In investing, a “glide path” describes how and when a portfolio gradually becomes less risky as you move toward retirement. The concept is perhaps best known with regards to Target Retirement and Lifecycle funds where you pick the “Fund of Funds” by the date of retirement. The mutual fund company has its experts decide on what the ideal glide path should be and then implements it as your retirement date approaches.
A Traditional Glide Path
Graphing the asset allocation of the Vanguard Target Retirement Funds gives you an idea of what a “typical” glide path might look like, but there are significant differences between the various mutual fund companies, as discussed here.
Vanguard Target Retirement Fund Glide Path
As you can see, an investor who is 25+ years away from retirement gets put into a portfolio that is 90% stocks and 10% bonds. That gradually decreases until at retirement it is about 55% stocks and 45% bonds. Then, about 8 years after retirement, it shifts to a portfolio of about 30% stocks.
There are a few things worth pointing out there.
- This is the Vanguard experts' idea of what a proper glide path should look like.
- They never have more than 90% stocks, or less than 30% stocks. This is somewhat similar to Benjamin Graham's rule to keep your stock allocation between 75% and 25%.
- The glide path becomes less aggressive as you go on. The glide paths of other Life Cycle funds are similar, sometimes a little more aggressive, and sometimes a little less aggressive, but basically they look the same. The main idea is that as you turn your “human capital” into “real capital” as you move through life, the less ability you have to take investment risk since you have less time to make up for losses.
A Glide Path Is Not Investing Doctrine
However, the concept of a glide path is hardly investment gospel. There isn't much data that suggests you should be following a glide path at all. The whole concept really comes from rules of thumb, like “hold your age in bonds” popularized by people like Jack Bogle. In this post, I'd like to point out a lot of other ways to do it, and explain their merits over a more traditional glide path.
7 Considerations for Designing Your Personal Glide Path
#1 Decrease Your Stocks By Age
One popular way to design your own personal glide path is by your age. I've seen “Bond percentage = Age,” I've seen “Bond percentage = Age- 10,” and I've even seen “Bond percentage = Age – 20.” So a 20-year-old would have a portfolio between 100/0 and 80/20, a 40-year-old would have a portfolio between 80/20 and 60/40, a 60-year-old would be between 60/40 and 40/60, and an 80-year-old would be between 40/60 and 20/80. The whole idea behind it is that someone who is older doesn't have as much time to recover from a temporary loss in the stock market, so he should have less of his assets in the stock market.
#2 Decrease Your Stocks by Time to Retirement
One problem with determining your asset allocation by age is that people retire at wildly different times. From the early retirement extreme folks retiring in their 30s, to the very early retirees in their 40s, to the early retirees in their 50s, there is a 30-year difference, even between those who “retire early.”
So perhaps the asset allocation should be determined not by your age, but by how far you are from retirement. So someone who is ten years out from retirement will have the same portfolio, whether they are 40 or 60. This is essentially how most Target Retirement/LifeCycle funds work.
#3 Decrease Stocks By Percent of “Enough”
However, why should time be an important factor at all? I mean, the real way to determine an asset allocation depends on your need, ability, and willingness to take risk. Someone who has almost enough to be financially independent has a whole lot less need to take risk than someone who only has 1/4 of their “number.” For example, perhaps the glide path looks like this:
- 0-10% = 100% stock
- 11-30% = 80% stock
- 31-60% = 70% stock
- 61-90% = 60% stock
- 91-110% = 50% stock
- 111%-150% = 40% stock
- 151%+ = 20% stock
#4 Why Decrease Stocks At All?
Perhaps the whole dogma that you should take less risk as you go along is wrong. Perhaps it is reasonable to hold the same asset allocation your entire life. You determined early on what you could tolerate as far as volatility and you just stuck with it.
Lots of people argue that your portfolio should just be 100% stock anyway except for money you need in the near future. I never hear real estate investors talking about needing to maintain a balance between equity real estate investments and hard money lending. Maybe the whole concept is wrong.
