When to reduce risk?

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RandomPointer
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When to reduce risk?

Post by RandomPointer » Sun Jul 16, 2017 9:47 am

Thanks to this forum, I am almost half-way to my target retirement balance.

I am using Core Four portfolio with 20% bond. My goal is to have 40% bond during retirement.

One thing that I do not understand is when to reduce risk? Should I start increasing bond allocation when my portfolio reaches certain amount? For example, after I hit 50%, should I start increasing my bond allocation? Or should I keep 80/20 until I hit my goal and immediately switch to 60/40?

Thesaints
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Re: When to reduce risk?

Post by Thesaints » Sun Jul 16, 2017 10:19 am

That depends on how close you get to your target.
Your present portfolio has a certain expected return (and a certain risk).
With that expected return would you reach your target sooner than you need ? If that were the case, you could alter your asset allocation and move to a different portfolio with lower expected return, but also lower risk.

Remember that asset allocation is a means, not an end. You want to get into retirement with 40% in bonds, but 40% of how much money ?

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Re: When to reduce risk?

Post by pkcrafter » Sun Jul 16, 2017 11:55 am

RandomPointer wrote:Thanks to this forum, I am almost half-way to my target retirement balance.

I am using Core Four portfolio with 20% bond. My goal is to have 40% bond during retirement.

One thing that I do not understand is when to reduce risk? Should I start increasing bond allocation when my portfolio reaches certain amount? For example, after I hit 50%, should I start increasing my bond allocation? Or should I keep 80/20 until I hit my goal and immediately switch to 60/40?
You have to think about need to take risk vs ability to take risk. For instance, if you are 80/20 you could experience a loss of 40% of you retirement assets. Actually I can't fairly call it a real loss because you still own all the shares, they are just worth less. The value will probably come back, but you can't be sure of when the recovery will be complete, so that is a risk you have to consider. If you are figuring on a 4% withdrawal rate and a temporary loss will put you up to 6% withdrawal, you could be in trouble.

If a 40% reduction in value concerns you or will cause you to have to modify your plans, then you don't want 80/20 within range of retirement. That probably means reducing risk about 5-7 years before your target date. If you don't have a real need to be 80/20, you have the option of reducing before that.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

Kennyt7
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Re: When to reduce risk?

Post by Kennyt7 » Sun Jul 16, 2017 12:51 pm

When nearing retirement and reaching your goal, you need to think preservation of capital(marginal utility of wealth)

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nisiprius
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Re: When to reduce risk?

Post by nisiprius » Sun Jul 16, 2017 1:15 pm

You need to soak yourself into the actual behavior of various portfolios--one way to do it is to go into PortfolioVisualizer, slide the cursor along the curve, and watch the numbers jump up and down.

Then you need to do your very best to assess how you feel about various levels of volatility and/or risk, as displayed by the various portfolios.

If you were investing during 2011, do your very best to remember exactly how you felt and acted during the 20% correction that lasted almost six months. If you were investing during 2008-2009, do your very best to remember exactly how you felt and acted during the 50% crash in the stock market at that time. Don't try to kid yourself, or impress anybody, or compare yourself to anybody's table of recommendations.

Assess the risk yourself, by whatever criteria make sense for you. Assess your risk tolerance for yourself, as best you can.

If you are like me, you will find that your risk tolerance declines with age. This is probably due to an intuitive understanding that the chances of really needing to use the money increases over time, and thus the chances of needing to sell stocks when they are down increases with time; that you can no longer shrug off declines with the idea that you won't need the money for forty years; and that the number of earnings years left in which to make up for portfolio declines with savings from salary decreases. The "official" glide slopes are based on some kind of numeric modeling of these things.

However, it's also possible that we just get timid with age. It doesn't matter. You need to match your portfolio to what your risk tolerance is, not to what someone says they think it should be.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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nisiprius
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Re: When to reduce risk?

Post by nisiprius » Sun Jul 16, 2017 1:20 pm

Generally speaking, what the people who calculate glide paths come up with is something like this:

Image

A fairly common pattern is that most of the de-risking is done during a somewhat narrow time period. They don't start de-risking in earnest until age 35-40, and they glide quickly enough to get most of the work done by age 55 or 60.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Random Walker
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Re: When to reduce risk?

Post by Random Walker » Sun Jul 16, 2017 1:22 pm

RandomPointer,
Monte Carlo Simulation could be a great aid in making that decision. That being said, the stock market has done great last 9 years, many people are ahead of where they thought they would be, portfolios have swelled, valuations have increased, and future expected returns have decreased. Not only have future expected returns decreased, the whole distribution of potential future returns is shifted left: potential good outcomes are more modest and potential bad outcomes worse.
Rather than blindly adjusting AA based on age, or steadfastly sticking to AA all the way to retirement, I think it makes sense to periodically (perhaps every 2-3 years) see where you are compared to your goals and if you're way ahead take some risk off the table. Sort of customizing the glide path to your unique circumstances. I don't really view this as market timing because it is a one way step wise path towards your retirement AA. You just sort of opportunistically decide when to take the steps. The default is always to stick to your current AA.

