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Asset Allocation

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(@golich428)
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Keep in mind that pretty much everything is negative YTD on an inflation adjusted basis - it is just a matter of degree.

I will cover near-term expenses with my allocations to the Money Market Fund and if necessary, the Ultra Short Term bond fund but I don't think I will need to draw from the latter. Because the bond funds are re-investing at higher rates, the funds will recover in about equivalent years indicated by the duration. This is an oversimplification but a reasonable estimate. The duration of the funds could go down since the cash flow from each bond is going to come earlier than when interest rates are lower.

Here is the link to Cullen Roche paper. I have not read it recently, but I don't think he explains how he gets the 18 years. I don't prescribe to his conclusion on asset allocation to classes such as gold and commodities, but the asset-liability concept and duration matching makes sense to me.

https://disciplinef.wpenginepowered.com/wp-content/uploads/2022/08/All-Duration-Investing-1.pdf

Here is an article written by William J. Bernstein who I think is one of the great thinkers when it comes to common sense investing. He also explains the duration concept as well as an approach to determining equity duration.

http://www.efficientfrontier.com/ef/999/duration.htm#:~:text=This%2010.96%20year%20period%20is,and%20duration%20are%20the%20same.)

There is also an omission error on the last line of my previous post. It should be YTD = - 26%. I would not want to have to cash this in to cover expenses.


   
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(@pizzaman)
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I have not read anything by William J. Bernstein, at least that I remember. He talks about asset allocation here:

http://www.efficientfrontier.com/aa/index.shtml

How the investor arrives at the "right" mix (asset allocation) is called "portfolio theory," and until recently small investors had precious little guidance in this vitally important area. How difficult is it to find the "right" mix? Surprisingly easy. Consider this: If over the past 10 or 20 years you had simply held a portfolio consisting of one quarter each of indexes of large U.S. stocks, small U.S. stocks, foreign stocks and high quality U.S. bonds, you would have beaten over 90% of all professional money managers and with considerably less risk. The amazing truth is that over a long enough time period almost any reasonably balanced indexed strategy will best the overwhelming majority of "professional" managers.

He has a fairly new book called Rational Expectations: Asset Allocation for Investing Adults 2014:

https://www.amazon.com/Rational-Expectations-Allocation-Investing-Adults/dp/0988780321/ref=sr_1_1?s=books&ie=UTF8&qid=1402287892&sr=1-1&keywords=rational+expectations+bernstein

Has anybody read it??


   
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(@pizzaman)
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Fritz Gilbert has a very popular retirement blog called The Retirement Manifesto

One of his most recent posts is how his bucket strategy is holding up in the 2022 bear market: https://www.theretirementmanifesto.com/the-bucket-strategy-in-a-bear-market/

I have a similar bucket strategy; bucket one has cash for 2 years of living expenses, bucket two has 5 years of short term bonds and now CDs, bucket three has broad US stock index funds. Not sure I like his asset allocation within his stock bucket but worth a look.


   
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(@pizzaman)
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In thinking about what your assent allocation should be for the next 10 years or so, here is a good article about how the economy is changing resulting in a "New Economy": https://www.advisorperspectives.com/commentaries/2022/12/03/the-economy-is-a-changin?bt_ee=gWhZuHUZDydfMbsTm3FLFHMg%2FnjgOJcmeKUyKkhsbED5M2MRcGTQLxhaBfxAXddW&bt_ts=1670670136056

The “new economy” we’ll face as the 2020s unfold won’t just be a more intense version of the old one. It will be fundamentally different—profound, irreversible, and rapid evolution beyond anyone’s ability to resist.

“These major structural changes go a long way toward explaining why growth is slowing in most of the world, inflation remains high, financial markets are unstable, and a surging dollar and interest rates have caused headaches in so many countries. Unfortunately, these changes also mean that global economic and financial outcomes are becoming harder to predict with a high degree of confidence.

So now we have three new paradigms.

  • Shorter, more reliable supply chains,

  • Even slower GDP growth, and

  • Tighter credit amid higher inflation.


   
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(@pizzaman)
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So, based on how the world looks now, and on a review of the 34 posts and 719 views on this thread (one of the most viewed threads) here are my inputs into PRC:

  • Still sticking with my 80/20 stock/bond allocation (all equities in US stock index funds) (moving TIPS mutual bond fund to short term CDs in January)
  • Inflation at 4%
  • Real stock growth at 3%
  • Real bond growth at 1%
  • Health care costs rising 2% faster than general inflation
  • Social Security decreasing by 20% in 2034 (hopefully this will improve greatly)
  • Tax brackets go back to pre-TCJA in 2026

Thoughts?? This forum has 1,000's of members and we would like to hear from more of you, maybe a new-years resolution 🥂


   
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(@wallace471)
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Vanguard has recently (11/29/22) released their latest VCMM outlook for 10-year annualized nominal return projections for various asset classes.

