How should I rebalance my asset allocation?
I am 54-years-old and plan on retiring at the age of 56 from a Federal Government position. I currently have approximately 25% of my total assets in aggressive non-IRA mutual funds. The other 75% of my assets are in the Federal TSP account, with 64% in the conservative G and F funds, and 36% in the stock funds. Since I have over half of my total assets in higher risk investments and stocks are at an all-time high currently, should I re-balance my accounts? If I re-balance and want to avoid paying taxes on my non-IRA accounts, should I transfer all of the money in my TSP account stock funds and the G and F funds to 100%?
We talk with our clients about the “glide path to retirement.” In your 30’s and even 40’s, it is appropriate to have a portion of assets set aside in low risk securities such as cash or short term government bonds for emergencies. The rest, particularly assets you won’t touch until retirement, should be 100% equities. After 50, we start dialing up the percentage of bonds to about 25% when you are 5 years from retirement, 30% or even 35% when you retire for good.
You actually have flipped that strategy with aggressive stock funds in your taxable (and immediately accessible) accounts, conservative bond funds in your TSP (retirement) account. We absolutely would NOT recommend that you place 100% of your TSP account in the G fund (which currently yields only 2.75%) or in the F fund (which is index to the Barclays Aggregate and currently yields 2.61%.) Those funds barely cover inflation, leaving you with a pretty poor retirement income stream. By comparison, we project that a 70% equity/30% bond allocation will earn, after fees, 6.5% over the next 20 years (the projections are derived from Ibbotson’s estimates.)
We would recommend that you rebalance your non-retirement accounts to all bonds over three years. Yes, you will have to pay capital gains taxes, but at least we can spread out the pain. For every $1000 that you reduce your stock exposure in your taxable accounts, invest $500 in the C Fund (large cap-S&P 500 index fund), $350 in the S Fund (mid and small cap index fund) and $150 in the I Fund (international index fund.) Thereafter, in retirement, set your asset allocation across all accounts so that you have 35% bonds (mostly in your taxable accounts, but some in your TSP), 55% US stocks, and 10% international stocks.
When you retire for good, you could draw 4% from your total portfolio assets without ever running out of money. You would draw first from your taxable accounts, probably drawing them down to zero after 10 or 15 years. Meanwhile, your TSP account would continue to grow tax deferred. Eventually (for sure starting at 70 ½) you would draw from your TSP for your retirement income.
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These are really good questions to be asking at your age as you're entering the "danger zone" for retirement planning. I'm going to try to keep this as simple as possible but due to the complexity of retirement planning for federal employees, each part affects the other parts so we want to be sure that the big picture is understood prior to making permanent decisions.
First things first, you would be well advised to examine your projected income at 56 and then view that in light of your overall financial situation. Estimates can be found in your department's benefits system: GRB for Air Force, EBIS for other DoD, EPP for DHS and USDA, etc.- I'm happy to generate an estimate for you if you need one or if you'd like to double check the numbers.
The reason for starting with income is because it sets the stage for everything else. I have found that 3 out of 5 federal employees I work with have sufficient income from their FERS pension and special supplement, that they can postpone drawing anything from TSP and other investments for at least the first 10 years of retirement. If this is your case, then not only should you not move money from the stock funds, but your best avenue might be to move more to F and C from G fund- because over that 10 year period you will still gain higher appreciation before you need to access the money. However, that depends which stock fund you're in currently. C is much more stable than S -here you can see that C fund has only dipped 1 year in the last 10 https://www.tsp.gov/InvestmentFunds/FundPerformance/annualReturns.html .
Secondly, balance matters. Adding a single zero can change the entire retirement plan. Risking 25% of a TSP with only $15,000 is different than risking 25% of $1,500,000 in TSP. Balance also interacts with our income plan as well. If you are needing to draw money immediately from TSP to fund your retirement while you wait for Social Security, you will need to move money to the safe accounts soon in order to be sure that the money will be there when you need it.
I hope this is helpful in deciding how to reallocate your accounts. Forgive me for bringing in subjects that don't seem to apply but I have seen federal employees leave hundreds of thousands of dollars behind when retiring because they didn't coordinate their retirement plan. In one case, an employee left a $110,000/yr job because they miscalculated expenses only to have to return to work somewhere else making $65,000/yr. Not only did they settle for a lower paying job, but they shortchanged themselves on all 3 parts of the FERS pension calculation- Years of service, High-3 salary, and the 10% pension bonus for working to age 62 and having at least 20 years!
Feel free to private message me with any specific questions because it pays to "Know before you Go!".
IF you could transfer these funds to an account with the same allocations that would allow you to attach STOP TRAIL Prices to those aggressive equities (Stocks or Exchange Traded Funds) to protect your downside, would you? Because there is really no clear cut sign that the Markets are going to slow down. BUT if Markets do consolidate or retract, then your equities would sell via STOP TRAIL Orders and place the proceeds into a CASH Position thus 'having your back' (Mutual Funds do not have this characteristic). I would take the position to look at you as still being 'young' and go after where the current volume will take you. i.e. Utilities?, Information Technology etc., and manage it Aggressively. This is just a guess, but with your current asset allocation I would estimate that you probably have 20-30% of the portfolio not working as G and F Funds DO NOT correlate well to the current growing Markets thus making that portion of the portfolio impotent.
Taxes would be due either way on your non-IRA funds at the time of withdrawal or "transfer" (only a Roth IRA or Roth employer account is federal tax free). If your non-IRA funds are in an individual taxable account, I would leave them because it provides withdrawal and investment flexibility (no Required Minimum Distributions). However, you might want to look at your expense ratios and consider the additional advantages of ETFs vs. mutual funds.
The main reason I think someone would consider rebalancing their asset allocation is to achieve, or maintain a specific risk profile. That being said, it should be based upon a repeatable, demonstrable process that shows your current risk profile (before rebalancing) and the proposed risk profile (after rebalancing).
Although taxes are always important, one CPA I know would say to his clients, ' you were never entitled to 100% of the profits of your taxable account, rather, 1-minus your marginal tax rate.. That's good advise. I would rather manage the risk of all my assets, including the taxable account, than avoid rebalancing those taxable assets, leaving them with more risk going into a sharp market downturn.
The key is to have a process that shows you current and proposed risk scores. Hope this helps.