Personal Investments • TPAW Asset Allocation question

Hi all,

I've been tinkering with the TPAW retirement planning tool the last few days (it's really cool) and have a few questions -

1. I've been using a ~70/30 stock bonds asset allocation in the simulations (using default returns), which I believe uses a 20 year tip return of ~1.8%. It is fair to assume this is a real yield vs nominal (I realize TIPS are inflation adjusted but just making sure)?

Yes, the expected return assumptions for stocks and bonds are real. The TIPS yield is the real yield obtained from "Daily Treasury Par Real Yield Curve Rates" here: https://home.treasury.gov/policy-issues ... statistics

2.When I use the 1/CAPE simulation, I need to get very aggressive on stocks but can't get to a 70/30 simulation. Why is this?

The 1/CAPE estimate for stocks is 2.7%. This is only a small premium over the expected return of bonds (TIPS yield of 1.8%). The low equity risk premium of 2.7% - 1.8% = 0.9% reduces the stock allocation per Merton's formula. So even if you increase risk tolerance to 24, you may not get to a 70/30 allocation (depending on your future cash flows).

(The default regression based estimate of the expected return of stocks is higher at 5.2% and so would imply a higher equity risk premium and a higher stock allocation.)

2. Given how high the CAPE has been, I've been sitting in a 50/50 stock/cash position with the cash in a 5% money market. I'm tempted to ride this portfolio for the next few years to see how low interest rates go and to see if we get another bout of inflation. For the time being is my cash delivering a similar yield as the 20 year TIPS simulation? I believe real yields are around 2.5 - 3%.

You can try to estimate the real yields by subtracting expected inflation rates using breakeven inflation rates available here: https://fred.stlouisfed.org/categories/33446

You may be getting high yields from money market funds, but there's no saying how long that would last. Longer term TIPS would lock in interest rates for longer.

3. I'm open to moving to 70/30 stocks/cash and I'm curious how this would affect TPAW simulations? I want to be cash heavy as this would equal ~5 years of annual consumption budget and if I retire in the next year or so, this would hopefully get me through a bear market.

I wouldn't recommend keeping a cash bucket and consuming from that to get through a bear market. Cash buckets can lead to haphazard asset allocation, not to mention a lot of confusion and arbitrary rules around when to dip in and when to replenish. Instead, keep everything in one bucket and adjust spending and asset allocation in line with the portfolio performance and expected return as calculated by TPAW. If the market drops, spending will decline. But if you are using 1/CAPE based expected returns (raw or regression based), expected returns will increase and your spending won't decline as much as the portfolio does. Stock allocation will increase if the equity risk premium has increased. The cash bucket doesn't help—it only causes confusion and mistakes.

For additional context, I'm in my mid-forties and am thinking of retiring the middle of next year. We have a low-seven figure portfolio with 50% in after-tax (cash) & 50% in 401k (QQQ, S&P, Gold, Intl). My wife still works and plans to till she's in her mid 50s early 60s. We live in CA and have zero debt. Monthly budget is about $8500, which TPAW simulations have shown is feasible with our portfolio size. We have a couple kids (college savings is in a separate account). We also have about $50k in an HSA.

I'd go with longer term TIPS instead of money market to better match your spending duration. Also reconsider QQQ—it's a risky bet on tech stocks.

Statistics: Posted by Ben Mathew — Mon Sep 16, 2024 1:49 am — Replies 1 — Views 182

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