The following post is by MPFJ staff writer, Marie. You can read more of Marie’s articles over at her own blog, Family Money Values. Enjoy!
What should your asset allocation strategy be once you are actually retired?
You know what it is.
As readers of My Personal Finance Journey, you know what asset allocation is. Jacob has written about it many times.
But, just to repeat: Asset allocation is the process of keeping your investment portfolio diversified across multiple different types of assets (asset classes like bonds and various types of stocks -domestic, international, and etc) in an effort to get the highest returns, avoid catastrophic loss across the portfolio in a downturn and still let you sleep at night. At least, that is my definition.
The goal of using an asset allocation strategy should also hopefully allow you to take some of the emotion out of investing, allowing for more logical and consistent decisions about what to keep and when to sell or buy.
Why asset allocation is important
In my terms, as a past project manager, asset allocation is a plan for investing. Without a plan you might end up where you want to be, but more likely, you won’t get there.
Forbes lists 10 of the reasons asset allocation is important in 10 Reasons Why Asset Allocation Is Everything For Retirement Saving:
To me, the one that makes most sense is the first they list, as explained in this quote from the article:
“Most returns are “explained” by asset allocation, in investment parlance. That means it matters more how you divide up the pot into bonds, U.S. stocks, international stocks, etc., than it does whether you pick the best (or worst) funds in each of those asset classes. “
The author cites multiple studies that claim that 100% of your returns are due to your asset allocation.
What is the typical recommendation for your target allocation (and why)?
Investing pundits try to help the masses of people investing by simplifying what we should stake out as our ‘target’ allocation. Here is what CNN Money quotes as the rule of thumb for your target:
“The old rule of thumb used to be that you should subtract your age from 100 – and that’s the percentage of your portfolio that you should keep in stocks. For example, if you’re 30, you should keep 70% of your portfolio in stocks. If you’re 70, you should keep 30% of your portfolio in stocks.
However, with Americans living longer and longer, many financial planners are now recommending that the rule should be closer to 110 or 120 minus your age. That’s because if you need to make your money last longer, you’ll need the extra growth that stocks can provide”.
The reason being that as you age, your income from non portfolio sources will most likely drop. Your portfolio becomes very important to your continued ability to buy groceries and pay your taxes. So, you must be ultra conservative as you approach retirement, so as not to lose your nest egg.
I’m 67 and retired since 2010 and I don’t buy it for my situation. You’ll see why later.
What should be included in your asset allocation?
You would think that figuring out what things you should include when allocating assets would be pretty simple, but sometimes this isn’t the case.
Jacob has raised this question before in several posts, like Should You Include Emergency Fund and Specifically-Earmarked Savings in Your Overall Asset Allocation? or Should You Incorporate Gold / Precious Metals in to Your Asset Allocation?
The American Association of Individual Investors has the following suggestion:
“An investment portfolio should consist of financial assets that you would be willing to sell for spending money or that generate some form of spending money, either now or some time in the future.”
The article suggests that you can make the decision by asking yourself (and your spouse) questions such as: can you put a dollar value on the asset; how much is it worth (if not much then maybe not include it); is it really an asset or is it instead a purchase that you consume – in other words, would you mind selling it for cash?
In New Take on Asset Allocation: Include Your House and Social Security, Anne Tergesen, the author, suggests that for some, it might be appropriate to include these things in your list of assets to allocate saying:
“So, for a 65-year-old woman who receives $25,000 in annual benefits, the value of those payments as an asset is about $500,000. Next, she would add that $500,000 to the bond portion of her investment portfolio.”
Whoa! Not for me. I like my house and won’t be selling it for spending money except as a total last resort. Plus, I don’t count my chickens before they hatch, do you?
So what should your asset allocation be once you retire?
Well, as Bonnie Baker, database technician, consultant and award winning speaker of the “Things I Wish They’d Told Me 8 Years Ago” DB2 database series always says in her presentations (yes I am an ex-mainframe programmer who used IBMs DB2 product!):
“IT DEPENDS!”
