Ask the grumpies: Resources for asset allocation?

Susan asks:

Since I got on top of my finances (I wrote to you before about this), we got married, and now I’m the finance person. My husband has similar values as me (spend < earn, save) which is good. He also believes in ‘put it in index funds’ – also good, but that’s where his thoughts stop. So he had all his 401k money in vanguard s&p500; no bonds. I need to have a conversation with him about asset allocation, ie, a choice of some percent of bonds. I plan to show him a morningstar chart of total market and total bond plotted over 20 years, and point him towards the bogleheads wiki. What other resources or reasoning can you suggest for him, and others who need to learn a bit more here? Preferably more concise than not, as I know the longer the page, the less likely he’ll actually read it.

(I know about target date funds, but we’re past that already for several reasons, including a sizeable taxable acct, and a sucky choice of funds in his 401k where the only reasonable choice is the 500 fund; my 403b is great, so that’s where most of bonds are)

This is a fun question.

Ok, so first, that morningstar chart is the place to go for what you’re asking, as is the Bogleheads Wiki.  So thank you for answering your question.  :)  Walter Updegrave has some good articles on asset allocation as well, but they tend to be based on specific situations so you’re probably best off with the Bogleheads Wiki.  (Note:  Updegrave recommends this questionnaire from Vanguard to figure out what % mix is right for you– according to it I should be 100% invested in stocks(!).)

Second, for the question you didn’t ask, asset allocation is both more and less complicated than it initially seems.  Which really means the experts understand the basic idea, and there’s heuristics (ex. 120 – your age in stocks, but there are many others) to use that generally won’t get you into trouble, but we really don’t know what the ideal portfolio mix is.  Even target-date funds will have different glide paths because they have different underlying beliefs about what the appropriate asset allocation is.

Your DH’s choice of 100% stocks may actually be a valid choice.

Including bonds in your portfolio is mainly important because the stock market is volatile over the short term, even though it generally goes up over the long term.  If your time horizon is long before you’re planning on taking assets out and you’re not very risk averse, then you may not need that many bonds because  you can trust that the market will eventually get better after a crash.  Bonds are safer than stocks and don’t track stocks, so they help to smooth out volatility in your portfolio.  However, bonds also give lower returns on average.

It is recommended for most people that you have some safe assets in your portfolio, because most of us don’t have infinite investing time horizons and there’s all sorts of unexpected emergencies that can happen.  Those safe assets don’t have to be bonds, though bonds are nice because although not as safe as an FDIC insured CD, they generally have higher returns than said CDs.  But if you have a lot invested in cash or CD ladders for whatever reason and you don’t yet have a huge 401(k) portfolio, you might not need bonds yet.  On the opposite side, if you have huge amounts of wealth and are planning on passing your inheritance on rather than drawing it down, you may also tilt towards stocks away from bonds because your horizon is infinite (though at huge amounts of wealth you should probably be looking at more complicated ways to dodge taxes).

IIRC, you’re (plural) in your early 40s but doing catch-up retirement savings.  That means your time horizon may be longer than that of many people in their 40s, meaning you might be willing to take on additional risk.  However, just because you may see yourself working longer doesn’t mean that the labor market will agree.  So having a more traditional bond allocation may make sense.

Now, does the bond allocation have to be in your DH’s portfolio?  You’re married and will most likely have to reallocate investments should you get a divorce.  So no, not at all.  My DH’s current portfolio has no bonds because he probably has the same stupid retirement company that your DH does– the only affordable thing is the S&P 500 fund.  So we also tilt more towards bonds in my Fidelity account.

So, bottom-line– it sounds like you already know what to do.  But your husband may be right about his asset allocation based on his levels of risk aversion.  This is something that you two may have to compromise on, but you’ll (plural) still be ok wherever you end up within that compromise.  It’s not like he’s 100% invested in company stock, which would truly be dangerous.

