Asset allocation for 5% return

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Tyler Aspect
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Re: Asset allocation for 5% return

Post by Tyler Aspect » Mon Nov 13, 2017 5:26 pm

I think the owner of the business wants to set up a cash balance plan with a 5% guarantee rate of return. Many has rightfully commented that the 5% guarantee is excessive and unsustainable. A safe guarantee rate can be tied to the yield of the 12 month Treasury Bills, but that guaranteed rate makes this into a high interest savings account at best.

Maybe an insurance provider such as TIAA can offer a better rate, but at a higher cost to the business.
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Jimsad
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Re: Asset allocation for 5% return

Post by Jimsad » Mon Nov 13, 2017 5:38 pm

Wrong funds ,
In a cash balance plan , the employees do not have to make any contributions (unlike 401k).
It is the employer who not only makes contributions ( not by reducing their pay- thus is in addition to their salary) to the account was on behalf of the employees but also gives the guaranteed return for duration of plan by taking risk of putting extra contributions if returns are low .
So I do not understand how the employees are getting a raw deal here?
We already have a 401 k with match .
This plan is in addition to that .

wrongfunds
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Re: Asset allocation for 5% return

Post by wrongfunds » Mon Nov 13, 2017 6:12 pm

Well, then I still have to ask as to where the number 5% came from? As everybody has said, that number is NOT possible using available market only.

If you are willing to backstop year after year as a cost of doing business and as part of employee compensation, then you can either use balanced investment and take risk that in some years you will have to put lot of money from the company's coffers or settle for one year treasury yield and backstop a known and smaller amount every single year.

I do not believe there is any other solution.

Why not just put the money in their retirement account and let them (aka available selection of the funds that you yourself will be using) put in their choice of funds?

Jimsad
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Re: Asset allocation for 5% return

Post by Jimsad » Mon Nov 13, 2017 6:38 pm

Thank you everyone for your input .
It helped me a lot .

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QuentinCrisp
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Re: Asset allocation for 5% return

Post by QuentinCrisp » Mon Nov 13, 2017 6:51 pm

I'll offer my 2 cents as a fellow small business owner with a cash balance plan, to add some additional perspective and perhaps to view the funding requirements through a different lens. I suspect OP's plan has a 5% guaranteed interest rate because the plan's funding for non-owner employees is relatively small compared to the owner's portion. If you lowered the % for non-owners or tied the % to actual market returns, there is a greater risk that the plan might run afoul of anti-discrimination rules. In that sense, 5% provides a level of safety for your plan in terms of compliance while keeping the required contributions somewhat low. My plan has a similar rate for that very reason. I manage the plan as I would any other retirement account such as my personal 401(k) or other tax deferred accounts with a conservative AA in the 50/50 to 60/40 range. My goal is not to generate (hypothetically) 5% per year to cover the guaranteed rate applicable to employees but to safely optimize returns over a multi year (or decade) time line just as with a 401(k). The 5% plus relatively small contributions made for employees is the price for being able to tax defer a substantial portion of owner profits. My personal view is that focusing on earning 5% per year return for each employee loses the bigger picture of how the plan works for owners over the long term. On last note, to manage the funds OP could consult an hourly advisor, but one can also retain an investment manager at an AUM rate much lower than the rate mentioned in OP's post (even less than half of the rate suggested by the OP), if there is desire to have another fiduciary on board to help manage risk.

Regards, Quentin

Jimsad
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Re: Asset allocation for 5% return

Post by Jimsad » Mon Nov 13, 2017 6:56 pm

I will study the returns of the various bond funds and treasuries as I plan on using these mainly .
The 5% was suggested by actuary who set up the plan .
Initially the assets wil not be very high.
So after the first year two , If I am badly falling short , I will consider an amendment to plan to lower the return rate to 3 or 4 %

Jimsad
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Re: Asset allocation for 5% return

Post by Jimsad » Mon Nov 13, 2017 6:59 pm

Thanks Quentin . Great to hear from someone who is actually
In my situation

ryman554
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Re: Asset allocation for 5% return

Post by ryman554 » Tue Nov 14, 2017 9:30 am

Jimsad wrote:
Mon Nov 13, 2017 4:51 pm
And I as the owner of the company take the risk
No, you as the owner of the company most certainly do not take the risk unless you have a personal liability if the company goes under. The company takes the risk. When the liabilities for this little plan become too large because you either underfunded it or took too big of a gamble because it costs too much to operate, what do you think happens to the free cash flow of the company?

So, let me restate: I now actually believe that the employees take the risk. And the investors in this plan (which could/would be yourself) take the risk. So, I guess you do take some risk, but not as the owner of the company, but as an investor in the plan.

Now that I am thinking about it some more: When (not if) the plan fails** I guess the employees and investors will want to go after somebody, and that just might be the plan administrator. So, I guess you do take some more risk, but not as owner of the company, but as the plan administrator.

All this for a tax break? You're gonna do what you're gonna do. You have been given the advise that, if you do this, you should just budget the 5% from company cash flow and be done with it. I'm guessing you aren't going to do that, either, so I would strongly suggest hiring an outside expert to run this thing for you, and purchase insurance to cover the arrears when it happens.

**because its' impossible to guarantee 5% and I, quite frankly, am not confident that you really quite grasp why yet, so are likely not particularly qualified to set this complex thing up. Disclosure: I'm not, nor are virtually any of the folks on this board, qualified either, but we know what we don't know.

wrongfunds
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Re: Asset allocation for 5% return

Post by wrongfunds » Tue Nov 14, 2017 9:48 am

Here is the confusing part. One does not become somebody who is in a position to start a successful company and being able to employ other people without being smart and determined. The smart person has to understand when he is trying to do something which is not possible to do given the current knowledge and the current environment What is being asked is equivalent to creating a perpetual motion machine.

