What asset allocation do you recommend for FIRE?

[dude]

I wound down to 50/50 back in late 2017, with retirement about a year and a half away (esp. in light of a 9+ year bull market). Recently, when the S&P was down @17%, I shifted 5% over from bonds to equities, which after the market drops resulted in a 52/47 allocation. I'm now less than 5 months from retirement and damn glad I didn't lose a shit-ton last year (my retirement account returned -1.65%). Like some others have mentioned, I'm also planning a rising glide path, eventually settling at 70/30. Just need to make it through a potential early bad sequence of returns first.

[Prairie Stash]

https://www.millennial-revolution.com/yield-shield/
A great place to get a perspective on the first few years of retirement, forgetting 30 years. If you can make 5 years, and another 5 years etc, eventually you make 30. The yield shield is an early FIRE strategy.

No one here is 100% equities. I'm being deliberately confrontational to prove a point and rant a little. Some people achieve 98%, but the other 2% really matters and dramtically effects sucess rates. I have something called "cash" that I include in my NW. Some people have an "Emergency Fund". If you have $0 in cash every month, you are 100% volatile and selling stocks monthly to pay the bills during a bear market. Lets say you instead have 2% cash, you can avoid 6 months of pain. Lets say you also get 2% dividends, now you can skip selling for 12 months. By having just a little diversity, cash, it can dramatically change monthly results.

Right now I'm about 60% equities, 35% house, 5% cash. My house cuts monthly bills by $1200 (after upkeep, bills etc,) so it yields about 4% in savings plus capital gain; my life would cost $45k if I rented, $30k by owning. Its the basic rent vs. own scenario, thats why its included. 

Sit back and imagine hunting a bear (market). If you FIRE at a bear, it gets pissed off and will either destroy you or fall over dead. Having extra ammo when hunting a bear is a good idea, my ammo is my cash and house. Hunting a bear is a short term experience, they can run fast but tire out quick. After that bear is dead, you can ride the next Bull market and enjoy prosperity, when you ride a bull asset allocation barely matters, its a wild ride and everyone is a winner.

When I FIRE I don't care if my acounts grow at a maximum amount, I just don't want the bear to eat me and I'll be fine.

[GoCubsGo]

MTB- Thanks for starting the thread, I'll be down the rabbit hole the next few weeks reading the great links you all have provided.   Also, the Ally CD I've moved some of the money into is yielding 2.75%, I think the no penalty one is around 2.2%.  I didn't really want to deal with bond risk since some of it was for college costs.

The topic also got me thinking about how to quantify the future with my rentals (let me know if I should start a new thread).  They throw cash off yearly, there is yearly principle reduction paid for by the renter and at some point 15 years from now I will own them outright.  With appreciation that could be a large asset.  There is risk but not a ton as my rentals held up phenomenally during the great recession.  I wonder if I should be a bit more aggressive with my AA because 15% of my investable assets are in fairly stable, predictable rental assets.  So many things to consider when coming up with a plan.....

[Classical_Liberal]

I currently don't have a clear strategy so I'm going to call it what it is... market timing.   The market run-up basically made me realize the end isn't far off and how to plan the glide path to get to that point is definitely something I need to research. 

I'd don't think it's insane to look at the CAPE to 10 year return correlation.  Particularly if someone is near FIRE date.  Putting some preset thresholds on allocation based on CAPE is a very sane form of market timing.  You'll find more information on this type on thing at bogleheads. Most here blindly follow MMM or JC Collins without personal research.  They are pretty good methods if this stuff doesn't interest you, but if you have a hobby interest, you could do better than a static allocation.

This is the best analysis of this. I use this rule to figure out a SWR based on current CAPE10. His formula would have you at 3.5% right now.

https://earlyretirementnow.com/2017/08/30/the-ultimate-guide-to-safe-withdrawal-rates-part-18-flexibility-cape-based-rules/

Right, that's good stuff, but I'm thinking in the sense of changing allocations  vs changing WR's.  ie when does it make sense to re-balance to lower equity allocation and into non-correlators. 