#5 Why Not Get MORE Aggressive?
In fact, there is a halfway decent argument that you can get more aggressive as you go along. You have gotten used to the volatility of your portfolio, and so each succeeding bear market bothers you less and less. In addition, you have more and more resources as you go along, so even if you lose a big chunk of them, you still have more than you used to.
Wade Pfau has argued that while you should have a relatively conservative portfolio around the time of retirement (a few years before and after) to reduce sequence of returns risk, you actually have a better chance of not running out of money in retirement by INCREASING your stock percentage throughout retirement.
Perhaps the best glide path is some combination–low risk early on when you don't have much, increasing risk throughout your 30s and 40s as you need your money to grow, then decreasing towards 60 to reduce sequence of returns risk, and then increasing again in retirement.
#6 Why A Smooth Transition?
In fact, as long as we're questioning investing doctrine, why have a smooth glide path? Why not just make big wholesale changes from time to time? Perhaps you can stay 75/25 from age 25 to age 55, then go to 50/50 all at once. And why make your changes dependent on age, time to retirement, or even a ratio of your assets to your “number”? Maybe the changes should be dependent on market valuations. Doesn't it seem smarter to reduce your risk five or six years into a bull market than one year into a bear? Obviously, this isn't much different from timing the market with all the risk that entails.
#7 The Effect of Debt Reduction
While we're on the subject of glide paths and asset allocation, let's take a moment to discuss how debt reduction affects your true asset allocation. In reality, your debts like mortgages and student loans are negative bonds.
So if you are a young attending with a $100K portfolio that is 50% stocks and 50% bonds, but still owe $100K in student loans and $400K on a mortgage, in reality, you don't have a 50/50 portfolio. Your $50K in bonds is more than completely canceled out by the $500K in debt. Even with a million dollar 50/50 portfolio and a $200K mortgage, your real asset allocation is more aggressive than you might think. You have $500K in stocks, $500K in bonds, and $200K in debt. So in reality, your portfolio isn't 50/50, it's 63/37.
So as you pay down debt throughout your life, your portfolio NATURALLY becomes less aggressive, even if you maintain the same asset allocation over time. Do you really need to decrease it further?
What Should You Do?
There are obviously many ways to skin a cat, and I have no idea what the right glide path is for you or anyone else. I can tell you what we've done since we started investing halfway through residency–nothing. We set a 75/25 portfolio then and we basically still have it. Whether that is right or wrong, I have no idea. And that's the point. Nobody knows. There is no right way to do this. Like with asset allocation, pick something reasonable and stick with it. In fact, this is a great thing to incorporate into your written Investing Policy Statement, but I confess we do not even address it in ours.
I'm pretty partial to the idea of reducing risk depending on ratios of how much you have to how much you need. Like rebalancing, that forces you to sell high and buy low and to naturally take less risk as your need to take risk falls. I'm also a bit partial to making bigger changes to your ratio from time to time, rather than a tiny change every year. I also like the idea of making changes that reduce your stock to bond ratio at some point in the investing cycle other than right after you experience big losses in stocks.
Remember that there is little benefit to a perfectly finely tuned asset allocation. It just doesn't matter THAT much, especially when compared to other things like your income, savings rate, and ability to stay the course. I mean, a 65/35 portfolio performs nearly the same as a 60/40 portfolio. So I expect at some point as we approach “enough” that we'll cut back to 60/40 or something like that.
What do you think? Do you have a glide path? How is it determined? Which of these “glide path” ideas are you partial to? Why do you think the classic glide path has become such a prominent investment dogma? Comment below!
There are more questions than answers, making it a great topic for discussion.
What’s best for the individual depends largely on two factors: risk tolerance and margin of safety.
If you are intolerant of risk and have just barely “enough” to retire securely (i.e. 20 to 25 years’ anticipated expenses), you’re better off with a somewhat conservative allocation that allows you to sleep well and reduces the risk of your money not lasting.
