Author Topic: Asset Allocation By Assets, Not Age  (Read 7796 times)

jstash

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Asset Allocation By Assets, Not Age
« on: June 30, 2014, 07:56:04 PM »
Most asset allocation advice seems to be related to age (e.g., "age in bonds"). But doesn't it make more sense, especially for the MMM community, to adjust your asset allocation according to assets? For example:

<$10,000 = 100/0 stocks/bonds
$10,000 - $25,000 = 90/10
$25,001 - $100,000 = 80/20
$100,001 - $500,000 = 70/30
$500,001 - $1,000,000 = 60/40
$1,000,000+ = 50/50

This is just an example, and each person could adjust this according to his or her risk tolerance. Alternatively, you could determine your bands by working backwards from your FIRE "number."

This approach would appear to have several benefits:

* It is more appropriate than age-based allocation for those Mustachians who retire early
* It is driven by financial goals rather than the inevitability of aging, thereby encouraging people to save toward the band threshold
* In a market downturn, one may drop into a lower band (with a higher percentage of stocks), which would encourage investors to even more aggressively purchase low-priced stocks out of their bond holdings as they rebalance

Thoughts?
« Last Edit: June 30, 2014, 08:11:31 PM by jstash »

Rezdent

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Re: Asset Allocation By Assets, Not Age
« Reply #1 on: June 30, 2014, 08:48:54 PM »
I'm confused.
Are you saying that the first 10,000 of someone's stash all goes to bonds?
If that's what your saying,  I don't think I'd want to do that - all eggs in 1 basket even for a short while at first...I'd prefer to diversify at the beginning and stay diverse throughout the accumulation phase.  But I am conservative.

jstash

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Re: Asset Allocation By Assets, Not Age
« Reply #2 on: June 30, 2014, 08:53:55 PM »
I'm confused.
Are you saying that the first 10,000 of someone's stash all goes to bonds?
If that's what your saying,  I don't think I'd want to do that - all eggs in 1 basket even for a short while at first...I'd prefer to diversify at the beginning and stay diverse throughout the accumulation phase.  But I am conservative.

No, I'm saying that if you are just beginning your 'stache and have less than $10,000, you would put 100% into stocks/equities. That's a very aggressive allocation, obviously, but if the market tanks you're only losing a few thousand dollars. Of course, everyone has a different risk tolerance, so you could adjust the levels I gave according to your own preference.

Emilyngh

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Re: Asset Allocation By Assets, Not Age
« Reply #3 on: June 30, 2014, 09:21:12 PM »
Most asset allocation advice seems to be related to age (e.g., "age in bonds"). But doesn't it make more sense, especially for the MMM community, to adjust your asset allocation according to assets? For example:

<$10,000 = 100/0 stocks/bonds
$10,000 - $25,000 = 90/10
$25,001 - $100,000 = 80/20
$100,001 - $500,000 = 70/30
$500,001 - $1,000,000 = 60/40
$1,000,000+ = 50/50

This is just an example, and each person could adjust this according to his or her risk tolerance. Alternatively, you could determine your bands by working backwards from your FIRE "number."

This approach would appear to have several benefits:

* It is more appropriate than age-based allocation for those Mustachians who retire early
* It is driven by financial goals rather than the inevitability of aging, thereby encouraging people to save toward the band threshold
* In a market downturn, one may drop into a lower band (with a higher percentage of stocks), which would encourage investors to even more aggressively purchase low-priced stocks out of their bond holdings as they rebalance

Thoughts?

Hmmm, well, according to this we would have a 70/30.   Which is very close to what we have.   So, since your model confirms what we already decided was best for us, I'm going to have to say "Great!   Exactly correct!   Great idea!"

jstash

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Re: Asset Allocation By Assets, Not Age
« Reply #4 on: July 01, 2014, 05:16:41 AM »
Most asset allocation advice seems to be related to age (e.g., "age in bonds"). But doesn't it make more sense, especially for the MMM community, to adjust your asset allocation according to assets? For example:

<$10,000 = 100/0 stocks/bonds
$10,000 - $25,000 = 90/10
$25,001 - $100,000 = 80/20
$100,001 - $500,000 = 70/30
$500,001 - $1,000,000 = 60/40
$1,000,000+ = 50/50

This is just an example, and each person could adjust this according to his or her risk tolerance. Alternatively, you could determine your bands by working backwards from your FIRE "number."

