Salary, Portfolio size, and Asset Allocation

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305pelusa
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Salary, Portfolio size, and Asset Allocation

Post by 305pelusa » Thu Jan 10, 2019 7:36 pm

Hello,
Pardon if it has been asked before. I could not find any threads on this but will welcome links if this has been asked before.

I see AA being generally determined by age and risk tolerance. However, shouldn't one's salary play a large role as well? If one thinks of a salary as some form of very generous bond, then person A at the same age and with the same risk tolerance as person B, but earning twice as much, has effectively a bigger allocation to fixed-income, stable (as far as job security goes of course) returns. Wouldn't it then make sense for person A to invest more heavily in stocks to achieve a similar level of "portfolio volatility" as person B?

Since it's a salary, maybe you associate the income as some form of "corporate bond". Since those return ~4% (very approximate here, just to make a point), then a 100k salary is like a 2.5 Million dollar, somewhat inflation-protected, long term bond that never gives you your capital back (so maybe some form of "annuity"). Someone earning 30k has more like a 750K bond. The former person needs to invest much more heavily in stocks to match the AA of the latter person it seems.

Moreover, this would also mean portfolio size also has some say in your AA. If you have nothing saved, and have a 100k salary, it's like all you have is that 2.5M bond and should fully invest in stocks. But with the same salary, age, and risk tolerance, if you had a 10M portfolio, then suddenly that 2.5M "bond" is a fraction of your AA and if you invested everything in stocks, it might resemble more of a 75/25 AA.


I know, I know, a salary is not truly a bond. You can't associate it as some bond price to take into account as AA. The examples above are just to illustrate a point, not to be followed. All I am asking is if salary and portfolio size should be considered at all in AA. That could mean people with few assets and high salaries need to invest much more heavily in stocks and people with huge savings and little income need to invest more heavily in bonds than what you would think based purely on age and risk tolerance.

Does that make any sense? :shock: Thanks for any help.

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Re: Salary, Portfolio size, and Asset Allocation

Post by livesoft » Thu Jan 10, 2019 7:41 pm

I think the standard mantra around here of using one's "need, ability, and willingness for risk" covers everything you stated.
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Re: Salary, Portfolio size, and Asset Allocation

Post by qwertyjazz » Thu Jan 10, 2019 8:23 pm

See stuff on ‘are you more a bond or stock?’ You do not get paid unless you keep your job so you need to count your analysis as to whether you are tenured faculty at a university or in sales etc
You also need to think through correlation of future income and changes in the stockmarket
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Re: Salary, Portfolio size, and Asset Allocation

Post by Grt2bOutdoors » Thu Jan 10, 2019 8:38 pm

Salary is a generous bond? Salary is inflation protected? How so?
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Re: Salary, Portfolio size, and Asset Allocation

Post by 2015 » Thu Jan 10, 2019 8:53 pm

Thankfully, I have read enough outside the very narrow fields of investing, personal finance, and microeconomics to disregard all theory related to asset allocation. Reality has a way of decimating even the most clever sounding theory. I have always and will continue to apportion my assets based on my historical relationship with risk of all kinds.

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Re: Salary, Portfolio size, and Asset Allocation

Post by corn18 » Thu Jan 10, 2019 8:58 pm

305pelusa wrote:
Thu Jan 10, 2019 7:36 pm
Does that make any sense? :shock: Thanks for any help.
It does not make any sense. If you remove the salary is a bond from the argument and just consider portfolio size, then I think there is some sense to it. If I had $10M in savings right now,

1. I would retire
2. I would set aside half of it for an endowment
3. $1M would go into 100% equities for my kids inheritance.
4. The other $4M would be 60/40 just like my current portfolio that I would live off of until I fly upside down through a barn.

I don't have $10M and I'm still saving for retirement so 60/40 it is at age 52. That matches my need, ability, and willingness for risk.
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Re: Salary, Portfolio size, and Asset Allocation

Post by KlangFool » Thu Jan 10, 2019 9:04 pm

OP,

You may enjoy the following thread.

viewtopic.php?t=5934

KlangFool

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Re: Salary, Portfolio size, and Asset Allocation

Post by KyleAAA » Thu Jan 10, 2019 9:06 pm

Bonds represent a contractual obligation. With few examples, salaries have no contractual guarantee. Therefore, it cannot be thought of as a bond. Human capital is its own thing, neither stock nor bond.

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Re: Salary, Portfolio size, and Asset Allocation

Post by 305pelusa » Thu Jan 10, 2019 9:12 pm

livesoft wrote:
Thu Jan 10, 2019 7:41 pm
I think the standard mantra around here of using one's "need, ability, and willingness for risk" covers everything you stated.
So an increase in salary increases your ability to take risk but decreases your need. And they balance each other out somewhat the same. Am I following?
qwertyjazz wrote:
Thu Jan 10, 2019 8:23 pm
See stuff on ‘are you more a bond or stock?’ You do not get paid unless you keep your job so you need to count your analysis as to whether you are tenured faculty at a university or in sales etc
You also need to think through correlation of future income and changes in the stockmarket
That's a good point and job nature is certainly a good question in its own right. If your job is more correlated with stocks, and fairly volatile (say, a startup) perhaps you think of it more like a stock.