25 Responses to “Ask the grumpies: Resources for asset allocation?”

  1. Mrs PoP Says:

    The NYTimes Your Money section had a 2 part series within the last few weeks on why 100% stocks is a reasonable allocation for some, Might be worth s read to see if it fits with your DH’s risk profile and long term plans.

    FWIW, we’re near a 90/10 split across all our accounts (we don’t track it super closely), which is roughly in line with the 120-age recommendation.

  2. Hypatia Cade Says:

    Two follow up questions:
    1) How to buy bonds in a way that maximizes tax savings and minimizes fees while still not “playing the market”
    2) My grandfather, who is quite savvy financially, has argued that if you have a home mortgage, even at an absurdly low interest rate, you should pay it off before buying bonds given current interest rates. Think of it as making a loan to other people (bonds) vs. paying off a loan to yourself (mortgage). Is this rational or not? Should equity in our home/the outstanding balance on our mortgage be treated as a cash asset or a bond or what in our approach to allocation?

    • chacha1 Says:

      you’re not actually asking me, but I will answer anyway because Advicey Pants. :-)

      my personal opinion is that you should not treat equity in your home as an asset at all if there is any outstanding balance on your mortgage, and you should not consider it an “investment” for retirement purposes because, unlike stocks, bonds, REITs and other tradable securities, a house does not appreciate (in real value) or produce income for you unless you sell it.
      the only scenarios in which a house is an investment are a) if you do not live in it (i.e. it’s a rental property) or b) if you are holding it specifically to sell & move at retirement.

      • nicoleandmaggie Says:

        It’s an investment in the same way that paying off credit card or car debt is an investment. Paying off debt is a “safe” use of funds. (Assuming you’re not going to go bankrupt, foreclose, or get repossessed.) So I don’t think she’s talking about buying the house as an investment, but conditional on having bought a house, paying off the debt on said house. And that is a form of asset allocation (and can change your cash flow).

      • Hypatia Cade Says:

        Yes, we have a house. We didn’t buy it TO BE an investment but rather because where we live and the rental market and time we plan to be here blah blah blah the house is the right choice. My question was more in the vein of given that we have a house… if we had $10K sitting around (and we’ve already maxed out our roths and maximally contributed to the IRA from our employer and have no credit card debt), should we put it into bonds or into a lump sum house payment?

      • nicoleandmaggie Says:

        ” if we had $10K sitting around (and we’ve already maxed out our roths and maximally contributed to the IRA from our employer and have no credit card debt), should we put it into bonds or into a lump sum house payment?”

        Either one! The lump sum house payment is the least risky option (assuming you wouldn’t ever foreclose) and provides opportunities for easier cashflow later. Bonds are slightly more risky, though safer that straight-up stocks.

        In terms of our revealed preference, we put the money in stocks in a taxable account (before we bought a house). After we got a house we saved up money in cash savings because we knew we wanted to take pre-tenure leave. Then after we got back, we made a lump sum payment into mortgage so as to reduce our risk from that because DH was probably going to quit his job at some point. Now our mortgage is trivially low and we’re maxing out retirement so we’ll either spend/donate excess money or add it to taxable stocks if we end up at a point with extra money (this year we’re spending more than we earn).

        So I dunno, for short term $, there’s CD ladders and mortgage prepayment. For longer term there’s stocks. I’m not sure I would put $ in bonds except as part of my retirement portfolio. I want my short-term safe investments to be super safe and my long-term investments to make average returns for the stock market. If I were super rich I might look into munis for tax reasons, but maybe not.

      • Debbie M Says:

        Mostly I agree that a house is not an investment. On the other hand, it does keep you from having to pay rent. Once it’s paid off, property taxes + insurance + repairs *should* be less than rent–you can think of that as your return. And you can think of the amount you’re investing as the amount you spend over what you would have spent if you were renting (that includes extra furniture, painting, lawn mower gas, etc.) while you’re paying off the mortgage.