If you are more risk tolerant (have maintained stock allocations through bear markets) and have more than enough to declare financial freedom, you’re able to leave more chips on the table, i.e. maintain a higher and perhaps increasing stock allocation over time.
I fall into the latter camp. I’m 90 / 10, risk tolerant, have about 30x anticipated expenses, and adding to the pile.
Cheers!
-PoF
Agree with these thoughts. I liked Phil DeMuth’s book ‘The Affluent Investor’ and have enough of a cushion that I see myself investing more for my children than myself so tend to be more aggressive and plan to become more so as my expected years left to live decrease.
Really depends on where you’re at age, spending/expenses, and retirement time line wise. I dislike any of the “rules of thumb” since they arent applicable at all to individuals. Too bad that the lifecycle idea of starting out levered and decreasing it as you near retirement wasnt mentioned, its a similar thought to the problem.
I do like people figuring out their needs, and adjusting their cash, bond, and equities ratios to insure against sequence and short term risks, while getting the most from their portfolio potential. Also agree that a “enough %” calculation makes some sense to preserve some baseline that just simply has no need to be exposed to undue risk.
All these things are however very individual, your spending level, retirement age, portfolio level, etc…so no one perfect thing exists as a formula. Probably could be done reasonably well though, with caveats about personal adjustments.
In other words, personal finance is indeed personal. No two people have the same temperament or walk the same path in life.
WCI great discussion of various guidelines, rules, and standards by WCI. Most of us select a blend of these, and they may drift a bit over time. If you wake up in a cold sweat in the middle of night, worrying about money, you probably need a tweak or two (or maybe to find a way to earn more money).
I did mention the effects of leverage from student loans/mortgage, although not specifically margin investing. Obviously, that’s also an approach used by real estate investors. Heavily levered early on, and decreasing as they approach retirement.
I use the glide path of the Fidelity/Vanguard target date funds. It helps maintain discipline, because it’s easy to “change your philosophy on glide paths” in response to market moves.
I think the traditional glide path comes from investors decreased appetite for risk as you get closer to retirement. If you poll investors asking “what’s the maximum percent loss you could handle in your portfolio”, my guess is that the number declines with increasing age. The glide path used by Vanguard / Fidelity reflects this correlation.
I would say that if you have tolerance for risk AND a good emergency fund, you probably can take more stocks. But this is a very personal question. Everyone should decide for himself.
I consider myself risk tolerant also but I am getting OLD now. When I decided to quit ob and go to 3 days per week I was 70/30. I am 65/35 now at 59. I keep trying to get to 60/40 but the market keeps rallying. I try to rebalance with new money/ dividends/ interest rather selling positions. I am trying to keep a larger cash/short term fund to ride out sequence issues. I think maybe 50/50 at 70.
I’ve always been 60/40 and plan to stay there. I’m at 35x expenses, age 65 and working part time because I want to. I’m cognizant of the danger of taking more risk than one needs to but don’t want to drop below 60/40.
Thanks for this. Luckily I was younger when I first learned this business because I now disagree with the age in bonds / proximity to retirement stuff- for us it’s too low a return and risk. And for some reason (being female? possibly, maybe just being smart?) I know markets are centuries long things and don’t react to market vagaries so we don’t need to protect ourselves from us.
Luckily again I reasonably counted CD ladder for college (soon) and weddings (now possible in any given year) and so our (to my mind) too much bonds portfolio is decreasing that amount with only a small loss (again I know only because the market is doing better than bonds at this moment) as we spend on those bigger ticket items. We are pretty flexible so we figure if our portfolio shrinks we spend less- the future (maybe) brides know their wedding has a budget we’ve planned for and we’ll be strict on that if that’s what the portfolio says.