This approach would appear to have several benefits:

* It is more appropriate than age-based allocation for those Mustachians who retire early
* It is driven by financial goals rather than the inevitability of aging, thereby encouraging people to save toward the band threshold
* In a market downturn, one may drop into a lower band (with a higher percentage of stocks), which would encourage investors to even more aggressively purchase low-priced stocks out of their bond holdings as they rebalance

Thoughts?

Hmmm, well, according to this we would have a 70/30.   Which is very close to what we have.   So, since your model confirms what we already decided was best for us, I'm going to have to say "Great!   Exactly correct!   Great idea!"

That's cool - if we both agree, it must be a good idea!

Notch

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Re: Asset Allocation By Assets, Not Age
« Reply #5 on: July 01, 2014, 05:43:08 AM »
I really like this.

matchewed

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Re: Asset Allocation By Assets, Not Age
« Reply #6 on: July 01, 2014, 05:51:46 AM »
Most asset allocation advice seems to be related to age (e.g., "age in bonds"). But doesn't it make more sense, especially for the MMM community, to adjust your asset allocation according to assets? For example:

<$10,000 = 100/0 stocks/bonds
$10,000 - $25,000 = 90/10
$25,001 - $100,000 = 80/20
$100,001 - $500,000 = 70/30
$500,001 - $1,000,000 = 60/40
$1,000,000+ = 50/50

This is just an example, and each person could adjust this according to his or her risk tolerance. Alternatively, you could determine your bands by working backwards from your FIRE "number."

This approach would appear to have several benefits:

* It is more appropriate than age-based allocation for those Mustachians who retire early
* It is driven by financial goals rather than the inevitability of aging, thereby encouraging people to save toward the band threshold
* In a market downturn, one may drop into a lower band (with a higher percentage of stocks), which would encourage investors to even more aggressively purchase low-priced stocks out of their bond holdings as they rebalance

Thoughts?

I think it's just as useful as any rule of thumb. In that it's not altogether that useful. Everyone will need to decide for themselves how comfortable they are with their AA and where they are in their financial "journey". This advice could be terrible for some people and great for others. Just leaving blanket money bands ignores all the other factors someone needs to evaluate when making an AA.

GrayGhost

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Re: Asset Allocation By Assets, Not Age
« Reply #7 on: July 01, 2014, 08:39:34 AM »
I don't know about putting 50/50 into stocks and bonds if you've got a mill invested, and that's because with money like that, I wouldn't be afraid of bear years at all. I guess what I'm saying is that if I barely had enough to FIRE, I might go to 40 or 50 percent bonds, but if I had an overfunded FIRE retirement plan, I'd probably drop down to 25% or so percent bonds, simply because the fluctuations of the day (or the year) would be inconsequential for me, and I'd be able to go toward a higher risk, higher rewards strategy.

Doesn't MMM himself recommend only 25% in bonds?

jstash

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Re: Asset Allocation By Assets, Not Age
« Reply #8 on: July 01, 2014, 09:11:42 AM »
I don't know about putting 50/50 into stocks and bonds if you've got a mill invested, and that's because with money like that, I wouldn't be afraid of bear years at all. I guess what I'm saying is that if I barely had enough to FIRE, I might go to 40 or 50 percent bonds, but if I had an overfunded FIRE retirement plan, I'd probably drop down to 25% or so percent bonds, simply because the fluctuations of the day (or the year) would be inconsequential for me, and I'd be able to go toward a higher risk, higher rewards strategy.

Doesn't MMM himself recommend only 25% in bonds?

Yeah, I'm pretty high-risk myself, but I also think there's something to be said for the whole "quit the game once you've won it" philosophy (which is why my example progressively dials down the risk). I'm far from a millionaire myself, but as a Mustachian, I don't know what difference having a million, vs. two or three million, would have on my daily life if I maintain a 30k/year lifestyle. But to each his/her own!

Edit: my daydream FIRE number is around 500k, so actually up to that point I'd still have a pretty aggressive (i.e., 70/30) allocation. After that point, I'd rather just play it safe. Game over.
« Last Edit: July 01, 2014, 09:15:05 AM by jstash »

rmendpara

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Re: Asset Allocation By Assets, Not Age
« Reply #9 on: July 01, 2014, 09:36:10 AM »
I don't know about putting 50/50 into stocks and bonds if you've got a mill invested, and that's because with money like that, I wouldn't be afraid of bear years at all. I guess what I'm saying is that if I barely had enough to FIRE, I might go to 40 or 50 percent bonds, but if I had an overfunded FIRE retirement plan, I'd probably drop down to 25% or so percent bonds, simply because the fluctuations of the day (or the year) would be inconsequential for me, and I'd be able to go toward a higher risk, higher rewards strategy.

