Should I change my asset allocation strategy?
I am approaching 50 years old, single, and have about $2,000,000 in total assets ($1,000,000 in a 401(k), $500,000 in cash, and $500,000 in stocks). I don't own a home but plan on buying one within the next couple of years. My monthly expenses are about $10,000 but if needed I could cut down to about $7,000. I have no debt. I am employed in a good position. Given all of this information, how well-positioned am I for the future? Should I be doing anything different with my asset allocation strategy?
You are well positioned regarding the amount you have amassed so congratulations on that part. But without knowing more about what strategy you employ I cannot really give you sage advice. I can give you some ideas that will generate questions for you to address. Most important, how will you protect these assets from a major correction or bear market? How will you respond emotionally if you lose 25% to 30% with your current allocation? Mike Tyson once said, "Everyone has a plan until they get punched in the face."
First, you say you are "employed in a good position" so I am assuming that you are not cannibilizing the $2Mn in order to meet the $10k monthly expenses. Also, are you saving or adding to the $2Mn nest egg? I really need a better picture of your current cash flow situation to come up with the assumed growth of your portfolio.
But let's just start with the nest egg portfolio & ignore the rest for a moment. I do think that with 25% in cash, you have a "cash drag" on your total overall portfolio. Believe me, I am not saying you need to be fully invested at all times and I am not a set it and forget "pie chart" advisor. Things change and so should your portfolio on an ongoing basis. Our shop is a fee based only, active management firm, and cash is absolutely an asset class. In fact, you dial up or dial down risk using cash depending upon the current market environment. Sometimes we will have 10%, sometimes 15%, and if the markets begin to break down we will have 40% or possibly more, or even use hedging techniques. Currently we have 10%. But if you have a static 25% at all times, especially in this low interest environment, that puts quite a drag on your overall investments making the hurdle rate for invested assets even higher.
You also didn't mention how the IRA is invested - stocks, bonds, commodities, cash etc...?? The IRA itself is just a type of account or receptacle for the investments. In this rising interest rate environment, bonds are much riskier than they were just a year ago. And virtually all bond sectors have lost money or just breaking even this year. This is why I would need a better picture to give you sound advice because I don't know how 50% is invested, but I do want to give you some broad strategies to think about.
We have a sell discipline for every position in our portfolio to prevent us from losing big in a major market correction. Regular market fluctuations and pullbacks are ok, healthy, and normal, but if certain levels are hit, then selling begets selling and risks increase & accelerate quickly. I can always get back in when the markets stabilize & selling subsides. The two main risks you have to manage are drawdown risk and whipsaw risk. If you minimize your drawdown risk (tight stops) then you increase whipsaw risk and overtrading occurs. If you minimize whipsaw risk (wider stops) then you have more drawdown. So these two risks are not positively correlated until you hit your maximum drawdown & are both are in defensive mode. I am not trying to get too technical, just want you to be aware that there may be a better way. And it is less emotional.
The main problem is that in this low rate environment, there isn't "safe money" currently that pays enough to keep up with inflation, and bonds are risky with the prospects of rising rates. So how do you participate and yet sleep at night knowing you have a maximum drawdown you are willing to endure and levels on each position. This way you can participate and have more of your idle cash working if the markets are acting pretty well. When it gets ugly, it is usually pretty obvious but most still don't take action as the see the deterioration.
Regarding buying a home, depending upon where you live, you may want to wait till rates rise & prices come down. Some markets have already topped & reversed and a few are still strong. So it is location location location. But I think when rates rise mortgage applications will continue to slow and you might pay a little higher interest rate, but could get a much cheaper price. This is a little more opinion than fact.
You are in a great position as far as assets, and if you employ a solid strategy that simply makes reasonable returns but protects and minimizes downside risks, you should be fine. Whatever you do, do not do an indexed annuity where the salesperson promises you "much of the upside but none of the downside." While it is true you will not get any of the downside, you will hardly get any of the upside either. They will show you "illustrations" of 6%, 7%, or even 8% but most all of them get in the low single digits and they have long surrender penalties. They are also very tax inefficient when you take the money out. What you need is strategy not products.
This was a lot to think about and I hope it helps, best of luck Dan Stewart CFA®
You are way ahead of the average person in your age group. A job well-done is in order! It seems like you have done some planning to accumulate your assets, but like other advisors who've responded, it would be a good idea for you to work with a competent financial planner to help solidify your goals and help guide you in areas outside of your investment portfolio. From the figures you provided, it appears you are doing a great job of saving annually toward retirement. On the surface, your situation looks very strong and your future appears bright. However, I do not know any of your specific goals. Whether you are well-positioned for the future depends on when you plan to stop working and how much you plan to spend in retirement. This can be a very detailed process, but one well worth the effort. A good financial planner can help you here.