In my thinking, the two major reasons for this are 1)Near drawdown and at peak sequence risk (or some other short term need for the money), and 2) CAPE is about 78% correlated to 10 year returns, soo really high CAPE means...  There may be more, but these are the only two that have been applicable to my personal experience.

[BicycleB]

Hi, everyone. My thinking about asset allocation changed today because of this article:

https://www.advisorperspectives.com/articles/2019/01/07/does-the-bucket-approach-destroy-wealth?bt_ee=FTU%2FsBNf%2FLUiHMmWwiQ4s%2FPvcHZiqdidGGmLKie5LRuYO378o7HycRIbJqe0nQFi&bt_ts=1546956764657

It summarizes research by a business professor in Spain, Javier Estrada, who made some detailed calculations about asset allocation and wealth preservation using data from 1900 to 2014 across 21 countries. His findings as I understand them:

1. Optimal allocation of stock vs bonds turned out to be 85% stock, 15% bonds
2. The difference compared to other studies was primarily because he measured success differently, trying to measure people's real concerns more accurately
3. Less accurate measurements using the same data would have recommended about 60/40; more accurate measurement, 85/15
4. In addition to being safer than 60/40, 85/15 frequently produced huge amounts of extra gains
5. In a separate study, Estrada compared static % allocation vs the bucket approach. Bucket sucked.

TL;DR - it seems that reducing our stock % doesn't make us much safer, but increasing stock makes us much richer. Default to 85% stock.

As Mr. Lazy, I will probably just ponder this for a bit, leaving my 70/30ish allocation in place, but wanted to share. All comments welcome.

PS. His measurements were to assess the results of numerous Monte Carlo simulations, not to strictly evaluate past results. Could there be an error in the Monte Carlo application? Very interested if anyone has the knowledge to sort this out.

[2Birds1Stone]

I guess my 50/50 is way off =D

[Classical_Liberal]

All comments welcome.

PS. His measurements were to assess the results of numerous Monte Carlo simulations, not to strictly evaluate past results. Could there be an error in the Monte Carlo application? Very interested if anyone has the knowledge to sort this out.

Monte Carlo's are random

Two numbers determine the expected final wealth distributions in Monte Carlo simulation programs: the average annual return (again, derived from current valuations/yields rather than historical ones) and the standard deviation of the average annual return. The Monte Carlo simulator then randomly selects a return for each year and calculates wealth values over the expected retirement period. This process repeats thousands of times to calculate the likelihood of possible outcomes

CAPE and 10 year return relationship is not random, its pretty highly correlated.  Plus this research proposes a static allocation, which is not what I, or anyone commenting here considering a bond tent, is proposing.  Lastly, I'll probably be slammed for this, but not all bonds and equities are the same.  Plus there are other asset classes some of which tend to correlate and other not correlate to a global fund.   

[Fatmouse]

Great thread!  I have been thinking about this topic a lot lately.

If we are talking about asset allocation in a complete vacuum, I agree with some comments that suggested being in at least 75% equities, in order to generate the returns necessary to support FIRE, per the Trinity study.  I think an allocation at least this aggressive is necessary in the wealth accumulation phase and the “early retirement” phase, for the 4% rule to work.

Under FIRE, one would not make their asset allocation more conservative than 75/25 (toward bonds) unless they had enough excess capital to be able to withstand smaller (but more consistent) returns.  This is why some folks suggested playing with different calculators and spreadsheets, to see what works for you.

In my personal experience, for myself, I do not think of my asset allocation in a vacuum.  Of my investments, my DH and I are at an 83/17 split of stocks/ bonds.  But our investments represent just 50% of our net worth. The other 50% of our net worth is in our primary residence equity, a pension (actuarial present value), and cash.  I think that makes my allocation way too conservative overall, especially given that DH and I are both still working.  My goal for 2019 is to get our investments up to 65% of our net worth by increasing new contributions, and to get our investments up to 80% of our net worth by the end of 2020.  And in the meantime, I would have no qualms about letting my asset allocation float up to 90/10 or even more aggressive.

