Good Day to All,
A Moderate Allocation mix is generally defined as a 60/40 blend of equity/bond or bond/equity. I'm going to set this at a 50/50 mix.
A couple plans to retire in the fall of this year.
---both will be 65 at the time
---Social Security available, they will not start the program, at this time
---both will enroll in Medicare, with a supplemental health/meds insurance policy
---they have decent pension plans from which they will be receiving monies
---no debt, other than normal recurring expenses; realty taxes, utilities, food, etc.
---they've calculated all known expenses, and their pensions will cover this area, at this time
---they have 9 months of living expenses readily available
---they have traditional and Roth IRA's
---Michigan, is their state of residence
They will roll their 401k's into IRA accts.; as the existing plans are slim on choices.
The rollover discussion centered around a moderate investment allocation, as noted above. They are decent with their knowledge of investments and pay attention to current events.
The mission, should you choose to accept (need the theme music) , are the choices.
The criteria:
---dollar cost average into the investments
---the goal within 6-12 months (the markets willing) is to have at least 10% in any given position
The 10% number is a critical part of this; as the feeling is that less than this amount may not have a viable affect upon a total portfolio. I tend to agree with this, too.
Active managed funds, indexes and eft's are acceptable choices.
The holdings could be as simple as VTI and LSBDX , each at 50%; or a combination of 10 funds to maintain the required 10% in a position. One may consider the 10 best balanced or moderate allocation funds over the past 5, 3 and 1 year periods and begin to move monies into these for the 10% to each going forward.
Or, 10% into each of a U.S. large, mid and small cap exposure and the remaining 20% equity exposure split between international developed and emerging. The bond holdings could be the 5 best mix in the multisector area.
ADDENDUM
I've been out of town. I will place replies, but will also add this information.
---The retiring couple has indicated that their traditional/Roth IRA's and the rollover 401k monies will total about $800K.
---Another part of their plan is to consult with at least 2 different fee only advisors for added input, regarding a portfolio.
Obviously, the portfolio could sustain a fairly large loss and this couple would not have to move to food stamps. 'Course, this (a large loss) is never part of an investment goal. Hopefully, a large loss would be avoided.
Lastly, ask a question; if you find an important piece of information absent.
Your thoughts will be appreciated.
Thank you and take care,
Catch
Comments
Regards,
Ted
dear catch 22: the age of an investor was not requested . will that be an issue?
no fire danger in twin falls. thanks for your concern
regards
Bill
20% next year. What do they do?
The stock market drops another 20% the next year.
What do they do?
First, glad to know that your area is not involved with the fires in the region.
The portfolio mix question is for a couple, both age 65, retiring this fall; and some other data in the list. Is this what you are asking?
Take care,
Catch
I know that they have used and watch 50 and 200 moving averages against a particular investment. I suspect this method may keep them out of deep trouble. They are not prone to slash and burn methods with either buying or selling and would likely sell down in pieces if and when the numbers begin to move against their positions.
Is your "What do they do?" question suggesting something else; aside from their assembling a portfolio suitable to them?
Take care,
Catch
Hi catch,
I meant to ask if a couple just in their 80s would want to avoid
index funds in the mix as it might be difficult to recover from
an 08-09 event at our age.
ignore if off topic criteria
again regards
Bill circa33
They are fully qualified for SS, but do not need to start the program at this time.
Thank you for noting this missing info, which has been edited.
Take care,
Catch
What is the maximum drawdown target?
Do these people have long-term care insurance in place?
Are there any after-tax investment accounts, or is everything pre-tax?
Thanks
SS goes away when one dies, right? Wouldn't a retiree want to access SS since these pools of money "dry up" when one dies? It would be the first pool I would access for income needs. Pensions often have survivor options as well as possible cash value (my pension pays out the unused dispursements to my beneficiaries)...being able to draw down this more slowly would be beneficial. I realise that SS has offsets and other wrinkles, but I like drinking from a pool that will eventually dry up as early as possible.
You noted:
So are these people going to need any dollars from their investments?
>>> Not at this point in time. Their "net, after tax" pensions will cover their living needs with monies remaining.
Their pension income will cover the cash flow needs for now, but for how long? Regularly, once in a while? What is the percentage of withdrawal needed on a regular basis in the future? That number has a huge impact on allocation strategies.
