An Age Old Question - Your Age in Bonds?

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Rick Ferri
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An Age Old Question - Your Age in Bonds?

Post by Rick Ferri » Sun Oct 11, 2009 5:14 pm

Age plays an important role in determining asset allocation. However, can you determine portfolio asset allocation based solely on a person’s chronological age? The general consensus is yes, the older you get, the less risk you should take. But is this naive model good enough or should adjustments be made? Young people tend to have more similar financial situations and do more easily fit a one-size-fits all model. However, older people have more diverse financial situations and adjustments to the age-in-bonds model are appropriate. Read An Age Old Question by Richard Ferri, CFA and Brigham Young University professor Craig Israelsen, Ph.D. Published this month in Financial Planning Magazine.

Enjoy!
Last edited by Rick Ferri on Sun Oct 11, 2009 5:45 pm, edited 1 time in total.

kenbrumy
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Post by kenbrumy » Sun Oct 11, 2009 5:30 pm

If financial advisors want to use a simple asset allocation model based on age as a starting point, they must be willing to adjust and adapt that simple model as their client gets older and their lives become more complex. Calculating a client’s allocation age is a simple idea with big implications for advi-sors who want to develop client-centered portfolios.
Your final paragraph says it all.

The overall article' point for this confirmed anal-retentive type is obvious. Those with other secure pension-type incomes can adjust fixed income with other equity allocations.

After my less than positive comment above, the article was a good description of things for FPs to consider in discussing asset allocation with their clients.

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AzRunner
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Post by AzRunner » Sun Oct 11, 2009 6:20 pm

Rick,

Thanks for the article link. I like the way you broke the portfolio in two for the 65 year-old couple that had accumulated $2 million but only needed $1 million to live on and would likely leave the other $1 million as an inheritance. That's a logical way to break the problem down and come up with a sensible allocation between stocks and bonds.

Norm

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Post by unclemick » Sun Oct 11, 2009 6:31 pm

Yep. Age 66, 40% income from pensions/SS and no plans to leave an inheritance is but one dot in a sea of data points/er possible clients.

Your point is well taken.

heh heh heh - now come up with a magic lamp and let me start over/younger with what I've learned as a Boglehead forum reader. :lol: :lol: :lol: :roll: .

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Post by DblDoc » Sun Oct 11, 2009 9:56 pm

unclemick wrote:Yep. Age 66, 40% income from pensions/SS and no plans to leave an inheritance is but one dot in a sea of data points/er possible clients.

Your point is well taken.

heh heh heh - now come up with a magic lamp and let me start over/younger with what I've learned as a Boglehead forum reader. :lol: :lol: :lol: :roll: .
And no doubt wish #2 would be the Saints win the Super Bowl!!!

DD

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Post by HueyLD » Sun Oct 11, 2009 10:20 pm

Rick,

I have a question on the recommended asset allocation for the 55-year old who is barely getting by.

It appears that she is going to be poor no matter what her asset allocation is. At the conservative 30/70 mix, her modest investments may not keep up with inflation, especially the higher than average senior inflation rates due to higher proportion of her expenses in health care.

This woman may have to work until death, or eat rice and beans and live in a trailer in her old age. I feel for her.

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Post by Levett » Mon Oct 12, 2009 5:46 am

Hi Huey,

I think the article all but says that about the first woman. It's a grim portrait.

"Let’s say the first 55-year-old woman is barely getting by. All she has saved for retirement is the small amount she has put aside in her 401(k). She has some housing debt and is caring for her aging parents, who are both in their eighties. This client has an allocation age of 70 based on her life situation because she has very high cash flow risk and is caring for elderly parents. She is financially vulnerable and cannot afford to lose any sizable amount of her savings."

Bob U.
There are some things that count that can't be counted, and some things that can be counted that don't count.

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Bruce
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Post by Bruce » Mon Oct 12, 2009 6:54 am

The other 55-year-old investor (who could handle more volatility) experienced a bigger loss (18.6%), but is also positioned to outperform during subsequent market rebounds.
Rick, good article,

My question, what is the "outperform" part of the equation in this article?