My question stands though. If two people with that same "stock"-ish job, same age, same risk tolerance, but person A earns twice as much, then shouldn't person A invest less in stocks than B does? Again, all factors the same.
Grt2bOutdoors wrote:
Thu Jan 10, 2019 8:38 pm
Salary is a generous bond? Salary is inflation protected? How so?
Generous because you didn't put much capital into. Wouldn't read too much into it though.

"Somewhat inflation protected" because wages, in general, rise to some extent with inflation. Not all, and not to the same extent as inflation. Once again, wouldn't read too much into it. It's hard to describe the concept. It's not quite a Bond as you don't get the capital back, but it's not quite an annuity cause you might lose your job. As long as it gets the point across, I'm happy.


corn18 wrote:
Thu Jan 10, 2019 8:58 pm
305pelusa wrote:
Thu Jan 10, 2019 7:36 pm
Does that make any sense? :shock: Thanks for any help.
It does not make any sense.
Well aight.



KlangFool wrote:
Thu Jan 10, 2019 9:04 pm
OP,

You may enjoy the following thread.

viewtopic.php?t=5934

KlangFool
That was very interesting. It is a different topic altogether but also sort of in line with what Im asking. What I did find interesting was this response on the thread:
White Coat Investor wrote:
Sun Sep 16, 2007 2:44 pm
Most people factor in their future working/income potential into their asset allocation when they consider their ability to take risk.
That's precisely what I am asking about. Personally, I had not even considered my income potential in my AA. I just kinda read about the age, tolerance, etc and figured some rough percentage. It wasn't until today that I realized that my salary is also a source of return (and for someone with a tiny portfolio, the biggest source of return) so that could have some implication in AA.

I am glad there are others who have noticed this. I will continue reading through the thread. Thank you for the find!

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Re: Salary, Portfolio size, and Asset Allocation

Post by CurlyDave » Thu Jan 10, 2019 9:13 pm

KyleAAA wrote:
Thu Jan 10, 2019 9:06 pm
Bonds represent a contractual obligation. With few examples, salaries have no contractual guarantee. Therefore, it cannot be thought of as a bond. Human capital is its own thing, neither stock nor bond.
Of course this is correct, BUT it does represent an asset class that we frequently do not take into account.

I suspect that some people do instinctively take human capital into account when setting an AA and policy statement. They may end up being the smart ones who do better than most.

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Re: Salary, Portfolio size, and Asset Allocation

Post by 2pedals » Thu Jan 10, 2019 9:44 pm

305pelusa wrote:
Thu Jan 10, 2019 7:36 pm
I see AA being generally determined by age and risk tolerance. However, shouldn't one's salary play a large role as well?
Yes and I think it is already accounted for. The general rules for determining AA were based on years of financial wisdom for folks that have a good job or excellent income flow to build savings for the future.

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Re: Salary, Portfolio size, and Asset Allocation

Post by 305pelusa » Thu Jan 10, 2019 10:11 pm

2pedals wrote:
Thu Jan 10, 2019 9:44 pm
305pelusa wrote:
Thu Jan 10, 2019 7:36 pm
I see AA being generally determined by age and risk tolerance. However, shouldn't one's salary play a large role as well?
Yes and I think it is already accounted for. The general rules for determining AA were based on years of financial wisdom for folks that have a good job or excellent income flow to build savings for the future.
Well, if it is accounted for (and I agree with you... I think it is to an extent), then what is the nominal salary used for these rules of thumb? I don't need an exact number. Just a ballpark. You think "Age in bonds" is recommended for people earning the median salary (~30k)? Or 60k? 120k? Human capital is without a doubt the absolute largest source of portfolio returns for young people like myself so this actually matters a lot. If an 80/20 is appropriate for someone earning the median salary at age 20, then said allocation is far more conservative for someone earning 4 times that amount for instance.

This effect would be even more pronounced with people like doctors who could easily earn 6+ times more than their contemporaries (forgetting any debts that might complicate the issue).

Also, the linked thread had another similar idea:
larryswedroe wrote:
Sun Sep 16, 2007 6:41 pm
market timer-dont have time to read the whole thread but one should take their labor capital into account when deciding on their asset allocation. Of course one should consider how it correlates with the economic cycle risks of stocks, and even greater economic cycle risks of size and value. This is point I have made often.
The more stable the job (less correlated with equity type risks) the more ability one has to take risk, and vice versa.
Also the longer the period of expected employment the more one can take risks.
But labor capital also has risks--like disability, death, etc. And those risks must be taken into account (via an well-thought-out risk management/insurance plan)
Not sure if that's just some random poster or actually Larry Swedroe but either way, it resonates with me. I wish there were some rules of thumb relating to this concept like "if you earn past X in a very stable job, you could reasonably increase stock exposure by Y" kinda deal. Or "if you are not managing to save Z money per month, then perhaps opt for a less risky portfolio".


