AssetBuilder Inc. Registered Investment Advisor - Simple Investing. Smart Future.

Scott,

Your response to JK in today’s article in the paper confuses me.  JK had a 45% exposure to equities and your answer to him was that he might want to reduce it slightly.

I retired at the end of 2007 at age 64 and my wife will retire early in 2009 at age 65.

After reading your articles for years, your book The Coming Generational Storm and looking at my own financial budget and projections, I had concluded that the greatest threat to our retirement security was the impact of inflation (and higher taxes). Both of our families have a history of a long life span.  I am just reading your new book Spend ‘til the End now where you may come to different conclusions.  BTW – you should have priced the book higher.  J

We have no debt, own our home, have maintained our standard of living with our current income level and project to do so after my wife retires.  We have health insurance, LTC insurance and a small amount of life insurance (for me only).  My pension has a 3% maximum COLA adjustment – my wife’s will be fixed.  We have a cash reserve of three years of current expenses in a Money Market and a three year CD ladder that is about 1/3 of the cash reserve amount.   We also plan to not take SS benefits until I am 70.

I will receive a cash distribution from my ex-company later this year.  Given my circumstances, at the end of the year I was planning to roll my 401K to an IRA, and use the cash distribution in an after tax account to build a 10 Speed Couch Potato Portfolio when the two are added together.  The tax deferred portion will have all of the fixed income components and the after tax portion will only have equities.  That would seem to provide the greatest protection against inflation with its higher exposure to equities.

Your advice to JK would seem to indicate, given today’s environment, that that one of the Couch Potato portfolios that is less heavily weighted in equities is preferable; e.g. the basic Couch Potato or the Four Square.

Am I reading incorrectly?

No, I haven't changed my perspective on asset allocation. Every study of portfolio survival I have seen indicates that the best range of equity ownership is 50 to 75 percent and the equity positions in the Couch Potato portfolios range from 50 to 80 percent. Only two of the portfolios, the ones with 9 and 10 components, exceed the 75 percent upper bound.

What you should have and what you can deal with, however, aren't the same thing. I am receiving many notes from readers who really can't tolerate the losses of the last 8 months or so. If it takes a lower allocation to equities to allow you to stand pat (rather than panic and sell as the market bottoms) then I will always choose the lower allocation. A need for less risk is what I sensed in the reader question and he was starting with an under-50 percent equity allocation.

Doing Monte Carlo simulations in ESPlanner Kotlikoff and I found that the longer your investment period, the greater the odds that your future consumption would be materially smaller rather than larger. Basically, the probability of results table becomes asymetric due to constant withdrawals. That argues for having a lower volatility portfolio--- one with less risk.

One work-around for this statistical reality is to start retirement with a very conservative withdrawal rate. This reduces the asymetic effect and increases the odds that your future consumption standard will be higher, not lower. Note that this requires sacrifice today for the possibility of increased consumption later when you may be either dead or living, but less capable of consuming.

Another work-around may--- repeat, MAY--- come from portfolio construction. The lower your portfolio standard deviation for any given portfolio return, the greater your potential starting withdrawal rate. When you build a portfolio with diverse assets--- particularly negatively correlated assets--- it is possible to have a higher return with less risk. That's what we're hoping to deliver at AssetBuilder--- portfolios that deliver higher returns per unit of risk.

Scott

Thank you for the response.  I understand.

It has been painful watching the last eight months especially as I rebalanced into more equities.