08, 2017 8:26 pm

My glide path is variable and doesn't depend on age at all. I know I'm on pace to retire much earlier than normal because of my income vs expenses. I also don't want to have to work longer than I need to. So what do I do?

Figure out how much I need for retirement based on my expenses. Lets say I decide I need $2m to comfortably retire and maintain my standard of living. Then I set what I want my AA to be when I retire. Lets say 50/50.

Then I calculate what I need my current AA to be based on how close I am to my goal. Lets say when I have $0 saved my AA is 100/0. Thus once I have $1m saved I'm half way to my goal, so my AA would be 75/25.

I keep a spreadsheet for this that updates whatever AA I need to be at given my current asset level. One interesting thing about this approach is that if the market tanks, I will rebalance. But because I have less money invested because of a crash (and thus am farther from my goal) my AA also changes (I am to take on more equity risk) so I rebalance for a larger amount that most that just have a static "age in bonds" AA would.

Of course the opposite is true in a bull market. My AA gets conservative faster in a bull market since I'm now closer to my goal. I like this because when I hit my goal I'm automatically at the correct AA, regardless of how old I am. The glide path just works out on its own.

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Re: How steep should the glide path be?

Post by KlangFool » Wed Feb 08, 2017 8:37 pm

vitaflo wrote:My glide path is variable and doesn't depend on age at all. I know I'm on pace to retire much earlier than normal because of my income vs expenses. I also don't want to have to work longer than I need to. So what do I do?

Figure out how much I need for retirement based on my expenses. Lets say I decide I need $2m to comfortably retire and maintain my standard of living. Then I set what I want my AA to be when I retire. Lets say 50/50.

Then I calculate what I need my current AA to be based on how close I am to my goal. Lets say when I have $0 saved my AA is 100/0. Thus once I have $1m saved I'm half way to my goal, so my AA would be 75/25.

I keep a spreadsheet for this that updates whatever AA I need to be at given my current asset level. One interesting thing about this approach is that if the market tanks, I will rebalance. But because I have less money invested because of a crash (and thus am farther from my goal) my AA also changes (I am to take on more equity risk) so I rebalance for a larger amount that most that just have a static "age in bonds" AA would.

Of course the opposite is true in a bull market. My AA gets conservative faster in a bull market since I'm now closer to my goal. I like this because when I hit my goal I'm automatically at the correct AA, regardless of how old I am. The glide path just works out on its own.
+1.

This is my approach too. The only difference is my starting AA is 70/30 and my ending AA is 60/40.

KlangFool

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Re: How steep should the glide path be?

Post by Phineas J. Whoopee » Wed Feb 08, 2017 9:01 pm

vitaflo wrote:My glide path is variable and doesn't depend on age at all. I know I'm on pace to retire much earlier than normal because of my income vs expenses. I also don't want to have to work longer than I need to. So what do I do?

...

I keep a spreadsheet for this that updates whatever AA I need to be at given my current asset level. One interesting thing about this approach is that if the market tanks, I will rebalance. But because I have less money invested because of a crash (and thus am farther from my goal) my AA also changes (I am to take on more equity risk) so I rebalance for a larger amount that most that just have a static "age in bonds" AA would.

Of course the opposite is true in a bull market. My AA gets conservative faster in a bull market since I'm now closer to my goal. I like this because when I hit my goal I'm automatically at the correct AA, regardless of how old I am. The glide path just works out on its own.
That's the approach I took, except my preplanned process only moved forward from more in equities to less. A decrease in portfolio value didn't reset me to a higher equity allocation, although rebalancing was certainly part of the plan.

I described what it was, and why I chose it, and how I implemented it, in this post; then a couple of years later I answered some questions about it.

I do not recommend it for most investors. I think in general an age-based approach, whether precise or approximate, is far more practical for the majority of people who even have the option of saving for retirement in the first place. I offer my plan as an alternative way of thinking about the glide-path concept. To quote myself from the first linked post: "I didn't design it with the purpose of writing a book telling people to follow it."

