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Retirement

The 7 Levels of Financial Freedom

December 9, 2021 by Rob Berger

Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

The Financial Independence, Retire Early (FIRE) movement has underscored the power of financial freedom. It’s the central theme in my book, Retire Before Mom and Dad. Indeed, financial freedom is the guiding principle of how I manage money.

While financial freedom sounds good, however, many see it as a destination that’s at best 30 or 40 years away. To them, it’s just a fancy way of describing retirement.

I couldn’t disagree more.

While it’s true that we can and should define what ultimate financial freedom looks like (see below), we can begin to reap the benefits in a very short period of time. Financial Freedom is more of a journey than a destination.

It’s for this reason that my book walks through what I call the 7 Levels of Financial Freedom. And that’s what we’ll cover in this article. Be sure to check out the free financial freedom calculator near the end of the article.

Table of Contents
  • 4 Key Foundational Principles of Financial Freedom
  • The 7 Levels of Financial Freedom
    • Level 1: One Month of Expenses Saved
    • Level 2: Three Months of Expenses Saved
    • Level 3: Six Months of Expenses
    • Level 4: One Year of Expenses
    • Level 5: Five Years of Expenses
    • Level 6: Ten Years of Expenses
    • Level 7: Twenty-Five Years of Expenses
  • A Simple Financial Freedom Calculator

4 Key Foundational Principles of Financial Freedom

First, there’s value to money that you never spend. This is counter to what must people think. Even retirement savings will eventually be spent, even if it’s decades later. Until the money is spent, and even for money we never spend, however, there is tremendous value.

What’s the value? Our freedom.

Second, the benefits of financial freedom are experienced much sooner than retirement. The ability to retire is an empowering feeling, but it’s not the only kind of empowerment that savings can afford. Lesser tiers of financial freedom can change someone’s mindset and options for the better. The seven levels below will explain this more clearly.  

Third, the levels of financial freedom are calculated based on monthly expenses, not income. The focus should be on how many months of living expenses our savings can cover. That’s real freedom. As a result, we focus on what percentage of our income we can save.

Finally, we use Bill Bengen’s 4%  withdrawal rule when calculating Level 7 Financial Freedom. In other words, we achieve the ultimate financial freedom when are savings equals 25x our annual expenses. For example, a retiree who spends $54,000 a year in retirement would need $1,350,000 to reach Level 7.

The 4% rule has come under fire lately. Some say that given high stock valuations and low bond yields, it’s no longer viable. Morningstar recently released a report claiming 3.3% is the new “safe” withdrawal rate. Time will tell who is right. For our purposes, we’ll continue to use 4% for planning purposes only.

The 7 Levels of Financial Freedom

For each level you’ll find how many months it will take to reach the level if you save 10%, 15%, 20% or 30% of your income. Keep in mind that the number of months won’t change for different income levels. In each case, it’s your savings rate that determines your time to each level.

You can run your own numbers with the financial freedom calculator here (described in more detail below).

Level 1: One Month of Expenses Saved

Level 1 might not seem like Financial Freedom, but it’s an important start to your journey. It’s here that you stop living paycheck-to-paycheck. You may only have a one-month cushion, but that’s a big deal. It gives you breathing room for when—not if—the unexpected happens.

Studies show that most people cannot come up with $400 for an emergency. According to a study by the Federal Reserve, 4 in 10 Americans couldn’t cover a $400 emergency with their savings. In other words, most Americans have not achieved Level 1 Financial Freedom.

Time to Level 1:

Savings RateMonths to Level 1
10%9
15%5.5
20%4
30%2.3
Assumes a 5.0% Rate of Return (very conservative)

Note that saving 20% cuts by more than half the time to Level 1 as compared to saving 10%. That’s because as we save more we spend less. We thus get the double benefit of saving more money and need less money to meet our goal of one month of expenses. I call this the Boomerang Affect in my book.

Also note that compounding has very little to do with reaching Level 1. We haven’t yet saved enough money over enough time to see the benefits of compounding. That comes around Level 4 and after, when the majority of our wealth is from compounding.