The portfolio size would also be relevant as the smaller the portfolio, the bigger your salary impacts it. If your portfolio is very large, salary is but a fraction of the returns. For someone with a tiny portfolio (me), this feels like a pretty relevant subject.

I appreciate the responses, thank you!

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Re: Salary, Portfolio size, and Asset Allocation

Post by Peter Foley » Thu Jan 10, 2019 10:23 pm

I would change the Op's wording slightly. Age, risk tolerance, and retirement savings (or net worth if you wish). While net worth is built into risk tolerance "ability to take risk", some individuals might define risk tolerance as simply willingness to take risk.

Obviously, a person with $10M in assets can adopt a more aggressive AA than a person with $1M. A person with $10M can reduce annual spending more easily than a person who has little room to reduce discretionary spending.

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Re: Salary, Portfolio size, and Asset Allocation

Post by 305pelusa » Thu Jan 10, 2019 10:35 pm

Peter Foley wrote:
Thu Jan 10, 2019 10:23 pm
I would change the Op's wording slightly. Age, risk tolerance, and retirement savings (or net worth if you wish). While net worth is built into risk tolerance "ability to take risk", some individuals might define risk tolerance as simply willingness to take risk.

Obviously, a person with $10M in assets can adopt a more aggressive AA than a person with $1M. A person with $10M can reduce annual spending more easily than a person who has little room to reduce discretionary spending.
Actually, that's an entirely different (and also interesting) concept.

My OP boils down to this:
1) Saved income from your salary acts as another form of "returns" in your portfolio. So it could be considered when setting AA. The bigger the salary, the more it would be considered.
2) As a portfolio is larger/net worth is larger, then the fraction of returns that come from your saved salary income becomes smaller. So the less of an effect your salary has on your AA. The returns are dominated by the portfolio returns themselves. This could mean that a retiree with, say 3M, does not even consider SS in terms of AA for instance. They would keep whatever AA they would have even without SS because the income is small enough compared to the portfolio returns that it wouldn't change much to take it into account.

What you are saying is that the size of the portolio itself could influence the AA. What I'm saying is that the size of the portfolio could dictate how much salary influences the AA. Is that clear? It's a subtle difference.

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Re: Salary, Portfolio size, and Asset Allocation

Post by MotoTrojan » Thu Jan 10, 2019 10:45 pm

Nope. If one makes $100K and the other $200K, but they both save 50% of their income, then the person with the larger "bond" still needs the same amount of growth as the $100K individual, in order to meet their retirement spending needs. If they both save $50K then the $200K salary allows such a high savings rate that that individual doesn't NEED to take as much risk with equities.

Salary is irrelevant; all that matters is your savings rate.

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Re: Salary, Portfolio size, and Asset Allocation

Post by 305pelusa » Thu Jan 10, 2019 10:54 pm

MotoTrojan wrote:
Thu Jan 10, 2019 10:45 pm
Nope. If one makes $100K and the other $200K, but they both save 50% of their income, then the person with the larger "bond" still needs the same amount of growth as the $100K individual, in order to meet their retirement spending needs. If they both save $50K then the $200K salary allows such a high savings rate that that individual doesn't NEED to take as much risk with equities.

Salary is irrelevant; all that matters is your savings rate.
Agreed. My assumption was that as salary goes up, so does saving rates because I'm assuming living costs are somewhat fixed. I did not state that assumption so that's my bad.

But I love your point so let's refine the question. Does savings rate influence AA? Specifically, should a person with a higher savings rate consider investing more in stocks if his/her job is stable or more in bonds if his/her job is volatile than an identical person (same job, same salary, same age, same risk tolerance) who has a lower savings rate?

I believe that encapsulates my question as well. I think it sounds a little more complicated but it is more precise. Any thoughts on that?

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Re: Salary, Portfolio size, and Asset Allocation

Post by 2pedals » Thu Jan 10, 2019 11:09 pm

305pelusa wrote:
Thu Jan 10, 2019 10:11 pm
Human capital is without a doubt the absolute largest source of portfolio returns for young people like myself so this actually matters a lot. If an 80/20 is appropriate for someone earning the median salary at age 20, then said allocation is far more conservative for someone earning 4 times that amount for instance.

This effect would be even more pronounced with people like doctors who could easily earn 6+ times more than their contemporaries (forgetting any debts that might complicate the issue).
The standard of living for people is all over place, but in general the more you make the less % you save. In my experience, successful wealth building is based on how well you can handle risks (don't flip out when the market goes down or things don't go as well as you planned), control costs by living within your means and by building income streams that can last a lifetime. Good salary is important, as well as low or no debt, good spending habits, a responsible spouse, healthy family etc, etc ....