Outperform relative to the poorer fifty five year old, or relative to what?

I thought the simplicity of index investing was to match the returns of the market, not worry about outperforming the market.

regards,
Bruce | | Winner of the 2017 Bogleheads Contest | | "Simplicity is the master key to financial success."

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Post by Ron » Mon Oct 12, 2009 7:16 am

AzRunner wrote:Rick,

Thanks for the article link. I like the way you broke the portfolio in two for the 65 year-old couple that had accumulated $2 million but only needed $1 million to live on and would likely leave the other $1 million as an inheritance. That's a logical way to break the problem down and come up with a sensible allocation between stocks and bonds.

Norm
Well, that's one way to look at it.

Another could be (looking at our personal situation) is that we start with the same portfolio value but leaving our remainder estate to charity. While we could be more conservative, we really don't gain anything other than possibly knowing that at least a certain base amount will be going to our named charities. That's why we don't feel our early retirement AA (60/40) is aggressive for our situation.

Every life, every story is different. The only true statement IMHO is "it all depends".... :lol:

- Ron

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Rick Ferri
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Post by Rick Ferri » Mon Oct 12, 2009 8:32 am

Bruce wrote:
The other 55-year-old investor (who could handle more volatility) experienced a bigger loss (18.6%), but is also positioned to outperform during subsequent market rebounds.
Rick, good article,

My question, what is the "outperform" part of the equation in this article? Outperform relative to the poorer fifty five year old, or relative to what?
I see your point. I did not write that particular sentence, but I read it as stocks should 'outperform' the fixed income portion cumulatively over time.

Rick Ferri

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Post by dbr » Mon Oct 12, 2009 9:32 am

Prospects in retirement are dominated by the adequacy of one's wealth relative to one's "needs" rather than by what AA is chosen. The examples that are "forced" to more conservative AA's are the one's who don't have enough money to meet their needs. There is no AA solution to this problem.

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Post by Boglenaut » Mon Oct 12, 2009 9:54 am

This was a very interesting article.

I was never a believer in the "one rule to rule them all".

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Post by Levett » Mon Oct 12, 2009 11:12 am

Well said, dbr. Bob U.
There are some things that count that can't be counted, and some things that can be counted that don't count.

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Post by sschullo » Mon Oct 12, 2009 12:02 pm

dbr wrote:Prospects in retirement are dominated by the adequacy of one's wealth relative to one's "needs" rather than by what AA is chosen. The examples that are "forced" to more conservative AA's are the one's who don't have enough money to meet their needs. There is no AA solution to this problem.
I second what bob u said. If one does not have enough money to live on they have really only one fairly safe option which admittedly is not available for everyone because it is dependent on their age and work history and one horrible option: First, the option is to work longer and save more.
If you decide to retire, 2nd option is potentially disastrous which is to take on more risk to "make up" for what you don't have.
Bottom line: as in the accumulation stage, during the distribution stage, live within your means.
Public School K-12 Educators: "Ask NOT what your annuity sales person can do for you, ask what you can do to be a Do-It-Yourselfer (DIY)."

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Post by TJAJ9 » Mon Oct 12, 2009 12:59 pm

I believe "age in bonds" is a good rule of thumb, but no rule of thumb should always be followed as is. It's a great starting point, which can then be adjusted accordingly to each person's circumstances.

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Re: An Age Old Question - Your Age in Bonds?

Post by iceport » Mon Oct 12, 2009 1:30 pm

Rick Ferri wrote:Age plays an important role in determining asset allocation. However, can you determine portfolio asset allocation based solely on a person’s chronological age?
Thanks for an interesting article. What you say makes a lot of sense.

With so many factors to consider other than age (including those you noted: wealth, financial obligations, pensions and family status ), why default to the age rule-of-thumb? Could you get to the same place with a more general, more universal default that is adjusted for all of the above factors?

