Sunday, March 8, 2020

My Asset Allocation in Retirement

Occasionally, I get questions about my portfolio’s asset allocation now that I'm retired. I’m happy to discuss it with the understanding that nobody should blindly follow what I do without thinking for themselves.

When it comes to the broad mix of stocks/bonds/real estate, my answer used to be very simple: 100% stocks. But now that I’m retired, I do have a fixed-income allocation that consists of high-interest savings accounts, GICs, and short-term government bonds.

My current mix is roughly 80% stocks and 20% fixed income, but I plan to increase the fixed income component over time. The way I think of it is that I have 5 years of my family’s spending in fixed income and the rest in stocks. Over time as I spend down my portfolio, the fixed income percentage will rise. For example, it will be up over 22% in a decade.

Some investors use a “bucket” strategy that resembles my approach, but there is a crucial difference. These investors typically plan to make active decisions about which bucket to withdraw from each year for spending. I don’t do that. I spend from my fixed income allocation and mechanically refill it without any regard for my opinions on the near future of the stock market.

When the stock market drops significantly (as it has recently), the drop in my portfolio makes the fixed income percentage grow above 20% faster than my family’s spending reduces it. In these situations, I can end up buying back some stocks to rebalance.

What I call my family’s monthly spending is calculated from my current portfolio size (less expected taxes). Currently, I take 20% of my after-tax portfolio and divide by 60 months. So, when my portfolio goes down, our monthly safe spending level goes down. So far this hasn’t been a problem for us because we rarely spend as much as my spreadsheet says we can spend. I guess that’s good for our sons’ inheritance.

My stock allocation consists mainly of 4 exchange-traded funds. The only exception is that after applying all my asset location rules, I still need more stocks in my taxable account where I’ve chosen to just buy the all-in-one fund VEQT instead of the 4 ETFs.

I’ve been asked why I don’t invest in real estate. The main reason is that I don’t expect it to outperform stocks over the long run. We’ll see over the coming decades if I turn out to be right about that. I do own a house, but I don’t think of it as part of my portfolio.

Overall, I’m pleased to handle my finances with a set of mechanical rules that can be coded into a spreadsheet. Some time ago a reader showed me how to have a spreadsheet email me if some aspect of my portfolio was out of balance and needed attention. So, I have little reason to monitor my finances on a daily or even weekly basis. Life is good.

8 comments:

  1. Hi James,
    I like your approach. I've been retired for about 5 years now, and manage our family (spouse and I) by myself.
    Your strategy looks very simple to manage.

    Some ETFs gains come from interest (100% tax), others from capital gains, taxed differently, so how do you deal with taxes every year? Especially in your taxable account.

    Would it be possible to get a copy of the spreadsheet you mentioned in your article? Thanks!

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    1. Hi Jackie,

      Each year I estimate my income from all sources except RRSP withdrawals, and then my wife and I each withdraw enough from RRSPs to use up the top of the second Ontario tax bracket. Generally, I try to avoid realizing capital gains, but dividends and interest income are unavoidable.

      I've tried a few times to create a more generic version of my spreadsheet to share, but too much of it is specific to my situation. If you're working on a specific part of your own spreadsheet and are looking for ideas, I'm happy to discuss.

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  2. Funny coincidence. I am 63, retired and have no pension. I am also 80 equity, 20 fixed income. But with the shocking market fall, quite a bit of my equity is down and my rate reset preferred shares are off 30% now! Scary times!

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    1. Unknown: Yes, these are scary times. Did you consider your preferred shares to be fixed income? I know they seem like it when they produce a nice steady dividend, but I only consider cash, GICs, and short-term government bonds to be fixed income.

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  3. The following link is a summary of retirement withdrawal strategies.
    https://humbledollar.com/2020/03/in-withdrawal/
    Your strategy is basically a variant of the systematic withdrawal strategy. The classic systematic withdrawal strategy is to take 4% of one's portfolio in the first year, and then withdraw the same inflation adjusted amount in subsequent years. In your strategy, you withdraw 4% of your portfolio each year. The upside is that you never have to worry about running out of money, as you do with the classic systematic withdrawal strategy. And I like your retirement asset allocation. People talk about matching asset with liabilities. It's possible to pproximately match assets with liabilities for the next 5 years with cash/fixed income. But after that 5 year period, I think it's debatable, especially in a taxable account. The downside of your strategy is the variability of income. If that's not an issue to you, then the strategy works well. William Bernstein has discussed variable systematic withdrawal strategies; it's either in his books and/or his website. IIRC, you probably can take out more than 4% each year.

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    1. Anonymous: The strategy I'm using looks similar to Bernstein's 4% rule, but the differences of taking out a percentage of the new portfolio level (which leads to variable income) and never running out of money are substantial. The income variability doesn't bother me mainly because we can't seem to spend all we're allowed to spend. Our strategy isn't based on a fixed 4%, though. I have a calculated percentage to take out each year that rises as I age. It happens to be 3.98% right now because I'm younger than the typical retiree, but it will rise to 4.4% at age 65, 5.31% at 75, and 7.38% at 85.

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  4. I have wondered if a simple rule like drawing from the equity portion of the portfolio if the S&P was up over ten percent in the previous year, drawing from bonds if the S&P was down ten percent, and withdrawing proportionally from both if it was in the midrange would be a simple and effective plan.

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    1. Anonymous: My own investigations of such rules for market-timing (rather than retirement withdrawal) is that they don't work:

      https://www.michaeljamesonmoney.com/2008/04/buy-low-sell-high-market-timing.html

      Any rule of the type you describe has you change your asset allocation in response to market returns. The question is whether you would have been better off just sticking to an asset allocation glidepath that is independent of market returns. My money is on the latter approach, but who knows what will work best in the future.

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