Author Topic: Diversification with FI Date Approaching  (Read 1807 times)

fluxgame

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Diversification with FI Date Approaching
« on: September 25, 2018, 12:26:09 PM »
I'm currently on track to reach my FI number in about 3 years and I'm currently invested 100% in VTSAX and VFIAX (other than day to day cash and a small emergency fund). With the current market climate, it seems pretty likely that the market is going to be down around the time I'm looking to transition from accumulation to draw-down. Given my short time frame, I'm wondering if it makes sense to move (at least) some of my money out of equities for the time being. The way I look at it, even moving all my money to a high-yield savings account/CD only adds 6 months of extra working time. Whereas, a 20% drop in the market would add close to two years. I know this question gets awfully close to "Should I time the market?", but is there something I'm not considering?

Retire-Canada

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Re: Diversification with FI Date Approaching
« Reply #1 on: September 25, 2018, 01:30:56 PM »
I'm sort of in the same boat. I'm getting close to FIRE, but not quite there yet. Left invested my stash will generate ~$220K more over 3 years [at 7% returns after inflation] than sitting in a "safe"" investment keeping pace with inflation. That return is not guaranteed of course [it could be higher and it could be lower], but neither is the prediction that there will be a crash or even smaller loses.  I have a fairly high savings rate, but I can't get to FIRE nearly as fast without the help of those market returns. So to me it seems like staying the course makes sense.

That said if I got to FIRE and there was a 20%-50% market crash I'd just keep working. I'd do that whether or not my money was in something "safe" partially mitigating the impact of the crash.

In your case what $ value of your portfolio would you need in "safe" investments such that you'd retire if the market suddenly dropped 30% or more? I'd answer that question and then shift your asset allocation over to match.

shinn497

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Re: Diversification with FI Date Approaching
« Reply #2 on: September 25, 2018, 05:53:59 PM »
Stay the course.

Andy R

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Re: Diversification with FI Date Approaching
« Reply #3 on: September 25, 2018, 06:50:37 PM »
Have you considered a bond tent to manage SOR risk?

fluxgame

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Re: Diversification with FI Date Approaching
« Reply #4 on: September 25, 2018, 07:11:56 PM »
Have you considered a bond tent to manage SOR risk?

That's essentially what I'm thinking of doing. I just didn't realize there was a term for it. Learned something new today!

I'd feel safer using cash rather than bonds though, given rising interest rates.

Retire-Canada

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Re: Diversification with FI Date Approaching
« Reply #5 on: September 25, 2018, 09:34:58 PM »
Have you considered a bond tent to manage SOR risk?

That's essentially what I'm thinking of doing. I just didn't realize there was a term for it. Learned something new today!

I'd feel safer using cash rather than bonds though, given rising interest rates.

How much money do you need to hold in cash to feel comfortable about this risk?

fluxgame

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Re: Diversification with FI Date Approaching
« Reply #6 on: September 25, 2018, 10:08:19 PM »
How much money do you need to hold in cash to feel comfortable about this risk?

I've been thinking about that question, but I haven't settled in on a good answer yet. At least enough to weather the recovery period after a potential bear-market. 20% (5 years of expenses)? But, my FI plan is definitely on the lean side, so I'm not sure that's enough enough to mitigate the SORR. If, worst case scenario, the market crashed the day after quitting my job and didn't recover until I'd exhausted my cash, I'd be sitting at 20x annual expenses rather than 25x. With not much room to reduce expenses in the plan, that'd put me in a bad spot. Perhaps 20% in cash and 40% in bonds, with a plan to shift those allocations back to equities over time.

Retire-Canada

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Re: Diversification with FI Date Approaching
« Reply #7 on: September 25, 2018, 10:16:58 PM »
Perhaps 20% in cash and 40% in bonds, with a plan to shift those allocations back to equities over time.

When you do your planning also consider the impact of 40% bonds & 20% cash vs. 40% equities on the longer-term survivability of your portfolio. cFIREsim is good for doing some wargaming. You'll want a plan for how you move back to a higher equities allocation.

Also do some analysis as to what your proposed allocation would do for you if say the next big crash is much later than expected..say 10 years and you miss out on the run up. Or if instead of a crash you get a long period of low returns as a sort of sideways correction.

You want to feel confident your plan will respond well to a variety of possible futures and not lock yourself mentally into one specific idea of what the future will be like. Sort of like the historians say we are always ready to fight the last war, but not ready for the next one.

MustacheAndaHalf

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Re: Diversification with FI Date Approaching
« Reply #8 on: September 26, 2018, 07:34:35 AM »
Formerly I would tell people to look at Vanguard's Target Date funds, which shift their allocation more and more towards bonds.  But the "bond tent" mentioned above is something I encountered in the "Case Studies" section of these forums in the past 1-2 months, and I believe it's correct.  I predict, but could be wrong, that it will become standard advice at some future point.

