Retirement Planning
I am 5 years away from retirement with an allocation now of 100% of my 401K in stocks. Every year I convert some of this to Roth 401Km, I currently have about 50K in that. I have a small amount in a taxable brokerage account, but I have earmarked whatever that earns in 5 years to help payoff my house earlier.
I am very nervous about what I see as the almost certain downturn in the economy coming soon. Should I start now, and change my allocation in my 401K to 80/20? 70/30? My allocation is in Vanguards S&P index fund. Any thoughts?
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Another vote for you to reduce your risks when you're this close to FI!
And sorry, my bond funds are here in Europe so just not applicable to you.
Now would be a very good if not lucky time to rebalance to e.g. 70/30. You are currently 100% equity and those are flying high right now. For me the bonds would be mostly short-term (more stable) and the percentage would depend on my required expenses and the length of financial crisis I personally consider plausible. In general, tax deferred accounts are the better location for bonds, so my example of 70/30 would apply across different account types (brokerage / 401k for you). Your choice of bond funds will be guided by your options in the 401k.
I've definitely heard on the podcast not to assume a total bond fund is all you need - just sell 30% and move it over. Curious what people do to diversify for risk in that 30% bond slice?
A short-term bonds index fund is not a total bond fund. Short-term bonds are just more stable.
Right, indeed that's what I'm asking about. If people have 30% intended for bonds, I assume they don't just plop it all in VBTLX. Do people split the slice into short/long, do they have other funds or bond-like asset classes they put in there?
I think that depends on the practical and psychological purpose of the bonds. In my case they (short-term) would cover a very extended downturn but there is enough in equities for growth. A mix of short-term and total bond market may be appropriate for many. Maybe 50/50 but I would want 50% of the bonds to cover at least 3 years of spending.
Assuming you are at or near your FI number, yes it is time to reduce the risk inherent in a 100% stock portfolio, which is really not designed for drawing down on.
But this needs to be part of an overall plan that starts with evaluating your expenses going forward and how much of your portfolio you need to spend.
If your goal is to spend the most money, then you want to diversify your portfolio to one with a higher safe withdrawal rate. 5% is easily achievable. On the other hand, if you plan to keep accumulating and your real plan is "don't spend much money", as in 3% or less of your portfolio, then you could actually hold up to 100% in stocks so long as you did not panic and sell in a market crash.
The reason this topic is confusing is that the actual plans of your favorite gurus are typically of the "don't spend much money" variety, in which case you can hold just about anything from 30-100% in stocks and its just a personal preference at that point.
^ 100% this.
Also, REALLY spend some time looking at numbers and imagining what it's like to lose a lot. If you have $1.5M and you lose 30% is 5 days, how do you feel? What is your plan for spending when that happens? Do you have less-correlated assets that should help?
Those are the sorts of things that can help you with the practicalities of managing day-to-day.
Listen to Frank. Not just bonds but true diversification is what you want. Long/Intermediate bonds, gold for sure. Value equities, not just growth (S&P).
as he said, have an overall strategy, pick a relative allocation that makes sense and limit taxes during the transition. Happy to chat about it as I just did this all myself.
I'd definitely like to hear your experience as I am about the same distance away from my FI number and looking to diversify.
Happy to chat. Send me an email at [email protected] and can figure out a time.
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In short, yes, you should temporarily reduce your equity allocation if you want to reduce your exposure to sequence of returns risk. Sequence of returns risk is highest in the "fragile decade" (the 5 years before and after starting to drawdown funds from your portfolio). Also called "the retirement red zone". The graph that most accurately shows the risk profile based on income you could sustainably withdraw from a portfolio that I've found is exhibit 2 (definitely not exhibit 1) in:
retireone.com
https://retireone.com/wp-content/uploads/2024/01/20210820_EFLS_A033_UnbundlingManagingSOR.pdf.Personally, I'd drop it at least to 70/30 (I'd be more comfortable with an overall - not just 401(k) but consider your total allocation - down to 60/40 during the retirement red zone). You can safely raise your allocation again a few years after starting drawdown, after exiting the retirement red zone. The idea for that is called a "bond tent" or a "rising equity glidepath". Wade Pfau, Ph.D. and Michael Kitces came up with it, and both Bengen (father of the 4% rule) and Karsten Jeske (also a Ph.D. economist) and author of the most comprehensive safe withdrawal rate research, all advocate for the rising equity glidepath a few years after starting retirement drawdown.
Thank you so much for your detailed response. I'm going to definitely make the changes. Any suggestions about which bond fund?
To be clear, I am not a financial advisor, and this is not financial advice. Consult your own fiduciary financial advisor for advice on your individual investments.
What I would do if I were investing in an individual bond fund for asset allocation ballast (to stabilize performance) is stick to US treasury funds (most SWR research uses intermediate term and some also uses short term; long term has high interest rate risk). Reason being that the risk premium is much higher for stocks than for bonds, so it doesn't make much sense to chase yield on bonds rather than using them primarily for reducing return volatility, and get the risk premium from your stocks.
Yes, of course that is understood. Thank you so very much😎
Regarding this Retirement Red Zone, would it also be true that you'd want to reduce SoRR even if you think the markets are going to do great? I.e. that you don't have to see a recession in the future to still want to insulate against unforeseen risk in this sensitive period.
Right! The general guidance would be to reduce equity allocation in the retirement red zone, regardless of your short term prediction on what the market (note market, rather than economy, as those don't always track) will do, for a couple reasons: