Winning the Game - Reducing Risk

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Topic Author
expatFIRE
Posts: 33
Joined: Sun Oct 30, 2016 12:53 am

Winning the Game - Reducing Risk

Post by expatFIRE » Wed Nov 13, 2019 7:53 pm

Hi Bogleheads,

I'm starting with the major question to begin with the end in mind. About 12 years ago I set up an Investment Policy Statement (IPS) with an AA of age in bonds. Currently at 37 and nearly $1.8 mil net worth, we are ahead of our goals. At our current savings rate we can hit $2.5 mil in 4 years (assuming about 2.5% real growth per year). If stock options mature, which I don't include in my net worth, we can probably hit that goal in less than 3 years.

At $2.5 mil and 3% withdrawal rate will provide $75,000/yr. We estimate "core" future expenses closer to $40,000/yr. I feel relatively confident in a 50/50 portfolio meeting that withdrawal rate over 50 years. I don't plan to quit working entirely, but would be doing more independent consulting or part time work and focusing on other personal projects and family. In a few years I would expect that part time work to cover at least our $40,000 core expenses.

I am thinking of following Bill Bernstein's advice in 20 to 25 times core expenses in safe assets. This would be $800,000 to $1 mil in safe (about 44% to 55% bonds). I don't feel a desire to go above 50% in safe assets.

Should I go from AA of 37% in bonds to 44% or 50% in bonds? Should I do this slowly over the next few years with dividends and future contributions, rebalance sooner than later (a taxable event), or a mix of both? Is there anything else I should consider?

DW is agnostic on the investment plan and it's difficult to discuss risks and tradeoffs except in very general terms. I still want to make sure she's on board with the decision and I'm being responsible with our nest egg.

As a side note, my career has been 90%+ expat life. It would be nice to spend more time with few remaining family, but we're not considering a move back the US at this time.

Appreciate any insight you have, thanks!

https://www.whitecoatinvestor.com/berns ... -the-game/

High Level Info
No debt. Currently a renter.

Tax Filing Status: MFJ

2020 Tax Rate:
24% Federal (but take Foreign Earned Income Exclusion)
0% State

Age: 37

Current Asset allocation: 57.2% Stocks, 36.4% Bonds, 6.4% REIT
Intl allocation: ~35% of stocks
Current portfolio: Approx $1.8 mil

Investments

Taxable:
25.6% VTSAX Vanguard Tot Stock Idx;Adm 0.05%
5.0% VPADX Vanguard Pac Stock;Adm 0.12%
5.0% VEUSX Vanguard Euro Stock;Adm 0.12%
5.0% VEMAX Vanguard EM St Ix;Adm 0.15%
11.0% VSIAX Vanguard Sm-Cp Val Idx;Adm 0.10%
7.3% VFSVX FTSE All World Ex-US Sm-Cp Val 0.31%
13.9% VWIUX Vanguard Intermediate-Term Tax-Exempt; Adm 0.12%
4.1% CDs @2% (March 2021 will move to muni-bonds)

His Roth IRA:
3.2% VGSLX Vanguard REIT Index Fund Admiral Shares 0.1%

Her Roth IRA:
1.3% VGRLX Vanguard Global REIT Index Fund Admiral Shares 0.1% (Plan to get Global REIT to 50% of total REIT)

401k:
15.2% VBTLX Vanguard Total Bond Market Index Fund Admiral Shares 0.05%
1.7% Stable value @ ~2.1%
1.7% IGREX Invesco Global Real Estate 0.93% (gradually reducing this to zero as future Roth IRA contributions are made)
(401k also includes Vanguard S&P500 and Extended Market indices at admiral shares E/R, but I’m first filling the 401k with bonds and REIT)

New annual contributions:
401k: $19,000 + $5,000 employer match
After Tax 401k --> Roth 401k In-Plan Rollover: $32,000 (Mega Backdoor Roth 401k)
Backdoor Roths: $12,000 (Self and Spouse)
I Bonds: $10,000 (wife is non-resident alien)
Taxable: $60,000+

lakpr
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Re: Winning the Game - Reducing Risk

Post by lakpr » Wed Nov 13, 2019 8:04 pm

The only characterization I object mildly to, in your post, is that the bonds are “safe assets”. If interest rates rise by a quarter point in the future, those bond assets are expected to drop by approximately 10%. It does not even need to be an actual event, the mere “expectation” of a rise in interest rates by a quarter percentage is enough to decimate the bonds (in a literal sense, “decimate” meaning killing it reducing a tenth of the original strength/numbers/values).

I therefore prefer a slightly higher stock allocation, 60:40 than 50:50. But 50:50 is fine too.

Drop everything into Vanguard Balanced Index fund, or Life Strategy Moderate Growth fund will get around the angst you are having and also keeps it simple for your DW. One fund. Everything goes into the fund, everything comes out of the fund. What can be simpler than that?

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Peter Foley
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Re: Winning the Game - Reducing Risk

Post by Peter Foley » Wed Nov 13, 2019 8:39 pm

I believe that age in bonds is a relatively conservative approach to investing as one approaches traditional retirement age.

I would not use that approach if I were considering retiring very early. Access to guaranteed income in retirement also changes the calculation.

Not knowing the implications of your expat life makes me hesitant to advise in any direction. 50% to 60% equities is a likely range.

MotoTrojan
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Re: Winning the Game - Reducing Risk

Post by MotoTrojan » Wed Nov 13, 2019 8:42 pm

Peter Foley wrote:
Wed Nov 13, 2019 8:39 pm
I believe that age in bonds is a relatively conservative approach to investing as one approaches traditional retirement age.

I would not use that approach if I were considering retiring very early. Access to guaranteed income in retirement also changes the calculation.

Not knowing the implications of your expat life makes me hesitant to advise in any direction. 50% to 60% equities is a likely range.
I agree with the 50-60% equity range as a lower bound given a <3% withdrawal rate. The real question is how accurately have you predicted your expenses.

Given that the market is at an all-time high I can't see any justification to not make the change in allocation right away, if it is what you want to be at anyways.

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Wiggums
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Re: Winning the Game - Reducing Risk

Post by Wiggums » Wed Nov 13, 2019 8:49 pm

MotoTrojan wrote:
Wed Nov 13, 2019 8:42 pm
Peter Foley wrote:
Wed Nov 13, 2019 8:39 pm
I believe that age in bonds is a relatively conservative approach to investing as one approaches traditional retirement age.

I would not use that approach if I were considering retiring very early. Access to guaranteed income in retirement also changes the calculation.

Not knowing the implications of your expat life makes me hesitant to advise in any direction. 50% to 60% equities is a likely range.
I agree with the 50-60% equity range as a lower bound given a <3% withdrawal rate. The real question is how accurately have you predicted your expenses.

Given that the market is at an all-time high I can't see any justification to not make the change in allocation right away, if it is what you want to be at anyways.
+1

venkman
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Re: Winning the Game - Reducing Risk

Post by venkman » Wed Nov 13, 2019 11:46 pm

lakpr wrote:
Wed Nov 13, 2019 8:04 pm
The only characterization I object mildly to, in your post, is that the bonds are “safe assets”. If interest rates rise by a quarter point in the future, those bond assets are expected to drop by approximately 10%. It does not even need to be an actual event, the mere “expectation” of a rise in interest rates by a quarter percentage is enough to decimate the bonds (in a literal sense, “decimate” meaning killing it reducing a tenth of the original strength/numbers/values).
I think you might have an incomplete understanding of how bonds work...