Doesn't MMM himself recommend only 25% in bonds?

Yeah, I'm pretty high-risk myself, but I also think there's something to be said for the whole "quit the game once you've won it" philosophy (which is why my example progressively dials down the risk). I'm far from a millionaire myself, but as a Mustachian, I don't know what difference having a million, vs. two or three million, would have on my daily life if I maintain a 30k/year lifestyle. But to each his/her own!

Edit: my daydream FIRE number is around 500k, so actually up to that point I'd still have a pretty aggressive (i.e., 70/30) allocation. After that point, I'd rather just play it safe. Game over.

Yeah, I'm also more risk tolerant, but I see that declining once my NW increases beyond $500k, $1m, etc.

At that point, I'd be satisfied with selling of $250k in assets to buy a rental property in cash and start generating $10k in rental income. Even if a recession hits, rent won't decline significantly, though if the market surges forward, the rent won't increase necessarily either. However, a small token is that I can reinvest the $10k however I want... perhaps back into the market.

Cottonswab

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Re: Asset Allocation By Assets, Not Age
« Reply #10 on: July 01, 2014, 09:50:03 AM »
I do not think that asset allocation should be based on age or assets.  Neither approach accounts for significant changes in risk and return due to factors such as current interest rates, valuation, inflation, personal spending needs, etc.

"Everything should be made as simple as possible, but not simpler." - Einstein

Asset allocation should primarily be based on the expected future return on investment of those assets and your desired liquidity (spending/consumption) goals.  So my advice would be:

1.  Have enough cash, bonds, employment income, etc. on hand to cover near-term (<5 years) expenses.
2.  Do "due dillegence" research on available long-term investment options.  Understand the risks and returns
3.  Predict return-on-investment (ROI) for the long-term investment options (based on current market prices)
4.  Rank investment options, based on ROI.
5.  Invest money on the highest ROI options, while maintaining "adequate" risk diversification/hedging.

dragoncar

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Re: Asset Allocation By Assets, Not Age
« Reply #11 on: July 01, 2014, 09:58:44 AM »
I don't know about putting 50/50 into stocks and bonds if you've got a mill invested, and that's because with money like that, I wouldn't be afraid of bear years at all. I guess what I'm saying is that if I barely had enough to FIRE, I might go to 40 or 50 percent bonds, but if I had an overfunded FIRE retirement plan, I'd probably drop down to 25% or so percent bonds, simply because the fluctuations of the day (or the year) would be inconsequential for me, and I'd be able to go toward a higher risk, higher rewards strategy.

Doesn't MMM himself recommend only 25% in bonds?

I'm on this camp-- call me a contrarian, but I plan to get more aggressive as my stache grows.  Something like 50/50 for my basic living expenses and 100:0 for everything above it. 

JoJoP

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Re: Asset Allocation By Assets, Not Age
« Reply #12 on: July 07, 2014, 06:44:11 PM »
[quote autho
[/quote]

Yeah, I'm pretty high-risk myself, but I also think there's something to be said for the whole "quit the game once you've won it" philosophy (which is why my example progressively dials down the risk). I'm far from a millionaire myself, but as a Mustachian, I don't know what difference having a million, vs. two or three million, would have on my daily life if I maintain a 30k/year lifestyle. But to each his/her own!

Edit: my daydream FIRE number is around 500k, so actually up to that point I'd still have a pretty aggressive (i.e., 70/30) allocation. After that point, I'd rather just play it safe. Game over.
[/quote]

Yeah, I'm also more risk tolerant, but I see that declining once my NW increases beyond $500k, $1m, etc.

At that point, I'd be satisfied with selling of $250k in assets to buy a rental property in cash and start generating $10k in rental income. Even if a recession hits, rent won't decline significantly, though if the market surges forward, the rent won't increase necessarily either. However, a small token is that I can reinvest the $10k however I want... perhaps back into the market.
[/quote]

I think it's important to look at all your assets, not just the ones in your stock portfolio, to ascertain whether or not you are diverse enough.  I have the vast majority of my net worth in rental real estate.   As I ponder buying another one, I think to myself-- "If I buy this property for 100K and make (roughly) 1000 a month, I'll be 12K richer every year, year in year out."  I can then use that steady income to invest in the stock market, and still have the real estate investment.  Plus, I'm even more diversified, because now I have stocks, real estate and rental income.   

kyleaaa

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Re: Asset Allocation By Assets, Not Age
« Reply #13 on: July 09, 2014, 02:01:08 PM »
Yes, this is reasonable.

frugalnacho

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Re: Asset Allocation By Assets, Not Age
« Reply #14 on: July 09, 2014, 02:14:08 PM »
If I am young and have 10 more years to FIRE, but currently have over 100k saved, why would I put any into bonds?  I have no intention of touching that 100k capital ever.

