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With the current fixed income environment, have you given any thought to your portfolio asset allocation?
For most of the last 15 years bonds paid next to nothing, a big fat zero actual return. For a stretch in 2021 they actually paid less than nothing: 10-year TIPS traded at negative real yields, meaning you were paying the government for the privilege of protecting your own purchasing power. In that world, equities weren’t one part of the growth engine. They were the only party in town.
That’s now changed. Depending on how you view your portfolio, it could mean you can reduce your equity level without harming your planned return.
Let’s say leading up to retirement, you or your advisor was reaching for a conservative 3% real return. To achieve that, with bonds contributing nothing towards the heavy lifting, your equity sleeve had to do all the work. Using standard long-term return assumptions, that solves out to an equity allocation around 66%, giving you roughly a 70:30 split.
With bonds now in positive territory, real yields pushing 1.5-2%, that changes the calculation considerably. You can flip the script to something closer to 30:70 and still expect that same targeted 3% real return. That’s not a small tweak. It’s a massive reduction in risk exposure.
Now before you go all “but, but, but,” I’m the first to admit there are lots of variables. You need an accurate handle on your long-term spending horizon before you can lock in current bond rates. Maybe your real goal is maximizing inheritance, or maybe your current plan can handle any amount of volatility and you’re happy with your allocation. Asset location and tax implications are another big one, and there are plenty more valid points besides.
But none of that negates the fact that, compared to a decade ago, your equity sleeve doesn’t need to be as large to deliver the same planned return.
Obviously this doesn’t mean you have to change anything. But to my mind, it’s worth considering the possible implications for your own situation, even if that’s just out of intellectual curiosity.
As for the calculations, I’m no Einstein and I’m not trying for a white paper. I fed the information into my local, friendly, house-trained AI and got it to crunch the numbers, then got another one to check its work. So if it’s wrong, I take full responsibility. After all, the AIs in question were probably busy plotting our eventual downfall at the time and couldn’t afford the compute cycles.
The sky high stock market, especially as to tech stocks, combined with the current elevated interest rates, have increased my desire for a little rebalancing.
We happen to have a large portion of our domestic equity allocation in taxable accounts, and have held the postions for decades. So any sales in order to rebalance would come with a hefty capital gains tax bill.
I recently took one step, which, while very modest, does avoid the tax problem. I turned off dividend reinvestment for VTI (Vanguard Total Stock Market), and a couple of other tech heavy ETFs, VGT (Vanguard Technology) and SCHB (Schwab Broad Market).
As future dividends are paid out in cash, I’ll probably roll it into money market funds rather than bonds. The MM interest rates are favorable–and probably getting better judging by the Fed’s current attitude–and I’m still a little gun shy on bonds given recent experience.
Hi Andrew,
When you write “I recently took one step, which, while very modest, does avoid the tax problem” I found myself nodding in agreement as I have recently turned off the automatic reinvestment of dividends in a tiny new equity position in our joint taxable account. My motivation in turning off the reinvestment is somewhat different than yours in that my primary goal is to simplify our tax basis record keeping by having dividends (mostly qualified) paid in cash to our settlement fund rather than being reinvested. I also am planning for this investment to hold any part of our future IRA RMDs that we do not currently plan to spend during our lifetime so our heirs should, hopefully, receive such assets without an embedded taxable gain.
Such basis tracking may be less important to you as I believe you live in one of the community property states (Texas) where the surviving spouse, when first spouse dies, typically gets a step up (or down) basis adjustment to 100% of the fair market value as of the date date of death for assets in a taxable brokerage account. Texas seems to have some interesting provisions in their Estates Codes including one about a community property survivorship agreement (CPSA) that may impact tax decision making. As I do not live in Texas I will pass on trying to understand that law.
Best, Bill
Hi, Bill, and thanks for your kind reply.
You’re right that we live in Texas and so the surviving spouse should benefit from a stepped up basis.
I wasn’t even aware of “community property survivorship agreements” till reading your post. It looks like they allow probate to be bypassed for the properties they cover. I think our estates will go through probate in any event, but in Texas, as along as you have a will, the probate process is usually pretty straightforward.
You said your main goal in turning off dividend reinvestment for that holding was to simplify cost basis records. I likewise have some mutual funds acquired decades ago for which I had to burn a weekend manually calculating the adjusted basis after including all the many dividend and capital gains that were reinvested. Once that chore was completed, I turned off reinvestment as I never wanted to re-figure those laboriously acquired bases!
But let me ask: As to the investment for which you wanted to simplify the cost basis record, you indicated it is new. Since in more recent years brokerage firms maintain and recalculate basis for us, what complications are you concerned with?
Thanks as always for your expertise,
Andrew