Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, April 22, 2019. You can also find the re-balance calendar for 2019 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

The Importance Of Fixed Income Returns For Retirement Spending

When it comes to retirement spending, it’s mostly agreed upon that a large amount of capital should be allocated to fixed income. However, it’s not well understood that the returns of fixed income portion are playing an important role in the overall wealth and portfolio allocation. 

Fixed income allocation

As we stated previously, an intuitive way to arrive at good allocations among stocks (risk assets) and bonds (fixed income) is to use a so called need based approach: first determine how much you can afford to invest in stocks. A rule of thumb is that you should invest in stocks for at least 15 years if you use a tactical asset allocation TAA or at least 20 years if you use a strategic asset allocation (buy and hold). 

Let’s again work through a few scenarios: 

1. If you are a young professional who is 20 or 30 something, you are pretty sure you can still work for more than 20 years. Thus, you can put aside all of your money in stocks if you are sure that your regular (salary) income will cover your ongoing needs. In this case, your allocation is 100% in stocks. 

Of course, if you think you need to tap your savings within 20 years (or 15 years if TAA) for some big events, you’ll need to put aside some portion to cover those events. You certainly don’t need to fully put aside the needed capital to fixed income as you might be able to obtain more money for these events from your jobs. So you probably can still allocate some or all to stocks in this case. 

2. If you are a mid age professional and ready to retire in 10 years, you again need to ask yourself how much you need from your current investments once you retire after 10 years and before 20 (or 15 if TAA) years You will need to allocate that portion to fixed income. You can then allocate the rest to stocks using a TAA or SAA. 

3. The above extends to even a retiree: even if you are now in retirement, it does not automatically force you to allocate 100% to fixed income. In fact, in most cases, after taking your pension, social security and other incomes into account, you probably only need some smaller percentage from your savings capital. In this case, you should again consider how much you really need in 15 or 20 years. You will then allocate the rest to stocks. 

In general, to maintain your purchase power for a long time, you probably should only spend 4% or so of your current capital every year (the spending can be increased with inflation rate). If you demand higher withdrawal or spending rate, you will probably leave less as estate after you are gone or you might even end up running out of money before that. This requires more close examination, case by case. 

It turns out that the percentage allocated for fixed income to cover your spending need in retirement greatly depends on the returns of your fixed income in a typical situation. Let’s look at them in more details. 

Fixed income returns affect how soon you need to tap into risk asset money

A simple approach is to mentally allocate how much to fixed income without thinking about its returns. For example, if you are withdrawing 4% from your fixed income portion every year, you would just simply estimate that it will take 10 years to use up 40% of your capital. So to make sure you don’t tap into stocks allocation within 20 years, you will need 80% in fixed income. 

Assuming 10% annualized return for the 20% allocated to stocks for 20 years, this 20% will now become 1.35x of the original capital, which is less than the inflation adjusted original capital (assume 2% of inflation, it would be 1.49x). 

The above allocation is certainly conservative. It assumes zero percent returns of fixed income. Also, there are many other scenarios that are needed to be considered. 

The following chart shows the data for stocks, bonds, annual spending and the inflation adjusted original power in an original 50% stocks and 50% bonds portfolio:

We can see that in this typical and ideal scenario where stocks appreciates at a constant 10% every year, in year 11, the value of stock portion exceeds the inflation adjusted original purchase power. On the other hand,  in year 18, the value of bond portion is almost depleted to 0. In this case, we can safely claim that 50% fixed income can sustain our spending long enough so that the stock portion can grow much higher value before rebalancing or needed for spending. 

However, if we assume our fixed income return is only 2% annually (the same as inflation), we see the following:

In this case, we are forced to tap into stocks in year 13 as bonds are depleted at that time, a 5 years in advance!

This 5-year advance can be really harmful, if, say instead of 10% stock growth for the first 10 years, in the 10th year, our stock portion dropped back to an inflation adjusted level (i.e. stocks only appreciated at 2% annually for the first 10 years). Even after this, if stocks resume 10% growth, we are forced to tap to stock portion in year 13. Unfortunately, at that point, stock portion is way off the original purchase power and now we are either forced to scale back our spending big time or have to suffer from using up all of our capital eventually. The following chart shows the situation: 


Note, if stocks indeed revert back to the 2% growth line like the above and fixed income actually grows at 6% per year, it will postpone tapping stock portion to year 18, much better, though at that time, stocks will be still less than the inflation adjusted original value (11.8k vs. 14k). But it’s closer and it’s still higher than the original value. So the damage is much less serious.

What the sample data in the above show us is that fixed income investments are important, especially for those who are in retirement or close to retirement. It becomes even more relevant in the current situation as stocks are now highly overvalued and they are expected to grow at 0-2% for the first 10 years or so, which is similar to the situation mentioned in the above. 

Market overview

US stocks are now approaching their all time high. Meanwhile, we are entering earnings report season. It’s widely expected that the last quarter’s earnings will have a negative year over year growth (see our previous newsletters). Investors, however, have decided to look over this and hope the next quarters will be brighter. We have no strong conviction one way or the other. What we do know is that stocks are highly valued and overly extended and thus we call for careful risk management while staying the course. 

For more detailed asset trend scores, please refer to 360° Market Overview

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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