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More to Risk Tolerance Than Just Age

A reader writes in, asking:

“One thing I don’t understand about target date funds is the implicit assumption that the only thing that should determine your asset allocation is how old you are. Doesn’t this seem like an obvious mistake?”

I’m not sure I’d say it’s a mistake how target date funds are constructed. But I absolutely agree that there’s more to risk tolerance and asset allocation than just the year in which you plan to retire.

For example, how stable is your income? A person with a secure, steady-paying job can take on more risk than a person with a job that could be lost at any minute or a person with a job that pays entirely based on commission.

What other assets do you have? If you have a very large emergency fund that you’re not counting as part of your portfolio, you can take on more risk in the portfolio than somebody with a smaller emergency fund.

What other assets would you have access to, if the need arose? Consider two young investors. One comes from a poor family and knows with 100% certainty that she wouldn’t be able to get any sort of financial assistance from friends or family if she lost her job. The other comes from an upper middle class background and knows that the Bank of Mom and Dad would chip in (at least to some extent) if a financial emergency came up. All else being equal, these two investors have very different levels of risk tolerance.

How much investing experience do you have? Have you been through a bear market before? Until you’ve experienced one, you should assume that it will feel worse than you’d naturally expect. If your portfolio is small relative to the size of your total available assets and you can therefore afford to make a mistake (e.g., sell out at or near the bottom in the event that you can’t handle the stress), then go ahead and build a high-risk portfolio. But if selling out would be a problem and you’ve never been through a bear market, you should probably consider a less risky allocation.

Do you have any need for the higher expected returns that come from a risky portfolio? For example, author/advisor Larry Swedroe has often written that he has a “low marginal utility of wealth” (marginal utility being the additional happiness you would get from more of the item in question), meaning that he has little to gain from a high-risk portfolio. Or, as Bill Bernstein puts it, ”if you’ve won the game, why keep playing?”

Target Retirement Funds and Risk Tolerance

Due to all of the above factors, an investor might want an allocation that doesn’t vary solely with age. For example, for a young investor who has a relatively low risk tolerance and who doesn’t expect that risk tolerance to change any time soon, a fixed 60% stock, 40% bond allocation may be a good fit. But the Target Retirement funds don’t offer that option. For investors who want an allocation that doesn’t vary with age, and who still want the simplicity of an all-in-one fund, Vanguard’s LifeStrategy funds can be a good fit.

Investing Blog Roundup: Bernstein on International Bonds and More

This week, Olly Ludwig of has an excellent interview with Bill Bernstein about his recent book If You Can. The interview covers a range of topics from why Bernstein doesn’t recommend owning international bonds, to how he’s trying to get the message of sensible investing out to millennials.

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3 Bad Reasons to Claim Social Security Early

Administrative note: My wife and I are moving this week, from St. Louis, Missouri to Manitou Springs, Colorado. As a result, there will be no articles this upcoming Friday (6/20) or Monday (6/23). Also, please be patient with me if I’m slower than usual in replying to emails.

There are many perfectly good reasons to claim Social Security early. For example:

  • You need the cash flow right now,
  • You are unmarried and have a shorter than average life expectancy,
  • You’re the higher earner in a married couple, and both you and your spouse have significantly shorter than average life expectancies,
  • You’re the lower earner in a married couple and either you or your spouse has a shorter than average life expectancy,
  • Inflation-adjusted interest rates are high, making the “take the money and invest it” strategy likely to work out well, or
  • You plan to take the money early and invest it in risky assets, you understand that there’s a significant possibility that you’ll end up worse-off as a result of that decision, and you can afford such an unfavorable outcome.

Unfortunately, people frequently claim Social Security early for reasons that don’t make a great deal of sense. Three especially common not-so-good reasons for taking Social Security early include:

  1. You want to spend more money in early retirement than in later retirement,
  2. You don’t want to work until age 70, and
  3. You want to leave behind money to your kids.

One way to assess the when-to-claim decision is to calculate the break-even point between two different strategies. For example, how long do you have to live for claiming at 70 to be a better strategy than claiming at age 62? As it turns out, if inflation-adjusted interest rates are below 2% or so, the break-even point occurs prior to age 83 (age 83 being the total life expectancy for an average 62-year-old).