I don't disagree with your statement but there is a lot a variations to the possibilities that could change what your general AA should be, i.e. everybody is different. I just don't see what is different or extreme about you. Bottom line, it is up to you to decide what your AA should be.
Last edited by 2pedals on Fri Jan 11, 2019 11:05 am, edited 1 time in total.

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Re: Salary, Portfolio size, and Asset Allocation

Post by KlangFool » Thu Jan 10, 2019 11:13 pm

305pelusa wrote:
Thu Jan 10, 2019 10:54 pm
MotoTrojan wrote:
Thu Jan 10, 2019 10:45 pm
Nope. If one makes $100K and the other $200K, but they both save 50% of their income, then the person with the larger "bond" still needs the same amount of growth as the $100K individual, in order to meet their retirement spending needs. If they both save $50K then the $200K salary allows such a high savings rate that that individual doesn't NEED to take as much risk with equities.

Salary is irrelevant; all that matters is your savings rate.
Agreed. My assumption was that as salary goes up, so does saving rates because I'm assuming living costs are somewhat fixed. I did not state that assumption so that's my bad.
305pelusa,

Even if that is true, the amount of taxes go up and take a larger bite of the income. Hence, it is not necessarily easier to save. So, depending on your marginal tax rate and tax bracket, your answer could be significantly different.

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Re: Salary, Portfolio size, and Asset Allocation

Post by White Coat Investor » Thu Jan 10, 2019 11:21 pm

305pelusa wrote:
Thu Jan 10, 2019 9:12 pm


That was very interesting. It is a different topic altogether but also sort of in line with what Im asking. What I did find interesting was this response on the thread:
White Coat Investor wrote:
Sun Sep 16, 2007 2:44 pm
Most people factor in their future working/income potential into their asset allocation when they consider their ability to take risk.
That's precisely what I am asking about. Personally, I had not even considered my income potential in my AA. I just kinda read about the age, tolerance, etc and figured some rough percentage. It wasn't until today that I realized that my salary is also a source of return (and for someone with a tiny portfolio, the biggest source of return) so that could have some implication in AA.

I am glad there are others who have noticed this. I will continue reading through the thread. Thank you for the find!
I don't really remember saying that, but then again it's been 12 years. Holy zombie thread.
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Re: Salary, Portfolio size, and Asset Allocation

Post by qwertyjazz » Fri Jan 11, 2019 6:47 am

No really read ‘are you a stock or a bond?’
https://www.kitces.com/blog/investing-a ... or-a-bond/

Above is a review
AA is just a model - need ability willingness to take risk is a very fuzzy concept
You may wind up at the same point as with the fuzzy model but you have a valid point - it just is not new or unique and has been studied a lot
If you want to understand your point - then read more - if you just want advice that will be good enough to live a really good life - pick any reasonable AA - it may or may not matter
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Re: Salary, Portfolio size, and Asset Allocation

Post by Horton » Fri Jan 11, 2019 9:20 am

You pose a good question, but it really needs to be reframed in terms of current/future savings rather than salary. As noted already above, which is better - making $500k and spending $500k OR making $80k and savings $60k. The latter is orders of magnitude better.

I recommend you read up on lifecycle investing. Bill Bernstein has a good, short book on this topic. Here is a link.

I personally develop my asset allocation taking into account the present value of future savings as sort of "human capital bond". Here are some excerpts from my personal Investment Policy Statement:
The purpose of our investment plan is to provide a stream of cash flows, beginning between ages X and Y, to fully cover expected expenses along with Z% surplus assets, excluding home equity, to cover unexpected expenses.

While working, our target asset allocation is determined such that:

- The present value of our future contributions plus our current allocation to fixed income will be sufficient to provide a fixed stream of cash flows between ages X and Y
- Any surplus is invested in Global Equity

The DFA 20XX Target Date Retirement Income Fund may serve as a handy asset allocation benchmark, particularly in the transition from working to retirement.

In retirement, our target asset allocation may determined such that:

- 100% of non-discretionary expenses are covered by Fixed Income (SPIAs or duration matched TIPS funds)
- 100% of discretionary expense budget is covered by Fixed Income (duration matched TIPS funds)
- Any surplus is invested in Global Equity
The allure, for me at least, is that this provides a quantitative and qualitative approach to developing my asset allocation, rather than just selecting the asset allocation du jour of the day. I update my model each year, allowing me to iterate and capture actual changes over the last year and expected future changes.

The downside is that this is a rather conservative approach, requiring that I save more than I might otherwise would if I used the 4% rule. But, it helps me sleep at night. So, I'm sticking with it.
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Re: Salary, Portfolio size, and Asset Allocation

Post by goingup » Fri Jan 11, 2019 9:37 am

305pelusa wrote:
Thu Jan 10, 2019 9:12 pm
My question stands though. If two people with that same "stock"-ish job, same age, same risk tolerance, but person A earns twice as much, then shouldn't person A invest less in stocks than B does? Again, all factors the same.
Exact opposite, in my experience. The more you earn and save, the more equity you may be comfortable holding. Lower earners often have less tolerance to lose because each dollar is more "dear".