RyanHesson

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Re: Asset Allocation By Assets, Not Age
« Reply #15 on: July 09, 2014, 02:49:39 PM »
Quote
Edit: my daydream FIRE number is around 500k, so actually up to that point I'd still have a pretty aggressive (i.e., 70/30) allocation. After that point, I'd rather just play it safe. Game over.

If that's because you expect to need 20K a year, and you're using the 4% safe withdrawal rule, you should know that the rule comes from the return you get on the money.  The idea being you get something like 7%, 2.3% is inflation, 4% is withdrawal, 0.7% is a little buffer. If you're doing bonds your returns are lower, you're going to have a lower rate that you can withdraw at safely.

jstash

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Re: Asset Allocation By Assets, Not Age
« Reply #16 on: July 09, 2014, 08:56:13 PM »
If I am young and have 10 more years to FIRE, but currently have over 100k saved, why would I put any into bonds?  I have no intention of touching that 100k capital ever.

Quote
Edit: my daydream FIRE number is around 500k, so actually up to that point I'd still have a pretty aggressive (i.e., 70/30) allocation. After that point, I'd rather just play it safe. Game over.

If that's because you expect to need 20K a year, and you're using the 4% safe withdrawal rule, you should know that the rule comes from the return you get on the money.  The idea being you get something like 7%, 2.3% is inflation, 4% is withdrawal, 0.7% is a little buffer. If you're doing bonds your returns are lower, you're going to have a lower rate that you can withdraw at safely.

If you check out FIRECalc, which we should all do when planning our individual retirement scenarios, it actually shows that allocations in the 50/50 to 100/0 range are nearly identical in successful 4% drawdown rates - however, a 50/50 allocation has a slightly higher rate of success than a 100/0 allocation.

lano

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Re: Asset Allocation By Assets, Not Age
« Reply #17 on: July 09, 2014, 09:45:08 PM »
Dr. Krugman has two blog post now about bonds and interest. 

http://krugman.blogs.nytimes.com/2014/07/08/class-and-monetary-policy/

http://krugman.blogs.nytimes.com/2014/07/09/on-losing-interest/

So I guess this is how it all starts... young, lean, energetic people who value their time and money invest in stocks and the ability of people to turn capital and labor into value. 

But as they age and accumulate wealth... they slow down... their minds are no longer interested in processing business ideas... at this point they just want to take a fixed rate and yell at anyone who tries to lower that rate through inflation.

:)

Crushtheturtle

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Re: Asset Allocation By Assets, Not Age
« Reply #18 on: July 10, 2014, 02:20:43 PM »
I reference a formula I saw on another bogle-ish website:

Current Bond % = (Retirement Bond %)(Current Portfolio $/ Target Portfolio $)

I.e. If I've decided I need a million dollars to retire (and I plan to hold 40% bonds in retirement) and I have $500,000 now, the formula has me hold 1/2 x 40% = 20% in bonds now. In other words, you throttle your risk back the closer you get to your number. Makes sense to me, but it's only a reference.

I wouldn't go more aggressive than 80/20 (considering rebalancing, studies show it returns as much if not more than 100/0) or more conservative than 40/60.
« Last Edit: July 10, 2014, 02:25:16 PM by Crushtheturtle »

Peter Gibbons

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Re: Asset Allocation By Assets, Not Age
« Reply #19 on: July 12, 2014, 08:32:23 PM »
I reference a formula I saw on another bogle-ish website:

Current Bond % = (Retirement Bond %)(Current Portfolio $/ Target Portfolio $)

I.e. If I've decided I need a million dollars to retire (and I plan to hold 40% bonds in retirement) and I have $500,000 now, the formula has me hold 1/2 x 40% = 20% in bonds now. In other words, you throttle your risk back the closer you get to your number. Makes sense to me, but it's only a reference.

I wouldn't go more aggressive than 80/20 (considering rebalancing, studies show it returns as much if not more than 100/0) or more conservative than 40/60.

This formula really resonated with me.  I love this idea !  Thanks for posting it.