Dave.

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Re: When to reduce risk?

Post by jbolden1517 » Sun Jul 16, 2017 2:01 pm

RandomPointer wrote:Thanks to this forum, I am almost half-way to my target retirement balance.

I am using Core Four portfolio with 20% bond. My goal is to have 40% bond during retirement.

One thing that I do not understand is when to reduce risk? Should I start increasing bond allocation when my portfolio reaches certain amount? For example, after I hit 50%, should I start increasing my bond allocation? Or should I keep 80/20 until I hit my goal and immediately switch to 60/40?
FWIW I think this is totally age based. For example if you are 50% of the way there to your retirement goal with one year to go likely you want to take on a lot of risk, postpone retirement for 2 years and try and hit the goal. If you are 10 years from the retirement then you can't reduce risk much. You still need 7% after inflation. The next 5 years decide if you go risky right into retirement or not. You don't want to be in the situation of 50% away with 1 year to go much more than you want to hit 125% of your goal. If you are 15 years away, congratulations, you definitely want to reduce risk you need about 4.7% inflation adjusted. Even if you miss you won't miss by much and that miss is likely to make a larger draw during retirement safe. And if you are 20 years away I'd say go ahead and build up the grandkid's inheritance.

Thesaints
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Re: When to reduce risk?

Post by Thesaints » Sun Jul 16, 2017 2:09 pm

nisiprius wrote:Generally speaking, what the people who calculate glide paths come up with is something like this:
The problem with these graphs is that they are obtained by averaging on so many levels and individual investors may deviate from the average, perhaps more often than not.

To begin with, those glide paths are averaged in time; the same glide path is good in 1997 and in 2017, except that they are not. Throughout "history", when downshifting to larger bond allocation one could could on a 2, perhaps even 3, percent return above inflation from bonds. That is certainly not true today.

Also, those graphs assume that investors retire around the same age and require around the same relative income from their capital. That is also not necessarily true and not only due to individual choices and needs, but also because in the past pensions were more widespread. Depending (almost) entirely on DCP plans is a new phenomenon. We are just seeing this new wave of people retiring now and by all accounts a majority of individual accounts appear underfunded. This will translate into retirement at a later age, which would in part invalidate glide paths used in the past. We will see how things turn out.

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SimpleGift
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Re: When to reduce risk?

Post by SimpleGift » Sun Jul 16, 2017 2:31 pm

RandomPointer wrote:One thing that I do not understand is when to reduce risk? Should I start increasing bond allocation when my portfolio reaches certain amount? For example, after I hit 50%, should I start increasing my bond allocation? Or should I keep 80/20 until I hit my goal and immediately switch to 60/40?
The glide path analysis can give an investor a good place to start thinking about risk reduction — but there are so many idiosyncratic elements to this decision, specific to each investor, that it's very hard to generalize. As an example, a few years ago we had a Forum poll asking Bogleheads their age versus their stock allocation (chart below):
  • Image
    NOTE: Data is from 217 Boglehead respondents, as of 7/4/15.
    Source: Bogleheads Survey
Obviously, the average Boglehead glide path line resulted from an enormous amount of individual variation.
Last edited by SimpleGift on Sun Jul 16, 2017 2:35 pm, edited 1 time in total.
Cordially, Todd

Thesaints
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Re: When to reduce risk?

Post by Thesaints » Sun Jul 16, 2017 2:34 pm

Yep, the reality is that very few people are "average". It is the same with the stock market, which on average returns 9/10% in a year, but if you go check, only in a small minority of years does indeed return that much and instead, more often than not, returns outside the -10/+20 percent bracket.

Individuals planning using exclusively averages expose themselves to substantial risks.

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willthrill81
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Re: When to reduce risk?

Post by willthrill81 » Sun Jul 16, 2017 2:50 pm

Another way to look at this is to look at how many years of spending you might want in bonds (i.e. secure), leaving the rest in stocks. You might decide that you want five (or whatever) years of retirement spending in bonds, for instance, and you might want to take something like 10 or 15 years to get there (i.e. move .33 to .5 of each year of spending from stocks to bonds). I know of one early retiree, Justin from Root of Good (www.rootofgood.com; great blog), who uses this method and only has a couple of years of spending in bonds plus another year or so in cash; the rest is in stocks.