With respect to your asset allocation strategy, the only information I know is that you have 25% of your portfolio in stocks and 25% in cash. I do not know how your $1 million 401(k) is allocated. I encourage you to view your portfolio as one large global portfolio. Based upon your goals, I may not include the cash as part of your portfolio since you may need to use some or all of it toward a home purchase. You have the flexibility to have a small mortgage, but it depends on the purchase price of your future home, etc.
Your investment allocation should be geared toward your specific goals and eventual spending when you stop working. You want to make sure you have enough assets that last for many years, which means you may still require long-term growth. If that is the case, then you may need to continue having exposure to growth assets like stocks or mutual funds/ETFs that invest in stocks. Additionally, I believe you should have exposure to more stable assets like bonds to keep your downside under control in the event we suffer through some bad markets, especially if you plan to use some of your $500k in cash for a home purchase. There is no reason to have an aggressive allocation. Again, working with a competent advisor in this area can be very helpful. They can do a good job of assessing what makes sense for you.
A competent planner will also help you with estate planning and make sure you have appropriate beneficiaries listed for your assets.
In summary, keep up the great work! Best of luck to you and continue staying proactive!
You are well positioned. Do not know what the allocation of the 401k plan is, but if one assumes it represents some version of a balanced portfolio, and some or all of the $500,000 in cash is earmarked for a house, things are looking good. Cash positions in after-tax accounts have a tough time generating a positive real rate of return once you consider tax on the interest earned and the impact of inflation. That's why cash in a portfolio is most often considered a short-term parking place.
When you ultimately buy a house, would assume that the interest "write off" for taxes would be helpful, and if borrowing rates stay at these levels, having some debt on the house probably makes some sense. So in the next 2 years you will need to consider the expected differences in the financing rate and home prices. Your analysis of where the world will be in the next two years, may cause you to want to buy a house sooner or later....just make sure you like the house!
At a spend rate of $10,000/month, you are spending $120,000/year, which means you would need about $3 million ($1.5 mil in a 401k and $1.5 in a taxable account) to fund the $120,000 annual spend w/o (in most cases) invading principal. Your effective tax rate could increase or decrease the $3 million estimate, as would the actual blend between 401k and regular assets at retirement.
Hope this helps,
You seem to be doing well with your overall savings. You seem to be doing quite well. A $2,000,000 portfolio should be able to provide you with a monthly cash-flow in retirement of between $5,000 and $7,000. Fortunately, you also have another 10+ years to retirement. So, if your portfolio grows to $3,000,000 (inflation adjusted) by the time you retire, you should be able to replace your income. You may want to consider hiring a fiduciary and fee-only financial adviser just to go over the details of your current asset allocation and provide you with more personalized projections based on your actual portfolio.
The $500,000 in cash seems high to me. I'll assume you are going to use $200,000 for the home down payment/purchase. You would still want another $50,000 to $100,000 in cash for an emergency fund and for liquidity (the exact amount would depend on your circumstances). You may also want to keep around $50,000 to make improvements to the home or other surprise maintenance issues. Together, these near-term cash needs only total $350,000 on the high end. Figure out how much cash you need in the near term and consider putting the rest of the cash into stocks or bonds. If you aren't currently maxing out your 401(k) at work, consider putting the cash there (up to $18,500 this year). This will allow you to invest the money, and receive a tax deduction.
Regarding your asset allocation strategy, it's hard to tell without knowing what your 401(k) is invested in. I'll assume you are likely in an age-weighted retirement fund, which would likely have you with 40% to 50% in bonds. Age-weighted funds are great for a do-it-yourself portfolio as they automatically do the things an adviser would do to keep your asset allocation appropriate. Unfortunately, they don't know your personal financial situation and risk tolerance, so they can't manage your money the way an adviser would, which is according to your own unique needs.
One: Based on the information provided, I believe you are very well positioned for the future.
Two: Given the information provided I could not recommend an asset allocation for you. To determine the proper asset allocation (mix of stocks, bonds, & cash) for a client, I factor in goals, time horizon, and cash flows. What price range is the expected price range for your home purchase? It is also unclear based on the info provided how much longer you intend to continue working.
- When do you plan to stop working?
- How much are you currently saving and planning to save each year until retirement? What types of accounts are you doing this in, 401k, IRAs, taxable brokerage account, etc.?
- How is your 401k currently allocated?
- What price range will your home price be?
Hypothetical: If you were to start living off your accumulated assets today and require $100,000 (pre-tax) a year from your $2,000,000 nest egg, then somewhere in the range of a 60/40 – 75/25 mix of stocks/fixed income would give you the best probabilities of maintaining cash flows and growing the portfolio over the remainder of your life.
Lastly, based on the information you provided there may be financial planning opportunities to save/invest in more tax efficient ways. I assume that you are not eligible for direct Roth IRA contributions due to a “high income,” however you likely are eligible to make IRA contributions on a non-deductible basis and then convert that IRA into a Roth IRA. This strategy should be considered. You should also consider municipal bonds within taxable brokerage accounts.