Classes, Allocations and Taxes...Oh My!
- One aspect of PRC that is challenging for me is the asset class, allocation and taxation tables. I fully understand and appreciate the value and purpose behind having them, but here’s what I’m struggling with:
- Finding a “best source for the ROR and SD for each class. The Bogleheads wiki page cites a few experts but either they don’t profile all the asset classes I have, or there seems wide variation in the ROR/SD numbers. How to choose?
- Taxation – I called my huge brokerage co. and they couldn’t shed light on this aspect. Again, I’m at a dead end.
- Are all three required to be filled out completely? If I can only pin down classes and allocation, do I forfeit accuracy because I don’t have taxation down? Is it an “all or nothing” required relationship between the three components?
- How much would even small errors, or choosing the wrong values, have on results over a long time horizon? Is it like NASA…a one inch miscalculation on Earth multiplied by XXX,XXX miles means you completely miss the Moon? Can even small unintentional errors at either of these three stages have that kind of effect and how would one recognize it if they made an incorrect choice?
- Given the above, is it better for the majority of us to stick to the pre-loaded classes (Money market, Stocks, Bonds), ROR’s, SD’s and taxation entries and keep it simple (stupid)?
Like me try to take this top down. While I think the PRC implementation is mathematically correct, filling in the numbers is far from an exact science because it's impossible to predict the future. So, I recommend looking at whatever sources you can find and then just use your best judgment to pick some numbers. I'm not a financial advisor but I'd suggest being conservative. The notion of small errors in this department really doesn't make much sense because there are no right answers when it comes to predicting what markets are going to do in the future. You could elect to go with PRC's default values, but there's no reason to think they're any better than your own numbers. They are fairly conservative, though, and they're what I use personally. Regarding the taxation, you do need to think about this just a bit because it does matter based on my studies. With that said, don't get carried away trying to make it exact. It doesn't matter THAT much. Basically, stocks could be entered as 100% "taxed as LTCG when withdrawn" and bonds and money markets could be entered as 100% "taxed as simple interest". That would get you close enough in my opinion. Realize too that the taxation issue ONLY relates to the regular investment account.
Thanks Stuart, your insights on the matter helps calibrate how my perspective regarding how I should be thinking about it.
Replying to topic 1: For ROR and SD, I use a Vanguard tool that compares performance/risk for many mutual funds, not just Vanguard's. This site also identifies similar products that might help with tax loss harvesting. I learned by looking at many combinations that similar funds have similar SD and that SD is more consistent over time than ROR.
Fidelity has a similar tool. I forgot to bookmark their site.
This part is the great unknown when doing retirement planning 🙂 I just passed my Series 65 and I'm in the process of setting up an investment advisory service that will use some pretty incredible tools to get retired and pre-retired folks to as perfect an asset allocation as possible for their specific risk tolerance, time horizon, and cash-flow needs in retirement. The analytics try to predict this as closely as possible based a ton of data, but again it's a crystal ball. I agree with Stuart that the Pralana defaults are conservative and reasonable. If you're feeling more optimistic or pessimistic, you can model that in Pralana.
For the taxes, look at your non-retirement accounts and when/how you'd be drawing money from them. If you sell stocks held less than a year, that's regular income. Over a year, and it's long-term capital gains on the growth over your cost basis. Interest from bonds, cash, money markets are regular income. Most dividends are qualified, and taxed per the LTCG (favorable) tables. Dividends that aren't qualified and are normal income are those from real estate investment trusts (REITs), employee stock options, master limited partnerships (MLPs), and tax-exempt companies.
Withdrawals from your traditional retirement accounts are regular income. Roths, of course, aren't taxed as long as you're within the withdrawal age/5-year rules or an exemption from those.
Financial Counselor/Retirement Planner
Money Coach Group, Inc
There are many sources available to the retail investor that you can use to help develop your ROR and SD inputs for the Monte Carlo calculations. Research Affiliates has a great interactive tool that allows you to look at historical and 10 year expectations based on a building block approach using current market conditions. Vanguard and JP Morgan are two others that provide a detailed annual report and market outlooks. Just google them and you can get their outlook. I know there are many others as well but I can't deal with more than a few.
I am also a member of "Money For the Rest of Us" (an online service) that I highly recommend you check out. He publishes expected 10 year ROR twice a year that I also use to develop my own range of possible outcomes.
I use this information to generate three scenarios (a low, base and high ROR expectation). I keep all other inputs the same and run it two see how sensitive my retirement plan is to these possible ROR's. This helps me determine how robust my plan is.