Level 2: Three Months of Expenses Saved

At Level 2, we reach what most financial gurus say is the minimum emergency fund you should have. You now have enough money in the bank to handle most emergencies. The money could even help you survive during a short-term job transition.

Reaching this point should taste sweet. If an unexpected expense pops up, there isn’t a need to borrow money to cover it. This is important given avoiding high-interest debt is essential to reaching financial freedom. 

Time to Level 2:

Savings RateYears to Level 2
10%2.1
15%1.4
20%1.0
30%0.6
Assumes a 5.0% Rate of Return

The effect of compounding interest is still in its nascent stage by Level 2. The example shows that around 5% of the ending balance comes from investment returns. Building wealth takes time.

The numbers do change when the savings rate changes. Changing the savings rate in the example to 20% instead of 10% halves the time it takes to reach Level 2. As an investor lives further and further below their means, their journey toward greater financial freedom becomes exponentially faster.

Level 3: Six Months of Expenses

Level 3 is simply the upper bound of an emergency fund, with 6 months of expenses. The balance should be able to cover the unfortunate possibility of all insurance deductibles coming due simultaneously. An extended unemployment period also would be manageable. Compound interest begins to become noticeable.   

Time to Level 3:

Savings RateYears to Level 3
10%2.1
15%1.4
20%1.0
30%0.6
Assumes a 5.0% Rate of Return

Level 4: One Year of Expenses

Level 4 is when things start to get interesting. Two things happen.

First, with one year of expenses saved, you can handle a significant bout of unemployment. Today the average person will change jobs 12 times during their lifetime. While we hope these transitions go smoothly, Level 4 Financial Freedom will help you ride out any bumps in the road.

Second, we start to see the benefits of compounding, something I call the Money Multiplier in my book. As we now know, most of our Freedom Fund doesn’t come from putting aside money each month. That’s how it starts, of course, when we are trying to reach Level 1, 2, or even 3.

Eventually, however, the money we save starts to earn a nice return. In fact, if done right, our investments will produce far more income than our jobs. That takes time, and it’s here at Level 4 that we start to get a glimpse of the power of the Money Multiplier.

Time to Level 4:

Savings RateYears to Level 4
10%7.5
15%5
20%3.7
30%2.2
Assumes a 5.0% Rate of Return

Level 5: Five Years of Expenses

At Level 5, you’ve already exceeded the savings that most will achieve in a lifetime. Assuming $50,000 in annual expenses (the round number makes the math easier), for example, you’ve amassed $250,000 in savings and investments. At a 9.3% return (the average return of an 80/20 portfolio over the last 90 years), your Freedom Fund will generate almost $25,000 in returns over the next 12 months. In other words, your investments are generating income approaching 50% of your annual spending.

Level 5 also represents a danger point. It’s here that some may become complacent. With so much money saved, it’s easy to return to old habits or to lose focus. Knowing that now will help you avoid this danger when you reach Level 5.

At this point you may be wondering what Level 5 Financial Freedom feels like. After all, one could say this is nothing more than traditional retirement savings. Oh, but it’s so much more!

Let me tell you a story.

In the middle of my career, I had a job that at times was very unpleasant. I have a vivid memory of a meeting with the boss. He was yelling at an employee on the phone. He was out of line. It was then I understood the true power of Financial Freedom.

While my wife and I hadn’t reached Level 7 at that time, we were right around Level 5. I knew I could walk out of that job if I needed to and we’d be fine financially. I wasn’t stuck. And it was a great feeling.

Less than a year later, I took a pay cut to pursue a new opportunity. I took that risk because I could; I wasn’t chained to my job or to the salary. It turned out to be the best career move of my life. And it was made possible because of Level 5 Financial Freedom.

This is an example of how money saved and never spent can have a profound effect on our lives.

Time to Level 5:

Savings RateYears to Level 5
10%23.6
15%17.7
20%13.9
30%9.2
Assumes a 5.0% Rate of Return

Level 6: Ten Years of Expenses

Level 6 is an important milestone. It’s here that your investment income will begin to equal and then exceed how much you are spending each year.