I’m concrete and like easy rules (like bonds = age…) and a math prof’s daughter so here’s one I invented (not- but who knows where I read it). When you invest (put money in) DCA (dollar cost average- can explain it if anyone doesn’t know it) and when you spend (take money out) portfolio size average. WHen working we socked away a set $ amount (though increasing as pay increased), and now if we ever push the limits of running out of money before we die (just started the spending phase and still figuring out what our actual budget is) we can’t use over 2% of portfolio. So if the market contracts a lot we spend less, when it’s flamboyant we may spend more. Just have to ensure we never start needing to spend as much or more than last year. THe potential brides might want to time the market.
I agree that being able to be flexible with your withdrawals has incredible value in combating sequence of returns risk.
Toughest (and most important) decision an investor makes, picking and sticking to an AA, and there are no right answers, ha!
One factor that plays heavily is how much you want to leave for your kids vs how much you want to spend it up in retirement.
In general, I subscribe to the theory of a temporary bond tent in the five years surrounding retirement, to reduce sequence of return risk, and then a gradual rising equity AA throughout retirement. As with many things, Michael Kitces has convinced me of its merit.
As for the appropriate AA for a younger accumulator or for myself, I honestly have no idea. I am arbitrarily 80/20, but I have a hard time rationalizing my bonds when asked.
Further complicating my AA, I have a larger and larger percentage of my net worth in a defined benefit cash balance plan invested at 60/40, which I count toward my overall AA. This has the practical effect of allowing my 401k/PSP and Roths to drift higher in equities, to maintain overall 80/20 AA.
I think a strong case can be made for younger accumulators to have an allocation to the much maligned long term bonds, rather than the often recommended intermediate bond fund, short term bonds, or TIPS. (But that is a longer discussion for another day).
I’m a resident in my mid-30s, will switch from residency to a pretty well-paying attending job in a couple years, and would like the option to retire in my 40s. Seems that for people like me there’s one more consideration to all this: there’s money I’ll be able to access immediately when I stop working, and then there’s money I can’t (or shouldn’t) easily touch until I’m 59 1/2. (And then there’s SS, which I shouldn’t touch until I’m 70.)
It seems intuitive that the pot of money I’d use for living expenses till I hit 59 1/2 should have a more conservative allocation than the rest of the money, because it’ll have less time to recover from a down market. Maybe 0/100 all muni bonds, even, since it’ll all be in taxable.
Still thinking about this and haven’t worked out the details. I’m sure someone else has?
I’m in this boat too – the next 2 years will be finishing up paying off any debt, then want to work hard for a couple of years (10-15) and husband will be re-entering the work place, but don’t want to wait until 59 1/2 to be able to enjoy my savings/work ethic.
https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/
Thanks for saving me that. I’m amazed how few people realize just how accessible retirement money is before 59 1/2.
No way, terrible idea unless of course you’ll somehow be able to save like 50x your desired retirement expenses by 40. Seems a bit of a stretch. You need to research longevity risk, aka, outliving your money. The more bonds you have the higher likelihood of this and portfolio failure much sooner than anticipated. Equities give the best long term chance to outpace inflation and increase purchasing power.
If you cant handle a little bit of normal market volatility when you retire, you cannot afford to retire. Obviously, if you plan to retire early you need to think about your taxable account as the main thing, and it will be for super savers anyway due to limits on everything else.
It’s not all the different from Bernstein’s idea of “when you win the game, quit playing.” Basically he says, if you have enough to live the rest of your life on a TIPS ladder, put those assets into a TIPS ladder. Any money above and beyond that can be invested VERY aggressively. There are really two schools of thought when it comes to retirement income- probability/investment based and safety first/insurance based. It’s really a spectrum though. You, like me, would likely find yourself quite a ways to the left on that spectrum. Bernstein and HDO…they’d be far to the right of us. But neither answer is necessarily wrong, just different priorities. Many roads to Dublin.
I dont actually disagree with that idea at all. I just misread that this person was not yet an attending and trying to retire AT 40, not sometime 40s. Just seemed like an impossible task especially if only in bonds. Even though if you tax adjust your market returns you’d be pretty surprised how well a muni fund compares.