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Re: Salary, Portfolio size, and Asset Allocation

Post by MotoTrojan » Fri Jan 11, 2019 10:49 am

305pelusa wrote:
Thu Jan 10, 2019 10:54 pm
MotoTrojan wrote:
Thu Jan 10, 2019 10:45 pm
Nope. If one makes $100K and the other $200K, but they both save 50% of their income, then the person with the larger "bond" still needs the same amount of growth as the $100K individual, in order to meet their retirement spending needs. If they both save $50K then the $200K salary allows such a high savings rate that that individual doesn't NEED to take as much risk with equities.

Salary is irrelevant; all that matters is your savings rate.
Agreed. My assumption was that as salary goes up, so does saving rates because I'm assuming living costs are somewhat fixed. I did not state that assumption so that's my bad.

But I love your point so let's refine the question. Does savings rate influence AA? Specifically, should a person with a higher savings rate consider investing more in stocks if his/her job is stable or more in bonds if his/her job is volatile than an identical person (same job, same salary, same age, same risk tolerance) who has a lower savings rate?

I believe that encapsulates my question as well. I think it sounds a little more complicated but it is more precise. Any thoughts on that?
But the person with a higher savings rate has less need to take risk, along with the increased ability you are referring to. Those are counter points.

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Re: Salary, Portfolio size, and Asset Allocation

Post by 305pelusa » Fri Jan 11, 2019 1:17 pm

MotoTrojan wrote:
Fri Jan 11, 2019 10:49 am
305pelusa wrote:
Thu Jan 10, 2019 10:54 pm
MotoTrojan wrote:
Thu Jan 10, 2019 10:45 pm
Nope. If one makes $100K and the other $200K, but they both save 50% of their income, then the person with the larger "bond" still needs the same amount of growth as the $100K individual, in order to meet their retirement spending needs. If they both save $50K then the $200K salary allows such a high savings rate that that individual doesn't NEED to take as much risk with equities.

Salary is irrelevant; all that matters is your savings rate.
Agreed. My assumption was that as salary goes up, so does saving rates because I'm assuming living costs are somewhat fixed. I did not state that assumption so that's my bad.

But I love your point so let's refine the question. Does savings rate influence AA? Specifically, should a person with a higher savings rate consider investing more in stocks if his/her job is stable or more in bonds if his/her job is volatile than an identical person (same job, same salary, same age, same risk tolerance) who has a lower savings rate?

I believe that encapsulates my question as well. I think it sounds a little more complicated but it is more precise. Any thoughts on that?
But the person with a higher savings rate has less need to take risk, along with the increased ability you are referring to. Those are counter points.
And the argument is that they counter each other by exact amounts such that they offset each other perfectly and hence savings rate is not relevant for AA?

My first impression is that it's unlikely but idk. I'm not super convinced

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Re: Salary, Portfolio size, and Asset Allocation

Post by Horton » Fri Jan 11, 2019 3:42 pm

305pelusa wrote:
Fri Jan 11, 2019 1:17 pm
MotoTrojan wrote:
Fri Jan 11, 2019 10:49 am
305pelusa wrote:
Thu Jan 10, 2019 10:54 pm
MotoTrojan wrote:
Thu Jan 10, 2019 10:45 pm
Nope. If one makes $100K and the other $200K, but they both save 50% of their income, then the person with the larger "bond" still needs the same amount of growth as the $100K individual, in order to meet their retirement spending needs. If they both save $50K then the $200K salary allows such a high savings rate that that individual doesn't NEED to take as much risk with equities.

Salary is irrelevant; all that matters is your savings rate.
Agreed. My assumption was that as salary goes up, so does saving rates because I'm assuming living costs are somewhat fixed. I did not state that assumption so that's my bad.

But I love your point so let's refine the question. Does savings rate influence AA? Specifically, should a person with a higher savings rate consider investing more in stocks if his/her job is stable or more in bonds if his/her job is volatile than an identical person (same job, same salary, same age, same risk tolerance) who has a lower savings rate?

I believe that encapsulates my question as well. I think it sounds a little more complicated but it is more precise. Any thoughts on that?
But the person with a higher savings rate has less need to take risk, along with the increased ability you are referring to. Those are counter points.
And the argument is that they counter each other by exact amounts such that they offset each other perfectly and hence savings rate is not relevant for AA?

My first impression is that it's unlikely but idk. I'm not super convinced
See my post above for background on my comments below.