Let’s again assume you spend $50,000 a year. At Level 6, you will have a Freedom Fund totaling $500,000. A 9.3% return will generate returns of $46,500 over the next 12 months, bringing your Freedom Fund to $546,500. The following year, with a Freedom Fund totaling almost $550,000, you will on average generate just over $50,000 a year.

Talk about a great feeling! You are working hard, earning an income, and spending $50,000 a year. At the same time, your Freedom Fund is generating returns equaling the same amount. Like a snowball rolling downhill, your wealth is multiplying before your very eyes.

Time to Level 7:

Savings RateYears to Level 6
10%34
15%26.9
20%22
30%15.5
Assumes a 5.0% Rate of Return

Level 7: Twenty-Five Years of Expenses

Level 7 is the Ultimate Financial Freedom. It’s here that you can completely retire from work if you so choose. Or, if you’re like me, you can work on projects you love while still earning an income. The choice is yours.

Level 7 enabled me to retire from the practice of law at 49. Following my retirement, I continued to run my personal finance blog, newsletter, and podcast. Two years later I sold my blog, but I still record a podcast each month, and I became a Deputy Editor at Forbes for a couple of years. These activities generated income. But I did them because I’m passionate about personal finance and investing.

When you reach Level 7, you can pursue your passions. That may mean keeping your job. There’s nothing wrong with that if that’s what you love. It may mean starting a business. Here’s the point—you decide for yourself what you’ll do when you reach Level 7. It’s a beautiful feeling.

Time to Level 7:

Savings RateYears to Level 7
10%50
15%41.9
20%35.9
30%27.4
Assumes a 5.0% Rate of Return

A Simple Financial Freedom Calculator

I’ve created a free financial freedom calculator in Google Sheets. The tool is simple to use. You simply input the following four things:

  1. Rate of return
  2. After-tax income
  3. Savings rate
  4. Current savings

From there the tool estimates how long it will take you to reach each level of financial freedom.

The tool has an investment rate of return of 5% input by default. This roughly represents the historical post-inflation return of a 60-40 stock/bond portfolio. You can change the assumption to whatever you like.

Debt is conspicuously missing from the spreadsheet. This is because debt payments are accounted for in the after-tax income section. Debt repayment is considered a recurring monthly expense. It’s possible to be financially free while having some debt and the calculations reflect that.

The baseline savings rate is listed at 10%. That number is in line with conventional retirement advice. Over an average 40-45 working life an investor would be on track to retire at 65 given a 10% savings rate. Again, that figure can be changed in the spreadsheet.

Finally, be sure to alter the current savings section. Many will be starting at more than zero. The number should include emergency short-term savings as well as retirement or brokerage account balances.

Final Thoughts

Financial freedom is the best thing money can buy. As I was working toward the goal, I viewed every dollar I saved as buying my financial freedom. At first it starts off slow, but it quickly builds to the point that compounding generates far more money than we could ever make at work. The key is to get started now.

And for those that want to track their progress with a more sophisticated tool, check out Personal Capital. It’s free and the best overall net worth, investment and retirement planning tool available today.

Filed Under: Investing, Retirement

4 Best Target Date Retirement Funds in 2023

December 2, 2021 by Rob Berger

Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

Target date retirement funds make investing in a 401(k) or IRA easy. Simply pick a fund that corresponds with when you plan to retire, and the fund does the rest. In this article we’ll look at several of the best target date retirement funds available today.

Table of Contents
  • 4 Best Target Date Retirement Funds
    • M1 Finance Target Date Retirement Funds
    • Vanguard Target-Date Retirement Funds
    • State Street Target Date Retirement Funds
    • Fidelity Freedom Index Funds
  • Target Date Retirement Funds in 401(k) Accounts
  • Backtesting Target Date Funds
  • Not All Target Date Funds are Good Investments
  • How Target Date Retirement Funds Work
  • The Downside of Target Date Funds for Retirees
  • Are Target Date Retirement Funds Diversified?
  • Final Thoughts

Target date retirement funds can be great tools for long-term investors. There are, however, factors that differentiate great target date funds from others I would not recommend. I’ve researched dozens of funds to identify the best options, as well as an example of a target date fund you should avoid.

