A few asset allocation questions

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MEA
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A few asset allocation questions

Post by MEA » Thu Nov 08, 2018 6:04 pm

As far as investing goes I have been very very fortunate. Over the years I have had long conversations about investing with both my grandfather and my father. They taught me about indexing, buy and hold, and everything else I needed to know. But their views on AA are very very different.

So In one ear I have advice from my father. In the other ear I have the advice from my grandfather (1908-1999). In my father’s view the risk is inflation. Dad was born in 1938. My grandfather always felt that the biggest risk is the stock market itself. I am at 50/50 now. It is a wonderful portfolio (went through October stress free), but I am a little bit concerned about missed opportunity cost.

How is our risk tolerance formed? Does it come from our life experience, or are we born with it?

Should my grandfather‘s opinion hold more weight than my father’s because he was alive in 1929?

Should my fathers opinion hold more weight than my grandfather’s because he is alive today and his view may be more relevant to the present time period?

I am finding AA to be the most difficult part of investing. I have my own opinions on these questions but I would love to hear the opinions of others. Hopefully I can learn something about how people arrived at their AA.
“Stay the course is the most important piece of advice I can give you.”-Bogle

Jon H
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Re: A few asset allocation questions

Post by Jon H » Thu Nov 08, 2018 8:32 pm

You’re going to get a variety of answers.

Your situation is unique so you will need to adjust your level of risk so you can sleep (whether that means decreasing or increasing your risk)

Here is what finally worked for me:
Worst case scenario in recent memory is about 50% market loss.
So, I figure I am good with trading 2-3 years worth of work savings to accept that level of risk (in other words 2-3 years worth of savings equals 50% stock market loss value).
At the moment, that is in the range of 40% US stock: 20% international stock :40% fixed income.

Once fixed income reaches 10 years worth of expenses for my financial independence phase, the rest will go into stock, at which time I won’t pay attention to asset allocation.
Consider gain and loss, but never be greedy and everything will be alright (fortune cookie)

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arcticpineapplecorp.
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Re: A few asset allocation questions

Post by arcticpineapplecorp. » Thu Nov 08, 2018 9:52 pm

very interesting questions and very interesting scenario.

There are different ways to look at risk (inflation risk vs. market risk are the two you're concerned about).
There are different ways to look at asset allocation.

Risk first --

I think inflation is a more intangible form of risk especially when it's lowish (as opposed to high inflation of the 70s/80s). You don't see your money losing purchasing power, but it is. But it could take 20 years to notice. This is why many don't start complaining about the price of everything until they are in their 40s/50s. They remember what they paid for a hamburger (or whatever) in their 20s and now in their late 40s/early 50s it could be twice the price (prices take 24 years to double if inflation is 3% per year, 20 years to double if inflation was 3.5% per year). So when you have that insight and you get to retirement in your 60s but realize you might live another 30-40 years and aren't working, it's pretty scary to think about the fact that you've got to get your savings to last and beat inflation at the same time you're withdrawing from them over decades.

People obviously are concerned about market risk and watching their nest egg decline. But there are declines most years. Maybe not 30% declines, but still, with time and experience you should get used to seeing your money go down and then up again (the market has gone up more than it's gone down) (https://www.businessinsider.com/histori ... ffs-2014-2). And most bull markets tend to run much longer than most bear markets. But people are still worried about a prolonged bear market. If you have enough in safer assets then you should be able to ride out even protracted bears. I give the example of the Target Date Funds which if you buy one that has a date that closely matches the year you plan to retire, when you get to that date it's allocated 50/50 stocks and bonds at retirement. Therefore half of your money is relatively safe (from a market risk perspective, inflation is another story regarding bonds and inflation). So if you have enough to last 30 years (4% safe withdrawl rate) then presumably you have enough safe money to last 15 years and therefore as long as a bear which affects the other half of your stock money doesn't last longer than 15 years, you should have enough to draw upon (from bonds) and allow your stocks to recover (don't touch them). The Great Depression was technically two deep recessions but if you want to lump them together since the second one started only 3 months after the first one ended then 1929-1945 (start to end) lasted 16 years. We haven't had anything like that since. Doesn't mean we can't. But hopefully we've learned some things since then regarding monetary and fiscal policy and how to lessen rather than prolong recessions. This is why learning one's history is important.

