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42.  How Much Stock Should I Own if I'm Saving for a Fixed Spending Goal? Thumbnail

42. How Much Stock Should I Own if I'm Saving for a Fixed Spending Goal?

Episode 42 – Notes


Asset Allocation for a Fixed Goal

-    you may have filled out an investment questionnaire or built an investment policy statement for your long-term retirement portfolio that deals with your retirement income 

-    Typical allocation is something between 40% and 70% in equities, with the balance being in fixed-income

-    The design point of this portfolio is to provide an income for the rest of your life that (ideally) will keep up with inflation

-    The nature of this portfolio is that it is perpetual, and that you will only withdraw a small portion of it over a long time frame

But, what about if you have a fixed savings goal?

-    ie. you want to buy a house in 5 years and want to invest for a down payment, you are paying for your kid’s university education, you are buying a company

-    the key difference being that the timeline is fixed, and at the end of the timeline, the entire bucket of funding will be dumped out

Quick Refresh on Asset Allocation

-    On Average, US Stocks returned 11.3% in the US between 1950 and 2020

-    On Average, US Bonds (mix of corporate and government) returned 5.9% in the US between 1950 and 200

-    So, if stocks return way more than bonds, can I just save for my short term goal all in stocks? NO

-    The table from JP Morgan’s guide to the markets show that over short periods of time (1 year periods) stocks have returned as much as 47% but dropped as much as 39%.

-    So, you wouldn’t want to be saving all of your money for a down payment in stocks, to have it go down by over 1/3 right before you have to empty the account and make the down payment

-    Over similar periods of time bonds have returned less, but they also have had smaller drawdowns

-    When you blend stocks and bonds together (the grey bars), the results become more moderate (less high highs, and less low lows).

So, what to do about a fixed goal??

-    Larry Swedroe, in his book “Your Complete Guide to a Successful and Secure Retirement” provides a table that I have used as a guideline with clients

-    It shows for a given time horizon, what percentage of equities you might consider for your portfolio that gives you reasonable chance at success

-    These results are modeled based on the outcomes using a Monte Carlo simulator with a minimum estimated odds of 90%. – note that previous chart was historical US data, and we don’t know what future brings, so we use a monte carlo simulator.  Monte carlo simulator simulates thousands of bull markets and bear markets and gives you odds of success for a future financial goal.

These results are a guideline only.

Remember that your need for certainty and ability to take risks run in opposition to eachother.  The more certainty you need, the less equity risk you can take in the short run.  

On the other hand, someone who has a goal of paying for their son or daughters first car for $20k, but who also makes far more income than they spend, and is well insured, and in a stable job, they have a “Plan B” that they can fall back on, and they may be able to take more risks in saving for fixed goals.

Your Complete Guide to a Successful and Secure Retirement: Swedroe, Larry, Grogan, Kevin, Pfau, Wade D.: 9780857197320: Books - Amazon.ca

Thanks for Listening!