4 Best Target Date Retirement Funds

For each of the target date funds below, we’ll explore the 2050 version. A 2050 fund is designed for those retiring around the year 2050. Each of these fund families offer funds in five-year increments (e.g., 2020, 2025, 2030).

M1 Finance Target Date Retirement Funds

M1 Finance retirement funds make the top of my list for several reasons. First, for each retirement year (e.g., 2020, 2025, 2030), M1 Finance offers three different funds. All of the other options below only offer one. Specifically, M1 Finance offers investors Aggressive, Moderate and Conservative options for each retirement year.

M1 Finance Target Date Retirement Funds

For example, the M1 Finance 2050 Aggressive Target Date Retirement Fund allocates just 3% to bonds, while its 2050 Conservative fund allocates 19% to bonds.

Second, each of M1 Finance’s funds (they call them Pies) include broad stock and bond exposure across more than a dozen low cost ETFs. Here, for example, are the ETFs used in the 2050 Aggressive fund:

M1 Finance 2050 Fund

Third, unlike the other funds in my list, there is no elevated expense ratio to pay. M1 Finance doesn’t charge a fee. The only fees are those associated with the low cost ETFs M1 uses in each portfolio, and these are lower than the fees a target date fund charges.

Finally, the fund for those now in retirement (the 2020 fund) is in my view the best option available. The Aggressive 2020 fund is approximately 60/40 stock to bond allocation a reasonable approach for retirees following the 4% rule. Without exception other retirement funds become far too conservative at this stage.

M1 Finance target date funds are automatically updated and rebalanced quarterly. There is no minimum initial investment required.

Summary

  • Expense Ratio: 0.08%
  • Dividend Yield: 1.831%
  • Minimum Investment: None
  • Website: M1 Finance

Vanguard Target-Date Retirement Funds

Vanguard’s 2050 offering, ticker VFIFX, is another solid option.

Vanguard Target Retirement 2050 Fund

The expense ratio for the fund is extremely reasonable at only 15 basis points (0.15%). Important to note given low fees often predict the later success of a fund. VFIFX checks that box. 

Turning to the Portfolio tab on Morningstar gives us a better look into the asset allocation of the fund.

Vanguard 2050 Fund Asset Allocation

Vanguard’s 2050 fund is 54% invested in US stocks and about 37% invested in international stocks. The remaining 9% of the fund is allocated to bonds. This aggressive investment mix makes sense given that it’s tailored for an investor with 30 years left to build their Portfolio. Keep in mind that this allocation will become more weighted toward fixed income as we get closer to 2050.

Vanguard implements this asset allocation plan using five Vanguard funds:

Vanguard 2050 Fund Portfolio

Five holdings doesn’t seem diversified. Here it’s important to understand that the number of funds in a portfolio tells us nothing about its overall diversification. We need to know what each of the funds owns. In this case, the holdings include thousands of stocks and more than 10,000 bonds. It’s well diversified.

Vanguard requires a $1,000 minimum initial investment.

Summary

  • Expense Ratio: 0.15%
  • Dividend Yield: 1.41%
  • Minimum Investment: $1,000
  • Website: Vanguard

State Street Target Date Retirement Funds

State Street’s 2050 target date retirement fund, ticker SSDLX, makes a strong impression with only a 9 basis point (.09%) expense ratio. It’s one of the least expensive options available today.

State Street Target Retirement 2050 Fund

Its asset allocation is similar to Vanguard’s.

State Street Target Retirement 2050 Asset Allocation

The Portfolio tab shows us the fund is invested 51% in U.S. stocks, 35% in international stocks, and about 10% in bonds. The holdings of the fund reveal more similarities to its Vanguard counterpart. It invests the fund in six index funds.

State Street Target Retirement 2050 Portfolio

Three stock funds and two bond funds substitute for the inverse with Vanguard’s offering. The U.S. stock portion of the fund is split into an S&P 500 large blend fund and a mid-cap growth fund. Still, State Street’s fund should perform in line with Vanguard’s, with the added benefit of the lower expense ratio we saw earlier. 