If I were really close to FIRE, these things would impact my asset allocation:
- How much do I have in cash?  How much do I want to keep in cash?
- What is my tax situation, given my income and my holdings/ unrealized capital gains?  Could I easily sell equities for cash if I wanted to, without incurring penalties or taxes?
- Do I own my home?
- Of my planned spending, how much is fixed?  How much is discretionary?
- Do I have any sources of income aside from my investments, especially fixed income?
- Is my spending even and predictable, or is it lumpy year to year?
- How is my health?  What is my plan for access to health insurance and health care in early retirement?  What does that do to my risk tolerance?

Stated another way:  If I did not yet have a big cash cushion saved, but I had high fixed expenses like a mortgage, or unpredictable expenses like being on a volatile open market for health insurance, then I would be more conservative in my asset allocation.  But, with the more conservative asset allocation, I would correspondingly drop my SWR a bit, or I would plan to withdraw less in years with bad performance (ie, accept more income volatility.). The overall effect is that I would need a bigger “magic number” to feel comfortable giving up W2 income in such a scenario.

Therefore, for me and DH, we have done and will continue to do things that improve our financial security, rather than get too wrapped up in a specific asset allocation.  Some of our plans and actions to address security and risk include::
- DH staying with his current state employer even if he could get higher salary elsewhere, because when he reaches 25 years of service he can access health insurance for the current employee premium cost, even once he retires.  This benefit is pure gold for us.
- Aligning our mortgage payoff date with our target retirement date by making some early mortgage payments now, so our expenses will drop in RE.
- Increased cash balances to cover 1-year of expenses after we bought our home, even though it meant pausing non-retirement investment new contributions for 18 months
- Of our 83/17 overall asset allocation, put the riskier holdings in retirement accounts and more steady holdings in taxable brokerage accounts.  For example, in percentage terms, I hold more international index funds in my Roth IRA, and I hold more S&P index in my taxable brokerage account.

Currently, I hope to FIRE in 2022 at age 38, and still plan for my husband to FIRE in 2036 years at his age 54.

[Classical_Liberal]

I agree with some comments that suggested being in at least 75% equities, in order to generate the returns necessary to support FIRE, per the Trinity study.  I think an allocation at least this aggressive is necessary in the wealth accumulation phase and the “early retirement” phase, for the 4% rule to work.

Under FIRE, one would not make their asset allocation more conservative than 75/25 (toward bonds) unless they had enough excess capital to be able to withstand smaller (but more consistent) returns.  This is why some folks suggested playing with different calculators and spreadsheets, to see what works for you.

Actually, lower return/lower volatility portfolios can increase SWR.  To illustrate the point, look at extremes.  Assume a completely static return rate.  All one needs for the 4% rule to work for 30 years (ie like the trinity study) is about 1.25% real.  Currently the 30 year TIPS would almost accommodate a 30 yr retirement, at 4% WR, guaranteed (sans taxes).  Crazy when you think about that, huh?  Yet TIPS are rarley discussed as an option for part of a portfolio (at MMM).  Again, not all stocks and bonds are the same.

Also, time in accumulation phase matters, because someone with a 80%+ savings rate really isn't all that reliant on investment returns to reach goal, whereas someone at a 50% or less is. 

I'm certainly not suggesting this type of allocation, just trying to make a point showing extremes. Personal goals and situation matter, where one is at in life matters. All of this should be considered in optimizing AA, just like we optimize spending.

[Fatmouse]

This is an informative reply, and it does get me thinking.

I have not previously heard an estimate that all one needs for the 4% rule to work for 30 years is about 1.25% real.

