Hey FAANG FIRE! I just scrapped a nearly finished 2,000 word newsletter on Asset Allocation and Asset Location. The truth is that these topics fill entire books and research papers and I didn’t think I could do it justice. Instead, I am just going to show you
I think while in an asset gathering stage (still working), bonds in 401k with stocks in taxable accounts works fine. Because you can rebalance with contributions (somewhat.. considering you don't necessarily want to decrease your 401k allocation).
But for rebalancing once you're not working, I think you still want bonds + international + US in all major categories (Roth, 401k/IRA, taxable), for rebalancing purposes. While small movements don't matter a lot, we've had some major asset class movements recently. And you can only truly rebalance if you can sell one asset class & buy another (once you don't make major contributions).
Another way to rebalance is to use withdrawals as a rebalancing strategy. I think that's reasonable in general, but I've found that assets get *far* more out of balance than withdrawals will be able to fix, if your savings get high enough :)
I’m beginning to come around to a similar pov. I’m running into a funny issue where nearly all my 401k would need to be bonds to hit my asset allocation while keeping bonds out of taxable.
This clearly seems suboptimal long term. Making rebalancing while minimizing taxable events also raises a good point.
Oh, one more idea. *Don't* reinvest dividends on your funds. That's another minor way (as your asset piles grow) to rebalance better.
Once I have 3-6 months of dividend cash in the money market account, I reinvest it all at once in the asset category which needs the most money. It's a way to slightly rebalance without any additional taxable events.
How do you manage rebalancing? Currently my portfolio was small enough to focus on my pre-tax account, where I set up automatic rebalancing. As I start earning more and other accounts get bigger, I'm not sure whether to bother with a custom allocation that I have to manually rebalance, or simply use a target-date fund.
I manually rebalance primarily with new contributions. That lets me control any potential tax consequences since much of my portfolio is in a taxable account.
If it is just in your 401k/Roth IRA having automatic rebalance is probably fine.
What tool did you use to compute your asset allocation percentages across all accounts? I tried looking it up in Monarch but don't see charts similar to yours.
Thank you for the post. I have an only slightly related question: what is the point of keeping bonds for people who are not going to retire in, say, at least a couple of decades? It seems that they have time enough to recover from a stock crash should one come, while being in a position to benefit from the much higher expected returns of stocks.
If you are wondering why 10% vs 0%. Trading in a very small amount of reduced volatility in exchange for slightly lower annual returns.
Both long retirements and long duration until retirement will skew towards a very equity heavy portfolio traditionally.
As you approach FIRE you become more sensitive to sequence of return risk and may wish to do something like a bond tent to help mitigate that risk... but you would still want to shift back into equities ~5 years post retirement if you anticipate a longer retirement.
I have been wondering the same thing here. I understand wanting to reduce risk as we approach early retirement. But if those bonds are in a retirement account, that's not accessible to 60 years anyways, I don't understand how having bonds in an locked up account will benefit us when we need to take distributions from our taxable account during early retirement and the market has dropped. What are your thoughts?
That's my reasoning too. However I was surprised to see you hold bonds because I thought (based on what I think your age range is) that you would still take around 10 years or so to retire.
First of all, a very good article that goes in depth as always. Secondly, I've been wondering this too. If you know you will FIRE >5 years, then why have any bonds at all let alone increasing your bond allocation from 10% to 15% (I think you wrote that in another article elsewhere.)? Wouldn't it be better to keep it all in stocks (and some alternatives) and avoid bonds altogether?
The first 5-10 years of early retirement are the most critical for long term success. Decreasing the risk of the portfolio going into those first years can help prevent a scenario where I need to sell equities during a crash.
It is sometimes referred to as an equity glidepath, although most glidepaths have an even higher bond % (and then transitions to equities after 5-10 years).
15% is striking the right balance for me going into full FIRE.
Thanks. And about your bonds location, what's the use of keeping all/most of your bonds in a tax- deferred account which you can't easily tap into until you're 59.5? Shouldn't bonds be in a taxable account then?
I think while in an asset gathering stage (still working), bonds in 401k with stocks in taxable accounts works fine. Because you can rebalance with contributions (somewhat.. considering you don't necessarily want to decrease your 401k allocation).