Summary

  • Expense Ratio: 0.09%
  • Dividend Yield: 1.32%
  • Minimum Investment: None
  • Website: State Street

Fidelity Freedom Index Funds

The final fund is Fidelity’s Freedom Index 2050 Investor, ticker FIPFX. The exact naming of this fund is important to note. FIPFX has the word index in the fund name. Fidelity offers another Freedom 2050 target-date fund, but the underlying holdings consist of actively managed mutual funds.

As a result, that fund charges 75 basis points (.75%) in fees. In contrast, the Freedom Index fund only charges 12 basis points (.12%). That expense ratio puts the Fidelity fund in between State Street’s and Vanguard’s options.

Fidelity Freedom Index 2050 Fund

The asset allocation of this fund is nearly identical to the Vanguard, State Street and M1 Finance Moderate funds.

Fidelity Freedom Index 2050 Fund Asset Allocation

Nothing surprising jumps out–53% of the fund is allocated to U.S. stocks and 37% to international stocks. Bonds fill out the remaining 10%. 

The holdings of the fund shouldn’t shock anyone either. Fidelity uses Fidelity index funds to implement its asset allocation.

Fidelity Freedom Index 2050 Fund Portfolio

Overall, another sensibly arranged portfolio–Diversified, low-cost, and convenient. 

Summary

  • Expense Ratio: 0.12%
  • Dividend Yield: 1.18%
  • Minimum Investment: None
  • Website: Fidelity

Target Date Retirement Funds in 401(k) Accounts

If target-date retirement funds are starting to seem like attractive options, it might be worth considering holding a target date fund in a 401k if one is available to you. Since company 401(k) plans often invest hundreds of millions at a time, mutual fund providers may offer companies an expense ratio discount to attract their business.

For example, ticker FRLPX is the Fidelity Freedom Index 2050 option offered in my 401(k) at Forbes. This version of the fund has the same asset allocation, holdings, and glide path but charges half the fees of the non-401(k) investor class fund. 

I mention this industry convention not only to highlight the fee difference but also to prevent any confusion when picking funds in a 401(k). If there’s any doubt as to whether one fund mirrors another, it’s best to check the Portfolio tab on the Morningstar listing for both funds and make sure the only difference is the expense ratio.

Backtesting Target Date Funds

For a performance comparison of the funds, we’ll be using Portfolio Visualizer. This site is great for backtesting portfolio options and provides a number of useful metrics for weighing funds. The data set will be limited by the age of the newest target-date retirement fund, but we have a reasonable length of time to compare the funds. 

Target Date Fund Performance

The 3 funds compete very closely with one another. The Fidelity fund ultimately wins out by only a couple hundred dollars. The standard deviation of the funds, a measure of portfolio volatility, is fairly uniform from fund to fund. The same goes for the maximum drawdown period of the funds. Safe to say, any of the three funds are reasonable and comparable options.

The M1 Finance fund has had similar return and risk characteristics.

Not All Target Date Funds are Good Investments

I’ve chosen one fund that exemplifies some suboptimal aspects that should signal investors to steer clear. I do this not to belittle the mutual fund company or fund in particular, but to illustrate what potential negative qualities of target date funds can cost investor’s future returns.

The fund is called the American Century One Choice 2050, ticker ARFMX. I would avoid the fund for two main reasons. 

American Century One Choice 2050 Fund

First off, the fund’s expense ratio is simply too high. American Century charges over 1%, making it more than 10 times as expensive as the fund options we’ve looked at. Unfortunately, that isn’t the end of the fees associated with investing in the fund. ARFMX has a front load fee, meaning there’s a sales charge paid every time you buy into the fund. Purchasing through a 401(k) would bypass that fee. Otherwise, and I can’t caution against this enough, that fee would recur every time a contribution is made.

ARFMX Fees

The second reason why I’m not a fan of this fund is its asset allocation.

American Century One Choice 2050 Asset Allocation

Remember that American Century’s target date is a 2050 fund just like the 4 funds we explored. That means the typical investor in the fund is 30 years away from retirement. Nevertheless, the fund allocations 22% in bonds. For some investors, that conservative approach might be attractive. But in my estimation, that is too cautious a strategy for investors with such long time horizons.

An 80/20 split between stocks and bonds is perfectly reasonable in a vacuum, but remember the fund will increase its bond allocation over time. Overall, the fund is a suboptimal choice given its fee burden and asset allocation. 