See: https://advisors.vanguard.com/insights/article/marketperspectivesdecember2022

The values obtained were based on running the model as of 9/30/22.


   
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(@pizzaman)
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Morningstar has a new report title - The State of Retirement Income: 2022

https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blt0cdaf6ab25075b47/6398c339313cec5f8f3b5c8a/The_State_Of_Retirement_Income_2022.pdf

One section talks about safe withdraw rates based on asset allocation:

Exhibit 2 Highest and Lowest Starting Safe Withdrawal %, by Asset Allocation
(Rolling 30-Year Periods, Starting From 1927-1992, 90% Success Rate

Source: Morningstar.

An asset allocation of 75% stocks and 25% bonds had the "best" worst withdraw rate of 3.7% and the second "best" best withdraw rate at 6.1%. The best withdraw rate was with stocks at 100%.


   
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(@pizzaman)
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10 year outlook??

I HOPE THEIR LONG-TERM PROJECTION ARE MORE ON TARGET

My, what a difference a year makes. Although I’m sympathetic with the uncertainty of long-term projects, J.P. Morgan’s change from 2022 to 2023 seems just a tad bit extreme. Still, I’m rooting for them to be right. “Our forecast annual return for a USD 60/40 stock-bond portfolio over the next 10-15 years leaps from 4.30% last year to 7.20%.” https://www.advisorperspectives.com/commentaries/2022/12/29/newsletter-december-2022?textlink&utm_source=boomtrain&utm_medium=email&utm_campaign=Economic+News+Roundup+2022-12-30+6800&bt_ee=Q7UEfs%2Fg316XBUJ5NZcS88m3Ca4%2FNfJ147NwHyBixtcWruuLjlLGCOou2nFJmb3%2F&bt_ts=1672426953308

Need I say more 🤐


   
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(@pizzaman)
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Morningstar did the something (page 4): https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blt0cdaf6ab25075b47/6398c339313cec5f8f3b5c8a/The_State_Of_Retirement_Income_2022.pdf

Notably, the return assumptions we used for this year’s study were appreciably higher than what we
employed when we conducted similar research late last year. That is not unexpected given that 2022’s
broad-market selloff has lowered equity valuations and increased bond yields. For example, MIM’s 30-
year forward equity-return assumptions as of Sept. 30, 2022, ranged from 9%-12%, depending on the
subasset class. By contrast, the equity-return assumptions in our 2021 research ranged from 6%-10.5%.
U.S. large-company stocks, which form the bulk of the equity portfolio, were at the low end of that
range.

Similarly, the 30-year fixed-income-return assumptions were also appreciably higher than what we
employed in last year’s research. Thanks to today’s higher yields, which are highly correlated with future
fixed-income returns, MIM’s return assumptions for U.S. investment-grade and non-U.S. bonds are
roughly 5% for Sept. 30, 2022. In our 2021 research, we assumed that returns from high-quality fixed-
income investments would be less than 3%.

So, should I increase my average stock return in PRC to, say, 7-9%?? O, and bonds to 5%??

It isn't clear if the % increases are real rates of return (incorporates inflation - 2.84%). Same for J.P. Morgan’s in previous post. Here is Morningstar's qualifier:

To provide withdrawal-rate guidance that considers current yields, valuations, and inflation, we turned
to our colleagues in Morningstar Investment Management. Like many firms, the MIM team develops
forward-looking asset-class return assumptions as well as assumptions about the expected volatility of
each asset class and future inflation levels

So I assume their numbers are real.


   
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(@golich428)
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(@pizzaman) The ROR estimates can be confusing when they don't specifically state if they are nominal or real. In the paper with link below from Morningstar they state that they are nominal. Also, in the safe withdrawal paper they say that bond returns are estimated to be about 5% and inflation of 2.8%. If the 5% were real the nominal would be about 7.8% which is not at all realistic so I think there estimates are nominal. Also, most forecasters use a 10 year time period not 30 year as stated by Morningstar in the safe withdrawal rate paper. A 30 year projection will likely be higher than a 10 year depending on the starting conditions and valuations. I don't specifically rely on one estimate for my model. I stress test it with low return expectations to add a margin of safety to my plan. I also don't really need high rates of return because I rely on stable income from annuities, pensions and social security to cover a large portion of my spending needs.

https://www.morningstar.com/articles/1124635/why-investors-should-lower-expectations-for-making-money-on-stocks


   
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(@ricke)
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The assumptions to use probably depend on the case you are thinking about.

