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Tagged: retirement planning

Simplicity vs. Flexibility In Your Portfolio

By Scott Roark, MBA, PhD | December 18, 2020

There is much to be said for the practice of simplifying and de-cluttering in life.  It seems like I keep seeing consultants and tools that will help you clean out and organize your garage, your food pantry, or your closet.  It seems that the hoarding gene (apparently it resides in a region on Chromosome 14) is relatively widespread among us.

It turns out that this tendency to accumulate clutter can be fairly common in the financial arena as well.  If you change jobs, move around or respond to financial services marketing, chances are that you have more accounts than are really necessary for a smoothly functioning life.  While there may be some arguments to having more than a couple of accounts for a particular category, it may sometimes be easier to keep track of financial matters when you are not dealing with endless statements at the end of each month. This logic also transfers to the actual investments that make up your multiple accounts. The financial services industry has attempted to provide simplicity with an investment vehicle called a Target Date Fund.

Target Date Funds have been marketed is as a simplifying tool for retirement savings.  They can be appealing because, in one fund, you can get a well-diversified holding that can achieve a targeted asset allocation (or at least get very close to one). The theory behind Target Date Funds is rather than having a portfolio with a dozen or more varying asset classes, one simple fund may do it all. As a quick overview of Target Date funds, they have dates contained in their name that roughly correspond to a “targeted retirement date”, often occurring in 5-year increments. Funds with a target date in their name closest to the current year will theoretically have less volatility and more fixed income and cash-like holdings in them while funds with a target date in their name furthest from the current year will be invested in a more growth-oriented manner. For example, a fund sponsor may have funds that range from a 2020 fund that might have 35% in stocks and 65% in fixed income and cash-like holdings while a 2065 fund could be allocated to 90% stocks and just 10% in fixed income and cash-like holdings.

Obviously, a full discussion of Target Date funds is beyond the scope of this simple article.  I will get into more depth on these complex funds in the future, perhaps on one of our EDU podcasts! But in terms of adding simplicity to your portfolio, they may be an attractive tool, especially in the accumulation phase of retirement planning – that period of time when you’re just adding to your portfolio every month and you are not taking any distributions.

However, in retirement when you begin sending your savings and living off them, I would argue the simplicity that Target Date funds offer starts to lose its appeal.  In the distribution phase of retirement planning investment flexibility become more valuable than account holding simplicity.  Unfortunately, that is where a Target Date fund can lose some appeal.  For instance, consider the situation of March 2020 when the Corona Virus scare had the equity markets down 30%+ in a short period of time. However, in the same period, some fixed income and cash-like holdings (not all, but some) held steady or even gained in value.  If you were taking a $20,000 quarterly distribution from your retirement funds in March, it would have been nice to pull from the fixed income or cash-like holdings that were more stable in value and had not dropped rather than selling your stock holdings which had likely dropped in value. This is where the simplicity of a Target Date fund loses out to its inflexibility.  If all your assets are in a Target Date fund, you can’t choose to sell the winners and leave the losers alone. If the Target Date fund’s “losers” dropped enough that they took the entire fund’s value down, even though the fund holds some “winners”, you must still sell the entire fund as one. There is no picking and choosing allowed!  It is the proverbial “Throwing the baby out with the bathwater” conundrum.

When you are close to, or in retirement and you are actively spending from your portfolio, I think it is better to have the flexibility that comes from breaking your actual retirement portfolio into its constituent parts.  At Jim Saulnier & Associates we call this “positioning” and it allows you the flexibility to pick and choose what holdings you sell under what market conditions.

Target Date funds and others in their ilk, do offer simplicity and can be a useful option to busy professionals lacking the time and inclination to monitor and manage an investment portfolio during their accumulation years. But in retirement, when assets must be sold to fund your spending needs, I would suggest you opt away from simplicity and begin “positioning” your portfolio for spending by utilizing separate low-cost passive asset classes in your portfolio for the spending flexibility they afford. After all, babies should not be thrown out with the bathwater!


Additional Disclosure:

Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is no guarantee of future results. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including loss of principal.

Asset Allocation and Asset Positioning

By Scott Roark, MBA, PhD | November 23, 2020

Asset Allocation

One of the most important decisions investors make is the “asset allocation” decision.  This is the decision about the broad categories of investments that will be held in a portfolio.  In the broadest sense, these categories would be things like stocks and bonds.  But many times, investors also consider other categories of assets like cash, commodities and real estate and maybe even more esoteric categories like private equity, blockchain currencies (e.g. bitcoin) and vintage cars.  In this article, we’re going to stick with a mix of asset types (also called “asset classes”) that addresses the needs of the vast majority of investors – stocks, bonds and cash.  And in terms of how investors participate in these asset classes, I’m going to assume that broad based ETFs are used for stocks and bonds and a money market fund is the stand-in for cash.