But it might be limited to early retirees, since optimizing makes much more sense for people who retire for 40+ years, rather than ~15-20 years.  Take a look at the following article, which suggests various glide paths for dealing with sequence of returns risk:
https://earlyretirementnow.com/2017/09/13/the-ultimate-guide-to-safe-withdrawal-rates-part-19-equity-glidepaths/

fluxgame

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Re: Diversification with FI Date Approaching
« Reply #9 on: September 26, 2018, 08:38:07 AM »
That gives me quite a bit to mull over, thanks. Based on Big ERN's analysis it sounds like a 40% equity allocation is too conservative, but the "glidepaths" that he studies are also more conservative than I was thinking. I'll have to spend some time with cFireSim to figure out the sweet spot for me.

TheAnonOne

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Re: Diversification with FI Date Approaching
« Reply #10 on: September 28, 2018, 01:29:00 PM »
The "adding two years before fire for 20% drop" is probably less accurate than you think.

Did you add 2 years in January when VTI dropped 18%?

If it drops and you continue working for an extra year, you will have purchased at an immense discount and when it recovers you will likely be richer than you planned. It isn't so cut and dry.

I am basically 100% VTSAX as well (though I've been buying international to try for 10% int )

Adam Zapple

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Re: Diversification with FI Date Approaching
« Reply #11 on: September 28, 2018, 07:07:22 PM »
I just suggested this in another thread but if you are looking to hedge against downside risk, I would suggest reading up on Ray Dalio's all-weather strategy.  The numbers are impressive.  This was outlined in "Money, Master the Game" by Tony Robbins.  There are plenty of articles on it. 

The asset mix has never lost more than 3 percent in any bear market including the great depression and great recession and boasts an average annual return of around 10 percent.  As I mentioned in the other thread, I would anticipate future returns may lag slightly due to rising interest rates but it is still a solid portfolio for hedging against a bull market IMO and a very safe short or long-term strategy.  This is the asset allocation Dalio personally uses for his family trust, although he uses leverage instruments etc.

30% Equities,
40% Long-Term Treasuries,
15% Intermediate-Term Treasuries,
7.5% Gold
7.5% Diversified Commodities.
« Last Edit: September 29, 2018, 02:52:36 PM by Adam Zapple »

Andy R

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Re: Diversification with FI Date Approaching
« Reply #12 on: September 28, 2018, 07:51:14 PM »
I just suggested this in another thread but if you are looking to hedge against downside risk, I would suggest reading up on Ray Dalio's all-weather strategy.  The numbers are impressive.  This was outlined in "Money, Master the Game" by Tony Robbins.  There are plenty of articles on it. 

The asset mix has never lost more than 3 percent in any bear market including the great depression and great recession and boasts an average annual return of around 10 percent.  As I mentioned in the other thread, I would anticipate future returns may lag slightly due to rising interest rates but it is still a solid portfolio for hedging against a bull market IMO and a very safe short or long-term strategy.  This is the asset allocation Dalio personally uses for his family trust, although he uses leverage instruments etc.

30% Equities,
40% Long-Term Treasuries,
15% Intermediate-Term Treasuries,
5% Gold
5% Diversified Commodities.

The future returns are not going to lag "slightly". I think you'd want to be 80 years and dying soon if you went with this.
This is the same guy that Anthony Robbins wrote about, but left out a fundamental part of the strategy which then makes the whole thing an utter waste of time. The original idea is to use leverage on the (smaller) equities side to increase returns, while having a higher proportion of "stable" assets to reduce the volatility. Without the leverage, the whole system is just ridiculous. Don't really understand why Anthony Robbins seems to think that the most fundamental piece of the puzzle can be thrown out and the strategy still useful. Anthony Robbins - fantastic motivator and businessman, horrendous financial advisor.

If that is somehow not enough of why to ignore this nonsense, we are coming off a multi-decade bull run on bonds as interest rates have steadily gone from ridiculous highs to lower and lower lows until it is a couple of percent from zero. The only way bonds will continue to return what they have over the last 3 decades if if the country ends up so badly that the interest rates keep getting lower and lower until it is in deflation territory.
The past does not indicate the future.

I think the Dalio strategy (with leverage as originally built around the idea) is somewhat interesting (at least from a theoretical idea), but without it, the whole thing breaks down and frankly is ridiculous. Good luck to anyone who believes this, implements it, and then runs out of money well before they die.