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HomerJ
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Re: Winning the Game - Reducing Risk

Post by HomerJ » Wed Nov 13, 2019 11:56 pm

lakpr wrote:
Wed Nov 13, 2019 8:04 pm
The only characterization I object mildly to, in your post, is that the bonds are “safe assets”. If interest rates rise by a quarter point in the future, those bond assets are expected to drop by approximately 10%. It does not even need to be an actual event, the mere “expectation” of a rise in interest rates by a quarter percentage is enough to decimate the bonds (in a literal sense, “decimate” meaning killing it reducing a tenth of the original strength/numbers/values).
This is incorrect. A 0.25% rise in the interest rate will not cause intermediate bonds to drop 10%.
The J stands for Jay

KlangFool
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Re: Winning the Game - Reducing Risk

Post by KlangFool » Thu Nov 14, 2019 12:03 am

OP,

With 3 to 4 years to go, why not go to 50/50 now and get it done? Why so complicated? The difference is so minimal that why over-complicate the process?

I am 3 to 4 years from reaching my number. My final AA is 60/40. I am 60/40 now.

KlangFool

retired@50
Posts: 611
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Re: Winning the Game - Reducing Risk

Post by retired@50 » Thu Nov 14, 2019 12:16 am

HomerJ wrote:
Wed Nov 13, 2019 11:56 pm
lakpr wrote:
Wed Nov 13, 2019 8:04 pm
The only characterization I object mildly to, in your post, is that the bonds are “safe assets”. If interest rates rise by a quarter point in the future, those bond assets are expected to drop by approximately 10%. It does not even need to be an actual event, the mere “expectation” of a rise in interest rates by a quarter percentage is enough to decimate the bonds (in a literal sense, “decimate” meaning killing it reducing a tenth of the original strength/numbers/values).
This is incorrect. A 0.25% rise in the interest rate will not cause intermediate bonds to drop 10%.
I think the price movement based on interest rate changes goes like this... A snippet from the Investopedia website.

As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration. If a bond has a duration of five years and interest rates increase 1%, the bond’s price will drop by approximately 5% (1% X 5 years). Likewise, if interest rates fall by 1%, the same bond’s price will increase by about 5% (1% X 5 years).

Regards,

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HomerJ
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Re: Winning the Game - Reducing Risk

Post by HomerJ » Thu Nov 14, 2019 12:24 am

retired@50 wrote:
Thu Nov 14, 2019 12:16 am
HomerJ wrote:
Wed Nov 13, 2019 11:56 pm
lakpr wrote:
Wed Nov 13, 2019 8:04 pm
The only characterization I object mildly to, in your post, is that the bonds are “safe assets”. If interest rates rise by a quarter point in the future, those bond assets are expected to drop by approximately 10%. It does not even need to be an actual event, the mere “expectation” of a rise in interest rates by a quarter percentage is enough to decimate the bonds (in a literal sense, “decimate” meaning killing it reducing a tenth of the original strength/numbers/values).
This is incorrect. A 0.25% rise in the interest rate will not cause intermediate bonds to drop 10%.
I think the price movement based on interest rate changes goes like this... A snippet from the Investopedia website.

As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration. If a bond has a duration of five years and interest rates increase 1%, the bond’s price will drop by approximately 5% (1% X 5 years). Likewise, if interest rates fall by 1%, the same bond’s price will increase by about 5% (1% X 5 years).

Regards,
Yes, that's about right...

The nice thing is... bonds are self-correcting... Interest rates go up 1%, sure, the bond fund may drop 5%, but now you're getting 1% more yield from new bonds that are bought by the fund, and you slowly gain it all back.

And vice versa... Interest rates drop 1%, the fund may gain 5%, but the yield goes down, and you make less per year.

Bonds are fairly steady-eddy because they self-correct like this.

The real danger to nominal bonds is inflation, not interest rate moves.
The J stands for Jay

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Watty
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Re: Winning the Game - Reducing Risk

Post by Watty » Thu Nov 14, 2019 12:25 am

expatFIRE wrote:
Wed Nov 13, 2019 7:53 pm
Appreciate any insight you have, thanks!

...
No debt. Currently a renter.
One way to declare that you have won the game and to take some money off the table is to have a paid off house.

There are lots of reasons that buying a house might not be right for you now but you could set up a conservative house fund to be able to buy a house for cash someday when owning a house is right for you.

Unless you are likely to retire in an expensive area you might be able to buy a house someday for a couple of hundred thousand dollars which is just a small percentage of your nest egg but setting that aside would reduce your overall risk.

Topic Author
expatFIRE
Posts: 33
Joined: Sun Oct 30, 2016 12:53 am

Re: Winning the Game - Reducing Risk

Post by expatFIRE » Thu Nov 14, 2019 7:00 am

Peter Foley wrote:
Wed Nov 13, 2019 8:39 pm
I believe that age in bonds is a relatively conservative approach to investing as one approaches traditional retirement age.

I would not use that approach if I were considering retiring very early. Access to guaranteed income in retirement also changes the calculation.

Not knowing the implications of your expat life makes me hesitant to advise in any direction. 50% to 60% equities is a likely range.
Peter,

Would it be correct to assume that you feel age in bonds is not conservative for an early retiree? As to guaranteed income, would that be an annuity (probably need to wait until a more traditional retirement age), Series I Bonds (maxing those each year), or a pension (don't have one).

Approximately 2/3 of my net worth is in Taxable. The remaining 1/3 is in 401k/IRA (roughly half Roth and half Traditional.

Long story short for the expat life:
  • No state tax. Federal tax may be 5 to 7% at most for years with high expenses. $75,000 expense estimate includes paying taxes.
  • Affordable health care options (travel insurance for trips to US).
  • Purchasing apartment is expensive. Renting is a better deal (in this country). Non-housing expenses are cheaper. We don't need a lot. We're used to 500 sqft.
  • Potentially can use wife's non-resident alien status to avoid all capital gains taxes.
  • Some uncertainty to where we will live long term.
  • We'd plan to keep expenses low at first to hopefully grow assets longer term. That may be why I have some hesitation to decrease stock allocation (at least too much).
  • Flights home can be expensive but with flexibility and travel points it can be relatively cheap.
Not sure if you have specific thoughts as to how being an expat affects AA. Appreciate your reply.

Topic Author
expatFIRE
Posts: 33
Joined: Sun Oct 30, 2016 12:53 am

Re: Winning the Game - Reducing Risk

Post by expatFIRE » Thu Nov 14, 2019 7:15 am

MotoTrojan wrote:
Wed Nov 13, 2019 8:42 pm
I agree with the 50-60% equity range as a lower bound given a <3% withdrawal rate. The real question is how accurately have you predicted your expenses.

Given that the market is at an all-time high I can't see any justification to not make the change in allocation right away, if it is what you want to be at anyways.
I would plan to withdraw 3%, not sub-3%, if that makes a difference. Core expenses calculated by how much I have to transfer locally plus what my wife is now making this year.

I'm learning towards an "immediate" change to 60/40 stock/bond within the next three months, and sitting on the decision to move to 50/50 at a later date.

One challenge I have is that the stock market has historically almost always be at an all-time high, so we hope that continues into the future. The literature seems to suggest more aggressive stock allocations for early retirement (i.e. 80/20), but also slightly higher withdrawal rates (i.e. 3.5%). It still appears prudent that 60/40 or 50/50 should support a 3% withdrawal rate for 50 years, I do expect to earn some income, and we don't come close to $75,000 in expenses.

Still it seems prudent to reduce stock exposure if I'm close to hitting my numbers. I imagine it's not much of a burden to work a few extra years, than have the potential to work a few years left but have the risk that I have to work a whole lot longer. For example, it'd be better to know I have a 4 to 6 year time frame than to take more risk but potentially have a 2 to 12+ year time frame. That trade off is what I'm having a difficult time quantifying.

Topic Author
expatFIRE
Posts: 33
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Thu Nov 14, 2019 7:18 am

KlangFool wrote:
Thu Nov 14, 2019 12:03 am
OP,

With 3 to 4 years to go, why not go to 50/50 now and get it done? Why so complicated? The difference is so minimal that why over-complicate the process?