Now about Asset Allocation --
Jack Bogle has said he has half his money in stocks and half in bonds and half the time he worries he isn't taking enough risk and the other half the time he worries he is taking too much risk. That's how it is. You'll never have the perfect portfolio. You'll always wonder if you're missing gains from stocks by holding bonds or you'll wonder if you are taking too much risk and should hold more bonds and so on.

What many do is pick an allocation that allows a maximum loss (like what Larry Swedroe provided based on the 73-74 bear market):

Image

Other's might look at an allocation that delivers a return they need like this (these are only examples from past returns):

Image

Obviously you have to join the two. You might want to earn 7% a year (80/20 from above) but you might not want to risk a 35% loss (80/20 from above). So you've got to marry the risk/return profile.

You can do planning. If you've won the game, you can stop playing (don't need to take risk). You might be more aggressive than you need to be. Why shoot for 7% returns when you could achieve your goal with less risk and getting 5% instead?

Short of that, you could just follow a similar glide path as the target date funds. You could do worse.

You're also asking if our opinions about investing are shaped by our experiences. I'm not sure how they couldn't be. My father's big conern was inflation but that was because he lived through the 70s-80s when it was higher than average/historical. But he was also concerned with risk because he lost money investing in individual stocks. But he took the wrong risks. He took concentrated risks that didn't pay off. He also thought the stock market was riskier because it was up to so many factors outside his control. So he started a business thinking he'd have more control over many factors. He didn't learn his lesson though because he concentrated his risk in his business. He also didn't set things up so that as his human capital decreased as he got older, he could protect his assets. Instead, he lost it all. I have learned much from the types of risk my father took and what he could have/should have learned but didn't. I don't thnk about risk the same way he did and I think differently about the risks he took than he did. So our experiences are very personal and we learn things (and maybe don't learn other things that others see). Good to ask these questions. Hopefully some of this helps. Let us know.
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

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MEA
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Re: A few asset allocation questions

Post by MEA » Sat Nov 10, 2018 8:03 am

arcticpineapplecorp. wrote:
Thu Nov 08, 2018 9:52 pm
very interesting questions and very interesting scenario.

There are different ways to look at risk (inflation risk vs. market risk are the two you're concerned about).
There are different ways to look at asset allocation.

Risk first --

I think inflation is a more intangible form of risk especially when it's lowish (as opposed to high inflation of the 70s/80s). You don't see your money losing purchasing power, but it is. But it could take 20 years to notice. This is why many don't start complaining about the price of everything until they are in their 40s/50s. They remember what they paid for a hamburger (or whatever) in their 20s and now in their late 40s/early 50s it could be twice the price (prices take 24 years to double if inflation is 3% per year, 20 years to double if inflation was 3.5% per year). So when you have that insight and you get to retirement in your 60s but realize you might live another 30-40 years and aren't working, it's pretty scary to think about the fact that you've got to get your savings to last and beat inflation at the same time you're withdrawing from them over decades.

People obviously are concerned about market risk and watching their nest egg decline. But there are declines most years. Maybe not 30% declines, but still, with time and experience you should get used to seeing your money go down and then up again (the market has gone up more than it's gone down) (https://www.businessinsider.com/histori ... ffs-2014-2). And most bull markets tend to run much longer than most bear markets. But people are still worried about a prolonged bear market. If you have enough in safer assets then you should be able to ride out even protracted bears. I give the example of the Target Date Funds which if you buy one that has a date that closely matches the year you plan to retire, when you get to that date it's allocated 50/50 stocks and bonds at retirement. Therefore half of your money is relatively safe (from a market risk perspective, inflation is another story regarding bonds and inflation). So if you have enough to last 30 years (4% safe withdrawl rate) then presumably you have enough safe money to last 15 years and therefore as long as a bear which affects the other half of your stock money doesn't last longer than 15 years, you should have enough to draw upon (from bonds) and allow your stocks to recover (don't touch them). The Great Depression was technically two deep recessions but if you want to lump them together since the second one started only 3 months after the first one ended then 1929-1945 (start to end) lasted 16 years. We haven't had anything like that since. Doesn't mean we can't. But hopefully we've learned some things since then regarding monetary and fiscal policy and how to lessen rather than prolong recessions. This is why learning one's history is important.

Now about Asset Allocation --
Jack Bogle has said he has half his money in stocks and half in bonds and half the time he worries he isn't taking enough risk and the other half the time he worries he is taking too much risk. That's how it is. You'll never have the perfect portfolio. You'll always wonder if you're missing gains from stocks by holding bonds or you'll wonder if you are taking too much risk and should hold more bonds and so on.