The American Century fund performance in comparison to Vanguard’s offering should bear out my concerns. 

American Century One Choice 2050 Performance

That data for this backtest in Portfolio Visualizer goes back to 2009. The fund’s fees and asset allocation drag on the ugly duckling fund to the tune of almost a full percent less in returns.

The key point is to recognize that not all target date funds are created equal.

How Target Date Retirement Funds Work

Target date retirement funds feature a date in their name. For example, the funds we’ve discussed are 2050 funds. The date corresponds to the investor’s planned retirement date. Somebody seeking to retire in about 30 years would be especially interested in 2050 funds.

Target date retirement fund offerings are typically spaced out in 5-year increments, meaning there are 2045 and 2055 versions of the funds we’ve explored. Picking a retirement date is not an exact science and things do change. Still, having a target date in the fund name provides some useful information about the fund’s asset allocation today and in the future. 

Target date retirement funds hold a combination of U.S. stocks, international stocks, and bonds. The specific weighting of those asset classes adjusts over time and can vary between mutual fund companies. The expense ratio associated with target date funds goes, in part, toward paying for these adjustments. Allocation adjustments are made based on “glide paths”, which are predetermined rebalancing plans that each target date retirement fund follows.

As investors get closer to their chosen retirement date, target date funds shift more heavily toward bonds and away from stocks. This shift is meant to reduce portfolio volatility during investors’ retirements. An attractive approach in theory but one that can create some pitfalls, which we’ll address next. 

The Downside of Target Date Funds for Retirees

Target date funds are a reasonable approach to investing for retirement. Once you reach retirement, however, these funds have a downside. They become far too conservative.

These funds follow a declining glide path. That simply means that as we get closer to retirement, the funds move stock investments over to bond investments. That in itself is reasonable. The problem is that they become far too conservative.

For example, the Vanguard Target Retirement 2015 fund is only 30% invested in stocks. A retiree six years in might want the security of a healthy bond allocation, but I would argue there’s such thing as being too safe. Granted, I’ve shifted my own investments into safer investments in retirement. Still, I wouldn’t recommend divesting a portfolio of stocks past the 50% mark.

In fact, Bill Bengen, the father of the 4% rule, found that a retiree’s portfolio should have 50% to 75% in stocks. Anything less and their odds of running out of money early go up.

With the exception of M1 Finance, each of the target date funds mentioned above fall well below the 50% equity floor.

Are Target Date Retirement Funds Diversified?

Diversification is important to any investor. Investing in a single mutual fund seems counter to that idea, but not in the case of target date retirement funds. Target date retirement funds provide ready-made diversified portfolios that hold thousands of domestic and international stocks and tens of thousands of bonds of various credit qualities. So yes, these funds are well diversified.

Final Thoughts

While I don’t personally invest in target date retirement funds, they are still reasonable and effective options. I advocate that investors start their wealth-building plans with a 3-fund portfolio. That said, the solid target date fund options we’ve discussed are all reasonable approaches to retirement investing.

Filed Under: Investing, Retirement

Capitalize Review–A Free 401k Rollover Service

October 19, 2021 by Rob Berger

Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

Rolling over a 401k to an IRA is a hassle. I know from personal experience. Capitalize, a venture capital backed technology company, looks to take the hassle out of 401k rollovers.

The company offers a free service that handles all of the paperwork to safely transfer a 401k to an IRA. It never has access to your money and can help you choose an IRA if you want. In this review of Capitalize, I’ll look at the details of how the service works and how they manage to offer it for free.

Capitalize QuickTake

Get Started
  • Free 401k rollover service
  • 4.9/5.0 Trustpilot Rating
  • Works with most IRA providers
  • Capitalize never has custody of your money

About Capitalize

Co-founders Gaurav Sharma and Chris Phillips launched Capitalize in 2020. The mission of the company is simple–to make the 401k rollover process easy. It raised $12.5 million in capital earlier this year. It has 17 employees and a TrustPilot customer rating of 4.9 out of 5.0.

Capitalize Review

How Capitalize Works

Capitalize follows a simple 3-step process.

