Archives for June 2019

A reader writes in, asking:

“I’ve read everywhere that, if retired, one should have money to live on, invested in other than equities to protect against a market downturn (to reduce sequence of return risk, and to try to avoid locking in big losses, especially in the first 10 years of retirement).

My first question is: what would you consider enough of a downturn (amount and/or duration?) that you would recommend not selling equities if possible? I’ve yet to see anyone clarify this. A market drop of 15%? More?

My second questions is this: my taxable account has an all stock allocation because that is what Vanguard says is optimal. If there is a big market downturn/crash/recession, I will be selling stocks as that’s all I have in my taxable account. This is contrary to much of what I’ve read as recommended. When I asked my Vanguard CFP about this, his response was that yes I’d be selling stocks in the taxable account but my portfolio will be rebalanced so the portfolio as a whole will be selling bonds to buy more stock. That does seem to make sense to me. Is there some flaw to this explanation?”

Firstly the one easy part: the Vanguard CFP is correct. It’s the overall allocation of the portfolio that matters, rather than the allocation of any individual account. And from an overall asset allocation standpoint, selling stocks (or anything else) in your taxable account doesn’t (usually) matter, because you can simultaneously make transactions in retirement accounts to adjust the overall allocation back to whatever you want it to be.

And he is correct that if your portfolio is rebalanced during a stock market downturn, you will not only not be selling stocks but will in fact be buying them.

For anybody attempting to use “don’t sell stocks during a downturn” as a stand-alone rule though, it’s a challenge. It’s one of those vague statements that sounds like it makes great sense — hard to argue with, even. But once you try to turn that into an actual plan of action, you start to realize that you need something more specific/concrete than that.

There’s the question you noted: how bad does a downturn have to be, before I should avoid selling stocks?

There’s also the question of how many years worth of spending you want to keep in bonds, in order to avoid selling anything other than bonds when the stock market is doing poorly. That is, exactly how long of a downturn should you plan for? (Though if you prefer a conservative allocation anyway, this generally wouldn’t be an issue in early retirement, as you already prefer to have many years of spending in bonds.)

This doesn’t mean that “not selling stocks during a downturn” is a bad strategy, but you will have to choose some answers to the above questions. And — just like any other asset allocation question — there is not one answer that everybody agrees upon. There’s no consensus as to the specifics.

About as close as you can get to a consensus for managing asset allocation in retirement is something along these lines:

• Diversify, in the sense of “not having a large percentage invested in any one company.”
• Diversify, in the sense of “own stocks and bonds, and own some international too.”
• Keep costs low.
• Make sure that your asset allocation does not make you uncomfortable — and will not make you uncomfortable even when the market is doing poorly.
• Have a specific plan for how you will change (or not change) your allocation as you age and in various market circumstances. For example, will you rebalance into stocks when the market falls, or not? And will you rebalance out of stocks as the market rises, or not? Having a specific plan is better than making it up as you go along. (If nothing else, it helps you keep your sanity: “I’m sticking to the plan” — whatever the exact plan happens to be.)
• Keep your spending rate low-ish if at all possible (below 4% in early retirement — ideally even below 3.5%; a higher rate is OK later in retirement).
• If your spending rate is low-ish, then any diversified allocation should be OK. A higher stock allocation is likely to result in a larger bequest (and/or higher spending late in retirement) and a bumpier ride along the way.