jmndu99 wrote:...
Phineas,
The part about "What happened was the stock runup pushed the value of my portfolio over a pre-defined multiple of expenses, at which point my IPS says to modestly reduce the risk of my portfolio by changing from 60/40 to 50/50." is of interest to me.
Can you explain how you cam up with "... value of my portfolio over a pre-defined multiple of expenses..." Can you point me to resources for this activity please?
Hi jmndu99, happy to help.
I started contemplating all this as I thought about retiring early or switching to a financially riskier but more personally fulfilling career, and how those decisions might affect the age-in-bonds rough guideline.
If you're asking how I came up with the rule:
I began with the rough, planning-only guideline of taking an initial 4% of the portfolio, adjusted for inflation each subsequent year. That would mean having a portfolio value of 25 times expenses. The safer 3% would mean 33 times.
I don't like to get overly precise about events and data that are far off, so
I just arbitrarily set the following thresholds see the edit below for myself. I can't strongly defend them, but I don't think anybody can strongly attack them. It doesn't matter because it's all very much based on my own personal situation, and may not apply to others. I didn't design it with the purpose of writing a book telling people to follow it.
The important thing is to reduce risk as I progress toward adequate funding levels, and to stick to the plan. Earlier this year the portfolio made it up and over 30 times expenses. The plan does not say to increase my stock percentage if the market drops - the sequence only moves forward, not backward.
I was at 70/30 when I settled on these rules, with a multiple a little below 20.
Up to 25 times expenses: 70/30
Above 25 but below 30 times expenses: 60/40
Above 30 but below 35 times expenses: 50/50
Above 35 times expenses: 40/60
[Edited to add]
I forgot all about one part of the reasoning behind those numbers: They result in a fairly constant-size stock holding. In effect, the gains are being safely set aside in bonds, until I get up to 35 times expenses at which point the stock holding can start to grow again. I don't know how I came to leave that out. It was a very important factor in choosing the thresholds.
If you're asking how I calculate:
I calculate everything in real dollars and, to be conservative, assume the remaining portfolio value keeps up with inflation but no more.
Expenses: I have a budget, which I've been using for a long time. I know how much I expect to spend each year, and I add income taxes to that amount to come up with the total annual withdrawal.
Portfolio value: I use Microsoft Money. I've set up a portfolio called "Retirement: All." I regularly update prices (a simple portfolio means not having very many to update). I don't bother to tax adjust because tax-deferred accounts are the great majority of the resources, so for planning purposes I treat everything as if it's taxable in the year I use it. When it comes time to take assets out I'll calculate the taxes more precisely each year.
Calculation: Portfolio value / (expenses + income tax).
For this purpose, and this purpose only, I ignore Social Security. As that time comes nearer I could adjust to take it into account, but already I'm at the second-lowest stock allocation specified by the rule, so it won't really make much difference, saying again: for this purpose and this purpose only.
If you're asking how I got so far so fast:
1) Save and invest;
2) Rebalance and invest all the way down and all the way back up our recent interesting times in the stock market;
3) Cut my living expenses by 40%, thereby simultaneously decreasing the amount I have to accumulate, and increasing the amount I can save.
I've carved my policy with an axe, not a scalpel.
Does that help?
PJW