>>> Their pensions, as is common, do not have a C.O.L.A. adjustments based upon CPI or similar. They are aware of purchase power loss from inflation from this circumstance.
Six to seven years forward will find both of them to begin the required minimum distributions from their "traditional" IRA monies, which will be 90% of their tax sheltered monies. The remaining 10%, more or less; is in Roth IRA's. Caluclations indicate that the RMD rates on IRA's are about 3.6% of the IRA values for the first year and increases slightly in percentage terms, going forward. Five years forward will also allow them to maximize their social security withdrawal amounts at age 70, versus any withdrawals prior to this age.
What is the maximum drawdown target?
>>> Their drawdown maximum would be near 5%; but the RMD (in 6 years) from the IRA's would include about 3.6% of this amount.
Do these people have long-term care insurance in place?
>>> This has been discussed, too. LTC insurance is not in place at this time; and the facts of the skyrocketing costs, insurers leaving the market place and existing contracts being adjusted for some folks will be investigated further. Although not LTC insurance, they will purchase supplemental insurance with their Medicare coverage; as well as drug prescription insurance. Their health background is very good; as well as that of their parents and family.
Are there any after-tax investment accounts, or is everything pre-tax?
>>> All monies to be invested is either traditional or Roth IRA's.
A brief summary would conclude that this couple have always been prudent with their monies, controlled their household budget/expenses and maintained a watch upon their invested monies. They have a good grasp of knowledge and overview of various investment styles and/or sectors to the point of understanding the variances. They understand the differences among the various equity or bond types/styles, be they domestic or international. They are not novice investors; and would be capable of asking very good questions, if having a discussion with an investment advisor. Other family members have stable employment and not likely to "move back home" to be supported and/or need financial help. Some monies from this couple will be placed towards 529 accounts for college.
Their good money habits over many years has allowed them to be at a most positive monetary point at this time in their lives. Although their pension monies will have much less purchasing power in 20 years, they will have income flow from SS (likely, with some form of CPI adjustments) and the RMD monies from the IRA's.
This couple has arrangements in place related to their estate settlement, upon their deaths.
They will enjoy their retirement time with some travel and not be sitting on their butts, at home, in the recliner chair.
Thank you, Bob. Hopefully, the above information provides a better overall view for consideration of their investments going forward.
Take care,
Catch
I personally enjoy the mutual fund portfolio game, but I know that the portfolio has to match everything else mentioned above. A fiduciary working personally for you is always a good investment, even if the meeting is a one time process. In fact, take a visit to the buckeye state and give BobC a call. Or is that blasphemy for a true "Blue" Michigan guy
I won't disagree with this point. A surviving spouse would have access, to a given monetary point; from the spouses SS, upon the death of one. I place this area as the "take a chance" that neither will pass away between the age of 65 and 70. The SS monthly amounts increase a great deal when waiting until age 70 to begin SS.
Their pensions will each have a survivor (albeit less monies) benefit.
You noted: " Pensions often have survivor options as well as possible cash value (my pension pays out the unused dispursements to my beneficiaries."
Are you saying that your pension is payable to others, besides a spouse? You used the word, beneficiaries.
Thank you, bee.
Take care,
Catch
They do have a plan in place for inheritance. They also plan some travel, both in Michigan (lots to discover and enjoy in this state) and perhaps some "snowbird" travel to Florida or the Alabama gulf coast for a few months during Michigan's bone chilling winter period.
Take care,
Catch
http://www.gocomics.com/bignate/2011/09/15
http://www.commonsenseatwork.com.php5-1.ord1-1.websitetestlink.com/2006/04/a-camel-looks-like-a-horse-designed-by-a-committee/
I agree. But still looking for some observations/comments for such a portfolio; and I don't know a better starting place, than here at MFO. Yes, the whole mix of retirement planning is more than an investment portfolio. This is not an attempt at a full estate plan or related.
As to Ohio, and for our house; the leaning has always been towards Michigan State. Both Michigan teams and Ohio always have "fun" in sports. As a side note and to the lite side of life; back in the day of paper maps being produced by a State (still done today for the tourist trade), found the following on a 1973 Michigan map issued by the state: Most state maps have portions of nearby states shown; and the 1973 map had two small towns listed on the map, east and south of Toledo, OH. One was "MgoBlu" and the other was something like "OhioBluit". Someone at a state office had some fun.