So really just a misread on my part.
As for buckets, yes thats more like what Im referring to, I think it decreases the overall allocation to a higher equity balance, but in truth havent run out the calcs. Was thinking since that would be a more nominal amount that portion could stay somewhat static and the allocation to equities could be allowed to grow. Interesting to balance the what one needs with the why not. Nothing wrong with decreasing as a % of over funded amount increases. I think thats an idea that could really be expounded upon.
These are of course super saver ideas, not necessarily generally applicable.
You’re talking about a bucket strategy. It has its pluses and minuses. It’s most just mental compartmentalization though. It’s really all one portfolio even if your pre-59 1/2 account is 40/60 and your post-59 1/2 account is 60/40.
There’s certainly nothing I’d do in my 30s about that question. You need to be aggressive investing, but mostly saving, if you’re not even going to be out of residency until your late 30s and want to retire in your 40s.
I used to be in the Vanguard Target Date fund that was 90/10 but after switching to Vanguard’s Managed Services we decided that a 100% stock allocation was better and have been using it ever since. I am in my early 30s (not a doctor).
I had previously read the Wade Pfau study you mentioned in this article and found that very interesting. As of now I feel that I will implement this strategy when I do retire but we’ll see how well my tolerance for risk hols up.
I’m using a strategy that is a modified version of that suggested in Lifecycle investing by Nalebuff and Ayres. Essentially you take as much risk as possible until you hit your target and then decrease risk. So for me I’ve calculated I will be FI at 3.3 M + a paid off house. At retirement I plan to be 60% S, 40% B. That means I will need 1.92M in stock to retire. Essentially my plan is be 100% in stocks while still having a mortgage until I hit 1.92 million. After that I will prioritize paying off my mortgage. Finally I will put all my excess capital into bonds until I hit my number. From then on I will rebalance to stay at 60/40. The goal, in my opinion, shouldn’t be to reduce yearly variance, but to reduce variance at retirement. What is the the point of stability in your 30s if you fail to hit your number by retirement?
I was hoping this was in the post since it fits in so nicely. I am also doing a version of that. Yes the point of bonds should be to allow for a more regular SWR early on during the early sequence risk years.
Lots of wisdom in that approach. I like how it emphasizes that the competition isn’t between you and the market or you and another investor, but between you and your goals.
I think your penultimate paragraph captures the idea: “There’s little benefit to a perfectly finely tuned asset allocation…when compared to things like income, savings rate, and the ability to stay the course.” Morningstar had a great – but lengthy – article on this in their most recent publication. Here’s a link: http://www.morningstar.com/advisor/t/118267914/build-savings-to-expand-wealth.htm. Their premise is that consistent savings toward your goal is the most important variable in the wealth building formula.
I just realized that the link I posted was a subscription link. Try this one instead if you have difficulty with the above: http://www.nxtbook.com/nxtbooks/morningstar/magazine_20170203/index.php#/36.
Good comments and questions, WCI.
For what it’s worth, for our traditional asset class holdings, I plan to keep my “Swensen” allocation (so 30% to treasuries–that’s my bond allocation) for the duration.
The other thing we’re trying to do is simplify as we age. A glide path of ever-declining complexity so to speak…
As I have 15 to 20-years left, I have been using my monthly contributions to get to around to 80/20, not including the equity in our home. As I have been reading different blogs, it seems that a higher percentage of stocks gives you a higher probability of making it to the “end”.
Of course, I think I have the stomach for volatility, we shall see. If not, I do have the ability to shift my monthly contributions to bond funds and/or CDs.
cd :O)
I often considered my student debt a bond- payments made are a guaranteed 3% return. Now, however, I am thinking of paying down my debt completely before investing in taxable accounts. Consider it a safer return on investment.
