• Client L, Part 5: Re-Start

    Progress on client L’s retirement planing stalled out in the last month of the summer as he and I were on vacation and then dealing with the headaches of school start-up. To reorient us on what we need to do to he requested an e-mail that outlined the way forward. I’m posting a lightly edited version of it here in case it is of use to humanity.

    Step 1. Nail down what you can/need to save and what rate of return you need. The inputs come from your current and estimated retirement budget. You need to plug those inputs into retirement calculators to estimate the average rate of return you require to meet your goal. Here are some relevant links with the details:

    Step 2. Your required return gives you some guidance as to what your stock/bond asset allocation (AA) should be. You’ll want to set it for an expected return above what you require (i.e. with higher stocks, lower bonds) and then gradually trend it toward more bonds, less stocks over time. A reasonable real return for stocks is 5% and for bonds is 2%. So if you need a real return of 3% over the long term then setting an AA for, say 4% now might make sense. To do that you’d set stocks at 67% and bonds at 33% (*). Relevant links:

    I break the stock portion of my portfolio into a 50/50 split between the entire US stock market and international stocks. That is, if my stocks are 70% of my portfolio then US equities are 35% and international are 35%. For the bond side an intermediate Treasury fund (or an approximation thereof) or a total US investment grade fund are fine. I use a 50/50 split between nominal and inflation protected Treasuries but that is a bit of a fine point.

    Step 3. With your target AA set the next step is to select funds to accomplish it. Roughly speaking you want to construct from the funds available something that is representative of the total US stock market, something representative of non-US equities, and something representing all investment grade bonds or at least an intermediate term Treasury fund. Then you just combine those to match your target AA.

    It sounds so simple, but this can be a big headache if you’ve got a lot of funds available and don’t really know what they are. What to do?

    This problem can be solved in two ways. One way is to gather all the information necessary to figure out what what your fund options are. Which are stock, which are bond? What kind of stock funds? What kind of bond funds? What are the expense ratios? The details matter. Much of it can be found from fund administrators and Morningstar. This is the hard way.

    The second way is easier: just gather the expense ratios and ticker symbols and put the entire question to the Bogleheads. There is no harm in doing this anyway, at least as a second opinion. The format to do this is at posted on the Bogleheads Forum. You’ll have to create an account on the Forum to submit a portfolio question. Feel free to tell them I sent you (my screen name there is “sewall”).

    (*) This is a crude approximation since the return of a mix of asset classes depends on their correlation, which I’ve ignored for simplicity. Consult a more sophisticated retirement calculator for more precise planning.

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