For "will I run out of money/need to cut back", I use the "Historical Sequence Analysis" on the Analysis-Run Analysis sheet and pick the worst-case-so far of 1965 or 1966. For "will I need a bulldozer to push around my money like Scrooge McDuck", I select Historical Results and aim for something in the middle (the extremely great returns all happened after huge downturns, we're not in that territory, at least not yet). For "what is most likely", I try to shoot for something like the 20-25th percentile of returns, figuring that we will be slower growth, maybe similar to today's Europe.

Pizza Man's December 10 post gives me about the same as the worst-so-far 1965 starting year. So if a "worst case" is what was intended, that's pretty representative. If that was supposed to be the central value, it seems awfully conservative.


   
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(@pizzaman)
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@golich428 Confusing is an understatement 😮. These articles throw around numbers and percentages with abandon 🤡. The Morningstar article you referenced states that the historical U.S. equity yearly average is 12%-13% before inflation. From what I have seen, and I admit it varies a lot, the nominal annualized S&P 500 return (dividends reinvested) from 1926 to 2022 is 10.1% with a real return of 6.9%. You would think that would be an easy number to get consistently. I use these webs site for my numbers:

https://dqydj.com/sp-500-return-calculator/

https://ycharts.com/indicators/us_inflation_rate

I am not picking on your article reference, many of the ones I post can be just as ridiculous. The article states: “The next 10 years will be different than the last 10 years, ... It will be more normal.” And then said: Returns on stocks in the next decade will appear “minuscule” at 4%-5%, he says, mainly because “equity returns for three of the last four decades were far above average.” What??? So the past 4 decades don't figure into the average? Over what time frame is his average based on? What is normal? The S&P 500 real return from 1981 to 2022 was 7.8%. I would say normal is the historical average from 1926 to 2022 - 6.9% real return, I'll take that investment return any day with a smile 🙂.


   
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(@hines202)
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I'd bear in mind that these 10 year projections from Vanguard and other shouldn't just be plugged into anyone's Pralana assumptions, unless you only expect to live for ten years. Many folks doing this just prior to or just in retirement are looking at at least 30 years. So, avoid overthinking things, be diverse, be realistic. Time is better spent making sure your expenses are correct and well thought out.

Speaking of diversity, I'm attaching a chart of VXUS (Vanguard Total International stock market minus US in yellow) and VTI (Total US stock market in blue). You see the rewards of diversity there in several periods in the past year where international outperforms. Just like bonds outperformed stocks during the lost decade. If we can see an end to the Ukraine war this year, we may see a rebuilding boom in the region, and economic stimulus as a result. Vanguard and the other advisor-only forward looking calls I've been on still project international ex-US to outperform US in the ten year timeframe. I have a bunch of those calls coming up, so we'll see if things have changed.

Happy New Year everyone! Sorry I've been away, but the decision to add tax strategy/planning for clients resulted in a very busy December. Roth conversion palooza! Glad that's over. On to 2023 and I'm very excited about the changes we'll see in PRC Gold 🙂


   
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(@wallace471)
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Vanguard model comparisons of equity/fixed income "traditional" 60/40 vs. "time-varying" 50/50 allocations have recently appeared in the press (e.g. MarketWatch, ThinkAdvisor, etc.).

See: https://www.marketwatch.com/story/vanguard-says-the-outlook-for-the-60-40-model-is-looking-rosier-but-heres-the-asset-allocation-it-prefers-the-most-11672918734?mod=home-page

https://www.thinkadvisor.com/2023/01/06/this-type-of-portfolio-offers-best-odds-of-success-according-to-vanguard/

The original report from Vanguard with more detail actually appears to be at this link:

https://corporate.vanguard.com/content/dam/corp/research/pdf/isg_vemo_2023.pdf

Note Figure II-17 (page 57), which appeared in the Jan. 5 2023 MarketWatch piece.

It seems that the idea is that a 50/50 "time varying" asset allocation (TVAA) portfolio (based on 10 year projection models) may provide a more favorable risk/return. There are more international elements in their fixed income allocations for the 50/50 TVAA vs. the 60/40. Equities in the TVAA 50/50 have equal parts Developed and Emerging markets contributing to the equity allocation. Presumably, the TVAA portfolio changes over time, compared to the "static" balanced portfolios.

See also:

https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/portfolio-construction-principles-inform-possibilities.html?sf259667267=1


   
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(@pizzaman)
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@ricke Pizza Man's December 10 post gives me about the same as the worst-so-far 1965 starting year. That's very interesting 🧐 I hadn't thought of it as a worst case, maybe on the low end (success rate) of likely cases. What numbers did you input for the 1965 starting year?


   
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