Should this calculator for stock-bond glide change for MDs. Most people make solid money by 25. Physicians typically are 28-33 before making their “adult” income. Granted $50K in training is plenty of money and what most Americans make….
For instance, I am planning on staying aggressive until 45 and then changing my allocations. That or until my net worth is substantial and I feel it needs more protection. Otherwise I continue to work and save. For me there is always a pension at the end of the road for a safety net.
It is great to see an article that challenges conventional teaching on bonds. I just don’t see how bonds will produce any meaningful return over the next 20 to 30 years based off of current, rising rates. If you start saving early, and accumulate a portfolio that can absorb market fluctuations, I would much rather take the returns of the stock market over the next 30 years rather than instill a short term stabilizer with bonds that will likely drag down the returns over the next several decades. If you are close to retirement and “barely have enough”, then you probably need the stabilizing effect of bonds.
Using the phrase “rising” implies a knowledge of the future. Did you mean to imply that you know what interest rates will do for the next 20-30 years?
And while 2% isn’t a very attractive return, it does beat -40%.
Bonds are like an insurance policy. Unfortunately they do not provide the same insurance as they used to, and the payout will be less, but its still insurance. Thats how I currently view them. I dont want my insurance to pay out on anything really.
If rates rise towards 3-3.5% (10y) I think bonds will be much more attractive at that point from an insurance point of view.
I currently have a fixed asset allocation of 40:40:20 (stocks:bonds:other). I have enough money. I’m very comfortable with both the growth and lack of volatility. Currently I don’t have plans to change that and it could stay that way forever.
Also, Vanguard made recent changes to their 529 plans. They are on a glide path too, but it is much faster changing than the retirement funds since the teen years fly by (financially anyway – maybe not for stressed out parents!). http://wealthydoc.com/blog/your-glide-path-to-college-costs
Use a target date fund as a core investment in tax deferred retirement accounts. The target date need not match your own age. The beauty is it’s auto-rebalancing; reducing your own work and attention needed. During the next bear market, when we are down 25%, I’ll switch into a more aggressive target date fund ( 2060) to exploit the run up on stocks. Meanwhile, I am building a bond tent around the core, as retirement is in 24 months.
There is no such thing as a perfect asset allocation, unless you can predict the future markets, including interest rates, inflation, market moves, etc.
Two minor points:
# 1 Realize that the next bear market may not involve a 25% drop.
# 2 Make sure you write down exactly what you will do in the next bear market and follow your written plan. You may find it harder than you think to “overrebalance” i.e. get more aggressive when the financial world feels like it is going to “hell in a handbasket.”
my bear market plan during RMD years: ( required approx. 4% withdraw )
-10%……..withdraw 4% from TD fund per routine
-20%……..withdraw 4% from total bond
-25%……..switch to more aggressive TD fund
-30% …….withdraw 4% from bond fund and transfer portion to new TD fund
-40%……..withdraw 4% from bond fund
Historically, the ave. bear market drops 25% and lasts two years. No market is average, but I will last 4 years into a bear market without drawing from TD fund. Until RMD years, I’ll use taxable accounts. Meanwhile , the tax differed accounts use low maintenance TD funds .
I have a grand plan for a recession as well, that is magnitudes more aggressive than yours.
However, I am concerned about how I will actually feel and behave since I have no delusions it will be as calm and collected and rational as you wish you will. Fingers crossed.
@jz Im Interested to know if you’ve actually done this during a downturn or just the plan for next one yet? Having never been through one myself with money at risk, I always wonder what I’ll actually do in the situation.
There is a big difference between such planning before and after retirement. As a retiree, I agree that any type of formula glide path is foolish. Here is what I do as a retiree.