Thank you for your thoughts.
Take care,
Catch
It is a pleasure to be introduced to a couple who have managed their life together so well. They are in a grand place because of their composite financial skills and savings disciplines.
I suspect they need a robust congratulations more than a financial plan. They have made all the right choices. They only need to be encouraged to continue their march. Given your description, they are adequately knowledgeable in investment matters.
It appears that this couple are not interested in visiting FMO on a daily basis. Given their profile, a totally passive Index approach might be their cup of tea. Vanguard mutual funds/ETFs might satisfy all their requirements.
Why not simply show them Paul Farrell’s Lazy portfolios? As you know, these are summarized at:
http://www.marketwatch.com/lazyportfolio/portfolio/fundadvice-ultimate-buy-hold
Rather then linking to the general listing of all the Lazy portfolios, I directly addressed the FundAdvice Ultimate portfolio because it represents an integration of academic research findings into its construction.
That’s the first step of my two step education program. The second step is going to the explanation of how the Ultimate Buy and Hold portfolio was assembled. Here is the Link to that excellent summary paper:
http://www.merriman.com/PDFs/UltimateBuyAndHold.pdf
Paul Merriman builds and documents his recommendations in an orderly, logical fashion. He demonstrates how diversification controls risk by mitigating overall portfolio standard deviation. It is a comprehensive tour-de-force.
That’s all that is essential.
Depending on the size of the portfolio, I would allow the happy couple to add units to satisfy their preferences. I would contribute perturbation advice only after their first choices and ideas were clearly expressed. I want them to own the portfolio since they will more likely stay the course if they designed it themselves. Also, it adds to their confidence.
Since asked, I might proffer these peripheral suggestions and guidelines.
The folks seem to prefer a 50/50 equity/bond split. That’s conventional wisdom and might not reflect all the options really available to this well-adjusted pair.
At 65, at least one of them will survive for 20 plus years. Given the data, they are financially secure and have even planned for their wealth transfer to progeny. They have successfully touched all the mandatory financial bases. They are now free to plan like an institution instead of like individual investors.
A 50/50 mix might not be the best mix given their circumstances and the current poor interest rate environment. Perhaps they should entertain a more aggressive equity fraction. A 70 % equity percentage might be very acceptable. Of course, that depends on their risk aversion profile. The option should be presented; the final decision is always theirs.
If the total Index approach is too tame for the folks, I would certainly accept their desire for some active management psrticipation. I would remind them of how difficult a task it is to identify an active management team that will persistently generate positive Alpha. If necessary, I would evoke John Bogle and company to document that position. To satisfy any excitement tendencies, I would endorse a portfolio with a maximum of 20 % actively managed components. I really believe that 10 % is a more wealth preserving allocation.
Wow! My comments are a little frightening, even to me. Over decades, I’ve morphed from the active mutual fund management camp to a passive perspective. God, I fear I’ve been Bogleheaded. No not yet; at least not completely so.
Catch, I hope you find my rant helpful. My most salient recommendation is that you interact with these folks in a manner that they feel like the designers and owners of their portfolio. That feeling equates to a commitment to stay with the program even under challenging conditions.
Best Wishes.
Good luck in retirement.
There may be another variable here: we're assuming that both members of this couple are equally "knowledgeable in investment matters". The description of this couples circumstances is virtually identical to ours, and unfortunately in our case the financial knowledge is emphatically not equally distributed.
What we have here is a situation where between pension income and future SS income it is unlikely that the investment pool will need to be utilized for day-to-day living expenses. In that case, thought must be given to the management of the investment pool after the demise of one of the two partners.
If both are equally financially adept, this may not be an issue. However if that is not the case, then should the partner lacking the financial acumen be the surviving partner, the future guidance of these assets does become extremely important. This would argue either for an extremely passive construct needing little if any active management, or perhaps the engagement of a trusted financial adviser.
None of this is easy.