I am 3 to 4 years from reaching my number. My final AA is 60/40. I am 60/40 now.

KlangFool
KlangFool,

Do you plan to actually retire when you reach your number in 3 to 4 years, or continue to earn an income in some way? How many years do you assume you withdraw from your portfolio?

Topic Author
expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Thu Nov 14, 2019 7:34 am

Watty wrote:
Thu Nov 14, 2019 12:25 am
expatFIRE wrote:
Wed Nov 13, 2019 7:53 pm
Appreciate any insight you have, thanks!

...
No debt. Currently a renter.
One way to declare that you have won the game and to take some money off the table is to have a paid off house.

There are lots of reasons that buying a house might not be right for you now but you could set up a conservative house fund to be able to buy a house for cash someday when owning a house is right for you.

Unless you are likely to retire in an expensive area you might be able to buy a house someday for a couple of hundred thousand dollars which is just a small percentage of your nest egg but setting that aside would reduce your overall risk.
Watty,

I do agree that over the very long term, owning a house can make sense. It doesn't make sense where we're at currently. Our rent is cheap compared to the purchase price.

We have a few goals that don't require expensive housing initially (countries and areas with cheap housing where I can work part time or in a less stressful role, hiking the Appalachian Trail, visiting national parks, etc.). Currently DW is not crazy about the US, and neither am I to be honest. I'd want DW to see a few states before we decide a place to buy. But she has a larger family than I do, so we'll likely be in the area for a while.

If we eventually find ourselves in the US or in a place where it makes sense to buy, then we could consider an apartment or house purchase. In the $300,000 range would be only 12% of the final portfolio value. The remaining $2.2 mil should generate $66,000 and be a reasonable income with a paid off house. We're used to small apartments so we don't need that much.

Topic Author
expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Thu Nov 14, 2019 7:42 am

lakpr wrote:
Wed Nov 13, 2019 8:04 pm
The only characterization I object mildly to, in your post, is that the bonds are “safe assets”. If interest rates rise by a quarter point in the future, those bond assets are expected to drop by approximately 10%. It does not even need to be an actual event, the mere “expectation” of a rise in interest rates by a quarter percentage is enough to decimate the bonds (in a literal sense, “decimate” meaning killing it reducing a tenth of the original strength/numbers/values).

I therefore prefer a slightly higher stock allocation, 60:40 than 50:50. But 50:50 is fine too.

Drop everything into Vanguard Balanced Index fund, or Life Strategy Moderate Growth fund will get around the angst you are having and also keeps it simple for your DW. One fund. Everything goes into the fund, everything comes out of the fund. What can be simpler than that?
I expect Series I bonds, cash, CDs, muni-bond and total bond funds to be reasonably close to their current real value within the next 5 to 10 years. Stocks may be at half their value at any time, and may not recover for an extended period of time.

The one fund solution wouldn't work in this case. Around 2/3 the portfolio is in Taxable, with significant unrealized capital gains. I'm working on increasing the Series I bonds over time, and decreasing the muni bonds, but the $10,000 contribution limit per SSN is taking a long time to build up.

KlangFool
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Re: Winning the Game - Reducing Risk

Post by KlangFool » Thu Nov 14, 2019 8:26 am

expatFIRE wrote:
Thu Nov 14, 2019 7:18 am
KlangFool wrote:
Thu Nov 14, 2019 12:03 am
OP,

With 3 to 4 years to go, why not go to 50/50 now and get it done? Why so complicated? The difference is so minimal that why over-complicate the process?

I am 3 to 4 years from reaching my number. My final AA is 60/40. I am 60/40 now.

KlangFool
KlangFool,

Do you plan to actually retire when you reach your number in 3 to 4 years, or continue to earn an income in some way? How many years do you assume you withdraw from your portfolio?
1) I will be FI. Working will be optional.

2) Forever is the assumption. With social security, my portfolio is 50 times my retirement expense.

KlangFool

aristotelian
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Re: Winning the Game - Reducing Risk

Post by aristotelian » Thu Nov 14, 2019 8:53 am

There are no safe assets. Any assets that are safe from market risk are subject to inflation risk. In fact, for lengthy retirements, all the evidence has shown that equity heavy portfolio perform the best because you need returns to stay ahead of inflation. With a 3% withdrawal, it probably doesn't matter what you do, but I would want at least 30% in stocks and preferably more like 50%.

vipertom1970
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Re: Winning the Game - Reducing Risk

Post by vipertom1970 » Thu Nov 14, 2019 1:04 pm

I won the game, age 50 but still in 60/40 allocation.

misterjohnny
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Re: Winning the Game - Reducing Risk

Post by misterjohnny » Thu Nov 14, 2019 1:39 pm

If adjusting your AA immediately causes a taxable event, I would not do it in this manner. I would put all future savings into bonds and slowly get to your AA.

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Kevin M
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Re: Winning the Game - Reducing Risk

Post by Kevin M » Thu Nov 14, 2019 2:36 pm

lakpr wrote:
Wed Nov 13, 2019 8:04 pm
The only characterization I object mildly to, in your post, is that the bonds are “safe assets”.
This is true in general, however the types of bonds being discussed are relatively safe compared to stocks.

An asset is safe if it matches a liability in terms of maturity or duration and unit of account. If you have a real liability of $10K in 10 years, the unit of account is purchasing power, and $10K in a 10-year TIPS is a safe asset. If you have a nominal liability of $10K in 10 years, the unit of account is dollars, and $10K in a 10-year nominal Treasury is a safe asset.
lakpr wrote:
Wed Nov 13, 2019 8:04 pm
If interest rates rise by a quarter point in the future, those bond assets are expected to drop by approximately 10%.
This would only be true for a bond or bond fund with a duration of 40 years. Others have already explained this.
lakpr wrote:
Wed Nov 13, 2019 8:04 pm
It does not even need to be an actual event, the mere “expectation” of a rise in interest rates by a quarter percentage is enough to decimate the bonds (in a literal sense, “decimate” meaning killing it reducing a tenth of the original strength/numbers/values).
This is not true. Bond price and bond yield are inversely related by a mathematical formula. An expectation of a yield change does not cause a change in bond price; yield and (actual) price always change together, as dictated by the mathematical formula that governs them.

The other problem with the quoted statement is that "interest rates" isn't really a thing that affects the price of a particular bond. It's the yield of a particular bond that is related to the price of that bond. The yield on a 10-year Treasury could drop on a day when the yield of a 1-year Treasury increases. The Fed could lower the federal funds rate, but 10-year Treasury yield could increase.

Kevin
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4nursebee
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Re: Winning the Game - Reducing Risk

Post by 4nursebee » Thu Nov 14, 2019 2:47 pm

Looks like you are doing well.
I don’t value bonds the way you do.
Why do you accept Bernstein bond rules?
What are your goals?

The data all tells me that in the long run we will be better off in stocks. We are building reserves to weather storms.
4nursebee

averagedude
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Re: Winning the Game - Reducing Risk

Post by averagedude » Thu Nov 14, 2019 2:58 pm

If you are going to increase your bond allocation, it is better to do it when stocks are at all time highs. You never should reassess your appetite of risk after markets crash. Me personally, with a low safe withdrawal rate mixed with your willingness to deploy your human capital in the future, I would stick with a moderate (60/40) portfolio.

deikel
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Re: Winning the Game - Reducing Risk

Post by deikel » Thu Nov 14, 2019 4:23 pm

at 2.5 mil you would have won the game in a variety of ways actually:

for 40k expenses a year, you would only need 2 % withdrawal (and some leftover)

You could get this in a savings account, with 100% bonds, and funny enough, you can even get this with 100% stocks and just taking dividends ...and everything in between...there is no risk for you anymore...

In your position, I would actually go 100% stock (since you went over the 'need safety border' already), pay for core expenses out of dividends and enjoy good stock years with additional money provided by Mr Market above and beyond the principle plus inflation each year.

