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Investing Blog Roundup: Market Valuations and Retirement Asset Allocation

Housekeeping note: We have family and friends visiting from out of town this week and early next week, so there will be no article on Monday.

This week researchers Wade Pfau and Michael Kitces released a new paper looking at an assortment of different asset allocation strategies in retirement — ranging from various static allocations, to various “glide path” allocations that either increase or decrease the stock portion over time, to various valuation-based allocations that adjust the stock/bond ratio over time based on whether stock valuations are high or low.

The paper and the authors’ respective summary articles can be found here:

If I were to offer my own very brief summary, it would be as follows:

  • Based on historical US data, adjusting asset allocation based on market valuations has modestly improved results for retirement portfolios, and
  • A fixed 60%-stock allocation is pretty darned good as well.

Investing Articles

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A Look at Vanguard’s Managed Payout Fund

A reader recently wrote in asking for a discussion of the Vanguard Managed Payout Fund — how it works and what it might be good for.

In short, the fund is meant to be a tool for investors who are spending from their portfolios (i.e., retirees). It’s an all-in-one fund (like the LifeStrategy or Target Retirement funds), but it also implements a withdrawal strategy for you. In other words, the fund handles not only asset allocation and rebalancing, but also the implementation of a distribution strategy. Pretty neat idea, in my opinion.

What is the Distribution Strategy?

Perhaps the best way to assess the Managed Payout Fund’s distribution strategy is to compare it to other strategies.

The best known retirement distribution strategy is the classic “4% rule,” in which the retiree spends 4% of the portfolio balance in the first year of retirement, then automatically adjusts spending upward each year in keeping with inflation, regardless of how the portfolio performs. The advantage of this strategy is a steady level of spending (in inflation-adjusted terms), with the disadvantage being that someday the portfolio (and, therefore, the spending) could hit zero if things go poorly.

An alternative, equally simple strategy is to take 4% out of the portfolio each and every year. Relative to the classic “4rule,” this results in widely varying levels of spending (which is undesirable), but it has the advantage of never fully depleting the portfolio.

The strategy of the Vanguard Managed Payout Fund sits between these two — with a level of spending that does vary based on portfolio performance, but that is “smoothed” by basing the withdrawal on the average share price over multiple years. (Specifically, the fund sets a monthly distribution in January of each year, based on 4% of the fund’s average share price over the last three years.)

Vanguard Managed Payout Asset Allocation

As of this writing, the Managed Payout Fund’s allocation is as follows:

  • Vanguard Total Stock Market Index Fund 25.0%,
  • Vanguard Global Minimum Volatility Fund 20.1%,
  • Vanguard Total International Stock Index Fund 14.9%,
  • Vanguard Total Bond Market II Index Fund Investor Shares 13.3%,
  • Vanguard Market Neutral Fund Investor Shares 10.0%,
  • Vanguard Total International Bond Index Fund 6.9%,
  • Vanguard Emerging Markets Stock Index Fund Investor Shares 5.1%, and
  • Commodities 4.7%.

Frankly, I’m not exactly a fan of this allocation. I’m not talking here about the stock/bond allocation (though with a net** stock allocation of roughly 65%, it is rather aggressive for many retirees) or the US/international allocation. I’m talking about the fact that roughly one third of the portfolio is actively managed. If I were to bet on active management, it would be Vanguard’s that I’d want to bet on, given their low costs and strong track record. But I’d rather have the option to use this sort of all-in-one tool without having to make such a bet.

Conclusion

In short, Vanguard’s Managed Payout Fund might be a good fit for investors who:

  • Are retired and drawing from their portfolios,
  • Appreciate the simplicity of an all-in-one fund and an automated distribution strategy,
  • Don’t have any qualms about active management, and
  • Find that the fund’s allocation is a good fit for their risk tolerance.

In addition, like all funds-of-funds, this fund will be less tax-efficient than a DIY portfolio with individual index funds, making it somewhat less desirable for investors with significant assets in taxable accounts.

** I say “net” stock allocation because the Market Neutral Fund shouldn’t, in theory, be contributing any stock market volatility.

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Investing Blog Roundup: Fixed Indexed Annuities

As I’ve written on several occasions, I’m a big fan of annuities as a tool for providing retirement income. But that doesn’t really extend beyond boring lifetime annuities. Fixed indexed annuities (a.k.a. equity indexed annuities) are an entirely different animal. And as Allan Roth explains this week, there are a number of potential “gotchas” involved with such products.

Investing Articles

Other Money-Related Articles

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How Big Does Your Portfolio Have to Be Before It Should Look Different?

A reader writes in, asking:

“For the last several years I’ve been following a basic Boglehead strategy with a few index funds. How big does a portfolio have to be before it makes sense to start moving into other strategies?”

