Author Topic: Asset allocation  (Read 6093 times)

FrugalFan

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Asset allocation
« on: May 24, 2015, 11:36:12 AM »
I'm about to start moving our money into index funds. I'm just curious about what asset allocation people around here are comfortable with? Our retirement horizon is probably 10-15 years, and we have a pension plan. How should our pension plan factor into our allocation?

thedayisbrave

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Re: Asset allocation
« Reply #1 on: May 24, 2015, 11:47:28 AM »
"People around here" is a very, very broad range. 

Many well known finance experts advise an asset allocation based on age.  But the more accurate way to assess one's potential AA is to look at need and ability to take risk.  The general consensus however is that the younger you are, the more aggressive you can afford to be, as you have more time to bounce back from any market downturns - but that's also provided that you don't panic sell when the market goes south.  It's kind of a catch 22.

You can pick one to start and then trim your sails as you get closer to your goal. 

I'll let others more seasoned than myself address the pension issue, but personally I am 100% equities at 25 years of age.

I think posting your age, approximate size of your current stash, and any more details you feel comfortable providing would helpful.

forummm

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Re: Asset allocation
« Reply #2 on: May 24, 2015, 11:54:46 AM »
One approach some recommend: Take the amount of your pension in today's dollars, and then see how much it would cost you to buy a pension of that amount with cash today. That's how much you have "invested in bonds" already. That amount is probably much more than you have in stocks. So your retirement account funds could be 100% stocks and your overall asset allocation would be good.

Another approach some recommend: How comfortable will you be when (not if) the amount you have in stocks drops by 30% or 50%? If you will be panicking and will sell your stocks, then you should not be 100% stocks in your retirement accounts, and should probably have a much lower number. If you will be calm and wise and realize that the market will go back up over time and that selling is the worst thing you could do, then you are OK being very heavily concentrated in stocks.

I'm 100% stocks and have been since 2000. But I am very calm and logical and won't be tempted to sell and won't be panicked. You may be very different than me.

FrugalFan

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Re: Asset allocation
« Reply #3 on: May 24, 2015, 12:08:06 PM »
I'm 38, husband is 41. Jointly, 200k invested plus 33k more to invest, 260k in pension. But our pension is not all invested in bonds. My brother works in financial planning for a big bank and he says he would also be in 100% stocks (Unfortunately, he told me last night they are still in debt repayment mode and have zero invested. Makes me sad).

forummm

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Re: Asset allocation
« Reply #4 on: May 24, 2015, 12:12:26 PM »
So your pension isn't a set amount of dollars per year? How does that work?

FrugalFan

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Re: Asset allocation
« Reply #5 on: May 24, 2015, 12:20:45 PM »
It's a hybrid pension with some features of defined benefits and defined contributions. It does provide a minimum amount that can be substantially lower than the expected amount if the investments do poorly. I don't understand it 100%.

forummm

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Re: Asset allocation
« Reply #6 on: May 24, 2015, 12:32:51 PM »
How old are you and what age does your pension kick in? Is there a Canadian social security style pension that you'll get as well? When does that start?

Mighty-Dollar

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Re: Asset allocation
« Reply #7 on: May 24, 2015, 03:52:43 PM »
I'm about to start moving our money into index funds. I'm just curious about what asset allocation people around here are comfortable with? Our retirement horizon is probably 10-15 years, and we have a pension plan. How should our pension plan factor into our allocation?
There's all kinds of web sites that help you decide on your stock/bond allocation ratio. Here's 2: 
https://personal.vanguard.com/us/funds/tools/recommendation?reset=true
https://gps.ricedelman.com/

Jim Cramer's general bond allocation ratio recommendation. :
Younger than 30 - No reason to own bonds
In your 30's - 10% to 20% bonds
In your 40's - 20% to 30% bonds
In your 50's - 30% to 40% bonds
60 to retirement - 40% to 50% bonds
After retirement: Own some stocks, approximately one-third of your portfolio. Focus on high yielding stocks that can generate more income with less risk. Although Bob Brinker recommends more exposure to stocks with a 50/50 allocation for a 70 year old.

