Hypothetical question: Retirement portfolio development

**jIM_Ohio** · 10-03-2008, 03:52 AM

Ray-

"hands off" then rebalance "once per year" are opposites of one another. The ambiguity will skew responses (did you really mean hands off or did you really mean rebalance once per year).

I am in the rebalance once per year house, because if you are in the "hands off" camp, the only choice is probably target retirement funds (pick a date, send in $1000/month and retire 30 years later).

The asset allocation of the "total market" is about
75% large cap
18% mid cap
7% small cap

this can be checked by running a total stock market index fund through morningstar x-ray.

If that allocation is good for you, an easy way is just buy a total market index fund and be done. I believe that an investor can outperform the market by overweighting sectors and asset classes, so I own more of the little stuff than the market.

My allocation 30 years prior to retirement would be:
45% large cap
15% mid cap
15% small cap
15% international large cap
5% international small cap
5% emerging markets

The total market has about 75% in large/mid combined (according to morningstar)
Many definitions of mid cap exist, and my mid holdings xray to have about 20% large, 50% mid and 30% small. Getting this exact allocation will depend on definitions of mid and small.

Once the allocation is chosen and understood, the next step is choosing a brokerage or management company which can list all holdings on one statement.

Choose the brokerage based on costs and convenience. Keep costs low and look for an easy to use web site and easy to understand information.

I like T Rowe Price.

Then choose funds at that management company which fit the allocation. One fund per asset class. Look at 5 year returns, expenses, and dividends paid/ fund yield.

$1000/month is too much for an IRA, and $12k per year is just under the max for a 401k. If all money is in tax advantaged accounts, little consequence to fund selection step. If taxes are an issue, then fund selection is much more important. Make sure the funds in taxable accounts do not have large distributions or dividends.

My funds at T Rowe Price are:

Equity Income (PRFDX- large cap)
Mid Cap Growth (RPMGX-mid cap)
Diversified Mid Cap Growth (PRDMX-mid cap)
Small Cap Value (PRSVX-small cap)
New Horizons (PRNHX-small cap)
Diversified Small Cap Growth (PRDSX-small cap)
International Growth and Income (TRIGX-international large cap)
International Discovery (PRIDX-International small cap)

Wife also owns some emerging markets and other funds, plus I own emerging markets in my 401k, so no emerging markets in my IRA accounts. T Rowe has an emerging markets fund which is quite good.

As far as rebalancing, not the percentages (45%-15%-5%) used and the unit sizes (9-3-1). Once per year adjust contributions based on previous years performance.

Year 1 monthly contribution amounts would be
$450
$150
$150
$150
$50
$50

If the mid cap has $1000 more than the small cap fund at years end, adjust the contributions for the next year to be

$450
$70
$230
$150
$50
$50

so at end of year 2 all things being contant is a rebalanced portfolio.
The alternative is to buy/sell to rebalance to 45-15-15-15-5-5 allocation. If this is all tax advantaged OK, but I still would not advise SELLING once per year. History has proven that most bull markets and outperformance lasts longer than 12 months, so selling winners is not suggested by me on a regular basis.

--
You mentioned a 30 year time horizon. This is the plan for the first TEN (10) years. At year 11 a bond position needs to be added. First 10% of bond position comes from large cap (reduce from 45% to 35%) then reduce mid cap and small cap (15% to 10%) then start reducing each domestic sector 1% for any bond position higher than 20% total.

Create the bond position by selling 1% of all holdings at end of year 10.

contributions:
Year 10=2% bonds
Year 20=20% bonds (add 2% bonds per year)
Year 30=30% bonds (add 1% bonds per year)

The gradual move to bonds prevents the need from selling winners (what if year 10 is in middle of a bull?), gradual shifts are less risky. Use same rebalancing technique as before (add contributions to underperforming assets).

** BUY LOW**- this technique guarantees the only equty classes getting NEW MONEY in years 11-20 are the ones which are underperforming (because the bond positions will need significant contributions to keep up with increasing portfolio from 2% to 4%, then 4% to 6%... so the high performing asset classes can ride, but get no new money).

**kork13** · 10-03-2008, 06:12 AM

You said alot of good here, Jim, but i'll ask one question to start. You mention aiming for low costs.... for mutual funds, what sort of expense ratios are generally considered "good"? Do these expectations change with the type of MF it is, such as between index funds, target date funds, commodity/sector funds, standard asset class targeting funds, etc.?

**atomicrc11** · 10-03-2008, 06:30 AM

If you are looking for minimal work on your investment, just go with someone like Fidelity, Charles Schwab, Vanguard or T. Rowe Price and use a Target Date Fund. It will automatically adjust asset classes as you approach retirement. In the case of a 30 year retirement, a Target Date fund for 2040 would probably work best. Fidelity has a Freedom 2040 fund that you can invest in with no minimum to open, you just need to invest $200/month. T. Rowe Price has a similar offering for their Target Date funds.