If my salary miraculously doubled tomorrow and I kept my expenses the same, that would allow my savings rate to more or less triple, settings aside some noise from taxes and other such things. With all the additional savings, I would either (a) plan an earlier retirement date range (asset allocation may stay about the same or it could get a lot more conservative if I plan to retire much sooner) or (b) keep the same retirement date range and invest more in equities (because I would have a larger surplus).
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Re: Salary, Portfolio size, and Asset Allocation

Post by MotoTrojan » Fri Jan 11, 2019 3:54 pm

305pelusa wrote:
Fri Jan 11, 2019 1:17 pm
MotoTrojan wrote:
Fri Jan 11, 2019 10:49 am
305pelusa wrote:
Thu Jan 10, 2019 10:54 pm
MotoTrojan wrote:
Thu Jan 10, 2019 10:45 pm
Nope. If one makes $100K and the other $200K, but they both save 50% of their income, then the person with the larger "bond" still needs the same amount of growth as the $100K individual, in order to meet their retirement spending needs. If they both save $50K then the $200K salary allows such a high savings rate that that individual doesn't NEED to take as much risk with equities.

Salary is irrelevant; all that matters is your savings rate.
Agreed. My assumption was that as salary goes up, so does saving rates because I'm assuming living costs are somewhat fixed. I did not state that assumption so that's my bad.

But I love your point so let's refine the question. Does savings rate influence AA? Specifically, should a person with a higher savings rate consider investing more in stocks if his/her job is stable or more in bonds if his/her job is volatile than an identical person (same job, same salary, same age, same risk tolerance) who has a lower savings rate?

I believe that encapsulates my question as well. I think it sounds a little more complicated but it is more precise. Any thoughts on that?
But the person with a higher savings rate has less need to take risk, along with the increased ability you are referring to. Those are counter points.
And the argument is that they counter each other by exact amounts such that they offset each other perfectly and hence savings rate is not relevant for AA?

My first impression is that it's unlikely but idk. I'm not super convinced
I never said that the counter by exact amounts, but they do counter. You can never know the exact/perfect AA without knowing the returns for the rest of your investing lifetime in advance. It is a highly personal decision, but I am simply stating that a higher savings rate doesn't automatically mean the only logic choice is to take on more risk, as you technically need less growth (risk) for the same earning/investing timeframe.

n00b
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Re: Salary, Portfolio size, and Asset Allocation

Post by n00b » Fri Jan 11, 2019 4:37 pm

I think that one's employment prospects and earning potential have a place in determining one's appetite for risk, especially in relation to one's living expenses, but people with high incomes may also have high living expenses.

A somewhat related idea may be the counting of a pension as a bond but the argument against doing so is that the pension impacts both the ability and the need to take risk.

A person with high income and low living expenses may have more ability to take risk but also less need.

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305pelusa
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Re: Salary, Portfolio size, and Asset Allocation

Post by 305pelusa » Fri Jan 11, 2019 7:38 pm

MotoTrojan wrote:
Fri Jan 11, 2019 3:54 pm
305pelusa wrote:
Fri Jan 11, 2019 1:17 pm
MotoTrojan wrote:
Fri Jan 11, 2019 10:49 am
305pelusa wrote:
Thu Jan 10, 2019 10:54 pm
MotoTrojan wrote:
Thu Jan 10, 2019 10:45 pm
Nope. If one makes $100K and the other $200K, but they both save 50% of their income, then the person with the larger "bond" still needs the same amount of growth as the $100K individual, in order to meet their retirement spending needs. If they both save $50K then the $200K salary allows such a high savings rate that that individual doesn't NEED to take as much risk with equities.

Salary is irrelevant; all that matters is your savings rate.
Agreed. My assumption was that as salary goes up, so does saving rates because I'm assuming living costs are somewhat fixed. I did not state that assumption so that's my bad.

But I love your point so let's refine the question. Does savings rate influence AA? Specifically, should a person with a higher savings rate consider investing more in stocks if his/her job is stable or more in bonds if his/her job is volatile than an identical person (same job, same salary, same age, same risk tolerance) who has a lower savings rate?

I believe that encapsulates my question as well. I think it sounds a little more complicated but it is more precise. Any thoughts on that?
But the person with a higher savings rate has less need to take risk, along with the increased ability you are referring to. Those are counter points.
And the argument is that they counter each other by exact amounts such that they offset each other perfectly and hence savings rate is not relevant for AA?

My first impression is that it's unlikely but idk. I'm not super convinced
I never said that the counter by exact amounts, but they do counter. You can never know the exact/perfect AA without knowing the returns for the rest of your investing lifetime in advance. It is a highly personal decision, but I am simply stating that a higher savings rate doesn't automatically mean the only logic choice is to take on more risk, as you technically need less growth (risk) for the same earning/investing timeframe.
Let me give you a hypothetical scenario. You own 1M in stocks and 1M in bonds. You like your 50/50 allocation and feel happy.

But the next day, your dad wins the lottery, buys 1M in bonds and gives it to you because he loves you. Ignore taxes for a second. Now you have 1M in stocks and 2M in bonds.