There are certain portfolio-related considerations that can become relevant as your wealth grows to a certain point. For example:

  • If your portfolio starts to get to the point that estate taxes might be an issue (with the exemption currently at $5.34 million – or twice that if married) and your primary goal is leaving money to heirs rather than funding your retirement, purchasing life insurance as an investment can make sense, or
  • If you have a larger, mostly taxable, 7-figure portfolio and a desire to be hands-on, individual stocks can make sense for the large-cap part of the portfolio — not with the idea of picking stocks that will outperform, but rather with the idea of creating a portfolio that roughly replicates the overall large-cap part of the market, while having expenses of zero (no expense ratios and no commissions) and having the ability to tax-loss harvest very aggressively due to having many unique holdings.

But, the truth is, most investors’ portfolios never reach those points — or even come close.

In addition, the basic principles of diversifying and keeping costs low remain applicable regardless of portfolio size.

As a result, for most people, it’s not exactly portfolio size that causes a need for a significant change to the portfolio. Instead, it’s usually a change in life/career stage that dictates major changes. That is, once the primary objective for the portfolio changes from an accumulation goal (i.e., accumulating assets while not exceeding your tolerance for volatility) to a spending related goal (e.g., satisfying $X of spending each year), the ideal tools for the job change somewhat.

Specifically, as you near retirement, it can make a lot of sense to start shifting toward a liability-matching strategy with a portion of the portfolio — creating a “safe floor of income” with things like Social Securityannuities, or TIPS. As author/advisor Bill Bernstein puts it, “If you’ve won the game, why keep playing it?”

Of course, portfolio size is a factor in determining when you make the shift from living off of work income to living off of the portfolio, but it’s only one of several factors (including ability to continue work, interest in continuing work, anticipated level of spending per year, and anticipated level of non-portfolio income per year).

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Investing Blog Roundup: Is a 4% Withdrawal Rate Too High These Days?

Last week, I linked to an article from Wade Pfau and David Blanchett discussing the usefulness (and limitations) of Monte Carlo simulations. This week, Pfau and Blanchett follow up with an article that uses Monte Carlo simulations to address the question of whether a 4% withdrawal rate is still a good idea for today’s retirees:

Other Money-Related Articles

Thanks for reading!

When Does it Make Sense for Married Taxpayers to File Separately?

A reader writes in, asking:

“Under what circumstances does it make sense for a married couple to file separate tax returns rather than file jointly?”

In most cases, it doesn’t make sense. That is, in most cases, a married couple will end up paying more total tax by filing separately than by filing jointly. There are, broadly speaking, two reasons for this.

Reasons Not to File Separately

First, by filing separately, you’re made ineligible for a number of tax breaks, including (but not limited to):

  • The student loan interest deduction,
  • The American Opportunity Credit,
  • The Lifetime Learning Credit,
  • The earned income credit,
  • The premium tax credit (with a possible exception for victims of domestic abuse),
  • The child and dependent care credit (with a possible exception for married people who live in separate homes), and
  • The adoption credit (also with a possible exception for married people who live in separate homes).

The second reason has to do with tax brackets. For married couples in which one spouse earns significantly more than the other, filing jointly allows the income from that higher-earning spouse to stay in a lower tax bracket. Conversely, if the couple files separately, the low-tax-bracket space of the spouse with no/low earnings will go unused.

Reasons to File Separately

There are four general types of reasons for filing separately.

The first reason is simply that the couple is in fact separated (though still married) and filing jointly simply wouldn’t be feasible.

A second, less common reason for filing separately is that one of the spouses has to publicly disclose his/her tax returns for some reason, and the couple wants to keep as much information private as possible (by keeping it off the publicly-disclosed return).

A third reason for one spouse wanting to file separately is to avoid being made jointly liable for any amounts due on the other spouse’s return. (If this is a concern for you, you would do well to discuss the issue with a tax attorney.)

Finally, there are some uncommon cases in which filing separately can actually result in tax savings. These cases tend to be the result of the couple wanting to take better advantage of a particular deduction that is reduced by a certain percentage of their income. For example, the itemized deduction for medical expenses is reduced by 10% of your adjusted gross income (7.5% if you’re age 65 or over). As a result, if one spouse has a lot of medical expenses in a given year, it can sometimes make sense to file separately so that the amount by which the deduction is reduced is a smaller figure (because it’s based on just that spouse’s income rather than the couple’s combined income).

Other deductions that could provide a similar motivation to file separately would include:

  • The itemized deduction for casualty losses, which is reduced by 10% of your adjusted gross income, and
  • Miscellaneous itemized deductions that are (collectively) reduced by 2% of your adjusted gross income (e.g,. unreimbursed employee expenses and tax preparation fees).

Of note: If you’re claiming one of these itemized deductions, rather than simply filing separately, it’s important to do the math both ways (i.e., filing separately and jointly) to see which works better, as the disadvantages of separate filing that we discussed above often outweigh the additional savings you might get from being able to claim a larger itemized deduction.

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