For bad years, hunker down or keep 5 years worth of living expenses in cash.

I would forgo bonds at this point. I think you are way overshooting...
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immediately and destroy any copy or remembrance of it.

DesertDiva
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Re: Winning the Game - Reducing Risk

Post by DesertDiva » Thu Nov 14, 2019 4:33 pm

aristotelian wrote:
Thu Nov 14, 2019 8:53 am
There are no safe assets. Any assets that are safe from market risk are subject to inflation risk. In fact, for lengthy retirements, all the evidence has shown that equity heavy portfolio perform the best because you need returns to stay ahead of inflation. With a 3% withdrawal, it probably doesn't matter what you do, but I would want at least 30% in stocks and preferably more like 50%.
Good summary. Stocks are necessary for growth; bonds serve as a ballast.

AHTFY
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Re: Winning the Game - Reducing Risk

Post by AHTFY » Thu Nov 14, 2019 6:08 pm

deikel wrote:
Thu Nov 14, 2019 4:23 pm
at 2.5 mil you would have won the game in a variety of ways actually:

for 40k expenses a year, you would only need 2 % withdrawal (and some leftover)

You could get this in a savings account, with 100% bonds, and funny enough, you can even get this with 100% stocks and just taking dividends ...and everything in between...there is no risk for you anymore...

In your position, I would actually go 100% stock (since you went over the 'need safety border' already), pay for core expenses out of dividends and enjoy good stock years with additional money provided by Mr Market above and beyond the principle plus inflation each year.

For bad years, hunker down or keep 5 years worth of living expenses in cash.

I would forgo bonds at this point. I think you are way overshooting...
This only works if the OP can bear to possibly see his portfolio go from 2.5M to 1.25M if the market drops 50% (or more), as it did in 2000 and 2008.

At a minimum, as you suggest, he'd probably want 5 years of living expenses in cash (money market) or even in a short-term bond fund or Treasury/CD ladder. That would only require about $200k or less than 10% of his portfolio.

But I suspect he'd want to be even more even more conservative than that. Perhaps a 10-year fixed income investment, which would be about 20% of his portfolio. As for me, I'd prefer a standard 60-40 portfolio, but everyone is different.

Topic Author
expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Sat Nov 16, 2019 1:12 am

KlangFool wrote:
Thu Nov 14, 2019 8:26 am
expatFIRE wrote:
Thu Nov 14, 2019 7:18 am
KlangFool wrote:
Thu Nov 14, 2019 12:03 am
OP,

With 3 to 4 years to go, why not go to 50/50 now and get it done? Why so complicated? The difference is so minimal that why over-complicate the process?

I am 3 to 4 years from reaching my number. My final AA is 60/40. I am 60/40 now.

KlangFool
KlangFool,

Do you plan to actually retire when you reach your number in 3 to 4 years, or continue to earn an income in some way? How many years do you assume you withdraw from your portfolio?
1) I will be FI. Working will be optional.

2) Forever is the assumption. With social security, my portfolio is 50 times my retirement expense.

KlangFool
It does not appear an over complication to consider the asset allocation in relation to the withdrawal rate and retirement duration. Your 2% withdrawals are likely overly conservative, and only 66% of the 3% withdrawals I plan to utilize. I don't think there's any question that 2% is a perpetual withdrawal rate. 3% may or may not be a perpetual withdrawal rate after 60 years with a 60/40 or 50/50 portfolio.

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expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Sat Nov 16, 2019 1:26 am

misterjohnny wrote:
Thu Nov 14, 2019 1:39 pm
If adjusting your AA immediately causes a taxable event, I would not do it in this manner. I would put all future savings into bonds and slowly get to your AA.
It would be a taxable event, so I'm likely going to be getting there slowly with new contributions and dividends.

I also just realized that if I count company preferred stock in the overall AA, I'm closer to 35% bonds, which may be where some of this angst is coming from. It's not something I've typically considered in this AA equation because it's illiquid.

If I move from 37% to 40% bonds in my 'liquid' portfolio, then I'd be closer to age in bonds in my overall AA (including preferred stock). It would take about a year to get to that allocation, sooner if there's a stock option liquidity event.

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expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Sat Nov 16, 2019 1:32 am

AHTFY wrote:
Thu Nov 14, 2019 6:08 pm
deikel wrote:
Thu Nov 14, 2019 4:23 pm
at 2.5 mil you would have won the game in a variety of ways actually:

for 40k expenses a year, you would only need 2 % withdrawal (and some leftover)

You could get this in a savings account, with 100% bonds, and funny enough, you can even get this with 100% stocks and just taking dividends ...and everything in between...there is no risk for you anymore...

In your position, I would actually go 100% stock (since you went over the 'need safety border' already), pay for core expenses out of dividends and enjoy good stock years with additional money provided by Mr Market above and beyond the principle plus inflation each year.

For bad years, hunker down or keep 5 years worth of living expenses in cash.

I would forgo bonds at this point. I think you are way overshooting...
This only works if the OP can bear to possibly see his portfolio go from 2.5M to 1.25M if the market drops 50% (or more), as it did in 2000 and 2008.

At a minimum, as you suggest, he'd probably want 5 years of living expenses in cash (money market) or even in a short-term bond fund or Treasury/CD ladder. That would only require about $200k or less than 10% of his portfolio.

But I suspect he'd want to be even more even more conservative than that. Perhaps a 10-year fixed income investment, which would be about 20% of his portfolio. As for me, I'd prefer a standard 60-40 portfolio, but everyone is different.
I do see that some people could look at the dividend yield of stocks compared to a low withdrawal rate (2 or 3%) and go 100% stocks with a large cash cushion. But that's certainly not me. I didn't even particularly enjoy losing a year of savings when stocks dropped the last quarter of 2018. It didn't stop me from following the IPS and rebalancing, but it certainly wasn't a pleasant experience.

I also see stocks as able to drop more than 50%, and in a Japan-esque scenario never recover from inflation adjusted highs. Any number of geo-political events could cause this to happen, and black swan events are much more common than we like to predict.

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expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Sat Nov 16, 2019 1:50 am

4nursebee wrote:
Thu Nov 14, 2019 2:47 pm
Looks like you are doing well.
I don’t value bonds the way you do.
Why do you accept Bernstein bond rules?
What are your goals?

The data all tells me that in the long run we will be better off in stocks. We are building reserves to weather storms.
I like this thought framework. My goal is to have a portfolio that will maintain it's inflation adjusted value after 60 years of 3% withdrawal rates, with the lowest possible stock allocation. This is probably closer to a 60/40 portfolio. It would appear 50/50 wouldn't be as suitable for this time duration.

It's not only Bernstein I trust, but also Pfau, Otar, Swedroe, etc. Given the black swan (fat tail) risk for stocks, my personal view is to have a portfolio with the least amount of stocks as possible to have a higher likelihood of achieving goals within a fairly predictable time frame.

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expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Sat Nov 16, 2019 2:05 am

aristotelian wrote:
Thu Nov 14, 2019 8:53 am
There are no safe assets. Any assets that are safe from market risk are subject to inflation risk. In fact, for lengthy retirements, all the evidence has shown that equity heavy portfolio perform the best because you need returns to stay ahead of inflation. With a 3% withdrawal, it probably doesn't matter what you do, but I would want at least 30% in stocks and preferably more like 50%.
Aristotelian,

I understand what you are saying. The main retirement risks are market, inflation, and longevity. I consider them in this specific order.

I hope DW and I have significant longevity risk. This is addressed with low withdrawal rates (3%) and spending flexibility to reduce that rate if needed (2%). In addition, later in life I can consider an annuity.

The Fed has reasonable controls in place for inflation. Even if those controls don't work, reasonably high inflation leads to higher future bond returns. In addition, there are assets that can address that risk to some degree, such as Series I bonds and TIPS (which aren't available in my 401k but will be when I roll the money to an IRA). Stocks in theory should also help with inflation in the long run.