What many do is pick an allocation that allows a maximum loss (like what Larry Swedroe provided based on the 73-74 bear market):

Image

Other's might look at an allocation that delivers a return they need like this (these are only examples from past returns):

Image

Obviously you have to join the two. You might want to earn 7% a year (80/20 from above) but you might not want to risk a 35% loss (80/20 from above). So you've got to marry the risk/return profile.

You can do planning. If you've won the game, you can stop playing (don't need to take risk). You might be more aggressive than you need to be. Why shoot for 7% returns when you could achieve your goal with less risk and getting 5% instead?

Short of that, you could just follow a similar glide path as the target date funds. You could do worse.

You're also asking if our opinions about investing are shaped by our experiences. I'm not sure how they couldn't be. My father's big conern was inflation but that was because he lived through the 70s-80s when it was higher than average/historical. But he was also concerned with risk because he lost money investing in individual stocks. But he took the wrong risks. He took concentrated risks that didn't pay off. He also thought the stock market was riskier because it was up to so many factors outside his control. So he started a business thinking he'd have more control over many factors. He didn't learn his lesson though because he concentrated his risk in his business. He also didn't set things up so that as his human capital decreased as he got older, he could protect his assets. Instead, he lost it all. I have learned much from the types of risk my father took and what he could have/should have learned but didn't. I don't thnk about risk the same way he did and I think differently about the risks he took than he did. So our experiences are very personal and we learn things (and maybe don't learn other things that others see). Good to ask these questions. Hopefully some of this helps. Let us know.
It does help. Thanks for taking the time to write it. This thread is really just a continuation of one I started about two years ago.viewtopic.php?f=10&t=200167&p=3065260#p3065260

You helped me out then too. About six months ago I decided to switch to a balanced portfolio. After thinking about it a lot I ended up 25% in MM, 25% VTBIX, 50% VTSAX. The difference has been like night and day. I don’t look at the markets much anymore. I am very comfortable now. But now I’m wondering if I went to far? I probably should be a little bit uncomfortable?
“Stay the course is the most important piece of advice I can give you.”-Bogle

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arcticpineapplecorp.
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Re: A few asset allocation questions

Post by arcticpineapplecorp. » Sat Nov 10, 2018 8:23 am

MEA wrote:
Sat Nov 10, 2018 8:03 am
It does help. Thanks for taking the time to write it. This thread is really just a continuation of one I started about two years ago.viewtopic.php?f=10&t=200167&p=3065260#p3065260

You helped me out then too. About six months ago I decided to switch to a balanced portfolio. After thinking about it a lot I ended up 25% in MM, 25% VTBIX, 50% VTSAX. The difference has been like night and day. I don’t look at the markets much anymore. I am very comfortable now. But now I’m wondering if I went to far? I probably should be a little bit uncomfortable?
Some would say it's best to have a portfolio that lets you sleep well at night. Everyone's comfort level is different. Guess that's why there can be disparities with comfort level and investments between couples (one is willing to take more risk than the other). They've got to work that out somehow between them. And that comfort level can obviously change with time. Many (not all) are more comfortable with taking more risk in their 20s than they are in their 50s for obvious reasons. Though I've seen it go the other way as well, and that increased comfort with risk sometimes only comes with age and/or experience.
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

Dandy
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Re: A few asset allocation questions

Post by Dandy » Sat Nov 10, 2018 8:28 am

Determining your risk tolerance and translating that into an investment allocation is an educated guess translated into another educated guess. And those guesses would likely change depending on your investing experience and age. Most in the accumulation stage can tolerate market declines without too much stress. They are contributing each paycheck and getting a company match and have years/decades before they plan to use those assets.

As the nest egg grows and you age the dollar amount at risk and the declining human capital can, and maybe should, have you reexamine your level of risk. e.g. If you are 30 with 200k in your 401k with a good job and the market drops 25% you have 150k. If you are 58 with a nest egg of 1.5 million a 25% drop is 375k. That can affect your tolerance for risk and how you translate that into an allocation. You may have assumed that 1.5 million would grow to 2+ million in a few years and you could retire with ease. Now you are worried about the 1.5 dropping further and/or not growing back in time for your retirement. And of course when the market drops a lot it can affect your employment and reemployment especially at age 58.