Step 1: Locating your 401k

While this may seem odd to some, many people have long forgotten about an old 401k account. Or perhaps they don’t know how to access it. In step 1, Capitalize will help you locate your 401k if you need the help.

I searched for an old company that no longer exists (they went bankrupt). Capitalize found the company’s 401k plan, to my surprise.

Step 2: Choose an IRA

Here you can use an existing IRA if you have one. Otherwise, Capitalize can help you choose a new IRA. To help you pick an IRA, the tool walks through a number of questions:

  1. Whether you want to manage your investments or have them managed for you
  2. What factors are most important to you, including low fees, long standing brand, easy to use, and access to a human advisor.
  3. How much money you have in your 401k (some IRA accounts have minimum deposit requirements).

Based on answer these questions, Capitalize suggests a number of IRA providers. For me, the top choices were Betterment, Wealthfront, Fidelity and Vanguard, among others.

At this step in the process, you create a Capitalize account with an email and password. Once created, you can click a link to open an IRA account at your chosen firm

Step 3: Submit 401k Info

Finally, you submit information about your existing 401k. This allows Capitalize to initiate the 401k rollover process. I found this process to be extremely quick and easy as I walked through it as part of this review.

What 401k Accounts Does Capitalize Worth With?

Capitalize works with all major 401k providers, as one would expect. This includes Fidelity, Empower, Vanguard and T.Rowe Price. For those with smaller providers, Capitalize allows you to search for your retirement account by your former employer’s name.

How does it do this? Workplace retirement accounts like a 401k must be registered with the federal government. In fact, you can search what are called Form 5500 returns yourself here at the Department of Labor’s website. The search feature is a bit hard to navigate. Fortunately, Capitalize makes it much easier.

If your 401k provider is not listed, just search for your company. Capitalize will then track down the 401k plan for you.

In addition, Capitalize works with both traditional and Roth 401k accounts, as well as 403b accounts.

What IRA Accounts Does Capitalize Work With?

If you need to open an IRA, Capitalize offers a variety of options. These include traditional brokers (Fidelity, Vanguard, Merrill, ETrade, TD Ameritrade), robo-advisors (SoFi, Betterment, Wealthfront), and some newer brokers (Ally, TradeStation).

You can also use your existing rollover IRA account if you have one.

How Long does a 401k Rollover Take with Capitalize?

It depends. It can take from a few days to a few weeks. The time varies because the processes that must be followed vary from one 401k provider to another.

How is Capitalize Free?

Capitalize makes money if a customer opens a new IRA account through its platform. This raises an important question. Does Capitalize’s revenue model influence the IRA accounts that it recommends? According to Capitalize, the answer is no:

If you choose to open up an IRA with one of the providers on our platform then we may be compensated. This helps us keep the service free for users, but none of those providers is ever allowed to impact the content on our site. It also never affects the fees you pay as a customer. If you’ve ever used a site like Nerdwallet, Credit Karma or Lending Tree then you’ll be familiar with this model. Our reputation depends on you feeling like we provide an honest, independent product. 

I can add to their list of sites that earn money through partners RobBerger.com. My site makes money from some of the tools and services discussed on this site, including Capitalize.

My approach to this is simple. I’ll only recommend a product or service that (1) I use or (2) would feel comfortable recommending to my mom or my children. However, you should always be aware of a company’s financial incentives and undertake your own due diligence to make the best decision for you and your situation.

Capitalize Alternatives

At the moment, the only alternative to Capitalize that I’m aware of is to do it yourself. If you take that route, one tip is to contact your IRA provider first. They can often help you through the process, although you’ll have to do all of the legwork.

Final Thoughts

I’ve rolled over 401k accounts a number of times. Fortunately, I’ve never encountered significant issues, but it is a hassle. The last rollover a few months ago required a lot of paperwork, faxing and scanning. It would have been much easier if I had help.

I’ll be rolling over another 401k in December. I’ll definitely be using Capitalize. Why not take the free help?