I believe it depends not just upon your age but also on a whole lot of other things. Here are a few of the things I think matter.
- How big is your portfolio?
In general, I think (and I am NOT an investment professional, by the way) that if you are post-retirement and living solely off your portfolio income and principal, you do need to consider being ultra conservative. Of course, even this depends – how big is your portfolio? If you have tens of millions, you probably can be a bit more exuberant in your investment selections.
- What are you including in your asset list to allocate?
If you are targeting a fairly aggressive allocation, are you leaving assets out that can mitigate the risk?
If you are satisfied with less, you won’t need as much income. If you like to shop impulsively, travel, spend on hobby’s grandkids or give considerable amounts to your favorite causes, you will need more backing and higher levels of income.
- How much debt do you have?
With debt, especially debt on things you need to live (ahem… your home), you need to make sure your portfolio will continue to kick off enough to cover the debt.
- What other sources of income do you have and how reliable are they?
If all your current needs and wants are covered by income that doesn’t include that from your portfolio, then you can be more aggressive in seeking higher returns with more risk.
What we do
My spouse and I are ordinary folks who worked and saved hard for a really long time. We aren’t finance gurus but we do believe we have done well enough.
In our situation, those ‘it depends’ items are as follow.
He gets a pension equal to 3/4 of his working salary. I collect social security but also have $600K + in a traditional IRA, from which I will start having to take required minimum distributions in a few years. We paid off our mortgage in 1993 and have a fully paid vacation condo as well, only travel when I force the issue, live a fairly inexpensive lifestyle that is well covered by his pension alone and we have a significant net worth (putting us solidly in the upper middle class). We have no debt and pay off credit cards in full each month. Our kids and grandkids don’t require supplemental support and except for my mother-in-law we have no family financial obligations.
While I was still working, I bought into the idea of reducing exposure to risk by moving our target asset allocation more to the ‘safe’ side. But now I am rethinking that after 5 years of no salary income and no money problems.
Our current target allocation is:
- 35% Large Cap stocks and mutual funds
- 20% Small-midcap stocks and mutual funds
- 15% International stocks and mutual funds
- 25% bonds
- 5% cash (or near cash)
So… 70/25/5
The rule of thumb quoted above, tells me I should be targeting 54% in stock instead of 70%. That just doesn’t make sense to me in our situation.
What I include in my asset list:
I exclude many of our assets from our allocation strategy. I only include liquid assets like bank accounts, investment accounts, and etc. I exclude our home, our condo, his cash value in the life insurance, and I definitely never include money we don’t have yet (like future pension or social security payments).
Because I exclude all of those things, I feel we have a pretty big security net. We can continue to sleep in our beds, keep food on the table, and stay retired even if our portfolio falls to zero.
How to get to and maintain allocation targets
Setting an allocation target and actually meeting it are two very different things – and both have benefits.
Just setting a target forces you to list what you own and owe, think about and discuss risk, review your lifestyle desires and more.
Meeting and maintaining your targets maximizes your hoped for returns, and can take some of the emotion out of buying and selling.
I must confess that I have historically had trouble maintaining our target allocation. However, I’m sort of a control freak and also kind of thrifty. I don’t want anyone else managing our money and I certainly don’t want to pay them a percent of my managed asset base to do it.
Therefore, it is up to me to track where we are with our asset mix and decide what to do about meeting the allocation targets.
I’m also a buy and hold type investor and really hate to sell. Unless there is good reason (like the investment really sucks AND I need a capital loss for tax purposes), I tend to try to balance with dividends and new purchases. This negates one of the benefits of an asset allocation strategy – selling when a class of assets has risen in price, putting you over your allocation in that class.
How I check my progress towards target allocations
Once a quarter, I produce Quicken a report of all of our liquid investments, classified by asset type (bonds, the various types of stocks and cash). Since I manually classify these assets by type in Quicken, I really should also be checking that classification each time. This is hard to do with mutual funds and is a constantly moving target as to how much of each fund is actually invested in what type of asset. Sometimes even the actual stock I own can change from large cap to mid or vice versa.