At 65, without some plan in place, I'd be very worried about your hypothetical couple. My experience is that one "grows" into a plan over time. Put another way, plans "evolve" over time as our knowledge base and needs change. So, without prior experience - a starting point so to speak- I'd be very worried about these two. Mike's suggestion to seek professional guidance is probably the best advice.
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Yikes - that sounds so negative. ... My 2 cents "constructive" input is that they could do worse than to invest the sum in a good moderate allocation fund. PRWCX, OAKBX, and VWELX come to mind
And Catch - Be careful with that 60-40 figure. While it is true some funds achieve a "moderate" positioning with that mix, others do not. The difference lies mainly in the hedging strategies the managers employ. I think OAKBX, in particular, does a nice job hedging with longer term bonds and companies having exposure to natural resources and commodities. DODBX, on the other hand, tilts much more towards being an aggressive equity-like fund. I know you said to use a 50-50 mix, but I believe the same caution would apply.
Hi Old Joe,
Thank you for your comments.
I understand and appreciate your observation that a household is likely to have disparate asymmetric investment know-how. Initially, that asymmetry existed in our family too. But it can be rather easily addressed.
That possibility is precisely the reason why I suggested that Catch expose his happy couple to the two websites that I referenced, especially the Paul Merriman paper.
Since at least one member of the team (note that I consistently refer to the family unit as a team effort) has been exposed to various length market moving averages, it is likely that my recommended Internet resources are overly simplistic for that informed member.
However, as a minimum, these references should be reviewed together and should get the couple on the same page for the proposed portfolio. The two-step Internet visits are an educational adventure with a goal towards achieving investment equality.
I understand the risks and potential shortcomings of leading a horse to water, but some efforts must be made to equalize the knowledge base. To further advance that goal, I would recommend a short, targeted investment book like Dan Solin’s “The Smartest Investment Book You’ll Ever Read”. Although the title is presumptuous, at 166 pages in length, it is a breezy and informative introduction to what could be a simple subject.
Anecdotally, within a short time, my wife’s limited smarts and interests over investment matters were largely erased. She is presently an avid and hungry reader of the WSJ, and more thoroughly absorbs it than I do. Change is always possible.
Thanks again for your insights. I’m currently and quietly working on my kids in that same direction. They’re a tougher target, but I am gaining headway.
Best Wishes.
>> They retire this year and the stock market drops
20% next year. What do they do?
The stock market drops another 20% the next year.
What do they do?
I never get this sort of handwringing, cut-by-one-third equity question. In such a situation there is nothing to be done (except buy) other than to hang on. If you think it at all likely, you cannot just have 9mos in savings. You should do that asymmetrical barbell thing Taleb or someone advises, all cash and individual bonds plus a smattering of high-vol / speculative small-cap stocks. It's like asking what they do if the asteroid strikes near Michigan. What's the point of the question?
It's like asking what they do if the asteroid strikes near Michigan. What's the point
of the question?
Here's your asteroid.
You say “…there is nothing to be done (except buy) other than to hang on.”
Do you understand the Sequence of Return Risk as it relates to
the shortened time period of retirement?
Example One -
You retire and the first year of that retirement the market rises 27%.
The next year it rises 7%. The next year it drops 13%.
The average annualized return is 7%.
The Age of Ruin (age at which you run out of money) is 94.9.
Example Two –
The first year of retirement the market drops 12%.
The next year it rises 8% and the next year it rises 28%.
The average annualized return is 8% - higher than Example One.
But the Age of Ruin is 83.5. That’s a difference of more than eleven years.
What caused this significant difference?
Another example – this one from T. Rowe Price Money calculator.
Retire at 65 with a $750,000 nest egg.
Withdraw $4,400 a month and receive $26,499 in SS.
Chances of money lasting 30 years is 90%.
Same scenario except that the market experiences a 30% drop during
the first year of retirement.
The result is that there is now only a 50% chance of the money lasting 30 years.
It’s the Sequence of Return Risk that makes the “hang on” strategy
a potential failure.
Hi AKAFlack,
It’s good that you still participate on this forum. Your views are always respected.
You are spot on-target that accumulated portfolio value is pathway dependent. We would all hate to experience a significant down year immediately after our retirement date. Depending on the magnitude of the downturn, immediate action might be necessary. More on this later.