**mrpaseo** · 10-03-2008, 08:50 AM

Great info everyone, it's late and I need to bunk down for the night, I will respond to everything tomorrow (I have an early morning so I need to get some rest).

Thank you all for your responses,
Ray

**jIM_Ohio** · 10-03-2008, 12:52 PM

Originally posted by kork13 View Post

You said alot of good here, Jim, but i'll ask one question to start. You mention aiming for low costs.... for mutual funds, what sort of expense ratios are generally considered "good"? Do these expectations change with the type of MF it is, such as between index funds, target date funds, commodity/sector funds, standard asset class targeting funds, etc.?

I shoot for expense ratios below .8% for large cap funds, 1% for most other asset classes (expect higher expenses for small caps and international funds).

I do not screen funds based on expenses, I screen them on what they invest in, the strategy they use, then use expenses as a tiebreaker if two funds have met those screens.

Because I choose my brokerage first (T Rowe Price in most cases), the list of funds per asset class is usually between 1-3. By the time I look at philosophy I am usually only looking at one fund, maybe two.

Do the same process at a larger company (like Fidelity) and you will have a larger selection of funds.

Example-
Look for a diversified large cap fund
T Rowe has 3-4 (Equity Income, Dividend growth, Blue Chip Growth and Growth)
Fidelity would probably have close to 12 (more than one of each type above, plus probably contra fund etc still meeting the screen criteria)
Vanguard has more than one index fund which covers that asset class, so choosing which index to use to hit the asset class is tough as well.

**mrpaseo** · 10-03-2008, 09:31 PM

Originally posted by jIM_Ohio View Post

Ray-

"hands off" then rebalance "once per year" are opposites of one another. The ambiguity will skew responses (did you really mean hands off or did you really mean rebalance once per year).

What I ment is, I would not (The investor) try to micro manage/daytrade the portfolio. I often hear about people constantly turning over their holdings to try to maximise their profits. In this case (And how I manage my funds) I rebalance annually. I do not sell, I just adjust my monthly asset allocation to each fund to bring it back on line.

I am in the rebalance once per year house, because if you are in the "hands off" camp, the only choice is probably target retirement funds (pick a date, send in $1000/month and retire 30 years later).

I have one of these set up now. Just a prtion of my porfolio though.

The asset allocation of the "total market" is about
75% large cap
18% mid cap
7% small cap

this can be checked by running a total stock market index fund through morningstar x-ray.

I'm not sure what this mean, is this global or just the USA, is this all indexes or jst the S&P? Sorry I really am in the learning phase on a lot of this. I know a lot about getting out of debt and the importance of saving for the future, but the individual investment area I am trying to learn (Thus this question)

If that allocation is good for you, an easy way is just buy a total market index fund and be done. I believe that an investor can outperform the market by overweighting sectors and asset classes, so I own more of the little stuff than the market.

This part I understand, I also have an Index bund, I believe the total market fund you mentioned includes the total market rather than just one index... Makes since to me.

My allocation 30 years prior to retirement would be:
45% large cap
15% mid cap
15% small cap
15% international large cap
5% international small cap
5% emerging markets

I like this, looks good. One of my issues in research is trying to figure out what is large cap, small cap etc. Unless it has these identifiers in the name of the fund, I don't know how to easily identify them.

The total market has about 75% in large/mid combined (according to morningstar)
Many definitions of mid cap exist, and my mid holdings xray to have about 20% large, 50% mid and 30% small. Getting this exact allocation will depend on definitions of mid and small.

I will need more explanation on this one. "Holding xray" I do not understand. From what I can tell, you are sayinf that some MID CAP Funds, actually hold some small, med and larger CAPs but the average is MID?

Once the allocation is chosen and understood, the next step is choosing a brokerage or management company which can list all holdings on one statement.

At this time I am in three different families (Vanguard, Fidelity and Janus). I like Fidelities format and their research tools are pretty good. I believe Vanguard has lower costs though. I need to do some more research in these two funds. I hear TRP is promoted a lot on this site and I havenothing against them but I already have three fund families so I'm not excited about venturing out into another.

Choose the brokerage based on costs and convenience. Keep costs low and look for an easy to use web site and easy to understand information.

I like T Rowe Price.

Then choose funds at that management company which fit the allocation. One fund per asset class. Look at 5 year returns, expenses, and dividends paid/ fund yield.

Good info, this is probably were I would get started. I need to learn the ramifications of dividents/taxes.

$1000/month is too much for an IRA, and $12k per year is just under the max for a 401k. If all money is in tax advantaged accounts, little consequence to fund selection step. If taxes are an issue, then fund selection is much more important. Make sure the funds in taxable accounts do not have large distributions or dividends.