FrugalFan

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Re: Asset allocation
« Reply #8 on: May 24, 2015, 05:50:30 PM »
How old are you and what age does your pension kick in? Is there a Canadian social security style pension that you'll get as well? When does that start?

I'm 38 and he's 41. Our pension is complicated. The earliest we can retire with a pension is 55. If we retire before 55, we have to take a lump sum or leave it in the pension program and start getting a pension only at 65. This all makes trying to plan for FIRE a bit of a challenge. We will get some money from a Canada Pension Plan, which we can start receiving at 60, but we won't get much, especially if we retire early, as we haven't been working all that long due to a long education. We probably won't get much old age security, if any, which starts at 65 since we'll probably be earning too much.

FrugalFan

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Re: Asset allocation
« Reply #9 on: May 24, 2015, 05:55:21 PM »
I'm about to start moving our money into index funds. I'm just curious about what asset allocation people around here are comfortable with? Our retirement horizon is probably 10-15 years, and we have a pension plan. How should our pension plan factor into our allocation?
There's all kinds of web sites that help you decide on your stock/bond allocation ratio. Here's 2: 
https://personal.vanguard.com/us/funds/tools/recommendation?reset=true
https://gps.ricedelman.com/

Jim Cramer's general bond allocation ratio recommendation. :
Younger than 30 - No reason to own bonds
In your 30's - 10% to 20% bonds
In your 40's - 20% to 30% bonds
In your 50's - 30% to 40% bonds
60 to retirement - 40% to 50% bonds
After retirement: Own some stocks, approximately one-third of your portfolio. Focus on high yielding stocks that can generate more income with less risk. Although Bob Brinker recommends more exposure to stocks with a 50/50 allocation for a 70 year old.

Thank you for the links. One suggested 30% bonds and one 35% based on the quizzes. On the one hand, I feel like a bond allocation tied to your age, as is often recommended, can be too conservative. On the other hand, if we decide to retire early, we will be closer to retirement than suggested by our age. And I do like the idea of being able to sell bonds and buy more stocks if there is a really big market decline.

forummm

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Re: Asset allocation
« Reply #10 on: May 24, 2015, 06:22:22 PM »
I'm about to start moving our money into index funds. I'm just curious about what asset allocation people around here are comfortable with? Our retirement horizon is probably 10-15 years, and we have a pension plan. How should our pension plan factor into our allocation?
There's all kinds of web sites that help you decide on your stock/bond allocation ratio. Here's 2: 
https://personal.vanguard.com/us/funds/tools/recommendation?reset=true
https://gps.ricedelman.com/

Jim Cramer's general bond allocation ratio recommendation. :
Younger than 30 - No reason to own bonds
In your 30's - 10% to 20% bonds
In your 40's - 20% to 30% bonds
In your 50's - 30% to 40% bonds
60 to retirement - 40% to 50% bonds
After retirement: Own some stocks, approximately one-third of your portfolio. Focus on high yielding stocks that can generate more income with less risk. Although Bob Brinker recommends more exposure to stocks with a 50/50 allocation for a 70 year old.

Thank you for the links. One suggested 30% bonds and one 35% based on the quizzes. On the one hand, I feel like a bond allocation tied to your age, as is often recommended, can be too conservative. On the other hand, if we decide to retire early, we will be closer to retirement than suggested by our age. And I do like the idea of being able to sell bonds and buy more stocks if there is a really big market decline.

That kind of market timing is really hard to do successfully. I don't think most people should do it unless they really know what they are doing. It's hard to know when the bottom of the market it. What if the market goes down 25% and you sell all your bonds, and then the market goes down another 25%? Now you're 100% stock and the market is volatile. It's probably best for most people to just keep their asset allocation fixed. If the market goes down, you sell a small amount of bonds to keep that percentage the same.

RichMoose

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Re: Asset allocation
« Reply #11 on: May 25, 2015, 10:11:47 AM »
Based on your age and the timeline you've given, it makes the most sense to just count on retiring at 55 so you get your normal pension. You can get around this if your savings are substantial enough to make your need to pension income a much smaller factor in retirement, but I'm assuming this will lengthen your suggested timeline.

