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.

13 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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  5. Hi Michael,

    I've been following your articles and logic behind some of your ideas and am trying to incorporate them into my own plans. Just wondering how you got to your starting asset allocation of 80/20?

    I do know that you adjust that as time goes on based on 5 years of "Safe Spending" and adjustments for CAPE levels but was the 80/20 a comfort level for bonds that you started with or was there some other logic in setting this level?

    A bit on me. I've just retired 1 year ago, so year 1 has been pretty good as far as market returns. I set my bond allocation at 60% to start for protection from a major downturn in the first few years and adjusting back to 40% bonds over the next few years.

    I also use a conservative maximum annual withdrawal based on ARVA (Annually Recalculated Virtual Annuity). I assume you are aware of this model.


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    1. Hi Ed,

      The 80/20 I have now falls out of the math based on a set of assumptions and my age. The method I use is broadly similar to ARVA, but the devil is in the details (the assumptions about returns, etc.). The full paper I point to in the following glidepath article explains the method I use.

      https://www.michaeljamesonmoney.com/2020/05/calculating-my-retirement-glidepath.html

      I wouldn't want anyone to blindly follow the method I use personally. I have some margin in my net worth and I've proven to myself that I'm not fearful through stock market crashes after surviving the tech crash around 2000 and the 2009 bottom. It's likely that most retired people should be more conservative than I am.

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  6. Thx Michael,

    I would never follow blindly. Just looking at seeing and understanding new ideas that might or might not work for me.

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  7. Hi Michael,

    The only problem I see with this is what I've been going through with my mother-in-law. She is now 97...good for her. You need to have someway of adjusting the plan as one gets closer to the planned end date. Having a 5 year fixed income portfolio at age 95 when the plan is using up all the funds by 100 is not good if the person actually lives paste the maximum 100. You may need some funds more than 5 years down the road.

    Not exactly sure how this various from any plan that runs out at 100 but at least with other plans having some equities in the mix right to the end there is the potential for funds post the 100 age.

    What I did, starting at age 90, was make sure there was going to be enough funds for at least 10 years and then adjusting if needed to do the best with what there was. If that meant increasing equity exposure a bit or dropping some un-needed expenses, etc. that was done. I was lucky in that she has a fairly good pension that covers a good majority of annual expenses.

    This is a more of a beware of this situation possibility and maybe have a plan B for when you get there. Maybe at age 90 adjust and maintain the portfolio for a 10 year time frame each year??

    Thoughts,

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    1. Hi Ed,

      What you described is exactly what I do. I set a minimum number of years of life left of 10. I wrote a post where I provided a spreadsheet that includes this idea:

      https://www.michaeljamesonmoney.com/2014/01/treating-your-entire-portfolio-like.html

      If I do end up living past 100, I'll have less to spend each year, but at least I won't spend myself off a cliff into poverty on my 100th birthday.

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