I have set up a computer model that computes the amount of after-tax inflation-adjusted cash that will be available to me each year until I die (the model calculates investment assets declining to zero at an assumed age of death of 100). Needless to say, there are many alternative modeling assumptions possible. I determine a base case annual available spend using somewhat conservative assumptions, and compare this to my actual retirement spending. I then test alternative scenarios, including reasonable worst case scenarios, by changing assumptions. All of this is done on a spreadsheet that is continually updated. With this data, I plan my annual spending, including possible large expenditures (e.g., second home), and annual gifting. I am always aware of what a once-in-a-lifetime large market decline or large inflation will do to my annual available spend, so I plan for that contingency as appropriate. If my base case assumptions prove too conservative in subsequent years, my annual available spend will grow and I can adjust accordingly. I can easily see from the model how much will be left for heirs if I die prior to the conservative assumed model age of 100.
I do this and it works. Every year I plan to spend my base case annual available spend, as continually updated. If my personal financial circumstances differed, I might chose to spend more or less than this. If we were to suffer a permanent 50% market decline, I know how I would handle it.
No formulas. Simply a continually updated spending plan adjusted for changes in circumstances.
I just reread the above comment and realized that it has nothing to do with the specific subject matter of the blog, selecting and revising asset allocations. In defense of my (perhaps major) oversight, I’ll quote WCI from above:
” We set a 75/25 portfolio then and we basically still have it. Whether that is right or wrong, I have no idea. And that’s the point. Nobody knows. There is no right way to do this. Like with asset allocation, pick something reasonable and stick with it.”
FWIW, our investment asset allocation is 50-50. I could easily defend a larger or smaller allocation, but that is not of major importance with respect to my retirement planning. What is important is to know where I stand financially at all times and plan accordingly.
While I’m not sure the majority of retirees are going to take it to your level, I’m a big advocate for adjusting and continually updating as you go.
Adjusting and continually updating can be part of glide paths, guidelines, guard rails, SWR, MCS, and dozens of variations. These simple rules and formulas may be good for marketing, or fun to play with, but are largely worthless. What is important is to have the knowledge of all material facts that are relevant to your specific situation, and the analytical ability to plan accordingly. Unfortunately, doing it right involves a level of financial, tax and computer modeling skills beyond that of most retirees. Such skills may be possessed by some financial advisors, but the approach I suggest is not commercial. All of the simple rules and formulas are very marketable and involve little work. Why would an advisor instead choose to apply an analysis that may be confusing to his client, and which involves adding substantial additional work, none of which will be compensated under a % of AUM fee structure.
I think that most of the people who have considered asset allocation and are planning for financial goals have gone through the mental gymnastics that WCI led us through in this well written piece. Even though it is important to have rules (to protect you from abandoning a well thought plan in a moment of perceived crisis), I also believe that it is important to stay flexible, nimble, and not too dogmatic.
Not only will your life circumstances change, you will internally change throughout life, as will your goals and aspirations. It seems ludicrous that a financial plan made in your 20’s will be suitable for you in your 50’s or 80’s. (Those in your 50’s and older, do you even recognize your 20’s self? 😉 )
Great post! It’s clear that this is another case where “personal” finance is personal. I’ll say what I recently did. I came up with an IPS (investment policy statement) where I address the broad stock/bond asset allocation (in my case 70/30). But, knowing I tend to tinker, I also added upper and lower “bands” where I could shift my allocation based on whether I felt it was time to be defensive or aggressive. I borrow from Howard Marks’ idea that every investor ought to know when it is time to be more defensive (expensive market) and when it is time to be more aggressive (cheap market). So, again in my case, my 70/30 stock/bond portfolio has bands of 60/40 (defensive) to 80/20 (aggressive). For me personally this ensures that I don’t take too big a bet either way, always having some allocation to stocks, and always some allocation to bonds. I can see a time when I shift the default allocation to 60/40 and bands to 50/50 and 70/30.
I think Benjamin Graham’s quote is apt here (from memory, so forgive inaccuracies): “Do you want to eat well or do you want to sleep well?” By the way, in one of his speeches, Ben Graham said that nobody should ever have more than a 70% equity allocation. I know this is controversial, but coming from a giant like Graham, it gave me pause.