Market risk is the largest unknown, and most subject to black swan events. The only way I know how to address this risk is to utilize the least amount of stocks necessary to meet my goals.

There is no safety in assets or in life. However there is a minimal acceptable level of risk. I consider Series I bonds, VBTLX, muni bond, TIPS, and annuities to meet this definition. Muni bonds do as well to a lesser degree.

RogerR
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Re: Winning the Game - Reducing Risk

Post by RogerR » Sat Nov 16, 2019 2:21 am

expatFIRE wrote:
Sat Nov 16, 2019 1:32 am
AHTFY wrote:
Thu Nov 14, 2019 6:08 pm
deikel wrote:
Thu Nov 14, 2019 4:23 pm
at 2.5 mil you would have won the game in a variety of ways actually:

for 40k expenses a year, you would only need 2 % withdrawal (and some leftover)

You could get this in a savings account, with 100% bonds, and funny enough, you can even get this with 100% stocks and just taking dividends ...and everything in between...there is no risk for you anymore...

In your position, I would actually go 100% stock (since you went over the 'need safety border' already), pay for core expenses out of dividends and enjoy good stock years with additional money provided by Mr Market above and beyond the principle plus inflation each year.

For bad years, hunker down or keep 5 years worth of living expenses in cash.

I would forgo bonds at this point. I think you are way overshooting...
This only works if the OP can bear to possibly see his portfolio go from 2.5M to 1.25M if the market drops 50% (or more), as it did in 2000 and 2008.

At a minimum, as you suggest, he'd probably want 5 years of living expenses in cash (money market) or even in a short-term bond fund or Treasury/CD ladder. That would only require about $200k or less than 10% of his portfolio.

But I suspect he'd want to be even more even more conservative than that. Perhaps a 10-year fixed income investment, which would be about 20% of his portfolio. As for me, I'd prefer a standard 60-40 portfolio, but everyone is different.
I do see that some people could look at the dividend yield of stocks compared to a low withdrawal rate (2 or 3%) and go 100% stocks with a large cash cushion. But that's certainly not me. I didn't even particularly enjoy losing a year of savings when stocks dropped the last quarter of 2018. It didn't stop me from following the IPS and rebalancing, but it certainly wasn't a pleasant experience.

I also see stocks as able to drop more than 50%, and in a Japan-esque scenario never recover from inflation adjusted highs. Any number of geo-political events could cause this to happen, and black swan events are much more common than we like to predict.
You can play with portfoliovisualizer and perform Monte Carlo simulations for various parameter sets. 50/50 allocation between the S&P500 (eg. ishares IVV) and Total US bond (eg. ishares AGG) will leave your principal intact even in the 10th percentile assuming 3% WR. That’s what I do using UCITS versions of above ETF’s to avoid cap gain taxes (I’m currently a non-resident US alien). So with AA 50/50, 2 ETF’s and WR 3% you have indeed won the game.

snowox
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Re: Winning the Game - Reducing Risk

Post by snowox » Sat Nov 16, 2019 5:40 am

vipertom1970 wrote:
Thu Nov 14, 2019 1:04 pm
I won the game, age 50 but still in 60/40 allocation.

Exactly the same for me!

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Re: Winning the Game - Reducing Risk

Post by aristotelian » Sat Nov 16, 2019 8:44 am

expatFIRE wrote:
Sat Nov 16, 2019 2:05 am

Aristotelian,

I understand what you are saying. The main retirement risks are market, inflation, and longevity. I consider them in this specific order.

I hope DW and I have significant longevity risk. This is addressed with low withdrawal rates (3%) and spending flexibility to reduce that rate if needed (2%). In addition, later in life I can consider an annuity.

The Fed has reasonable controls in place for inflation. Even if those controls don't work, reasonably high inflation leads to higher future bond returns. In addition, there are assets that can address that risk to some degree, such as Series I bonds and TIPS (which aren't available in my 401k but will be when I roll the money to an IRA). Stocks in theory should also help with inflation in the long run.

Market risk is the largest unknown, and most subject to black swan events. The only way I know how to address this risk is to utilize the least amount of stocks necessary to meet my goals.

There is no safety in assets or in life. However there is a minimal acceptable level of risk. I consider Series I bonds, VBTLX, muni bond, TIPS, and annuities to meet this definition. Muni bonds do as well to a lesser degree.
Agreed on most points. I was not really arguing with your portfolio, what you have proposed is reasonably diversified. I just take issue with the concept of bonds as "safe". Yes, stocks are most subject to short term volatility. However, again, history says that stocks increase portfolio success rates for longer retirements and higher withdrawal rates and bonds are actually riskiest. Just look at ERN's chart and see where the green is concentrated and (most importantly) where the red is concentrated. https://earlyretirementnow.com/2016/12/ ... t-1-intro/

If you want a bond-centric portfolio, you need to be okay with a low withdrawal rate, and even so you are actually increasing the risk of failure.

You say the market is "most subject to black swan" but by definition stock crashes are not really black swan events since there are many historical precedents for them. Is it possible you (and policymakers starting with the current head of the executive branch) are taking for granted present low inflation rates? What happens when everyone piles into low interest rate bonds thinking they are safe?

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Re: Winning the Game - Reducing Risk

Post by mary1492 » Sat Nov 16, 2019 3:53 pm

.....
Last edited by mary1492 on Wed Dec 04, 2019 10:21 pm, edited 1 time in total.

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Kevin M
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Re: Winning the Game - Reducing Risk

Post by Kevin M » Sat Nov 16, 2019 4:57 pm

If you assume you have an investment that is safe in real terms, such as a TIPS ladder, you can use the spreadsheet RATE function to determine the real rate required for a given number of years and a given withdrawal rate. For example, for 60 years at 3% WR:

=RATE(60, 3%, -1, 0)

This returns 2.18%, which I interpret as requiring a 2.18% real return at 3% WR to last 60 years. I don't think there's currently any safe investment that will provide a 2.2% real return--the 30-year TIPS yield is only about 0.6%, and that only gets you to 30 years, not 60.

Consider using safe assets to get you to 30 years, and stocks for the rest.

=RATE(30,3%, -1,0)

This returns -0.67%, so even a negative real return of this rate gets you to 30 years. A TIPS ladder would work for that, since TIPS yields currently are positive for all maturities of 5 years and greater. But the formula assumes you put 100% of your assets into the TIPS ladder.

At a 0% real return, you'd have to put 90% of your portfolio into the TIPS ladder to last 30 years:

=- PV(0%, 30, 3%, 0)

Kevin
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am
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Re: Winning the Game - Reducing Risk

Post by am » Sat Nov 16, 2019 10:25 pm

mary1492 wrote:
Sat Nov 16, 2019 3:53 pm
Already FIREd here - currently age 55, and been at it 7 years now.

My AA is 2/98 - that's right, 98% bonds (CDs, Treasuries, Munis) - and I love it! There is absolutely nothing wrong with a (very) conservative AA if you already have enough money. I have very little desire for exposure to equities at this time.

Do what feels right for you, and ignore anyone who tells you that you must have higher equity allocation or else.

If you've mapped out your expenses, left a bit of room for the unexpected, then definitely go with what will keep you stress free and allow you to sleep well.

You're still very young, so if things begin to look like they are not going well, you can always go back to work, or take something part-time to supplement things a bit.
You’ll get hurt if inflation comes back.

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Re: Winning the Game - Reducing Risk

Post by mary1492 » Sun Nov 17, 2019 4:49 am

.....
Last edited by mary1492 on Wed Dec 04, 2019 10:21 pm, edited 2 times in total.