To figure out your asset allocation, start by calculating the minimum value of your monthly pension assuming your are staying in until 55. Use this towards your bond allocation for the overall portfolio. Assume the rest of your pension is in stocks as the results are variable depending on market performance.

Aim to have an overall bond allocation of somewhere between 10% and 50%. How much exactly depends on your own comfort level with risk. If in previous market downturns you've sold stocks, called your planner in a panic to move around investments and bought gold, or if you find yourself checking markets often and being happy or upset over minor gains and losses in your current portfolio I would have at least 25% in bonds. Just remember that bonds are likely to perform weak over the foreseeable future as interest rates are historically low.

Also, take a peek at these links if you haven't seem them already.

http://canadiancouchpotato.com/2010/11/10/ready-willing-and-able-to-take-risk/

http://canadiancouchpotato.com/wp-content/uploads/2015/01/CCP-Model-Portfolios-Vanguard.pdf


FrugalFan

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Re: Asset allocation
« Reply #12 on: May 25, 2015, 11:19:37 AM »
I'm about to start moving our money into index funds. I'm just curious about what asset allocation people around here are comfortable with? Our retirement horizon is probably 10-15 years, and we have a pension plan. How should our pension plan factor into our allocation?
There's all kinds of web sites that help you decide on your stock/bond allocation ratio. Here's 2: 
https://personal.vanguard.com/us/funds/tools/recommendation?reset=true
https://gps.ricedelman.com/

Jim Cramer's general bond allocation ratio recommendation. :
Younger than 30 - No reason to own bonds
In your 30's - 10% to 20% bonds
In your 40's - 20% to 30% bonds
In your 50's - 30% to 40% bonds
60 to retirement - 40% to 50% bonds
After retirement: Own some stocks, approximately one-third of your portfolio. Focus on high yielding stocks that can generate more income with less risk. Although Bob Brinker recommends more exposure to stocks with a 50/50 allocation for a 70 year old.

Thank you for the links. One suggested 30% bonds and one 35% based on the quizzes. On the one hand, I feel like a bond allocation tied to your age, as is often recommended, can be too conservative. On the other hand, if we decide to retire early, we will be closer to retirement than suggested by our age. And I do like the idea of being able to sell bonds and buy more stocks if there is a really big market decline.

That kind of market timing is really hard to do successfully. I don't think most people should do it unless they really know what they are doing. It's hard to know when the bottom of the market it. What if the market goes down 25% and you sell all your bonds, and then the market goes down another 25%? Now you're 100% stock and the market is volatile. It's probably best for most people to just keep their asset allocation fixed. If the market goes down, you sell a small amount of bonds to keep that percentage the same.

Sorry, I should have mentioned that it would indeed have been to keep asset allocation fixed. My first approach would be to put my monthly contribution to whichever allocated asset is underperforming, but I assume that during large market downturns, even that would leave me with an unbalanced asset allocation and only then would I sell some bonds to reach that balance.

FrugalFan

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Re: Asset allocation
« Reply #13 on: May 25, 2015, 11:31:48 AM »
Based on your age and the timeline you've given, it makes the most sense to just count on retiring at 55 so you get your normal pension. You can get around this if your savings are substantial enough to make your need to pension income a much smaller factor in retirement, but I'm assuming this will lengthen your suggested timeline.

To figure out your asset allocation, start by calculating the minimum value of your monthly pension assuming your are staying in until 55. Use this towards your bond allocation for the overall portfolio. Assume the rest of your pension is in stocks as the results are variable depending on market performance.

Aim to have an overall bond allocation of somewhere between 10% and 50%. How much exactly depends on your own comfort level with risk. If in previous market downturns you've sold stocks, called your planner in a panic to move around investments and bought gold, or if you find yourself checking markets often and being happy or upset over minor gains and losses in your current portfolio I would have at least 25% in bonds. Just remember that bonds are likely to perform weak over the foreseeable future as interest rates are historically low.