I guess such a calculation might also be tied to personal circumstances.  Health insurance and health care often have double digit annual inflation increases, and housing in many parts of the country has high annual inflation increases.  For my investments, I would assume I would need to do better than 1.25% real, given some things get more expensive faster than others.  But, if I had more absolute life necessities factored in at a fixed cost (ie, had long-term disability insurance, owned a home and expected never to relocate), I would have more confidence in accepting lower returns.

Or, I would need enough “extra” capital that there is no reason to take risks to get higher returns, even in spite of the risks of inflation.

[Classical_Liberal]

Or, I would need enough “extra” capital that there is no reason to take risks to get higher returns, even in spite of the risks of inflation.

Well, a TIPS adjusts based on inflation, so that should be covered.  Of course, personal inflation may be greater or lesser than the CPI.  Again, personal situation matters. 

The other side of this is absolutely no upside.  So, although you could have a 100% chance of 4% rule for 30 years at a fixed, inflation adjusted 1.25%, there is 0% chance you get 31 years.  Which is why 100% TIPS is probably a bad idea.  Still though, having an anchor in drawdown, which reduces both downside and upside can increase SWR, even if overall returns are reduced.

[Andy R]

This is the best analysis of this. I use this rule to figure out a SWR based on current CAPE10. His formula would have you at 3.5% right now.

https://earlyretirementnow.com/2017/08/30/the-ultimate-guide-to-safe-withdrawal-rates-part-18-flexibility-cape-based-rules/

Can you see where he says that he uses CAPE 1.75/0.5 instead of CAPE 1.00/0.5 or one of the others?

[Fatmouse]

This is the best analysis of this. I use this rule to figure out a SWR based on current CAPE10. His formula would have you at 3.5% right now.

https://earlyretirementnow.com/2017/08/30/the-ultimate-guide-to-safe-withdrawal-rates-part-18-flexibility-cape-based-rules/

Great link!  Thanks for sharing.  This is the type of stuff that keeps me coming back to these forum boards.

[chasesfish]

This is an awesome thread!   I wanted to add a few things:

@2Birds1Stone - Thanks for sharing Early Retirement Now's series.  This is the most comprehensive write-up you'll find.  I am specifically thinking about applying an equity glide path in my early retirement, starting with a higher bond percentage and slowly moving that more towards stocks.

Lots of comments about REITs.  I'm a HUGE fan for early retirees.  All the writing out there seem to either love directly owned rental real estate or a stock/bond portfolio, but ignore REITs.   REITs are a broad category, so VNQ doesn't have a great track record.  The last recession was also real estate driven, which hit REITs harder.   I don't expect that to happen the same way in the future.  History doesn't repeat itself, but it does rhyme.  REITs are already funds, pick the fund that matches your personal risk tolerance and move on.  I think you can create a portfolio of lower risk REITs paying 5.5% to 6% with dividend increases similar to the rate of inflation.  That's a nice compliment to a stock/bond portfolio.

I share my asset allocation on my site with my personal choices, but I'll probably have to make a post since I find myself defending REITs constantly.

[SeattleCPA]

I currently don't have a clear strategy so I'm going to call it what it is... market timing.   The market run-up basically made me realize the end isn't far off and how to plan the glide path to get to that point is definitely something I need to research. 

I'd don't think it's insane to look at the CAPE to 10 year return correlation.  Particularly if someone is near FIRE date.  Putting some preset thresholds on allocation based on CAPE is a very sane form of market timing.  You'll find more information on this type on thing at bogleheads. Most here blindly follow MMM or JC Collins without personal research.  They are pretty good methods if this stuff doesn't interest you, but if you have a hobby interest, you could do better than a static allocation.

The Boglehead known as "Siamond" did a good writeup on this: https://finpage.blog/2018/02/28/cape-and-safe-withdrawal-rates/

I actually blogged about his post at my little blog (basically agreeing with his points)

[SeattleCPA]

I currently don't have a clear strategy so I'm going to call it what it is... market timing.   The market run-up basically made me realize the end isn't far off and how to plan the glide path to get to that point is definitely something I need to research. 