But for rebalancing once you're not working, I think you still want bonds + international + US in all major categories (Roth, 401k/IRA, taxable), for rebalancing purposes. While small movements don't matter a lot, we've had some major asset class movements recently. And you can only truly rebalance if you can sell one asset class & buy another (once you don't make major contributions).
Another way to rebalance is to use withdrawals as a rebalancing strategy. I think that's reasonable in general, but I've found that assets get *far* more out of balance than withdrawals will be able to fix, if your savings get high enough :)
I’m beginning to come around to a similar pov. I’m running into a funny issue where nearly all my 401k would need to be bonds to hit my asset allocation while keeping bonds out of taxable.
This clearly seems suboptimal long term. Making rebalancing while minimizing taxable events also raises a good point.
Oh, one more idea. *Don't* reinvest dividends on your funds. That's another minor way (as your asset piles grow) to rebalance better.
Once I have 3-6 months of dividend cash in the money market account, I reinvest it all at once in the asset category which needs the most money. It's a way to slightly rebalance without any additional taxable events.
Good call out.
I always turn auto reinvestment off in my taxable to prevent ending up with a bunch of wash sales when I tax loss harvest.
How do you manage rebalancing? Currently my portfolio was small enough to focus on my pre-tax account, where I set up automatic rebalancing. As I start earning more and other accounts get bigger, I'm not sure whether to bother with a custom allocation that I have to manually rebalance, or simply use a target-date fund.
I manually rebalance primarily with new contributions. That lets me control any potential tax consequences since much of my portfolio is in a taxable account.
If it is just in your 401k/Roth IRA having automatic rebalance is probably fine.
What tool did you use to compute your asset allocation percentages across all accounts? I tried looking it up in Monarch but don't see charts similar to yours.
It is a mix of Empower personal dash (the square tree maps) and Quicken Classic (the pies).
Thank you for the post. I have an only slightly related question: what is the point of keeping bonds for people who are not going to retire in, say, at least a couple of decades? It seems that they have time enough to recover from a stock crash should one come, while being in a position to benefit from the much higher expected returns of stocks.
If you are wondering why 10% vs 0%. Trading in a very small amount of reduced volatility in exchange for slightly lower annual returns.
Both long retirements and long duration until retirement will skew towards a very equity heavy portfolio traditionally.
As you approach FIRE you become more sensitive to sequence of return risk and may wish to do something like a bond tent to help mitigate that risk... but you would still want to shift back into equities ~5 years post retirement if you anticipate a longer retirement.
I have been wondering the same thing here. I understand wanting to reduce risk as we approach early retirement. But if those bonds are in a retirement account, that's not accessible to 60 years anyways, I don't understand how having bonds in an locked up account will benefit us when we need to take distributions from our taxable account during early retirement and the market has dropped. What are your thoughts?
That's my reasoning too. However I was surprised to see you hold bonds because I thought (based on what I think your age range is) that you would still take around 10 years or so to retire.
My plan was to be able to FIRE in <5 years. So closer to FIRE with a very long retirement.
Post Meta layoff has me wondering if that <5 years is actually sooner. Although I wouldn’t say FIRE while my partner is still working.
First of all, a very good article that goes in depth as always. Secondly, I've been wondering this too. If you know you will FIRE >5 years, then why have any bonds at all let alone increasing your bond allocation from 10% to 15% (I think you wrote that in another article elsewhere.)? Wouldn't it be better to keep it all in stocks (and some alternatives) and avoid bonds altogether?
The first 5-10 years of early retirement are the most critical for long term success. Decreasing the risk of the portfolio going into those first years can help prevent a scenario where I need to sell equities during a crash.
It is sometimes referred to as an equity glidepath, although most glidepaths have an even higher bond % (and then transitions to equities after 5-10 years).
15% is striking the right balance for me going into full FIRE.
Here is a good counter-point that says 100% before retirement could be fine: https://earlyretirementnow.com/2021/03/02/pre-retirement-glidepaths-swr-series-part-43/
Thanks. And about your bonds location, what's the use of keeping all/most of your bonds in a tax- deferred account which you can't easily tap into until you're 59.5? Shouldn't bonds be in a taxable account then?
Amazing article, as always!