The Beacon

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Re: Diversification with FI Date Approaching
« Reply #13 on: September 28, 2018, 07:55:40 PM »
I am in a similar situation.  With the current state of the trade war, I think it will last for a while. What it means is that the tariffs will bite into companies profits in 2019 or 2020 when the tax cut loses it momentum.  Thus, a possible recession could be around the corner.  In addition,  the bull is a bit long in the tooth by itself.  Here is my strategy cope with the possible SOR risk.  Before I pull the plug, I should have 
1: 3 years of cash. a CD ladder
2: 2 years of fixed income like a total Bond fund, Muni Bonds and some REITS
3:  Stocks.  Just an index fund in my case.

This will give me at least a cushion of 5 years.  I have a couple of small side hustles, which will help a bit here and there. 
« Last Edit: September 28, 2018, 07:57:30 PM by The Beacon »

Adam Zapple

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Re: Diversification with FI Date Approaching
« Reply #14 on: September 29, 2018, 02:51:50 PM »
I just suggested this in another thread but if you are looking to hedge against downside risk, I would suggest reading up on Ray Dalio's all-weather strategy.  The numbers are impressive.  This was outlined in "Money, Master the Game" by Tony Robbins.  There are plenty of articles on it. 

The asset mix has never lost more than 3 percent in any bear market including the great depression and great recession and boasts an average annual return of around 10 percent.  As I mentioned in the other thread, I would anticipate future returns may lag slightly due to rising interest rates but it is still a solid portfolio for hedging against a bull market IMO and a very safe short or long-term strategy.  This is the asset allocation Dalio personally uses for his family trust, although he uses leverage instruments etc.

30% Equities,
40% Long-Term Treasuries,
15% Intermediate-Term Treasuries,
5% Gold
5% Diversified Commodities.

The future returns are not going to lag "slightly". I think you'd want to be 80 years and dying soon if you went with this.
This is the same guy that Anthony Robbins wrote about, but left out a fundamental part of the strategy which then makes the whole thing an utter waste of time. The original idea is to use leverage on the (smaller) equities side to increase returns, while having a higher proportion of "stable" assets to reduce the volatility. Without the leverage, the whole system is just ridiculous. Don't really understand why Anthony Robbins seems to think that the most fundamental piece of the puzzle can be thrown out and the strategy still useful. Anthony Robbins - fantastic motivator and businessman, horrendous financial advisor.

If that is somehow not enough of why to ignore this nonsense, we are coming off a multi-decade bull run on bonds as interest rates have steadily gone from ridiculous highs to lower and lower lows until it is a couple of percent from zero. The only way bonds will continue to return what they have over the last 3 decades if if the country ends up so badly that the interest rates keep getting lower and lower until it is in deflation territory.
The past does not indicate the future.

I think the Dalio strategy (with leverage as originally built around the idea) is somewhat interesting (at least from a theoretical idea), but without it, the whole thing breaks down and frankly is ridiculous. Good luck to anyone who believes this, implements it, and then runs out of money well before they die.

Here is the link to the Bridgewater whitepaper on the strategy https://www.bridgewater.com/resources/all-weather-story.pdf.  One thing that is mentioned in the whitepaper is the use of TIPS, but at quick glance, I could not find reference to how much of the total bond portion should be in inflation-protected securities. 

All of the backtesting I've seen in regards to this strategy have been from the 1970's on without the use of leverage on the equity portion.  As you pointed out, the recent bull run on bonds skews these numbers to make the strategy appear better than it probably is over a longer time horizon.  Before 1970 or so it is apparently difficult to price commodities (not available to individual investors?) and gold and the dollar were linked.  I agree that Robbins selling this as a strategy for "unsophisticated" investors is bogus.  How exactly one would go about implementing it I have not yet figured out as I just read Robbins' book last week.  Maybe I'll start a new thread once I've dug deeper and have a better grasp on it.  Also, I have updated the original numbers, Gold and Commodities should be 7.5% each.

grettman

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Re: Diversification with FI Date Approaching
« Reply #15 on: September 29, 2018, 05:29:33 PM »
a 20% drop in the market would add close to two years.

What if you do what you propose and it drops 20% a month, a year or two years after you retire?  What then?

fluxgame

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Re: Diversification with FI Date Approaching
« Reply #16 on: September 29, 2018, 06:59:47 PM »
a 20% drop in the market would add close to two years.

What if you do what you propose and it drops 20% a month, a year or two years after you retire?  What then?

I'm not sure what you're getting at. If that happens, by having a 5 year buffer in more stable investments, I've mitigated much of the risk of a crash early in retirement. If things get so bad that a 5 year buffer isn't enough to save me, being 100% in equities certainly isn't going to make the situation better.