I'd don't think it's insane to look at the CAPE to 10 year return correlation.  Particularly if someone is near FIRE date.  Putting some preset thresholds on allocation based on CAPE is a very sane form of market timing.  You'll find more information on this type on thing at bogleheads. Most here blindly follow MMM or JC Collins without personal research.  They are pretty good methods if this stuff doesn't interest you, but if you have a hobby interest, you could do better than a static allocation.

This is the best analysis of this. I use this rule to figure out a SWR based on current CAPE10. His formula would have you at 3.5% right now.

https://earlyretirementnow.com/2017/08/30/the-ultimate-guide-to-safe-withdrawal-rates-part-18-flexibility-cape-based-rules/

I think version 2 of the early retirement now spreadsheet (which I think is better than cfiresim) appears here:

https://earlyretirementnow.com/2017/01/25/the-ultimate-guide-to-safe-withdrawal-rates-part-7-toolbox/

[SeattleCPA]

Could there be an error in the Monte Carlo application? Very interested if anyone has the knowledge to sort this out.

Yes. See here: https://www.kitces.com/blog/monte-carlo-analysis-risk-fat-tails-vs-safe-withdrawal-rates-rolling-historical-returns/

Also, I think some data does appear to show that you bear no extra risk with higher stock allocations. (You can pretty easily come to this conclusion with cfiresim.)

But look for fun at the cohort that retired in 2000. Plot out the folks who had a 100% stocks vs 60% stocks vs. 20% stocks. (All rest of money in intermediate term treasuries.)

The only people NOT going back to work are folks with 80% bonds.

Reason for edit? Too exaggerated. 80% bonds best... but 60/40 works okay too. Only 100% stocks investor is going back to work.

[MTBmustachian]

Currently, I hope to FIRE in 2022 at age 38, and still plan for my husband to FIRE in 2036 years at his age 54.

Right, this sort of thinking is exactly what I'm NOT talking about. If you're "retiring early" at the age of 54, you can get away with something like this (or only slightly more aggressive than this):

All one needs for the 4% rule to work for 30 years (ie like the trinity study) is about 1.25% real.  Currently the 30 year TIPS would almost accommodate a 30 yr retirement, at 4% WR, guaranteed (sans taxes).  Crazy when you think about that, huh?  Yet TIPS are rarley discussed as an option for part of a portfolio (at MMM). 

But that type of thinking doesn't work if you want to be retired for, say, 70 years or so.

REITs are already funds, pick the fund that matches your personal risk tolerance and move on.  I think you can create a portfolio of lower risk REITs paying 5.5% to 6% with dividend increases similar to the rate of inflation.  That's a nice compliment to a stock/bond portfolio.

I know that some REITs are broad swaths of the real estate market, (ie funds) but aren't plenty of them actually just single companies? Probably obvious that I'm still learning about this... probably need to sit down for a few hours with a thick book on REITs.

[Classical_Liberal]

All one needs for the 4% rule to work for 30 years (ie like the trinity study) is about 1.25% real.  Currently the 30 year TIPS would almost accommodate a 30 yr retirement, at 4% WR, guaranteed (sans taxes).  Crazy when you think about that, huh?  Yet TIPS are rarley discussed as an option for part of a portfolio (at MMM). 

But that type of thinking doesn't work if you want to be retired for, say, 70 years or so.

Which is exactly why I prefaced and followed up my comment the way I did.  The point is that low volatility means you don't need amazing returns to have a decent WR.  The point is equally valid with longer terms, you just need a bit higher rate of return.  The thing is, it's only the first decade or so that matters anyway for anyone invested in >50% stocks.  If the first decade sequence is good, your set for 30 years or 100 years. This is why risk mitigation of a bad sequence really only matters in initial drawdown phase, barring any world changing events.

See here: https://www.kitces.com/blog/monte-carlo-analysis-risk-fat-tails-vs-safe-withdrawal-rates-rolling-historical-returns/

Another great analysis from Kitces.  Thanks, I will use this for reference in the future!