Here's what I would do and find logical. I would most likely sell 0.5M of bonds and buy 0.5M of stocks to reach back to 50/50 (1.5M in each). This is the AA you like and just because your portfolio is bigger doesn't mean you should be deviating from your AA.

But what you seem to advice is to not do anything and stay at 1M stocks and 2 M bonds because, yes, your AA is more conservative now ("you can take more risk") but your portfolio is bigger now ("you don't need to take more risk"). So you liked your AA at 50/50 when you had 2M, but you want it at 33/66 when you have 3 M.

So answer me this: "Are you increasing your bond allocation as your portfolio is getting bigger?" Because I really, really doubt you do. I imagine you use the BH principle of just sticking to your AA and staying the course, even as your assets grow.

Now just think of that gifted bond as simply a large salary raise. If you keep your AA in the face of increases in salary, it is akin to being gifted bonds and not rebalancing the portfolio.

I guess that's OK with you but I thought the BH principle was to pick an AA and stick to it and stay the course. If you are given bonds, stocks crash, SS kicks in, increases in salary, decreases it stocks, etc, then you'd take the steps to rebalance it back to your desired allocation.

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Re: Salary, Portfolio size, and Asset Allocation

Post by LeisureLee » Fri Jan 11, 2019 7:59 pm

I think I see what you're getting at. I'm trying to decide if savings rate or retirement age are the best variable here.

If I've been saving for retirement and on the day I planned to retire my portfolio isn't as big as I'd planned, I would (try to) work longer.

The younger I am, the safer I feel planning on having to work longer, so I might choose a more aggressive asset allocation.

If I have a higher savings rate, then it takes fewer years to save up for retirement, and an extra annual contribution at the end is a larger percentage of the portfolio. This means it'll take fewer years to fix a given shortfall.

I think the reason that the maxim is "need, willingness, and ability" to take risk is to remind us that our psychology is crucial to the decision.

If my higher savings rate allows me to retire sooner, I have a greater ability to take risk. Will I use that extra ability to take more risk hoping to retire even sooner, or to take less risk because I can do so and still have a reasonable retirement age?

I can't speak for others, but what I've noticed personally is that as my need to take risk drops, my willingness seems to drop along with it. =)

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Re: Salary, Portfolio size, and Asset Allocation

Post by 2pedals » Fri Jan 11, 2019 8:14 pm

A big salary can be based an bad bosses, high cost of living, bad days, long days, unhappy customers, workplace stress, unsecured employment, nasty co-workers, lost hours doing something else you would rather not be doing, spousal stress, etc, etc. Bonds do not have that kind of emotional baggage.

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Re: Salary, Portfolio size, and Asset Allocation

Post by KlangFool » Fri Jan 11, 2019 8:31 pm

OP,

It is very simple.

You could not get the right answer because you have been using the wrong metric. Aka measurement.

A) It has nothing to do with income at all.

B) It has to do with the expense.

Let's assume that your goal is Financial Independent. And, your FI number is 30 times your current annual expense. Then, your question could be answered easily based on

1) Your portfolio size as a multiple of your current annual expense.

2) Your saving rate as a multiple of your current annual expense.

Let's call your current annual expense as X.

A) Your portfolio size is 10X and your saving rate is 3X

B) Your portfolio size is 10X and your saving rate is X

Your AA would be different from (A) versus (B).

Please note that we do not even need to know anything about your income at all. And, the answer will be the same whether your income is 100K or 1 million.

If your goal is retirement, just substitute current annual expense with retirement expense.

KlangFool

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305pelusa
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Re: Salary, Portfolio size, and Asset Allocation

Post by 305pelusa » Fri Jan 11, 2019 9:04 pm

KlangFool wrote:
Fri Jan 11, 2019 8:31 pm
OP,

It is very simple.

You could not get the right answer because you have been using the wrong metric. Aka measurement.

A) It has nothing to do with income at all.

B) It has to do with the expense.

Let's assume that your goal is Financial Independent. And, your FI number is 30 times your current annual expense. Then, your question could be answered easily based on

1) Your portfolio size as a multiple of your current annual expense.

2) Your saving rate as a multiple of your current annual expense.

Let's call your current annual expense as X.

A) Your portfolio size is 10X and your saving rate is 3X

B) Your portfolio size is 10X and your saving rate is X

Your AA would be different from (A) versus (B).

Please note that we do not even need to know anything about your income at all. And, the answer will be the same whether your income is 100K or 1 million.

If your goal is retirement, just substitute current annual expense with retirement expense.

KlangFool
Once again, I agree. It's about the savings rate not income. The only reason why I say income is selfish almost; it makes more sense for me personally to think of more money coming in, so more money going to portfolio because I'm personally not one who overspends.

But yes, like I said earlier, savings rate is more precise.