In dealing with many people in debt, I am finding that most families waste on average about 1000 dollars. This is where this number came from. I actually live about 1000 dollars below my income level so I will have this dollar amount to invest myself. This paragraph is great info, in my situation I can/will invest up to the max for my ROTH and the spouse' ROTH, then I will probably divert the remaining 2,000 to non retirement MFs. At this point the divident/distribution will come into play.

My funds at T Rowe Price are:

Equity Income (PRFDX- large cap)
Mid Cap Growth (RPMGX-mid cap)
Diversified Mid Cap Growth (PRDMX-mid cap)
Small Cap Value (PRSVX-small cap)
New Horizons (PRNHX-small cap)
Diversified Small Cap Growth (PRDSX-small cap)
International Growth and Income (TRIGX-international large cap)
International Discovery (PRIDX-International small cap)

This would be nice in Fidelity

Wife also owns some emerging markets and other funds, plus I own emerging markets in my 401k, so no emerging markets in my IRA accounts. T Rowe has an emerging markets fund which is quite good.

As a Soldier I do not have access to a 401k, so my primary retirement portfolio is focused around the ROTH IRAs. One of the reasons I asked this question is so I can learn to better diversify my portfolio. I currently hold four different funds/asset classes but wanted to ensure I was doing this right. From what I learned in this thread, I would like to further diversify.

As far as rebalancing, not the percentages (45%-15%-5%) used and the unit sizes (9-3-1). Once per year adjust contributions based on previous years performance.

Year 1 monthly contribution amounts would be
$450
$150
$150
$150
$50
$50

If the mid cap has $1000 more than the small cap fund at years end, adjust the contributions for the next year to be

$450
$70
$230
$150
$50
$50

so at end of year 2 all things being contant is a rebalanced portfolio.
The alternative is to buy/sell to rebalance to 45-15-15-15-5-5 allocation. If this is all tax advantaged OK, but I still would not advise SELLING once per year. History has proven that most bull markets and outperformance lasts longer than 12 months, so selling winners is not suggested by me on a regular basis.

I will not, and would not advise selling to rebalance, I just adjust my monthly contributions to rebalance as needed. If one fund end up way off track I will dump a chunk in it to bring it back on par, or will discontinue investing until I am rebalanced in that fund.

--
You mentioned a 30 year time horizon. This is the plan for the first TEN (10) years. At year 1

1 a bond position needs to be added. First 10% of bond position comes from large cap (reduce from 45% to 35%) then reduce mid cap and small cap (15% to 10%) then start reducing each domestic sector 1% for any bond position higher than 20% total.

Create the bond position by selling 1% of all holdings at end of year 10.

contributions:
Year 10=2% bonds
Year 20=20% bonds (add 2% bonds per year)
Year 30=30% bonds (add 1% bonds per year)

The gradual move to bonds prevents the need from selling winners (what if year 10 is in middle of a bull?), gradual shifts are less risky. Use same rebalancing technique as before (add contributions to underperforming assets).

Do you have access to excel and would you be willing to look at a spreadsheet for me to give your opinion?

** BUY LOW**- this technique guarantees the only equty classes getting NEW MONEY in years 11-20 are the ones which are underperforming (because the bond positions will need significant contributions to keep up with increasing portfolio from 2% to 4%, then 4% to 6%... so the high performing asset classes can ride, but get no new money).

Thank for your time and extended answer

Ray

**mrpaseo** · 10-04-2008, 05:47 AM

You mentioned a 30 year time horizon. This is the plan for the first TEN (10) years. At year 1

1 a bond position needs to be added. First 10% of bond position comes from large cap (reduce from 45% to 35%) then reduce mid cap and small cap (15% to 10%) then start reducing each domestic sector 1% for any bond position higher than 20% total.

Create the bond position by selling 1% of all holdings at end of year 10.

contributions:
Year 10=2% bonds
Year 20=20% bonds (add 2% bonds per year)
Year 30=30% bonds (add 1% bonds per year)

The gradual move to bonds prevents the need from selling winners (what if year 10 is in middle of a bull?), gradual shifts are less risky. Use same rebalancing technique as before (add contributions to underperforming assets).

Any chance of getting a breakdown of this year by year? I understand the first 10 years, there is no change, on year ten I see that I would sell 1% of all holdings to produce 10% bond fund. Then at years 10 I would start dropping the Large Cap by one percent per year until I hit the 20 year mark. This is where I get lost. Do I ride these for another 10 years then start the percentage drop in the Mid/Sm Domestic (US accounts right?) funds? or do I start at the 10 year mark to drop the other funds by one percent per year?

BTW, I do plan on implimenting this plan, it's a sound plan from what I have read in books and here on line and the ratios sound pretty good. Thank you very much for your input.