I think you have a reasonable allocation of 50/50 for most stages of life. If market drops keep you awake then you might need to scale back, if not you might be able to take more risk. Just keep in mind your asset level/goal and your age. I view investing as a means to an end i.e. to get enough to retire with a desired life style. Once I get to that asset level or close to it I don't need to take the same amount of risk. I don't need to double my "number" just get to it and then beat inflation and maybe a bit more. Truthfully, I think that is a minority view but it works for me. :happy

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MEA
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Re: A few asset allocation questions

Post by MEA » Sat Nov 10, 2018 3:19 pm

Dandy wrote:
Sat Nov 10, 2018 8:28 am
Determining your risk tolerance and translating that into an investment allocation is an educated guess translated into another educated guess. And those guesses would likely change depending on your investing experience and age. Most in the accumulation stage can tolerate market declines without too much stress. They are contributing each paycheck and getting a company match and have years/decades before they plan to use those assets.

As the nest egg grows and you age the dollar amount at risk and the declining human capital can, and maybe should, have you reexamine your level of risk. e.g. If you are 30 with 200k in your 401k with a good job and the market drops 25% you have 150k. If you are 58 with a nest egg of 1.5 million a 25% drop is 375k. That can affect your tolerance for risk and how you translate that into an allocation. You may have assumed that 1.5 million would grow to 2+ million in a few years and you could retire with ease. Now you are worried about the 1.5 dropping further and/or not growing back in time for your retirement. And of course when the market drops a lot it can affect your employment and reemployment especially at age 58.

I think you have a reasonable allocation of 50/50 for most stages of life. If market drops keep you awake then you might need to scale back, if not you might be able to take more risk. Just keep in mind your asset level/goal and your age. I view investing as a means to an end i.e. to get enough to retire with a desired life style. Once I get to that asset level or close to it I don't need to take the same amount of risk. I don't need to double my "number" just get to it and then beat inflation and maybe a bit more. Truthfully, I think that is a minority view but it works for me. :happy
Thanks for responding Dandy. It isn’t just a 50-50 portfolio though. I have to figure out how to work in the pension. It’s confusing with the two threads. I’m going to try to eliminate any confusion. I think the confusion comes from the way I ask questions.

We have the 50/50 IRA portfolio, but We also have a fixed pension. If I think of the pension as a bond, then the portfolio is 25/75. When I look at it this way it’s just seems ridiculous, I’m 54 and my wife is 56.

I made a little more money since the thread two years ago. So now if I use a 3% SWR the income from the IRA it would be equal to the income from the pension.

If the IRA was in the S&P 500 then the IRA and the pension make a 50/50 balanced portfolio. If I want to look at it that way. And that is what I have done for a long long time. But money came in really fast at the end, so there is a lot more money there now than I am used to looking at and managing. It freaked me out a little bit. I needed to take a time out. So what I did is split the IRA to 50/50.

Bogle suggests that you look at the portfolio as one thing, and use the pension as a bond. I listen to Bob Brinker more than anyone, and he strongly disagrees with this view. Now I don’t mean Bob’s view carries more weight. I just mean I literally listen to him on the radio more than anyone else. I know Bob isn’t very popular around here, but if you ignore his market timing (and that is what I do) his advice is similar to Bogle’s. He probably learned it from Bogle.

I think I agree with Bob. I don’t know though, Jack is awfully wise. Social Security would be part of it to. I think I just wanna ignore Social Security though. That would just be gravy if we get anything.

I look at this like a football game. We played for 30 minutes (years). We worked really hard, and it’s halftime now. I don’t want to start thinking that we won the game. I want to get a good game plan together and come out for the second half. Hopefully it will last 30 or 40 years. Hopefully.

I think halftime should be about two years. Retirement is two years away for us. I’m not in any hurry here. I need to take some time to try to understand things. We took a lot of risk when we were younger so I think I can afford to give myself a little break.

Every time I start to think about it I just seem to go around in circles and end up right back where I was when I started thinking about it. I don’t understand managing risk very well because I’ve never done it. And definitely need help.

I wish I had Added 5% bonds right from the beginning. I think this would have been so much easier if I had done it the normal way. Having some skin in the game can motivate you to understand what’s going on. I feel like I cheated myself out of a 30 year education of how bonds work. I can’t replace that now. I have to follow the advice of people that know. But whose advice do I followe?
Last edited by MEA on Sun Nov 11, 2018 7:28 am, edited 2 times in total.
“Stay the course is the most important piece of advice I can give you.”-Bogle

Dandy
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Re: A few asset allocation questions

Post by Dandy » Sat Nov 10, 2018 3:43 pm

A pension or social security is an income stream. It reduces your dependency on your portfolio to support your retirement. Your salary is also an income stream but people don't convert that into a pseudo bond. Let income streams be income and actual fixed income like bonds, Savings, Stable Value Funds be fixed income.

