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So the other day I found myself on GoCurryCracker.com catching up on some of his content, and I read through a post The 2018 GCC Asset Allocation.
In it, Jeremy talks about his asset allocation in retirement and why he decided to get a bit more conservative and increase his bond allocation to about 10%, leaving equity allocation at 90%.
Now, to the average reader, this doesn’t sound conservative at all. But the last time I met up with him in Chiang Mai, I was surprised to learn that his equity allocation at the time was 100%. I almost spit out my Thai Tea.
“Dude, are you nuts?!? Aren’t you worried about sequence of return risk? Don’t you keep a cash cushion? What about your Yield Shield?!?”
His response: “Meh”
Among the FI bloggers I’ve met in real life, Jeremy is easily the most optimistic person I know. He’s the type of person who would fly into a city where he’s never been to without any idea where he was going to sleep that night and just “figure it out.” As an obsessive planner, that would make me go nuts.
In fact, the last time we met, he told me a story of how he almost drowned trying to learn how to surf. He had fallen off his surfboard and gotten sucked down by a current. He remembered trying to claw his way up to the surface and thinking “Boy, if I don’t surface in the next 10 seconds I’m going to run out of air!” But then he did surface and made it back to shore. His lesson learned? “Whee! Let’s do it again!”
The funny thing is his wife Winnie is the exact opposite of him. When they met, her and FIRECracker immediately started bonding over how to haggle with vendors in Thailand. Winnie had apparently spent an hour haggling to get 25 baht off for a pair of jeans. Jeremy’s reaction was “Who cares! That’s less than a dollar!” Winnie’s reaction was to say “Yes, but with this 25 baht, I can get an icecream!” This immediately endeared her to FIRECracker as that’s exactly how she thinks. Naturally, when Jeremy tried to get her to learn how to surf with him, her reply was “No thanks. I will be here on the shore not dying.”
So when he explained his shift in allocation thusly, I had to laugh.
I’m a firm believer in the 100% equity portfolio. Statistics are a beautiful thing. You might phrase my thinking as, “We’ve won the game, so let it ride! Woohoo!”
The Missus has a different point of view, more along the “We’ve already won the game, let’s stop playing” persuasion. And persuade, she did.
That’s so Winnie.
But that article made me think of what we planned to do with our equity allocation over time. We’re 60/40, a pretty conservative ratio relative to cowboy Jeremy over there.
During our accumulation phase when we were still working, the usual financial literature would suggest that we should have taken a pretty aggressive investing stance, maybe starting off with 100% equity. Instead, we started at 60/40. At the time, we were intending to increase our equity allocation as we got more comfortable with investing, but as luck would have it the 2008 crash hit, and we struggled to just stay at break even. Fortunately, our 60/40 allocation got us back to even in just a year, and as a result we were relatively gun shy and didn’t increase our equity allocation, staying at 60/40 for most of our accumulation phase.
Then we retired.
After we retired, we found the 60/40 allocation pretty useful, so we kept it. By shifting our fixed-income allocation towards higher yielding assets like Preferred Shares, REITs, and High-Yield bonds, we built our Yield Shield and comfortably weathered the storm of the Saudi oil crash that happened just as we retired.
However, after we managed to stave off that disaster by not selling into a market storm and instead eating into our cash cushion, a strange thing happened: the market went up. And up. And up!
When we retired in 2015, we had $1M. Now, 2.5 years later, despite not working, our net worth has grown to $1.25M.
This has caused us to re-evaluate our Yield Shield. Right now, our yield is sitting around 3%. When we had $1M, that meant $30k a year. But now that we have $1.25M, 3% is $37,500. Our cash cushion of $50k, which covered us for ($50k / [$40k spending – $30k yield = $10k]) 5 years now covering us for 20 years. Clearly we were being too conservative and leaving gains on the table.
So as our portfolio went up, the equity portion also went up due to market gains.
As our portfolio grew, our Yield Shield grew as well. And when that Yield Shield started approaching my living expenses, I started thinking, “Hmm. Maybe I should start allocating more towards equity!” After all, equity is future gains vs. current income. But if my current income is already enough to pay for my living expenses, it makes no sense to give up future gains if I don’t need any more current income.
So my plan in retirement is to gradually increase my equity allocation. This will have the effect of reducing my Yield Shield, but as long as that Yield Shield continues to match my living expenses, I see no reason to give up future gains for current yield if I don’t need it.
That being said, 100% equities seems a bit nutso to me. Modern Portfolio Theory assumes that you own at least 2 assets so that you can rebalance between them as markets go up or down. But with 100% equities, you lose that ability to rebalance. So even if markets just keep going higher and higher, I don’t think I ever want to go over 80% equities.
Now hopefully this is where the majority of our retired life ends up. Rising equity markets increase our portfolio size to the point that 3% or even 2% dividend yields is more than enough to support our living expenses. I will sacrifice excess yield to get future capital gains in a heartbeat. Plus, equities are an excellent hedge against inflation, while fixed income is not. So it makes sense to pivot over time towards equities if you’re still young and have lots of years of retirement left ahead of you.
At a certain point, though, I do plan on going into bonds. Specifically, when I reach the “traditional” retirement age of 65. It’s pretty far in the future (30 years, in fact!) but when I become old and gray, it might make sense to trim my equity exposure. After all, my exposure to inflation is naturally limited by my remaining years, and at that point I plan on gradually shifting to fixed income.
Over time, I plan on gradually reducing my equity exposure as I get older until I hit a floor of 20/80.
So that’s my multi-decade retirement plan for our portfolio. I’m curious as to what you think. Let us know in the comments!
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