Also, take a peek at these links if you haven't seem them already.

http://canadiancouchpotato.com/2010/11/10/ready-willing-and-able-to-take-risk/

http://canadiancouchpotato.com/wp-content/uploads/2015/01/CCP-Model-Portfolios-Vanguard.pdf

Thank you. I value your opinion on this topic based on the other thread we were interacting in. A couple of months ago, I still assumed we would retire at 65 with a cushy pension and lots of play money, but then I found this site and a few others, and now the idea of not retiring until 55 is harder to swallow, especially after some serious illnesses and deaths in the family and among family friends either pre-retirement or just after retirement.

Great idea re: allocation! Just to clarify, if the minimum guarantee is 2944, and the estimate is 4052, I estimate about 73% bonds and 27% stocks. I then figure out what proportion of our current investments our current pension amounts are to balance the overall portfolio?

RichMoose

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Re: Asset allocation
« Reply #14 on: May 25, 2015, 11:42:59 AM »
Great idea re: allocation! Just to clarify, if the minimum guarantee is 2944, and the estimate is 4052, I estimate about 73% bonds and 27% stocks. I then figure out what proportion of our current investments our current pension amounts are to balance the overall portfolio?

I would use my lazy man's Future Value calculation for your pension. $2900 x 12 = $35000/yr guaranteed income (not bad BTW for blended DB/DC plan). Using 4% rule, $35000/.04 = $875,000. This is the value of the bond portion of your pension at age 55. It will actually be higher than this because your pension plan probably adjusts annually as your wages go up, but that's OK because this means your calculation should be very safe.

By this math it would make sense to invest everything else in stocks for now, until the value of your stocks hits $875,000. At that point you are 50/50 so you can choose whether or not to devote more to bonds again.

FrugalFan

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Re: Asset allocation
« Reply #15 on: May 25, 2015, 11:55:34 AM »
Great idea re: allocation! Just to clarify, if the minimum guarantee is 2944, and the estimate is 4052, I estimate about 73% bonds and 27% stocks. I then figure out what proportion of our current investments our current pension amounts are to balance the overall portfolio?

I would use my lazy man's Future Value calculation for your pension. $2900 x 12 = $35000/yr guaranteed income (not bad BTW for blended DB/DC plan). Using 4% rule, $35000/.04 = $875,000. This is the value of the bond portion of your pension at age 55. It will actually be higher than this because your pension plan probably adjusts annually as your wages go up, but that's OK because this means your calculation should be very safe.

By this math it would make sense to invest everything else in stocks for now, until the value of your stocks hits $875,000. At that point you are 50/50 so you can choose whether or not to devote more to bonds again.

Ah, got it! But are we talking $875k x 2 because my husband has a similar pension?

And in your opinion, it would be a bad idea to retire earlier and get a lump sum instead of the pension?

RichMoose

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Re: Asset allocation
« Reply #16 on: May 25, 2015, 01:05:35 PM »
Ah, got it! But are we talking $875k x 2 because my husband has a similar pension?

And in your opinion, it would be a bad idea to retire earlier and get a lump sum instead of the pension?

Yes, if you are both in the same pension plan it would be x2.

Lump-sums aren't always bad, but generally they are not as generous as staying in the plan. You have to keep that in mind in your retirement plan. If you have a lot of savings outside of your pension plan you may be in a position where you can sacrifice the stability of the pension plan and take the lumps on your taxes when you retire.

Retirement pension plans are designed that the last 5 years of your plan contribute significantly to your commuted value. If you retire 5 years early, you will likely reduce your guaranteed pension by a significant amount (say $1800 instead of $2900). This means your pension value by my math drops a lot, from $875,000 to $550,000. To make things easy lets say at age 50 your commuted value of each pension is $500,000. When you take a lump sum, it will be divided into two parts: 1) a large portion will go into a LIRA which is a locked in RRSP that you can withdraw from starting at age 55, with a few other exceptions for health emergencies etc. 2) a smaller, but still large portion will be paid out in cash. This part counts as regular income but you could elect to fill up any excess RRSP room with that to help reduce your tax bill for that year.