Specifically, is there any merit to the notion of using the "market portfolio" as the default AA, roughly 60/40 equity/fixed income, and making appropriate adjustments from there? (Isn't that similar to the approach advocated frequently for the equity-only allocations?)

The big advantage to a simple rule of thumb is that it makes it less likely that someone would get it wildly wrong. Does the market AA default (60/40) do essentially the same thing? Or does the age factor dominate all others combined?

--Pete

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Post by TJAJ9 » Mon Oct 12, 2009 1:40 pm

Some non-bogleheads might think "age in bonds" is a bit on the conservative side. That's why I think it's a good rule of thumb. An investor looking for guidance is better to be a bit conservative, rather then too aggressive, IMO. Better safe then sorry, as the saying goes.

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Post by KarlJ » Mon Oct 12, 2009 1:46 pm

I thought the article was very informative, especially the examples of the two 55 year old women. In the case of the second 55 year old with a generous pension and no debt or future foreseen liabilities the recommended allocation is 40% fixed income and 60% equities due to this individuals ability to handle higher risk. An argument could be made, however, that the second 55 year old does not have any need to take on higher risk since she has already “made it” and could therefore move to an allocation dominated by fixed income. What is wrong with this logic?

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Working Longer?

Post by EyeDee » Mon Oct 12, 2009 1:49 pm

sschullo wrote:If one does not have enough money to live on they have really only one fairly safe option which admittedly is not available for everyone because it is dependent on their age and work history and one horrible option: First, the option is to work longer and save more. . . .
.
Working longer is very often not an option – see ruralavalon’s Sat Oct 03, 2009 11:10 am post in this conversation: http://www.bogleheads.org/forum/viewtopic.php?t=43819

About: http://www.ebri.org/pdf/FFE129.15July09.Final.pdf
Randy

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Post by Levett » Mon Oct 12, 2009 1:58 pm

Hi Karl,

So far as I'm concerned, nothing is "wrong" with your logic.

I believe Bill Bernstein (and likely others) has remarked that if you've already won the game why keep on playing? 8) Bob U.
There are some things that count that can't be counted, and some things that can be counted that don't count.

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Post by DaveS » Mon Oct 12, 2009 1:58 pm

Don't forget the best system is your age in bonds in a down market, and you kids age in bonds in a up market. But it's hard to time the switch. Dave

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Post by Adrian Nenu » Mon Oct 12, 2009 2:08 pm

How much money can you stand to lose?

Can you make up the loss?

Can you sleep well with the loss?

Can you stay the course with the loss?

Can you rebalance with the loss?

These are questions investors must ask themselves because every investor is different. Boilerplate asset allocations based on age/time may or may not work because age is the only thing investors have in common. Think about that - nothing but age in common so asset allocations must be different to be suitable for each individual.

Adrian
anenu@tampabay.rr.com

dbr
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Post by dbr » Mon Oct 12, 2009 2:12 pm

KarlJ wrote:I thought the article was very informative, especially the examples of the two 55 year old women. In the case of the second 55 year old with a generous pension and no debt or future foreseen liabilities the recommended allocation is 40% fixed income and 60% equities due to this individuals ability to handle higher risk. An argument could be made, however, that the second 55 year old does not have any need to take on higher risk since she has already “made it” and could therefore move to an allocation dominated by fixed income. What is wrong with this logic?
I would personally prefer your logic to Rick's except on Mondays, Wednesdays, Fridays, and Sundays (when no preferences are mooted). I think this illustrates that if you want to question the concept and move beyond "age in bonds" you have to actually know how to arrive at a better answer. It is not sufficient to present an argument for one particular answer as the next person along may well present an equally persuasive argument for the opposite answer. Probably what is actually wrong with your logic is that the second 55 year old wants to exchange certainty of outcome for a probability that their wealth will increase more simply because they want to.

I like to start with the rule of thumb that everyone should be 49:51 stocks:bonds. This rule stems from the principle of ignorant diversification, is usually not too far from age in bonds, and with that little 1 point nuance, does not contradict Adrian's rule.

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