Stated differently, unless investors can safely earn inflation-adjusted investment returns of 2% or more (not possible at the moment, given current TIPS yields), most people (specifically, most unmarried people and higher earners in married couples) can maximize the total number of dollars they’ll have available to them over their lifetimes by claiming Social Security at 70 rather than at 62.

The key insight here is that maximizing the total dollars you have available to you over your lifetime isn’t the same thing as maximizing your standard of living in late retirement only. If you prefer, you can use that increased amount of lifetime wealth to spend more in early retirement. Or, if you prefer, you can simply accumulate those dollars and leave them to your heirs.

In other words, even if you:

  1. Want to retire at age 62 or earlier,
  2. Want to spend more in the early stage of retirement than in later retirement, and
  3. Want to leave behind money for the kids…

…there’s still a good chance that delaying Social Security until 70 is the best strategy.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Taxpayer Bill of Rights

This week, after years of urging from the National Taxpayer Advocate (a position within the IRS, with the job of advocating on behalf of taxpayers to both the IRS and Congress), the IRS has officially adopted a Taxpayer Bill of Rights.

This is big news, not because these rights are new — they’re not — but because it’s the first time taxpayers have had a clear collection of their rights when interacting with the IRS. And, if you don’t know your rights, it’s hard to put them to use.

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A Look at Vanguard’s Global Minimum Volatility Fund

This week, a reader wrote in asking about the Vanguard Global Minimum Volatility Fund that was launched in December 2013 — what it’s supposed to do, what it owns, and so on.

The fund is an actively managed stock fund. The fund’s investment strategy is to select stocks based on their individual volatility levels and correlation to each other, with the goal of delivering less overall volatility than a typical indexed stock portfolio.

What’s in the Portfolio?

Vanguard has stated that the plan is for the fund to have roughly half of its assets in U.S. stocks, and half in international stocks. And indeed, the fund currently has an allocation very close to that target.

The Global Minimum Volatility fund currently holds 241 stocks. While that’s not exactly a small number, it’s still far fewer than would be included in a typical broadly diversified index fund. For instance, a combination of Vanguard Total Stock Market Index Fund and Vanguard Total International Stock Index Fund would currently  include more than 9,000 stocks.

How Risky is the Fund?

On their “Risk Potential” meter, Vanguard rates the Global Minimum Volatility fund at 4/5, which is the same rating that they give the Vanguard Total Stock Market Index Fund. In other words, despite the low-volatility goal, it’s not as if Vanguard expects the new fund to be as safe as a bond fund. John Ameriks of Vanguard put it this way:

“You should not expect this fund to protect your principal in times of market downturns. We take a dim view of any stock fund that makes claims of safety from market loss or full downside protection. The objective of the fund is to deliver the least volatility that we can, subject to reasonable constraints on other important aspects of the portfolio. Zero volatility in times of market stress is not a reasonable expectation.”


The fund has an expense ratio of 0.30% (or 0.20% for Admiral shares, with a $50,000 minimum). There’s no ETF version of the fund.

My Personal Opinion

Given that we continue to be very happy with our simple one-fund solution, we won’t be adding the Global Minimum Volatility Fund to our portfolio.

But, frankly, even if we weren’t using an all-in-one fund, I still wouldn’t be inclined to add this fund to our portfolio, due to my general degree of pessimism about the value of active management. If I wanted to slightly reduce the risk level of my portfolio, I would simply adjust my stock/bond allocation slightly rather than moving a portion of my stock holdings into an actively managed stock fund that hopes to achieve lower levels of volatility than basic stock index funds.

That said, if I ever were to place a bet on active management, I would want to find a fund with rock-bottom costs, so as to minimize the hurdle that the fund managers have to overcome. And the cost of active management for this fund is much lower than that of most actively managed stock funds.

Investing Blog Roundup: Bill Bernstein’s Latest Book

Author/advisor Bill Bernstein (of Four Pillars fame) just released a new book in his “Investing for Adults” series. Having just gotten my hands on it, I can’t yet say much about the content other than what is included in the Amazon description. But I’ve been impressed with each of Bill’s books in the past, and I’m confident that this will be no different:

Rational Expectations: Asset Allocation for Investing Adults (Kindle version here)

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