PJW

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Re: How steep should the glide path be?

Post by Garco » Wed Feb 08, 2017 9:19 pm

A problem with using a fixed timetable for changing your AA as you move toward planned retirement year is that stuff happens. Ten years prior to my retirement was just fine (2004). Six years prior to retirement (2008) everything went bad. I got back to par in my retirement funds by the end of 2010, stayed flat in 2011, then had a couple of good years (judging by TR) and was significantly ahead of where I was in 2007 by the end of 2013. I retired in 2014. It was only in 2013-2014 that that I seriously tapered my exposure to equities. Had I done that before the economy stabilized and recovered after the recession, that recession could have seriously reduced my retirement welfare.

Whatever plan you have can fall apart because of events over which you have no control. These needn't be just in the economy or market. They can be in your family (serious illness or death of a family member), urgent needs of a relative (such as your own grown children), or your own disability due to accident or illness.

You can't just automate everything. In fact you can't necessarily set your retirement age or year. You could lose your job a few years before your planned time.

So you need to have some contingency plans, most of which mean you need to have more money set aside in some form.

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Re: How steep should the glide path be?

Post by jhfenton » Wed Feb 08, 2017 9:52 pm

KlangFool wrote:
vitaflo wrote:My glide path is variable and doesn't depend on age at all. I know I'm on pace to retire much earlier than normal because of my income vs expenses. I also don't want to have to work longer than I need to. So what do I do?

Figure out how much I need for retirement based on my expenses. Lets say I decide I need $2m to comfortably retire and maintain my standard of living. Then I set what I want my AA to be when I retire. Lets say 50/50.

Then I calculate what I need my current AA to be based on how close I am to my goal. Lets say when I have $0 saved my AA is 100/0. Thus once I have $1m saved I'm half way to my goal, so my AA would be 75/25.

I keep a spreadsheet for this that updates whatever AA I need to be at given my current asset level. One interesting thing about this approach is that if the market tanks, I will rebalance. But because I have less money invested because of a crash (and thus am farther from my goal) my AA also changes (I am to take on more equity risk) so I rebalance for a larger amount that most that just have a static "age in bonds" AA would.

Of course the opposite is true in a bull market. My AA gets conservative faster in a bull market since I'm now closer to my goal. I like this because when I hit my goal I'm automatically at the correct AA, regardless of how old I am. The glide path just works out on its own.
+1.

This is my approach too. The only difference is my starting AA is 70/30 and my ending AA is 60/40.

KlangFool
I like it better when vitaflo explains it. :beer

Actually, it's the endpoints that make it work for me. If I set my endpoints at 100% and 60% and my target at $2MM to $3MM, it puts me in the low to high 80%s in the mid-to-high six figures. Which is where I am, at 88%.

I'm going to think about this. I think I like the approach as an alternative to a straight 2% per year.

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Re: How steep should the glide path be?

Post by inbox788 » Thu Feb 09, 2017 1:46 am

How steep is your retirement date cutoff? I'm planning on adjusting the glidepath depending on how certain I'll be retiring on a specific date or age. If there's flexibility in the retirement age, the glidepath can be less steep. Plan on a few more conservative years right at or around retirement, and more aggressive at other times. Kind of a U shaped graph.

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Re: How steep should the glide path be?

Post by AlohaJoe » Thu Feb 09, 2017 2:21 am

HomerJ wrote:
AlohaJoe wrote:
FlyingMoose wrote:The ultimate reason for it seems to be to reduce sequence-of-returns risk at the beginning of retirement.
This is basically totally wrong :)

It is based on the life cycle theory of consumption and investing from Zvi Bodie, Robert Merton, and Paul Samuelson and is about your declining human capital. It doesn't really have anything at all to do with sequence of returns.
You'll have to explain that better. Sequence of returns risk is what I'm worried about. My human capital will be zero the day I retire.
The glidepath is based on the lifecycle model of finance; that's why (at least originally) most of these funds were called "lifecycle" funds. It is similar to but not the same as sequence of returns risk. That a glidepath also helps with sequence of returns risk is more like a secondary benefit, or happy accident, rather than the primary design reason. That's why I said calling it the "ultimate reason" was wrong. It wasn't the ultimate reason for the way they are designed.