This thread has given me plenty of food for thought and I appreciate all the responses. I'm just trying to invest consciously and taking into account all forms of portfolio returns in considering my AA such that I have a way to effectively manage risk.

With this form of thinking, one could make the argument that if my salary is cut (AND hence my savings rate decreases) that I have two options: cut expenses, or shift some of the stocks to bonds. Otherwise, I could be exposed to a larger level of risk than I want without noticing at all.

That's kinda what it all boils down to

KlangFool
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Re: Salary, Portfolio size, and Asset Allocation

Post by KlangFool » Fri Jan 11, 2019 9:09 pm

305pelusa wrote:
Fri Jan 11, 2019 9:04 pm

With this form of thinking, one could make the argument that if my salary is cut (AND hence my savings rate decreases) that I have two options: cut expenses, or shift some of the stocks to bonds. Otherwise, I could be exposed to a larger level of risk than I want without noticing at all.
305pelusa,

<<if my salary is cut >>

A) Or, you do not have to do anything if your portfolio is big enough.

B) Unless you have solid job security, you could be unemployed too. So, your AA should always account for that.

I believe after all said and done, you will find that 60/40 is good enough.

KlangFool

P.S.: My AA range from 70/30 to 60/40. My retirement AA would be 60/40.

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Re: Salary, Portfolio size, and Asset Allocation

Post by MotoTrojan » Fri Jan 11, 2019 9:13 pm

305pelusa wrote:
Fri Jan 11, 2019 7:38 pm
MotoTrojan wrote:
Fri Jan 11, 2019 3:54 pm
305pelusa wrote:
Fri Jan 11, 2019 1:17 pm
MotoTrojan wrote:
Fri Jan 11, 2019 10:49 am
305pelusa wrote:
Thu Jan 10, 2019 10:54 pm

Agreed. My assumption was that as salary goes up, so does saving rates because I'm assuming living costs are somewhat fixed. I did not state that assumption so that's my bad.

But I love your point so let's refine the question. Does savings rate influence AA? Specifically, should a person with a higher savings rate consider investing more in stocks if his/her job is stable or more in bonds if his/her job is volatile than an identical person (same job, same salary, same age, same risk tolerance) who has a lower savings rate?

I believe that encapsulates my question as well. I think it sounds a little more complicated but it is more precise. Any thoughts on that?
But the person with a higher savings rate has less need to take risk, along with the increased ability you are referring to. Those are counter points.
And the argument is that they counter each other by exact amounts such that they offset each other perfectly and hence savings rate is not relevant for AA?

My first impression is that it's unlikely but idk. I'm not super convinced
I never said that the counter by exact amounts, but they do counter. You can never know the exact/perfect AA without knowing the returns for the rest of your investing lifetime in advance. It is a highly personal decision, but I am simply stating that a higher savings rate doesn't automatically mean the only logic choice is to take on more risk, as you technically need less growth (risk) for the same earning/investing timeframe.
Let me give you a hypothetical scenario. You own 1M in stocks and 1M in bonds. You like your 50/50 allocation and feel happy.

But the next day, your dad wins the lottery, buys 1M in bonds and gives it to you because he loves you. Ignore taxes for a second. Now you have 1M in stocks and 2M in bonds.

Here's what I would do and find logical. I would most likely sell 0.5M of bonds and buy 0.5M of stocks to reach back to 50/50 (1.5M in each). This is the AA you like and just because your portfolio is bigger doesn't mean you should be deviating from your AA.

But what you seem to advice is to not do anything and stay at 1M stocks and 2 M bonds because, yes, your AA is more conservative now ("you can take more risk") but your portfolio is bigger now ("you don't need to take more risk"). So you liked your AA at 50/50 when you had 2M, but you want it at 33/66 when you have 3 M.

So answer me this: "Are you increasing your bond allocation as your portfolio is getting bigger?" Because I really, really doubt you do. I imagine you use the BH principle of just sticking to your AA and staying the course, even as your assets grow.

Now just think of that gifted bond as simply a large salary raise. If you keep your AA in the face of increases in salary, it is akin to being gifted bonds and not rebalancing the portfolio.

I guess that's OK with you but I thought the BH principle was to pick an AA and stick to it and stay the course. If you are given bonds, stocks crash, SS kicks in, increases in salary, decreases it stocks, etc, then you'd take the steps to rebalance it back to your desired allocation.
The Boglehead approach is to pick an AA based on your need, willingness, and ability to take risk. You are not supposed to make AA changes based on the market (no market timing) but you are supposed to make changes based on your N, W, and A. Your willingness may be unchanged, your ability has increased, but your need has decreased. Again, I have not stated what I would do or what I would suggest others do (I'd probably take the full $1M in equity) but my logic still applies.

It is the same reason it makes sense for someone in their early years to be 100/0, as they need more growth then, but once they have reached their number (won the game) they do not.

Again (again), I am not saying what to do, but there are certainly competing forces here and that isn't an opinion.

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