Having a pension allows you to take more risk than if you didn't have it -- but you don't have to take more risk. Keep things as they really are -- it is much easier and makes more sense. You actual investments are what is at risk when the market drops - usually doesn't involve your pension. So pseudo bonds tend to get people to have a more aggressive allocation than they realize. They can be lulled into a false sense of safety thinking they have more bond protection than they really have.

stan1
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Re: A few asset allocation questions

Post by stan1 » Sat Nov 10, 2018 4:01 pm

MEA wrote:
Thu Nov 08, 2018 6:04 pm

Should my grandfather‘s opinion hold more weight than my father’s because he was alive in 1929?

Should my fathers opinion hold more weight than my grandfather’s because he is alive today and his view may be more relevant to the present time period?
Maybe equal weight! Since your dad was born in 1938 you might be 50-60 years old? It's perfectly reasonable for someone in their 50s to have a 50/50 equity/bond asset allocation like you do especially if you are close to having a dollar amount you feel comfortable with heading into retirement with less income.

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MEA
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Re: A few asset allocation questions

Post by MEA » Sat Nov 10, 2018 4:22 pm

Dandy wrote:
Sat Nov 10, 2018 3:43 pm
A pension or social security is an income stream. It reduces your dependency on your portfolio to support your retirement. Your salary is also an income stream but people don't convert that into a pseudo bond. Let income streams be income and actual fixed income like bonds, Savings, Stable Value Funds be fixed income.

Having a pension allows you to take more risk than if you didn't have it -- but you don't have to take more risk. Keep things as they really are -- it is much easier and makes more sense. You actual investments are what is at risk when the market drops - usually doesn't involve your pension. So pseudo bonds tend to get people to have a more aggressive allocation than they realize. They can be lulled into a false sense of safety thinking they have more bond protection than they really have.
That makes a lot of sense to me. Thats the way I want to look at it. I just wish my thinking was in line with Bogle’s. It makes me think that I’m not understanding part of this. With trillion dollar deficits per year I may come to regret not listening to Bogle if we get above average inflation.
Last edited by MEA on Sun Nov 11, 2018 7:31 am, edited 1 time in total.
“Stay the course is the most important piece of advice I can give you.”-Bogle

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MEA
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Re: A few asset allocation questions

Post by MEA » Sat Nov 10, 2018 7:39 pm

Dandy wrote:
Sat Nov 10, 2018 3:43 pm
A pension or social security is an income stream. It reduces your dependency on your portfolio to support your retirement. Your salary is also an income stream but people don't convert that into a pseudo bond. Let income streams be income and actual fixed income like bonds, Savings, Stable Value Funds be fixed income.

Having a pension allows you to take more risk than if you didn't have it -- but you don't have to take more risk. Keep things as they really are -- it is much easier and makes more sense. You actual investments are what is at risk when the market drops - usually doesn't involve your pension. So pseudo bonds tend to get people to have a more aggressive allocation than they realize. They can be lulled into a false sense of safety thinking they have more bond protection than they really have.

After I read this a few more times I think I’m catching on. The pension is my income stream. Nothing has changed and we are just replacing our income stream from work to the pension. It does cover our income. Except for health insurance. There will be money in the fund for the first year but after that I’m going to have to buy our healthcare. I will have to take 1% out of the IRA to cover health insurance, and anything else unexpected so let’s say I take 2%. If healthcare goes up more than 2% a year then I’m going to have to cover that too with the IRA. So I can take 3% a year out of the IRA but if things get bad and the market goes down I should be able to cut back to 2%. So I just have to figure out how much risk I need to take to make the IRA last for 40 years with a 3% SWR. I think I do have to be 60/40 with the IRA. Do I have to be more than 60/40? I think the best way to get there is just do nothing and let the market do it. Does this sound like a good plan? Maybe I could let it drift up to 65/35. I already found out I can’t be 100%, but I am confident that I can stay the course at 65/35. I still have two years left to think about this. I think I’m on the right track now.
“Stay the course is the most important piece of advice I can give you.”-Bogle

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