      • nicoleandmaggie Says:

        @ DebbieM Not necessarily– not only are there big regional differences based on supply and demand (that you can see from say the NYTimes calculator), but there are returns to scale from owning a lot of units which drives down costs for landlords compared to single home owners. (Not to mention that some small landlords don’t understand that they’re charging too little because they don’t understand their full costs. Or there are tax laws like prop 13 in CA that can make renting from long time owners cheaper and some cities have rent control that keeps long-term renting even cheaper.)

        And such savings are at least partially capitalized into the cost of houses.

      • Hypatia Cade Says:

        Yeah, to be specific we live in a midwestern college town where the rental market is VERY expensive and the to-purchase market is relatively modest once you get out of the immediate downtown area ~ we’re talking blocks not miles here. So even when you add in all of those extra house related expenses purchasing is the right choice.

        And we’ve been aggressively paying off the mortgage (following my granddad’s advice)…though we occasionally wonder about that.

        If we continue at this pace we should have mortgage paid off in ~ 3-5 years and have the cashflow of house payment freed up. That aligns with when my current grant ends (no more guaranteed summer salary, though if I got another grant, perhaps…) and when FT childcare for one child ends (approximately equal to summer salary plus a bit). That said, if we look at our portfolio and 120-our age, we should have 20-25% in bonds and right now we have 0% in bonds…..

        The challenge with bonds is that outside of our IRA/Roth which are currently all stock index funds, we can’t figure out how to buy them. The local broker (there’s one) charges so much in fees that it doesn’t seem worth it. The online places don’t seem to do the things that boggleheads was recommending re: local bonds. Last year we sort of got paralyzed by possibilities and our goal is to become unparalyzed and make decisions (anything should have a higher return than our savings acct).

        Anyway, this is a helpful discussion and I’ll spend some time this weekend reading up on the links.

      • nicoleandmaggie Says:

        I’d recommend just buying some standard (non-muni) bond funds within your IRA/Roth/403(b)/457 as you go forward. Then buy stocks outside for longer term investing.

        Munis are still pretty risky given how local governments haven’t recovered from the recession, and given you’re in the midwest, you may be seeing more risk added unless you know your pipes aren’t filled with lead. If you’re going to take on risk, do it with stocks and stick to standard index bond funds within your taxable accounts for your bond portion.

        oddly, my FIL (the accountant) gave us the advice to not pre-pay our mortgage. But we did so in order to diversify risk (and because early pre-payments are worth more). Now that it’s small, we’re holding on to it until it’s gone naturally.

        tl:dr: don’t invest in munis (any time soon)

      • nicoleandmaggie Says:

        Note: barrons from 2 years ago disagrees with me: http://www.barrons.com/articles/its-a-great-time-to-buy-muni-bonds-1434169118

        But the reason they’re doing better is because they are riskier!

        Here’s Forbes’ how-to. Looks like you can get a fund from Vanguard, which would decrease the risk of say, your local muni defaulting. http://www.forbes.com/sites/baldwin/2012/01/06/the-smart-way-to-buy-tax-exempt-bonds/#2e11bb1c3648

        p.s. That Forbes article is really good. And not just because it agrees with me. :)

    • nicoleandmaggie Says:

      Wow, unfortunately I don’t know enough about the bond market to give really good answers to these questions (especially not #1– I just use whatever low-fee bond fund that bogleheads recommended for fidelity in my 403b), though I can answer #2 re: your grandfather vaguely.

      #2 Your grandfather is absolutely right in regards to two scenarios: 1. That you would never ever think of foreclosing on a house and 2. the bonds he’s talking about are US treasury bonds, which are the only truly “safe” asset. Other bond funds, while safer than stocks, are not actually as safe as paying off your mortgage. So they also tend to bring higher returns (on average, in general equilibrium) to compensate for risk. So depending on your risk tolerance, you may still want bonds in your portfolio. Additionally, bonds, real estate, and stocks, all move differently so having some of each allows you better diversification.

      • Hypatia Cade Says:

        The boggleheads book talks a lot about using bonds to offset tax liability especially since if you buy state or municipal bonds in your own state they often aren’t subject to state income tax and that this can be a way to reduce tax liability for things not in tax sheltered accts. For instance, you might put all of your stock allocation in an index fund via your IRA and all of your bond allocation using other assets. We aren’t really there yet in terms of having enough cash on hand outside of Roth/IRAs that this matters….but I can’t figure it out…. and we should be there in 5-7 years (or less).