After printing out the Quicken report, I then start fiddling with it. Currently, we are in a very low interest rate environment so I have put some of our cash into short term bonds to get more interest. I’ve also allocated our cash positions to various projects my spouse and I believe will be needed – things such as buying a new car, putting on a new roof and siding, investing more when prices come down, taking the family on vacation (OK, that one is really mainly mine) and etc.
When I figure out how much cash is in our portfolio, I subtract out the things on which we will be consuming (siding, roof, car, etc) as well as our emergency living money (in case those pensions and payments stop coming for whatever reason this would give us time to find jobs).
I also move the ‘cash’ that we have put into short term bonds out of the bond category.
Then I re-figure the percentages and figure out how much over or under we are in each category. This reduces our overall asset base and removes part of our bond portion (the part that is currently actually in bonds, but which, in our minds is actually cash).
Following that exercise (which takes me several hours), I ponder what to do about it. I write down action items to do during the coming quarter. These are things like, “keep looking for opportunities to buy bonds” or “buy Chevron (large cap that we already own shares of) while the price is down”.
Since we no longer are actively investing salary or pension income, any buys have to come from dividends or sales in another asset class.
While I am diligent about reviewing our allocation and deciding what to do, I must confess that I often don’t take action on the items I list. Sometimes this is because I get sidetracked. Other times it is a conscious decision that now is not the time.
It’s kind of a pain, so how could this be done differently? Here are a couple of ways to let someone or something else share the burden.
Should you use a portfolio manager?
There are firms, if you have enough money, that will manage your entire portfolio for you. They typically charge a percent of the portfolio value each period, and those percents can be pretty high.
I guess if you are a mega millionaire or a billionaire, these managers might be worth their cost, but for we average Janes, they are either not available or too pricey.
Should you use target date funds?
As this CNN Money article explains:
“Based on the year you expect to retire, target-date funds are supposed to invest in a mix of stocks, bonds and cash that reflect an age appropriate level of risk that changes as you get older.”
You are supposed to pick the date at which you want to retire, then let the fund control your money. You could, I presume, pick a date based on your risk tolerance as well, however. If you are very risk adverse, then you could pick a date closer to now, for instance, which would cause your money to be invested in things in which people closer to retirement are theoretically supposed to invest.
I never have liked target date funds (remember I’m kind of a control freak), and the above article notes also that you may be incurring more fees than you would want. In addition, these funds are typically one size fits all and don’t consider the particulars of your individual situation
Would robo advisors make this all easier?
In this 21st century, software companies, combined code writing talent with modern portfolio theory allow you to use robo advisors to manage your asset allocation/portfolio.
Main St article Top 10 Robo Advisors Ranked: Find the Best Automated Online Investing Services describes these as:
“Robo advisors– automated computer algorithms that allocate, deploy and rebalance our investments.”
All of these appear to be somewhat different variations on a theme. Many will, in addition to a fee of a percentage of your portfolio, also incur other fees, such as fund management fees, commissions, etc.
Some of them have absolutely no human component, while others allow you to decide how much control you or an advisor has over the assets. Some will automatically buy and sell to re-balance while others allow intervention or just provide suggestions.
The jury is still out on how viable these will be for other than absolute investing beginners (although reports are that the Millennials are loving them). As these robo advisors grow in flexibility and complexity, perhaps they will be able to take into account some of the things I consider today in defining and executing my own asset allocation strategy, things such as my individual lifestyle, portfolio levels, risk tolerance, and tax situation.
Wouldn’t it be nice just to not bother with all the work and have it all automated? But, as with liberty, eternal vigilance is the price of financial freedom.
How about you all? What’s your asset allocation strategy?
Share your experiences by commenting below!
***Photo courtesy https://pixabay.com/en/stock-exchange-bull-bear-securities-642896/