However, your Monte Carlo calculations are deeply flawed. It is not that the simulations themselves are wrong; it is that you corrupted the analyses by conflating a single probability analysis event into a double probabilistic sequence of events.
Your starting conditions were distorted by the combination of events that you postulated. In essence, you unwittingly created a Conditional Probability problem and contrasted it against a single Monte Carlo series.
A simple analogy that illustrates this error is that you initially generated the likelihood of the birth of a girl and then contrasted it with the probability of a blond girl being born. Adding constraints always reduces the combined probability.
If you propose to estimate the likelihood of Event A and Event B both happening, the probabilities of each must be multiplied together to get an overall probability. You failed to do so.
To again illustrate, let’s examine your T. Rowe Price Monte Carlo-based analysis in a little more detail.
By assuming a first year 30 % loss in the retirement portfolio, you dramatically changed the initial conditions of the problem Instead of retiring with a portfolio nest egg at the $750,000 level, the actual probabilistic assessment started a year later at the 0.7 X 750000. = $ 525,000 level. That’s not a fair comparison of equals.
By assuming a 30 % downdraft, you postulated a very unlikely event A. How unlikely?
Scanning the S&P 500 data from 1928 onward, only 3 equity annual return losses exceeded that horrendous performance. Using the historical data to establish a Black Swan Base Rate, that magnitude drop has about a 3.6 % likelihood of happening. Therefore, your scenario of a first year loss of 30 % followed by a conventional Monte Carlo simulation has a combined likelihood of under 3.6 %. The final result is dominated by the high, rare loss that you postulated as a given.
Personally, I will not develop white knuckles worrying over such an improbable investment series. By definition, Black Swans are unpredictable. I recall that you teach finance/investing at the Junior College level. I do worry about this type of faulty analysis finding its way onto the curriculum; it is a common mistake. Please do not make it in the classroom.
Now, there are simple but not always easy steps to protect against unhealthy equity surprises. A diversified portfolio mix of equities and bonds dampens the impact of a large equity downfall.
Proper asset allocation can reduce portfolio volatility (standard deviation) by about a factor of two without compromising expected annual returns. The lower portfolio standard deviation reduces the frequency of negative annual returns while mitigating the overall impact of a negative equity period. A 30 % equity loss might only mean a 12 % portfolio value reduction with bonds serving to cushion the whirlwind.
Finally, a retiree must always be flexible to adjust his withdrawal schedule. If returns fall short of expectations, simply pass on the inflation increase usually included in any competent retirement withdrawal plan.
If the downturn persists, the retiree has the option to again pass on the inflation adjustment and, if needed, modestly reduce the basic withdrawal rate. Sometimes hard times demand hard measures and a little sacrifice. Old soldiers understand the need for sacrifice.
I have done numerous Monte Carlo simulations that conclusively demonstrate that these modest drawdown devices greatly enhance the survival prospects of a portfolio during retirement.
I recognize that you know most of what I said. In haste, sometimes there is a disconnect between the brain and the keyboard. I am well aware of that disconnect.
Best Wishes.
I don;t have a spouse. At retirement my retirement account had a cash value. My pension payouts are based on a 25% contribution from my retirement account (its cash value) and 75% from my ex-employer. So say I receive $1,000...$250 comes from my cash value. Each pension payment nick my cash value by 25% of the total pension payment. If I pass before I liquidate my account's cash value my beneficiaries receive the remaining balance. My benficiary does not have to be a spouse.
• Fact: I retired in 2003
• Fact: A mere 5 years later the S&P took a 38% hit.
• Fact: Our reasonably diversified portfolio took a 20% hit.
• Fact: If we had been dependent upon that portfolio for living expenses things would have been very difficult indeed, and the portfolio's ability to support us to a reasonably old age would have been severely compromised.
Reality in our case was not too far removed from the points that Flack is trying to make. Don't tell me how "improbable" reality is. Murphy rules. Period.
I'll concede that in the example that Catch is postulating the situation would not be disastrous, because his retired couple have excellent income resources other than their life savings, and no significant debt, as do we. Only the circumstance that we were not dependent upon that portfolio allowed it the breathing room necessary to recover. What are the "probabilities" of the average working/retiring couple finding themselves in that fortunate situation? Let's see the math on that.
OJ