If you read the various literature (like prospectuses or SEC filings) it is clear that most of the funds weren't created to protect people from sequence of returns risks after they retire.

If all you care about is sequence of returns risk at the beginning of retirement then, as the OP suggests, you don't need to change your asset allocation from 90% stocks to 85% stocks at age 45 (or whatever your glidepath might be doing). You do that because your human capital is decreasing gradually (it doesn't go from 100% to 0% the day you retire) and because you believe in time diversification of equity risk (you now have less time to diversify across so are able to take less equity risk).

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Re: How steep should the glide path be?

Post by cherijoh » Thu Feb 09, 2017 6:54 am

jhfenton wrote:
cherijoh wrote:
jhfenton wrote: Um…we'll just have to disagree. I was happily 100% equities until age 45. I would have been greatly uncomfortable "wasting" 25% of my portfolio in bonds when it represented such a small portion of my lifetime earnings. I'm happily 88/12 at (almost) age 47. If you count expected future savings, we're still well under 50% equities.
Huh? Your asset allocation is based on what you have now - "expected future savings" has absolutely nothing to do with it. Not to mention the issue of counting chickens before they have hatched.
Absolutely, positively "expected future savings" should be considered. Some folks call it human capital. It's why a 25-year-old with a tiny portfolio, assuming his psychology permits, should be more aggressive than an about-to-retire 65 year old.
Yes, human capital should be taken into account, but you don't use it in some convoluted way to come up with "If you count expected future savings, we're still well under 50% equities." That is what I was questioning you about. You choose an AA appropriate for your stage in life and then you look at what the split is NOW.

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Re: How steep should the glide path be?

Post by KarenC » Thu Feb 09, 2017 7:05 am

KlangFool wrote:
vitaflo wrote:My glide path is variable and doesn't depend on age at all. I know I'm on pace to retire much earlier than normal because of my income vs expenses. I also don't want to have to work longer than I need to. So what do I do?

Figure out how much I need for retirement based on my expenses. Lets say I decide I need $2m to comfortably retire and maintain my standard of living. Then I set what I want my AA to be when I retire. Lets say 50/50.

Then I calculate what I need my current AA to be based on how close I am to my goal. Lets say when I have $0 saved my AA is 100/0. Thus once I have $1m saved I'm half way to my goal, so my AA would be 75/25.

I keep a spreadsheet for this that updates whatever AA I need to be at given my current asset level. One interesting thing about this approach is that if the market tanks, I will rebalance. But because I have less money invested because of a crash (and thus am farther from my goal) my AA also changes (I am to take on more equity risk) so I rebalance for a larger amount that most that just have a static "age in bonds" AA would.

Of course the opposite is true in a bull market. My AA gets conservative faster in a bull market since I'm now closer to my goal. I like this because when I hit my goal I'm automatically at the correct AA, regardless of how old I am. The glide path just works out on its own.
+1.

This is my approach too. The only difference is my starting AA is 70/30 and my ending AA is 60/40.

KlangFool
Reading this thread, I've realized that I've been following a hybrid of this strategy and the "classsic" glidepath. When I found out about the Boglehead philosophy, I started tracking the VG TR 2025; I had been 100% equities before that. After a while, I decided I had to some degree "won the game" and switched to tracking the VG TR 2020. In the future, I might be receiving a hitherto unexpected windfall, at which point I anticipate switching to tracking the VG TR 2015.

Karen
"How much you know is less important than how clearly you understand where the borders of your ignorance begin." — Jason Zweig

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