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expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Sun Nov 17, 2019 5:00 am

Kevin M wrote:
Sat Nov 16, 2019 4:57 pm
If you assume you have an investment that is safe in real terms, such as a TIPS ladder, you can use the spreadsheet RATE function to determine the real rate required for a given number of years and a given withdrawal rate. For example, for 60 years at 3% WR:

=RATE(60, 3%, -1, 0)

This returns 2.18%, which I interpret as requiring a 2.18% real return at 3% WR to last 60 years. I don't think there's currently any safe investment that will provide a 2.2% real return--the 30-year TIPS yield is only about 0.6%, and that only gets you to 30 years, not 60.

Consider using safe assets to get you to 30 years, and stocks for the rest.

=RATE(30,3%, -1,0)

This returns -0.67%, so even a negative real return of this rate gets you to 30 years. A TIPS ladder would work for that, since TIPS yields currently are positive for all maturities of 5 years and greater. But the formula assumes you put 100% of your assets into the TIPS ladder.

At a 0% real return, you'd have to put 90% of your portfolio into the TIPS ladder to last 30 years:

=- PV(0%, 30, 3%, 0)

Kevin
Kevin,

Thank you so much for this example. I was also able to find your earlier explanation: https://www.kevinoninvesting.com/2016/1 ... vings.html

I notice in your last example you use 0% real rate of return. Is there any reason you did not use 0.6% for the 30 year TIPS? Bonds could be reduced to 82% of the portfolio (instead of 90% in your example with zero real rate of return).

If I assume a 60 year retirement, 100% TIPS yielding 0.6% real, that's a safe withdrawal rate of 1.99%. If the retirement is reduced to 30 years, that's a safe withdrawal rate of 3.65%. If I solve for a 3% withdrawal rate, then a portfolio of TIPS can only last for 37.3 years.

After playing around with Excel for the other functions, I assumed 60 year retirement, 3% withdrawal rate, and 75% remaining portfolio balance:

=RATE(60,3%,-1,0.75)

If I did that right, that's a 2.84% required real annualized rate of return for the portfolio, compared with only 2.18% for portfolio depletion.

Using 0.5% for the 30 year TIPS rate and 40% of AA, the stocks would have to return at least 4.4% real annualized rate of return, compared to only 3.3% for portfolio depletion.

2.84 - (0.5%*40%) / 60% = 4.4%

This assumes there's no additional income (job, social security). That seems fairly realistic long term returns. I see that going above 40% for bonds may have issues because it requires the equity side of the portfolio to carry the difference, and going to 50% bonds gets close to what the US stock market has done historically (50% bonds with 75% portfolio value brings us closer to 5.17 real annualized stock returns).

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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Sun Nov 17, 2019 5:09 am

aristotelian wrote:
Sat Nov 16, 2019 8:44 am
expatFIRE wrote:
Sat Nov 16, 2019 2:05 am

Aristotelian,

I understand what you are saying. The main retirement risks are market, inflation, and longevity. I consider them in this specific order.

I hope DW and I have significant longevity risk. This is addressed with low withdrawal rates (3%) and spending flexibility to reduce that rate if needed (2%). In addition, later in life I can consider an annuity.

The Fed has reasonable controls in place for inflation. Even if those controls don't work, reasonably high inflation leads to higher future bond returns. In addition, there are assets that can address that risk to some degree, such as Series I bonds and TIPS (which aren't available in my 401k but will be when I roll the money to an IRA). Stocks in theory should also help with inflation in the long run.

Market risk is the largest unknown, and most subject to black swan events. The only way I know how to address this risk is to utilize the least amount of stocks necessary to meet my goals.

There is no safety in assets or in life. However there is a minimal acceptable level of risk. I consider Series I bonds, VBTLX, muni bond, TIPS, and annuities to meet this definition. Muni bonds do as well to a lesser degree.
Agreed on most points. I was not really arguing with your portfolio, what you have proposed is reasonably diversified. I just take issue with the concept of bonds as "safe". Yes, stocks are most subject to short term volatility. However, again, history says that stocks increase portfolio success rates for longer retirements and higher withdrawal rates and bonds are actually riskiest. Just look at ERN's chart and see where the green is concentrated and (most importantly) where the red is concentrated. https://earlyretirementnow.com/2016/12/ ... t-1-intro/

If you want a bond-centric portfolio, you need to be okay with a low withdrawal rate, and even so you are actually increasing the risk of failure.

You say the market is "most subject to black swan" but by definition stock crashes are not really black swan events since there are many historical precedents for them. Is it possible you (and policymakers starting with the current head of the executive branch) are taking for granted present low inflation rates? What happens when everyone piles into low interest rate bonds thinking they are safe?
Aristotelian,

I'm curious about your comment that the portfolio is "reasonably diversified." Is there something that appears missing, or am I reading too much into that statement?

The ERN series is very interesting, and it does seem to support higher stock allocations for early retirement. However, I do see in part 2 that a 50/50 portfolio has a 100% chance of surviving 60 years with a 3% withdrawal rate. It also has a 96% chance of ending the 60 year retirement with the starting portfolio value adjusted for inflation.

This seems to support that a 50/50 portfolio can sustain a 3% withdrawal rate in perpetuity, or at least practical perpetuity. It'd be nice if his data was available to look at other portfolio weights like 60/40, which are more common (at least here).

https://earlyretirementnow.com/2016/12/ ... depletion/

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Re: Winning the Game - Reducing Risk

Post by aristotelian » Sun Nov 17, 2019 11:17 am

expatFIRE wrote:
Sun Nov 17, 2019 5:09 am


Aristotelian,

I'm curious about your comment that the portfolio is "reasonably diversified." Is there something that appears missing, or am I reading too much into that statement?

The ERN series is very interesting, and it does seem to support higher stock allocations for early retirement. However, I do see in part 2 that a 50/50 portfolio has a 100% chance of surviving 60 years with a 3% withdrawal rate. It also has a 96% chance of ending the 60 year retirement with the starting portfolio value adjusted for inflation.

This seems to support that a 50/50 portfolio can sustain a 3% withdrawal rate in perpetuity, or at least practical perpetuity. It'd be nice if his data was available to look at other portfolio weights like 60/40, which are more common (at least here).
I didn't mean anything negative. You should be aware that historically, for any given withdrawal rate, more stock is in fact safer. 50/50 @ 3% should be failsafe, but at least historically 60/40 or 70/30 should be safer, e.g. if you should need to increase your spending.
Last edited by aristotelian on Sun Nov 17, 2019 2:59 pm, edited 1 time in total.

staustin
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Re: Winning the Game - Reducing Risk

Post by staustin » Sun Nov 17, 2019 11:33 am

mary1492 wrote:
Sat Nov 16, 2019 3:53 pm
Already FIREd here - currently age 55, and been at it 7 years now.

My AA is 2/98 - that's right, 98% bonds (CDs, Treasuries, Munis) - and I love it! There is absolutely nothing wrong with a (very) conservative AA if you already have enough money. I have very little desire for exposure to equities at this time.

Do what feels right for you, and ignore anyone who tells you that you must have higher equity allocation or else.

If you've mapped out your expenses, left a bit of room for the unexpected, then definitely go with what will keep you stress free and allow you to sleep well.

You're still very young, so if things begin to look like they are not going well, you can always go back to work, or take something part-time to supplement things a bit.
interesting... the dw and i are 30/70. could FIRE but haven't had the courage to pull the rip cord just yet. Curious, do you hold your Treasuries and Muni's via funds or directly hold.

mary1492
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Re: Winning the Game - Reducing Risk

Post by mary1492 » Sun Nov 17, 2019 11:51 am

.....
Last edited by mary1492 on Wed Dec 04, 2019 10:22 pm, edited 1 time in total.