There are a few important characteristics of asset classes that matter to investors, including average return, risk, liquidity and correlation. Each asset class will usually have slightly different expressions of these characteristics and several are listed below.

  • Average return reflects the expected total return of an asset is going forward. This return is made up of income and capital gains (price increases) that benefit the owner.  Over the past 100 years or so, stocks have had the highest average return, followed distantly by bonds with cash bringing up the rear.  According to the 2020 edition of the SBBI Yearbook, the average annual compound return for the various classes is:

Large-cap stocks                                 10.2%

Long-term corporate bonds                  6.1%

U.S. Treasury Bills (cash proxy)          3.3%

Inflation                                                2.9%

  • Risk reflects the uncertainty associated with returns and is frequently measured by the standard deviation of returns. The more ups and downs there are in the returns for an asset class, the higher the standard deviation will be.  From 1926-2019, stocks have been the riskiest asset class, followed by bonds and then by cash. Based on the 2020 SBBI Yearbook, the standard deviation of returns for the asset classes is:

Large-Cap stocks                                 19.8%

Long-term corporate bonds                  9.8%

U.S. Treasury Bills (cash proxy)          3.1%

Inflation                                                4.0%

  • Liquidity is really about the ease of converting an asset to cash without losing too much value in the conversion. The asset classes we are considering are very liquid.  Of more concern here is really the interaction between risk and liquidity.  It is easy to sell a stock ETF, but you don’t really want to do that when the market has tanked by 25%.  A better time to sell investments is when they have had a nice increase.
  • Correlation is the last important characteristic of asset classes that we will consider. Correlation touches on the diversification benefits of an investment – does having this asset reduce the overall risk of your portfolio?  This could also be thought of as a measure of how one asset zigs when another asset zags.

According to the 2020 SBBI Yearbook, the correlations between stocks, bonds and cash are all below 0.17 – which means they have generally contributed to diversification and reduced risk when held together in a portfolio.


Asset Positioning

The notion of asset positioning ties investing decisions related to asset allocation to spending decisions based on timing.  Many times, this is thought about as matching the timing of a known liability (spending need) to the characteristics of an asset.   Here are a few principles of matching that are commonly used in the accumulation phase of life (up to retirement):

Saving for retirement – there is a long horizon (anywhere from 20-40 years of future participation in the labor force), so a heavy dose of stocks is usually called for.  The need for a high average return to provide a sizable nest-egg and the fact that there is plenty of time to recover from a downturn means stock are an appropriate choice.

Saving for college education – this might be up to 18 years away if you start setting aside money at birth in a 529 account (use a stock-heavy allocation) all the way up to saving some money for next year when junior or juniorette starts college (use money market).

Saving for a house – if you are planning on buying a house in the next couple of years, the biggest need from an investment is stability.  If the money you’ve set aside for a down payment takes a 25% haircut from a market downturn, then perhaps the purchase decision has to be put off for quite some time.  Generally, for these needs that are imminent, setting aside money in low-risk money market accounts is best.

In retirement planning, asset positioning is also key.  At Jim Saulnier & Associates, we believe strongly in the need to position assets in such a way that spending decisions are aligned with investment decisions.  We work with our clients to move away from one catch-all portfolio to a portfolio that has been positioned with different mini-portfolios (also known as “sleeves” in our business) to meet different spending objectives.  For instance, we position clients such that they have a principal-protected sleeve for immediate spending needs (anywhere from 1-5 years of spending will be set aside in cash or cash-like holdings so that there is no risk of a market downturn causing a loss of spending power.  The drawback of this safe approach, especially in the past few months, has been the very low interest rates that can be earned on these kinds of investments.

For intermediate spending needs (from 5-10 years or more in the future), we may position clients where there is some modest level of risk, but also the opportunity to have the investments grow in value to keep up with and hopefully exceed inflation.

Because retirement can last anywhere from 10-30 years (or more), it is important to have some investments allocated to more aggressive holdings (i.e. stocks) that can continue to grow over time.

And because some needs don’t necessarily have a definite timetable attached – such as the need for long-term care – there may be sleeves set aside with a mix of immediate liquidity and longer-term growth potential.

Because of all these considerations, asset positioning is a dynamic process that requires on-going maintenance and attention.  We always want to manage investments in such a way that there is plenty of cash available for near-term spending while keeping an eye on longer term goals and needs of our clients.