If you follow this approach, it can look similar to the standard splits widely used, but it could look very different as well. Personally, I prefer this 'bucketed' approach conceptually and practically. I would probably opt for ten years of spending in bonds, which will probably mean that I'll enter retirement with something like a 60/40 portfolio, but if stocks go up like they usually do, my portfolio will probably get more stock heavy as time goes on.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: When to reduce risk?

Post by Thesaints » Sun Jul 16, 2017 3:02 pm

Not sure I understand.
I have 2 millions and live on less than 80k per year.
If I keep 240k in bonds/cash and 1760k in stocks and 2008 comes around, I find myself with the safe 240k and a loss close to 800k. My capital is reduced to 1.2 millions and if before I could draw less than 4%/year, now I have to draw more than 6.5%.
How did that technique help me in anything else than sticking my neck through the noose ?

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Re: When to reduce risk?

Post by willthrill81 » Sun Jul 16, 2017 3:40 pm

Thesaints wrote:Not sure I understand.
I have 2 millions and live on less than 80k per year.
If I keep 240k in bonds/cash and 1760k in stocks and 2008 comes around, I find myself with the safe 240k and a loss close to 800k. My capital is reduced to 1.2 millions and if before I could draw less than 4%/year, now I have to draw more than 6.5%.
How did that technique help me in anything else than sticking my neck through the noose ?
I'm guessing you're referring to my earlier post. Personally, I would lean toward ten years of spending in bonds, but in the case of the 2008-2009 bear market, you would have been fine regardless because the market rebounded quickly. Even with 100% in TSM, a 2007 retiree spending 4% of the initial portfolio plus inflation would have nearly $1.1 million today, adjusted for inflation.

Historically, the recovery from most bear markets occurs in just a few years, but of course there have been some instances where it took far longer, which is why I would prefer a decade of safe spending.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Explorer
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Re: When to reduce risk?

Post by Explorer » Sun Jul 16, 2017 5:08 pm

I am turning the risk dial down as the total portfolio size is increasing (and I am getting closer to retirement in a few years).

3 aspects of risk to consider: willingness to take, ability to take, and need to take. At the end of the day for me "the need to take risk" dominates my decisions..

So... you need to figure out your "need to take risk" and act accordingly.

Best wishes.
RandomPointer wrote:Thanks to this forum, I am almost half-way to my target retirement balance.

I am using Core Four portfolio with 20% bond. My goal is to have 40% bond during retirement.

One thing that I do not understand is when to reduce risk? Should I start increasing bond allocation when my portfolio reaches certain amount? For example, after I hit 50%, should I start increasing my bond allocation? Or should I keep 80/20 until I hit my goal and immediately switch to 60/40?

LRDave
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Re: When to reduce risk?

Post by LRDave » Sun Jul 16, 2017 5:47 pm

Kennyt7 wrote:When nearing retirement and reaching your goal, you need to think preservation of capital(marginal utility of wealth)
Tell me. My 92 year-old father is reaching for yield rather than thinking in terms of preserving capital. :annoyed

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willthrill81
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Re: When to reduce risk?

Post by willthrill81 » Sun Jul 16, 2017 5:52 pm

LRDave wrote:
Kennyt7 wrote:When nearing retirement and reaching your goal, you need to think preservation of capital(marginal utility of wealth)
Tell me. My 92 year-old father is reaching for yield rather than thinking in terms of preserving capital. :annoyed
To be honest, most 92 year olds don't have a lot of preserving left to do.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Phineas J. Whoopee
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Re: When to reduce risk?

Post by Phineas J. Whoopee » Sun Jul 16, 2017 7:45 pm

This is what I did and why, and a couple of years later I answered some questions about it.

For the record, I think an age-based asset allocation approach will be far more practical for most investors.

PJW

RandomPointer
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Re: When to reduce risk?

Post by RandomPointer » Sun Jul 16, 2017 10:01 pm

A lot of great replies. Thank you.

My expected annual return for my portfolio is 6%. Other than 2011 and 2015, I have been pleased with the return. I started properly investing with index funds in 2013, and I have data for my retirements from 2011. I started investing long before that, but I don't have the data anymore.

My original goal was to be working for another fifteen years, and be financially independent in ten years from this year. I have five years buffer for my target.

The target retirement balance was set based on 4% rule. If things go well, I will have more than enough in 2032 (15 years from now).

@Nisiprius, it is very difficult to judge how I would feel in that kind of volatility. The volatility is on my screen, and I know it is not real.

In 2011, I did not care about retirement money, I save enough every year to get company match. In 2011, I did not even look at my portfolio. In 2008-2009, I did not care, I had a small balance. The loss in investment can be recouped easily. The stake is higher now.

@Phineas, thanks for the pointer. That is really practical.

At this point, I think I will stay with my current plan, and revisit again every year. My goal remain the same, to be financially independent in ten years, and if I am ahead then I can reduce my risk.

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