      • nicoleandmaggie Says:

        Yeah, that’s advanced stuff. My father used to be into muni bonds (somewhere we have a post about what I told him to do when he sold $300K of muni bonds– they did not buy a place in portland, sadly). They’re riskier than they used to be. (He had some bonds for Vallejo, for example…)

        That kind of stuff is good if you run out of room in your 403(b)/401(k)/IRA/457/SEPA/etc. etc. etc. If you still have room in tax advantaged accounts, use that instead of worrying about munis. (And don’t put tax-advantaged bonds into tax-advantaged accounts!) Also if you’re at the point in which you run out of protected room, it is probably time to talk to a fee-only financial adviser/tax accountant who can help you figure out things for your state/city/etc.

      • nicoleandmaggie Says:

        (which is basically repeating what you said already.)

        Also, in case anybody cares, the spartan (fidelity) bond fund we chose is: FIBAX

  3. Susan Says:

    It’s not explicitly said on bogleheads, but my understanding of the general order of bond investing is: use a total-bond fund in your tax-advantaged account (401k, 403b, IRAs) to minimize its tax impact. We have VBTLX, vanguard’s total bond fund.

    If you have a taxable investing account, then your asset allocation is computed over all of your accounts, and you should still keep the bond % of your asset allocation in tax-advantaged. For example, if you had 50% of your portfolio in tax-advantaged and 50% in taxable, and you want a total allocation of 30% bonds, then 60% of your tax-advantaged would be in bonds (and none in taxable). So this is still simple enough.

    Then a) if your portfolio has much more money in taxable than tax-adv (for instance, you don’t have access to a 401/403, or you have a lot of income you’ve saved or a big cash inheritance) to the point that even 100% bond funds in your tax-adv. doesn’t get your overall AA where you want it; and possibly b) if you live in a state (NY and CA are two primary examples) with high state income tax, then you’d want to use a municipal bond fund (possibly a state-specific fund) because you are not taxed on the income from it in your state. My understanding breaks down here, because we’re not at a point of using this strategy.

    In re: mortgage vs bonds, one point of view is that the stock market typically returns 5-6% over the long term, while most mortgages these days are 3-4%. So you’d be better off investing extra money. This is/was different in days of higher interest rates, or when your mortgage ‘costs’ more than the market returns, or what your beliefs are about the long-term viability of the housing market.

    The second perspective is that you’re using the mortgage for leverage — and the more you pay it down, the less you’re taking advantage of that aspect of it.

    Thanks for providing the answer and discussion, nicoleandmaggie!

    • nicoleandmaggie Says:

      Here’s an interesting article on bond fund placement: http://news.morningstar.com/articlenet/article.aspx?id=2670
      I think the advice to put bond funds into tax-advantaged is because they generate more income to be taxed, but when bond returns are a lot lower than stock returns, the stocks can end up generating more taxable income. So it isn’t clear. There’s complications including expected income tax rate, expected, returns, etc. (Also: https://www.bogleheads.org/wiki/Tax-efficient_fund_placement ) Of course, if you have individual stocks taxable might be better if you would sell at a loss so you can get those tax advantages, or if you’re planning on donating to charity etc. And everything can change with an act of congress. So, who knows!

      Leverage is only a good thing if you’re willing to exchange a safe return for a potentially higher but riskier return. Given two identical average interest rate returns, the safer one is actually worth more (for anyone with any risk aversion at all). When we’re talking about the difference of a percentage point (or more), it comes down to risk tolerance– paying down the mortgage is a safe investment, putting money in the stock market is riskier but has higher returns. There’s no “right” answer about which is better– it completely depends on how an individual feels about risk.

