## Basic portfolio math question

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Kelly
Posts: 255
Joined: Sun Nov 18, 2012 7:39 am

### Basic portfolio math question

Here's the scenario: there are two time periods: ten years and beyond ten years to life expectancy. A large tax free income stream will begin in ten years. Expenses for the next ten years are to be kept in a 60/40 portfolio which amounts to 1/3 of the total assets. No bond portion is needed after ten years as the income stream is essentially a bond.

My basic question: would the outcome be the same if, instead of two portfolios of 60/40 and 100/0, there were one 87/13 portfolio. The 40% bond allocation in the portfolio that represents 1/3 of the total assets (13%=40%/3). By "outcome" I mean the probability of not depleting the assets.

I think it would be the same but would like a second opinion.

Thanks for any insight.

Kelly

dbr
Posts: 27207
Joined: Sun Mar 04, 2007 9:50 am

### Re: Basic portfolio math question

An income stream is not a bond and trying to do asset allocation thinking it is will result in a mess.

If you want to model the probability of when or how likely the actual portfolio will be depleted there are many models that do that as exemplified by www.firecalc.com In that model you enter your planned spending, your possible income streams with start dates, and your asset allocation. The output is a set of possible future scenarios for the value of your actual portfolio.

Note that your "income as a bond" can't be depleted because it is a lifetime income stream. Already calling it a bond makes no sense.

welderwannabe
Posts: 827
Joined: Fri Jun 16, 2017 8:32 am

### Re: Basic portfolio math question

You can value a bond by calculating the present value of sum of all of its future cash flows. I suppose you could do that here with this income stream. Your case doesn't seem all that different than calculating the present value of an annuity to me.

The wisdom of treating these future cash flows as the 'bond portion' of your AA is a different story. If I was in your shoes I would really want to understand the safety and risk of those future cash flows. How guaranteed and safe are they?
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

CAsage
Posts: 954
Joined: Sun Mar 27, 2016 6:25 pm

### Re: Basic portfolio math question

Your math sort of makes sense - adding two portfolios together to calculate asset %s would be right. Personally, I think a guaranteed income stream (like SS) is bond-like, and many people do calculate the PV to count that. Personal choice. However, you might be a little sporty to contain your next 10 years worth of needed funds in a 60/40 portfolio, because 10 year money isn't long enough to recover a big early crash.

I think the real questions here are, can you handle a short term crash, a 10 year flat market, is that projected future income stream really guaranteed and enough to reliably and conservatively cover your income needs?
Salvia Clevelandii "Winifred Gilman" my favorite. YMMV; not a professional advisor.

music_man
Posts: 135
Joined: Mon Apr 28, 2014 12:22 pm

### Re: Basic portfolio math question

Hard to tell with the hypothetical 2 scenarios, but I would approach it differently, and calculate based on expected expenses over the next 10 years, what rate of return you need to not deplete your assets over the next 10 years. Then, at the 10 year mark, do the same but factor in your tax-free lifetime income stream.

dbr
Posts: 27207
Joined: Sun Mar 04, 2007 9:50 am

### Re: Basic portfolio math question

music_man wrote:
Sun Oct 15, 2017 9:55 am
Hard to tell with the hypothetical 2 scenarios, but I would approach it differently, and calculate based on expected expenses over the next 10 years, what rate of return you need to not deplete your assets over the next 10 years. Then, at the 10 year mark, do the same but factor in your tax-free lifetime income stream.
That is what models like FireCalc and all its (sometimes more elaborate) cousins do with the added and very necessary feature that the variability of investment returns is explicitly taken into account along with inflation. The answer is a probabilistic one and can't easily be made simpler.

Kelly
Posts: 255
Joined: Sun Nov 18, 2012 7:39 am

### Re: Basic portfolio math question

music_man wrote:
Sun Oct 15, 2017 9:55 am
Hard to tell with the hypothetical 2 scenarios, but I would approach it differently, and calculate based on expected expenses over the next 10 years, what rate of return you need to not deplete your assets over the next 10 years. Then, at the 10 year mark, do the same but factor in your tax-free lifetime income stream.
I used a 0% real ror for the first ten year expenses.

Kelly