Lets say $400,000 goes into the LIRA and $100,000 is the "excess portion". You anticipated this payment so you didn't make any RRSP contributions for the last couple years and now you have $20,000 in RRSP room (paying more tax each year along the way). Even if you retire on January 1, your taxable income for that year will be $80,000 after the RRSP contribution. You would likely lose around $20,000 to taxes each that year ($40,000 total). That's probably more than a year of living expenses gone.

The $420,000 that you have been able to save from your pension value will turn into $560,000 when you turn 55 if it compounds at 6% return on investment. This will generate $1800 a month for life at a 4% SWR. This is significantly less than the $2900+ that you were promised and you took on a riskier investment portfolio because although 4% withdrawal rate on a 75/25 stock bond split portfolio is about 95% safe, it is not 100% guaranteed for life like your pension theoretically is.

Of course I'm just pulling numbers out of my butt here, but they are probably in the ballpark for reality. If you want to estimate the commuted value of your pension at age 50, just pull out your pension statements for the last 5 years. Looking at the estimated commuted value alone, calculate how much that is increasing percentage-wise each year on average. Then with a little math you can figure out the future value when you turn 50, or whatever other age you want.

I would say that you would be better off to keep the pension in the plan until you turn 65, but after taxes its likely not true. At 65 you will start to collect CPP/OAS so the pension just counts as extra income on top of that. It has the potential to increase your taxes significantly, maybe even resulting in clawbacks on OAS. That is something you will have to decide when you get your pension option package, there they will provide an estimate of your pension payments at age 65.

I don't know how flexible your employer is, but the best option might be changing to a 0.5 position when you want to slow down and ride it out to age 55. This way you will still be in the plan until 55. You pension estimates will go down a bit because your wages will drop, but it probably takes the average best 5 years of your earnings anyways (not the last 5 years).

I'm in a similar situation as you are, but I really don't care about my, or my wife's pension at all. In fact I'm looking at the pensions purely as a bonus and my retirement plan is based on the assumption that I won't have a pension at all. But I'm in a different situation because I plan to "retire" at age 35-40 tops, making sure my savings will generate more money that I need at 4% WR. Age 35-40 is a long way away from age 55 so it makes no sense at all for me to consider working an extra few years to get the pension without the headaches.

FrugalFan

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Re: Asset allocation
« Reply #17 on: May 25, 2015, 06:12:02 PM »
Wow, thank you for this. Truly. I feel like I should be paying you for this information! You were very close in your number estimates. We actually have a pretty good pension estimator website and the numbers for retiring at 50 would be 493000 to the LIRA and 157000 lump sum, plus slightly higher amounts for my husband (I didn't realize we couldn't touch the LIRA money until 55, so thank you for that). If I retire at 50 and leave the pension in until 65, the guaranteed minimum is 4000 per month. But I do think taxes would start to become an issue at that point, and I don't think we could accumulate enough savings to make it until 65 without a pension. I guess one issue is whether the 4% SWR is a fair comparison to the monthly pension amount, because the monthly pension amount is finite (as in nothing is left after you die), whereas the SWR leaves the capital untouched in theory. As of today, our employer actually does allow us to cut back to various proportions of reduced responsibility and pay. I'm a university professor, so I would have to decide at that point that my research career is pretty much over and I should focus more on teaching, since there is no way I could remain competitive on a 50% load or whatever, but I might be okay with that.

All of this depends on the markets in the next several years and the security of our employment of course, but based on what I think are pretty conservative estimates, I feel like we could feasibly retire before 55. By 55 we may have more than we really need for a comfortable retirement, and if we retired any later, the extra money definitely would not be worth the extra working years. The one thing I struggle with is that we wouldn't have enough to do a SWR from 50 to 55, so we would have to be burning down our capital until our pension kicks in. Makes me nervous. But you have given me ideas on how to include more real numbers into my spreadsheets instead of estimates for the pension amounts. Thank you!!! Maybe I'll post my spreadsheet once I crunch some numbers.