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Re: Winning the Game - Reducing Risk

Post by Kevin M » Sun Nov 17, 2019 1:52 pm

expatFIRE wrote:
Sun Nov 17, 2019 5:00 am
Kevin M wrote:
Sat Nov 16, 2019 4:57 pm
If you assume you have an investment that is safe in real terms, such as a TIPS ladder, you can use the spreadsheet RATE function to determine the real rate required for a given number of years and a given withdrawal rate. For example, for 60 years at 3% WR:

=RATE(60, 3%, -1, 0)

This returns 2.18%, which I interpret as requiring a 2.18% real return at 3% WR to last 60 years. I don't think there's currently any safe investment that will provide a 2.2% real return--the 30-year TIPS yield is only about 0.6%, and that only gets you to 30 years, not 60.

Consider using safe assets to get you to 30 years, and stocks for the rest.

=RATE(30,3%, -1,0)

This returns -0.67%, so even a negative real return of this rate gets you to 30 years. A TIPS ladder would work for that, since TIPS yields currently are positive for all maturities of 5 years and greater. But the formula assumes you put 100% of your assets into the TIPS ladder.

At a 0% real return, you'd have to put 90% of your portfolio into the TIPS ladder to last 30 years:

=- PV(0%, 30, 3%, 0)

Kevin
Kevin,

Thank you so much for this example. I was also able to find your earlier explanation: https://www.kevinoninvesting.com/2016/1 ... vings.html

I notice in your last example you use 0% real rate of return. Is there any reason you did not use 0.6% for the 30 year TIPS? Bonds could be reduced to 82% of the portfolio (instead of 90% in your example with zero real rate of return).
It's just a conservative starting point--we've seen periods when a TIPS ladder would have had negative real yields (the 30-year TIPS yield has never been negative, but all other maturities of 20 years and less have, so the average yield of a ladder would have been negative, in 2012 for example). Also, I figure anyone who's really interested can play with the formulas themselves, entering whatever values make sense to them--just as you've done!

Finally, I'm thinking in terms of a TIPS ladder, with TIPS maturing each year for 30 years (can't really build this now, because there are some multi-year gaps in TIPS maturities, so even this is somewhat conceptual), so the yield of the ladder would be lower than the 30-year TIPS yield. The average of the 5, 7 10, 20 and 30-year yields, available at treasury.gov, is 0.30%, so that might be more reasonable to use now than 0.6%.
expatFIRE wrote:
Sun Nov 17, 2019 5:00 am
If I assume a 60 year retirement, 100% TIPS yielding 0.6% real, that's a safe withdrawal rate of 1.99%. If the retirement is reduced to 30 years, that's a safe withdrawal rate of 3.65%. If I solve for a 3% withdrawal rate, then a portfolio of TIPS can only last for 37.3 years.
Yep, that's the right number of years (NPER) for those assumptions. At a more realistic 0.3% real for a ladder, it's about 35 years. Either way, a TIPS ladder at current yields wouldn't last 60 years.
expatFIRE wrote:
Sun Nov 17, 2019 5:00 am
After playing around with Excel for the other functions, I assumed 60 year retirement, 3% withdrawal rate, and 75% remaining portfolio balance:

=RATE(60,3%,-1,0.75)

If I did that right, that's a 2.84% required real annualized rate of return for the portfolio, compared with only 2.18% for portfolio depletion.
OK.
expatFIRE wrote:
Sun Nov 17, 2019 5:00 am
Using 0.5% for the 30 year TIPS rate and 40% of AA, the stocks would have to return at least 4.4% real annualized rate of return, compared to only 3.3% for portfolio depletion.

2.84 - (0.5%*40%) / 60% = 4.4%
Interesting approach. I'm not sure it makes a lot of sense to use the financial functions for risky assets; i.e., assets that don't provide certain return and periodic payments. With risky assets, you're back to a probabilistic approach, and back to using something like Monte Carlo with historical returns as the inputs. Many (most?) folks here seem to confuse probability with certainty, mostly assuming that US stock historical returns provide a population that can be relied on to provide reliable statistics to determine expected values and probability distributions. This ignores black swans, which I believe you have observed.

I was thinking more along the lines of something like a TIPS ladder as a liability-matching portfolio (LMP) for the first 30 years, with all withdrawals coming from it, and the rest of the portfolio held in stocks for the first 30 years (with no withdrawals), and then the stocks are used after 30 years to set up a portfolio for the last 30 years. I think what we're learning is that about 86% of the portfolio would be required for the LMP at a 0.3% real rate of return, which would leave only about 14% for stocks.

Without running more numbers to see how feasible something like this would be, I'm guessing that for a 60-year expected lifetime and a 3% withdrawal rate, you have no choice but to rely on a probabilistic approach, assuming as others do that US stock history is a reliable guide for the future. Reducing the withdrawal rate is one alternative. Perhaps incorporating the use of SPIAs is another, as these tend to allow larger withdrawal rates than a portfolio of relatively safe assets; i.e., assets with little uncertainty in returns for the given time period and unit of exchange (i.e., purchasing power for real liabilities, dollars for nominal liabilities).

Kevin
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Mon Nov 18, 2019 7:24 am

aristotelian wrote:
Sun Nov 17, 2019 11:17 am
[I didn't mean anything negative. You should be aware that historically, for any given withdrawal rate, more stock is in fact safer. 50/50 @ 3% should be failsafe, but at least historically 60/40 or 70/30 should be safer, e.g. if you should need to increase your spending.
Appreciate the response. I didn't take it as a negative but I was curious if there was something you saw as not being diversified.

I agree that the higher rates of return are needed for the portfolio to last longer. The equations from Kevin M and the ERN study definitely highlight that fact.

I just can't shake the drive for capital preservation. I'm not as concerned with return on capital as much as I am return of capital. I think at this point I'm leaning towards 60/40, and reevaluating if we get a large windfall or as net worth increases.

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Re: Winning the Game - Reducing Risk

Post by aristotelian » Mon Nov 18, 2019 8:15 am

expatFIRE wrote:
Mon Nov 18, 2019 7:24 am
aristotelian wrote:
Sun Nov 17, 2019 11:17 am
[I didn't mean anything negative. You should be aware that historically, for any given withdrawal rate, more stock is in fact safer. 50/50 @ 3% should be failsafe, but at least historically 60/40 or 70/30 should be safer, e.g. if you should need to increase your spending.
Appreciate the response. I didn't take it as a negative but I was curious if there was something you saw as not being diversified.

I agree that the higher rates of return are needed for the portfolio to last longer. The equations from Kevin M and the ERN study definitely highlight that fact.

I just can't shake the drive for capital preservation. I'm not as concerned with return on capital as much as I am return of capital. I think at this point I'm leaning towards 60/40, and reevaluating if we get a large windfall or as net worth increases.
I don't mean to push you into a higher stock allocation than you are comfortable with. A low withdrawal is also a possible solution--if you are sure you can stick to it.

Liability matching for your bridge years up to Social Security is another possibility. https://www.reddit.com/r/financialindep ... dge_years/

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expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Mon Nov 18, 2019 8:32 am

Kevin M wrote:
Sun Nov 17, 2019 1:52 pm
expatFIRE wrote:
Sun Nov 17, 2019 5:00 am
Using 0.5% for the 30 year TIPS rate and 40% of AA, the stocks would have to return at least 4.4% real annualized rate of return, compared to only 3.3% for portfolio depletion.

2.84 - (0.5%*40%) / 60% = 4.4%
Interesting approach. I'm not sure it makes a lot of sense to use the financial functions for risky assets; i.e., assets that don't provide certain return and periodic payments. With risky assets, you're back to a probabilistic approach, and back to using something like Monte Carlo with historical returns as the inputs. Many (most?) folks here seem to confuse probability with certainty, mostly assuming that US stock historical returns provide a population that can be relied on to provide reliable statistics to determine expected values and probability distributions. This ignores black swans, which I believe you have observed.