      That’s why some super-rich people have 100% in stocks (and other risky products), but Suze Orman has (or had– the article I read was from a while back) her wealth 100% in bonds. They’re both right, but Suze Orman is happy accepting lower returns for security (even though her returns, while still high, are not as high as they would be in stocks, but the losses aren’t as low either), whereas the 100% stock person is willing to take potential capital losses, especially temporary ones.

  4. Bardiac Says:

    This is an interesting discussion. I wonder, sometimes, about my own asset allocation. I figure my retirement will be funded through Social Security (a bit), my state pension (a bit more, unless the governor finds a way to get his hands on it), and my own retirement savings. I think I’ve been thinking of my state pension as a bit like a bond fund; it may go up or down a bit (there are rules limiting that), but (unless the governor gets his hands on it) it should be there at a basic level for me. (I also have a little in a bond fun in the retirement stuffs, but not as much as the pundits tend to suggest.) I don’t know if this strategy makes sense or not. :/

    • nicoleandmaggie Says:

      I can totally see Walker stealing your pensions. Though him trying that would probably be enough to finally get him kicked out of office and then there would be lawsuits and you’d probably end up with said pension at the end of it all. Ugh. But hey, if you were in IL, you wouldn’t even have social security, so there’s that… State DB pensions are really not as safe in places like WI or IL or Michigan as they ought to be. And there may be difficulty getting funds when whatever cluster@#@$ happens with state pensions as they go through the courts (they’re usually pretty good about letting people keep their pensions who already have them though, so maybe not an issue). Plus they can probably do things like not adjust pension amounts for inflation.

      If you haven’t sat down to figure out expected expenses in retirement compared to what you’re saving and whether or not you should be saving more outside of your pension, you really should do that. Next time I have a true break I’ll see if I can find the page where we link to calculators that answer then “am I saving enough” question. (They don’t all give the same answer even when given the same information though.)

    • Katie Says:

      I’m a newly minted State of Wisconsin employee and I have yet to wrap my head around the defined benefit plan and how I should be considering it in terms of asset allocation in my IRAs. I have a decent amount in a target date fund at Vanguard in Roth and rollover IRAs. Does having that defined benefit coming (in some amount) mean I should shift to more stocks in those accounts? Or should I pretend it doesn’t exist like I do with Social Security, since it’s vulnerable to the whims of the governor and changing laws over the next 30 years before I retire? I need to do more reading on this.

      Also, I wish you would do more money posts! I used to read a lot of personal finance blogs, but it seems harder to find things to read online if you already know a medium amount about money.

      • nicoleandmaggie Says:

        Technically you should be thinking of the DB plan as an annuity, which is what SS also is. You shouldn’t actually be pretending that SS doesn’t exist (it does and it will), but it doesn’t hurt to underestimate your earnings in retirement for most people since most people aren’t saving enough. Annuities are nice because they’re insurance against outliving your assets. So they’re pretty valuable. (Of course, people don’t tend to buy private annuities I think because they’re overpriced with fees but most economists think they’re not overpriced there’s just market failure.)

        But you are right that state pensions are vulnerable. (Company DB pensions are more regulated! It is really weird how that turned out.)

        In terms of what that should do to your asset allocation, I’m not entirely sure. In theory it should mean that you would shift into riskier assets (so toward stocks, away from bonds), but given politics, it’s harder to say. Usually they’re pretty good about not taking promised money away without some warning so you might be best off treating it as safe until you hear otherwise.

        [standard disclaimer, talk to someone who knows what they’re doing… etc.]

        We do money posts every monday and feel free to email us if you have any ask the grumpies questions!

      • Katie Says:

        Thanks! It’s not so much that I think Social Security is not going to exist, it’s more like I haven’t bothered to figure out what my benefit will be. (I do get and file those statements every year… maybe I should actually read it.) I need to understand better what I’ll be getting out of SS and the state defined benefit plan. A much bigger chunk of my paycheck is going to the defined benefit plan here than I was contributing to get the match at my last employer. (And old employer matched 8% to my 1%.) Since my takehome pay is less, it’s going to be hard to max out my Roth IRA like I have been doing.


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