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QuentinCrisp
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Re: Asset allocation for 5% return

Post by QuentinCrisp » Tue Nov 14, 2017 11:01 am

Op states, "I am in a situation where I need to manage an investment account to get 5% annual yearly return." I don't agree with this perspective. Rather, I would say OP established a cash plan balance that requires, as part of its operating obligations, a 5% return on employer contributions made on behalf of non-owner employees. The vested employee benefits in that plan are likely a very small portion of the total plan assets (single digit percentage), compared with the owner's much larger portion. I don't think the plan should be managed with the goal of ensuring an actual 5% return -- that's really just a cost of plan maintenance. Of course, if it is a struggle to fund the plan each year due to cash flow issues, then a cash balance plan is not the right plan for a small business. One can consider freezing the plan if funding is problematic, or terminating, though the IRS may take a careful look if the plan terminates less than 10 years after formation. But what I want to stress is the 5% should not be driving the plan's long term investments, but rather be viewed as a cost of maintaining the plan. If funding has become difficult, talk to your actuary about reducing the funding for owners until cash flow improves, or freezing the plan if its long term viability is in question.
Quentin

Jimsad
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Re: Asset allocation for 5% return

Post by Jimsad » Sat Nov 18, 2017 5:42 am

Thank you for replies .

Quentin and Ryman and others ,

Basically , the way I see it , the company should be able to guarantee 5% return for the participants ( cash balance plan is a type of pension plan with guaranteed benefit).

My perspective is at present time ,the company can afford to guarantee that , while the total holdings are in ‘low to mid 6 figures range’ even if the actual returns come back something crazy like negative 25%.

So my thinking is why not try it myself while the balances are on low side? This is because I do not believe the financial advisors have a magic formula to guarantee anything . What I learnt was that they choose conservative investments to mitigate too much downside risk.
So I am thinking of doing myself , and after a year or two , hire a Financial advisor if I am getting crazy returns every year.
Especially as balances increase , my threshold for hiring extra help will be lower .
I am leaning towards Vanguard life strategy income fund at this time but can go more conservative in future as needed .

Jimsad
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Re: Asset allocation for 5% return

Post by Jimsad » Sat Nov 18, 2017 5:57 am

My asset allocation is 65:35 (stocks :Bonds) for my personal investment portfolio which I do not think is appropriate for the cash balance plan as this plan has different objectives as I explained

Jimsad
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Re: Asset allocation for 5% return

Post by Jimsad » Sat Nov 18, 2017 5:57 am

My asset allocation is 65:35 (stocks :Bonds) for my personal investment portfolio which I do not think is appropriate for the cash balance plan as this plan has different objectives as I explained

ryman554
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Re: Asset allocation for 5% return

Post by ryman554 » Sat Nov 18, 2017 3:41 pm

Jimsad wrote:
Sat Nov 18, 2017 5:42 am
Thank you for replies .

Quentin and Ryman and others ,

Basically , the way I see it , the company should be able to guarantee 5% return for the participants ( cash balance plan is a type of pension plan with guaranteed benefit).

My perspective is at present time ,the company can afford to guarantee that , while the total holdings are in ‘low to mid 6 figures range’ even if the actual returns come back something crazy like negative 25%.

So my thinking is why not try it myself while the balances are on low side? This is because I do not believe the financial advisors have a magic formula to guarantee anything . What I learnt was that they choose conservative investments to mitigate too much downside risk.
You're darn straight they mitigate downside risk. Your'e basically funding a mini-pension/endowment -- except that you cannot rely on returning principal during downturns. There is a big difference, as you note, with being tolerant of low/negative returns by "not selling low" and being contractually/legally obligated to return 1.05x of the depositors money on demand (as in they choose to leave the company) each and every year.

Let's take the worst case -- 2008 and your company hits the skids so you have to layoff your entire workforce and/or access this deferred profit plan to keep the doors open. Whatever your plan is *has* to account for that -- or worse. Will it? Do you know what happens if you don't?

*If*, as you say, you can do this with returns of -25% today, you have a good business. Then is seems like a no-brainer to me to place/transfer that 1.05x/whatever in the equivalent of a checking account so your employees are sure to be whole and let the rest ride with whatever long-term growth strategy you have, knowing nothing of the recording or growth requirements of the plan.

gips
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Re: Asset allocation for 5% return

Post by gips » Sat Nov 18, 2017 3:58 pm

before I retired I was a co-owner of a 125 person business with expertise in providing consulting services to asset and wealth managers We knew an awful lot about managing money but chose to outsource everything outside of our core business focus and that would be my recommendation to you. Focus on building your business and let someone else manage this. The very fact that you're asking for an aa with a 5% return underscores this point.

look at it another way. Let's say the balance hits $1mm. Are you better off spending an hour (or more) a week looking at returns and managing asset allocation (and worrying about liability) or giving a company 1% of aum while your time is spent increasing revenue, reducing costs and improving control over your business?

bsteiner
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Re: Asset allocation for 5% return

Post by bsteiner » Sat Nov 18, 2017 6:04 pm

There's a good chance that any reasonable asset allocation will average 5% over a long enough time. But it might not.

If you don't want to take the chance that it won't, then instead of this, you could add a profit-sharing aspect to the 401(k) plan. A profit-sharing plan gives you flexibility as to the contributions. It's often possible, within certain limits, to contribute a higher percentage of compensation for you than for the employees.

A good actuary should be able to design a plan that best accomplishes your objectives.

Your lawyer should be able to recommend a good actuary.

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