I was thinking more along the lines of something like a TIPS ladder as a liability-matching portfolio (LMP) for the first 30 years, with all withdrawals coming from it, and the rest of the portfolio held in stocks for the first 30 years (with no withdrawals), and then the stocks are used after 30 years to set up a portfolio for the last 30 years. I think what we're learning is that about 86% of the portfolio would be required for the LMP at a 0.3% real rate of return, which would leave only about 14% for stocks.

Without running more numbers to see how feasible something like this would be, I'm guessing that for a 60-year expected lifetime and a 3% withdrawal rate, you have no choice but to rely on a probabilistic approach, assuming as others do that US stock history is a reliable guide for the future. Reducing the withdrawal rate is one alternative. Perhaps incorporating the use of SPIAs is another, as these tend to allow larger withdrawal rates than a portfolio of relatively safe assets; i.e., assets with little uncertainty in returns for the given time period and unit of exchange (i.e., purchasing power for real liabilities, dollars for nominal liabilities).

Kevin
It was eye-opening to see how increasing the percentage of the fixed income required increasing the returns for the remaining risky assets. The 3.3 to 4.4% real annualized return range for equities seems reasonable, compared to historical long term real annualized returns of 6.5% for US stocks and 5.2% for a total world fund since 1900:
https://monevator.com/world-stock-markets-data/

Could future returns be lower? Of course, but going from 5.2% down to 3.3% has a reasonable safety factor built in. On the other hand, if I look at 60 years for portfolio depletion with 30/70 stock/bonds, the required real annualized stock return is 6.1%. I don't have much confidence in achieving this return.

If you expect total world to behave as it has since 1900, then you could go as high as 64% bonds for this example and be less than 5.2% real stock return (60 years, portfolio depletion, 0.5% real bond return).

However, I'm not sure how this would factor in withdrawals and sequence of returns. I agree a probability based approach is likely needed, although with Monte Carlo the results are only as good as the assumptions.

Thanks for explaining the 30 year LMP. I think the LMP would come in to play if you're close to Social Security or to an age where SPIAs would make sense (e.g. 10 to 15 years out). This would be a way of bridging the gap to fixed income and avoiding sequence of returns risk. I'm not sure I'd want to trust only 14% of my portfolio to grow over 30 years to cover 30 years of expenses.

dbr
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Re: Winning the Game - Reducing Risk

Post by dbr » Mon Nov 18, 2019 9:50 am

The answer depends on what you want to do with all that money. The difference between holding more money than you need all in stocks and holding it all in bonds is how wealthy you want to try to be when you die. Another factor is contingencies. People can underestimate what needs might come to pass.

The advice is sometimes given to take no more risk than necessary, but it is also advisable to not be too narrow in diversity. Unless you have some good reason not to a starting point for thinking would be 50/50.

Note bonds are not risk free as principal can be eroded by inflation and returns can be too low to meet the outcomes one really wants. Funding retirement withdrawals is most risky for all bonds unless the withdrawal rate is quite low. It is also true that 100% bonds is fine if one is sure one is happy with the likely and unlikely consequences.

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Kevin M
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Re: Winning the Game - Reducing Risk

Post by Kevin M » Mon Nov 18, 2019 4:34 pm

expatFIRE wrote:
Mon Nov 18, 2019 8:32 am
Kevin M wrote:
Sun Nov 17, 2019 1:52 pm
expatFIRE wrote:
Sun Nov 17, 2019 5:00 am
Using 0.5% for the 30 year TIPS rate and 40% of AA, the stocks would have to return at least 4.4% real annualized rate of return, compared to only 3.3% for portfolio depletion.

2.84 - (0.5%*40%) / 60% = 4.4%
Interesting approach. I'm not sure it makes a lot of sense to use the financial functions for risky assets; i.e., assets that don't provide certain return and periodic payments. With risky assets, you're back to a probabilistic approach, and back to using something like Monte Carlo with historical returns as the inputs. Many (most?) folks here seem to confuse probability with certainty, mostly assuming that US stock historical returns provide a population that can be relied on to provide reliable statistics to determine expected values and probability distributions. This ignores black swans, which I believe you have observed.

I was thinking more along the lines of something like a TIPS ladder as a liability-matching portfolio (LMP) for the first 30 years, with all withdrawals coming from it, and the rest of the portfolio held in stocks for the first 30 years (with no withdrawals), and then the stocks are used after 30 years to set up a portfolio for the last 30 years. I think what we're learning is that about 86% of the portfolio would be required for the LMP at a 0.3% real rate of return, which would leave only about 14% for stocks.

Without running more numbers to see how feasible something like this would be, I'm guessing that for a 60-year expected lifetime and a 3% withdrawal rate, you have no choice but to rely on a probabilistic approach, assuming as others do that US stock history is a reliable guide for the future. Reducing the withdrawal rate is one alternative. Perhaps incorporating the use of SPIAs is another, as these tend to allow larger withdrawal rates than a portfolio of relatively safe assets; i.e., assets with little uncertainty in returns for the given time period and unit of exchange (i.e., purchasing power for real liabilities, dollars for nominal liabilities).

Kevin
<snip>
However, I'm not sure how this would factor in withdrawals and sequence of returns. I agree a probability based approach is likely needed, although with Monte Carlo the results are only as good as the assumptions.
Exactly. It's the sequence of returns risk that invalidates using the financial functions for risky assets, since there are no guaranteed, periodic payments, which is what the financial functions require.

And right again about the garbage in, garbage out aspect of Monte Carlo. If one uses historical, annual US stock returns as the statistical population, you are assuming that these returns have reliable expected value and probability distribution that are applicable to future returns. But there is research that has shown that there is significant uncertainty even in the expected return based on historical returns (I think this is referred to as standard error), not to mention the uncertainty in the probability distribution.
Thanks for explaining the 30 year LMP. I think the LMP would come in to play if you're close to Social Security or to an age where SPIAs would make sense (e.g. 10 to 15 years out). This would be a way of bridging the gap to fixed income and avoiding sequence of returns risk. I'm not sure I'd want to trust only 14% of my portfolio to grow over 30 years to cover 30 years of expenses.
I agree that a 30-year LMP probably does not make sense for a 3% withdrawal rate for the first 30 years of a 60 year retirement, but I disagree that it generally is only useful if one is close to SS, etc. At a 2% withdrawal rate, 0.3% real return, a portfolio of TIPS would last 54 years (of course one can only build a TIPS ladder out to 30 years), and 50% of the portfolio in TIPS would last 26 years.

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

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expatFIRE
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Re: Winning the Game - Reducing Risk

Post by expatFIRE » Tue Nov 19, 2019 7:40 am

dbr wrote:
Mon Nov 18, 2019 9:50 am
The answer depends on what you want to do with all that money. The difference between holding more money than you need all in stocks and holding it all in bonds is how wealthy you want to try to be when you die. Another factor is contingencies. People can underestimate what needs might come to pass.

The advice is sometimes given to take no more risk than necessary, but it is also advisable to not be too narrow in diversity. Unless you have some good reason not to a starting point for thinking would be 50/50.

Note bonds are not risk free as principal can be eroded by inflation and returns can be too low to meet the outcomes one really wants. Funding retirement withdrawals is most risky for all bonds unless the withdrawal rate is quite low. It is also true that 100% bonds is fine if one is sure one is happy with the likely and unlikely consequences.
I agree that bonds returns may not keep up with inflation. Some of my I Bond holdings are zero coupon, and personal CPI may be different than that calculated by the government.

One item I didn't specifically mention during this thread is the small cap value tilt (both US and international). Assuming I get rewarded for taking extra risk, it's possible that a tilted portfolio that's 60/40 or 50/50 has higher risk / returns than the same AA at market weights.

That is what I understand for Larry Swedroe's "Fat Tails" portfolio (e.g. 15% Small Cap Value, 15% Emerging Markets, 35% Short Term Treasuries, 35% TIPS). However I'm not comfortable with that level of possible tracking error.

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