Thanks,
Ray

**jIM_Ohio** · 10-04-2008, 01:08 PM

I chose not to quote because that will be too much work to isolate your responses from mine. Short responses like the last post work well (easy to quote and answer).

xray- this is a tool which looks at every mutual fund you own and tells you what they hold (in terms of small-mid-large and growth-blend-value). Before rebalancing, I would always xray to verify you hold what you think you hold.

Large cap is generally defined as total market cap greater than 5 billion.
Small cap is USUALLY defined as market cap under 2 billion (but greater than 500 million).
Mid cap would then generally be between 2 billion and 5 billion in market cap.

The issues with this:
1) Not all companies recognize the same limits
2) even if companies or funds recognize the limits, a fund may not sell a mid cap just because it grew into a large cap, or sell a large cap because it shrunk to a mid cap.
3) not all investors even recognize that mid caps exist as an asset class (to some there is large and small, to others there is only "total market".

S&P 500 is generally considered to be domestic large caps
Wilshire 5000 is generally considered to be total stock market
Wilshire 4500 is the total stock market MINUS the S&P 500 (anything not large cap)

If you run a wilshire 5000 index fund through xray, it will be 75% large and mid cap. Meaning the S&P 500 generally accounts for 75% of the value of the whole market.

**jIM_Ohio** · 10-04-2008, 01:20 PM

Originally posted by mrpaseo View Post

Any chance of getting a breakdown of this year by year? I understand the first 10 years, there is no change, on year ten I see that I would sell 1% of all holdings to produce 10% bond fund. Then at years 10 I would start dropping the Large Cap by one percent per year until I hit the 20 year mark. This is where I get lost. Do I ride these for another 10 years then start the percentage drop in the Mid/Sm Domestic (US accounts right?) funds? or do I start at the 10 year mark to drop the other funds by one percent per year?

BTW, I do plan on implimenting this plan, it's a sound plan from what I have read in books and here on line and the ratios sound pretty good. Thank you very much for your input.

Thanks,
Ray

year 1-10 100% equities or 90% equities and 10% cash (buy on dips)
year 11 add 2% bonds and reduce equites by 2%. 2% total.
year 12 add 2% bonds and reduce equites by 2%. 4% total.
year 13 add 2% bonds and reduce equites by 2%. 6% total.
year 14 add 2% bonds and reduce equites by 2%. 8% total.
year 15 add 2% bonds and reduce equites by 2%. 10% total.
year 16 add 2% bonds and reduce equites by 2%. 12% total.
year 17 add 2% bonds and reduce equites by 2%. 14% total.
year 18 add 2% bonds and reduce equites by 2%. 16% total.
year 19 add 2% bonds and reduce equites by 2%. 18% total.
year 20 add 2% bonds and reduce equites by 2%. 20% total.
year 21 add 1% bonds and reduce equites by 1%. 21% total.
year 22 add 1% bonds and reduce equites by 1%. 22% total.
year 23 add 1% bonds and reduce equites by 1%. 23% total.
year 24 add 1% bonds and reduce equites by 1%. 24% total.
year 25 add 1% bonds and reduce equites by 1%. 25% total.
year 26 add 1% bonds and reduce equites by 1%. 26% total.
year 27 add 1% bonds and reduce equites by 1%. 27% total.
year 28 add 1% bonds and reduce equites by 1%. 28% total.
year 29 add 1% bonds and reduce equites by 1%. 29% total.
year 30 add 1% bonds and reduce equites by 1%. 30% total.

**mrpaseo** · 10-05-2008, 04:16 AM

Before your post, I never new about this "x-ray", I think it's amazing. Here is a snapshot of my holdings:

Asset Allocation

Retirement Portfolio
Cash 1.83
U.S. Stocks 54.43
Foreign Stocks 23.95
Bonds 18.37
Other 1.42
Not Classified 0.00

I believe I need some moving around.
Ray

**jIM_Ohio** · 10-05-2008, 08:51 AM

Originally posted by mrpaseo View Post

Before your post, I never new about this "x-ray", I think it's amazing. Here is a snapshot of my holdings:

Asset Allocation

Retirement Portfolio
Cash 1.83
U.S. Stocks 54.43
Foreign Stocks 23.95
Bonds 18.37
Other 1.42
Not Classified 0.00

I believe I need some moving around.
Ray

Obviously you learn why some of us like the xray tool. You need to read your xray deeper. What was large-mid-small allocation?

**snafu** · 10-05-2008, 09:50 AM

Excellent jIM, wish I'd seen your allocation years ago! I've come to similar figures through trial and error.

The real trick to this is to keep your nerve and keep adding to your investments even while you see the 'crash and burn' around you. I keep telling myself this is buying my portfolio 'on sale.'

Hypothetical question: Retirement portfolio development