I’ve got a “tinker allowance” in my IPS too. Can’t say I’ve been too impressed with my ability to use it effectively though. My band is half the size of yours.
Graham’s numbers were no more than 75% and no less than 25% equity BTW.
Thanks for the correction on Graham’s numbers! I think using a flexible “band” is often an exercise in patience. For example, raising bond and lowering equity allocations lately has been the wrong move, but in the long run I think it pays to be contrarian, as long as you don’t make large bets one way or the other.
In the long run contrarians are mostly wrong. However, if you’re going to do it it should be infrequent and in size, otherwise whats the point? Thats a lot of work for limited upside.
My screen for whats going on in the world for aggressive vs. defensive is very simple.
Recession?
N-aggressive, btfd
Y-defensive, watch indicators or institute an MA/tactical style.
at some point get aggressive beta wise and maybe even leveraged.
My personal “glidepath” has been as follows:
100% stock from mid-90’s to early 2000’s (30-37)
80% stock:20% bonds from early 2000’s to 2010 (37-45)
70:30 from 2010 to 2015 (45-50)
60:40 from 2015 to present, and plan on staying here for a while with 90% of enough, give or take 10%.
And of course your 500 k cash pile!
can you afford a 50% equity loss near retirement
Learn the meaning of marginal utility of wealth
I am 18% stock when I retired age 62 as I do not want to erode principal and leave it to the kids 4-5% total return covers all my distributions-has worked beautifully
The trick if you want to be more aggressive is to OVERAVE by 20-25%
I’m confused about the role of debt in the portfolio. At first, you said it was a negative bond. Later, you said holding debt essentially made a portfolio more aggressive; also, the more you pay it down, the less aggressive it becomes.
So does debt serve as a bond (less aggressive) or a stock (more aggressive)? It seems like your example is treating debt as a pseudo-stock: “$500K in stocks, $500K in bonds, and $200K in debt. So in reality, your portfolio isn’t 50/50, it’s 63/37.”
So basically adding debt to your portfolio increases risk and the “stock” portion of the allocation?
Thanks for your time and help.
No, debt isn’t a stock. It’s a negative bond. So if you hold debt, it makes a portfolio more aggressive than it would be if you didn’t hold debt. So if you have $500K in stocks, $500K in bonds, and $200K in debt, the $200K in debt cancels out $200K of your bonds, so you really have a $500K stock:$300K bond portfolio. It increases the overall risk and expected return of the portfolio.
Does that make sense?
That makes sense. Thanks for the explanation.
I currently sit at about 80 percent stocks. I plan on staying at that in so far as how far ahead I’ve planned. I might want a less risky allocation in retirement but retirement for me is 20 years away at minimum. I do not plan on adjusting my allocation until I reach retirement. Once I need to use the money I can see favoring bonds a bit more heavily for liquidity and because I will have “won the game”. I’ll re-evaluate when I get there. Before that it won’t matter much because I don’t need the cash.
I think the general guidance or target date funds are ok for someone who does not wish to take the time to learn about personal finance and investing, something is better than nothing. That said, for readers of this site with more knowledge, personally adjusting it to the risk tolerance and margin of safety as PoF pointed out makes more sense. Each of us will have a different goal and tolerance. Trying to hit FI sooner than later but enjoy your job enough to work a few more years with a market pull back, more aggressive mix (me). Have a pension, or real estate or other income that would cover all the basic expenses, probably more aggressive even into “retirement” from main job. No other significant sources, close to retirement but big enough nest egg in investments, probably less aggressive. But we all will have different goals and a risk tolerance that lets us sleep at night, whether that is more a fear of having to work much later into our lives or running the risk of running out of money before we die, and all the potential scenarios in-between. For me now, 46, three years from when I could retire with a pension as a core retirement pillar, 85% stocks 15% bonds and alternative investments. I doubt I will go much less than 70% stocks in retirement, especially if I work a few more years and the pension is bigger.