Filed Under: Retirement

5 Best Retirement Planners and Apps (#1 is Free)

September 18, 2021 by Rob Berger

Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

Retirement calculators can help us plan and prepare to retire. When we are years away, these online tools can help us determine how much we should be saving. As we approach our time to retire, they can help us understand how much we can spend each year and which accounts should fund that spending.

Not all retirement tools, however, reach the same result. They take different approaches to what is a complex series of calculations and assumptions. One study examined five popular retirement planning software packages and found stark differences in outcomes. As a result, it recommended that individuals use “multiple programs before implementing an action plan based on the results.”

To that end, here is a list of the best retirement calculators, planners and software tools.

Editor’s Top Picks

Of all the retirement planners available today, two stand out among the rest:

  1. Personal Capital–It’s both free and comes with a robust set of features. Its retirement planner enables you to model everything from social security to pensions to one-time income (e.g., inheritance) and expenses (e.g., home renovation) during retirement. You can create multiple scenarios and run Monte Carlo simulations to see your chance of financial success (i.e., not running out of money).
  2. New Retirement–This tool allows you to model virtually every aspect of retirement. It projects future income, expenses and net worth. You can set income and expenses on a monthly, yearly or one-off basis. It can model social security, pensions and even Roth IRA conversions. There is an annual fee, although New Retirement does offer a free trial.

Best Retirement Calculators

What follows are my top 5 picks. The first three are retirement planners, allowing you to enter detailed information about your finances both before and after retirement. The final two options are more of retirement calculators. The inputs are much more limited, but these tools give you a quick estimate of when you can retire.

1. Personal Capital

Best all around retirement planner

Personal Capital is my favorite investing and retirement tool. In addition to being totally free, it’s extremely easy to use and rich in features. Once a user connects their 401k, IRA and other investment accounts, Personal Capital pulls all the data from the accounts into its Retirement Planner.

Personal Finance Retirement Planner

The Retirement Planner then allows users to model both income events (e.g., savings, sale of real estate, social security, pensions) and spending goals (e.g., retirement spending, travel, education). Users can also set up multiple scenarios to compare, such as retiring at different ages. Personal Capital then runs the data through a Monte Carlo simulation and reports the likelihood of the plan’s success.

Personal Capital is offering a $100 gift card. Here are the terms:

  • Sign up for Personal Capitals’ free, easy-to-use financial tools
  • Link bank and investment accounts of at least $250,000 (savings, investment accounts, employer-sponsored 401ks, etc.)
  • Receive a free, two-part financial analysis with our licensed experts before March 1st, 2023

You must use this link for the bonus.

Unique Feature: Users can create multiple scenarios (e.g., different retirement dates, different social security strategies) and compare how successful each will be.

Try Personal Capital

2. New Retirement

Most detailed retirement analysis

New Retirement is not for the faint of heart. The tool, which has both a free and paid version, enables users to model just about every aspect of retirement. For example, users can model social security claiming strategies, medicare coverage, annuities and pensions.

New Retirement Planner Dashboard

New Retirement handles the complexity of retirement planning in two ways. First, users can follow a quick start guide, answer a few simple questions, and have a complete snapshot of their retirement readiness in under five minutes.

Following that, users can dive into the details of everything from future healthcare costs to retirement savings contributions. New Retirement enables users to link investment and retirement accounts or enter them manually.

New Retirement offers three plans ranging in cost from free to $396 a year.

Unique Feature: New Retirement includes a Roth IRA conversion calculator to help users determine when and how much of a traditional IRA should be converted to a Roth IRA.

Try New Retirement

3. OnTrajectory

OnTrajectory is quickly becoming one of my favorite retirement planners. Like New Retirement, it allows you to map out just about everything related to both saving for retirement and spending during your golden years.

OnTrajectory Retirement Planner

It takes just seconds to get started. You’ll answer a few questions, and OnTrajectory will set up a projection of your future savings and spending. From there you can begin to enter data to fine tune every aspect of the plan.

The tool is divided into three sections–Income, Expenses and Accounts. You can link your accounts so they automatically update, or you can enter balances manually. For income, the tool accommodates everything from work to pensions to rental properties. Expenses include every type of expense imaginable, and you can group expenses to make reporting easier.

As for accounts, you can link or manually create 401k, IRA, HSA and taxable accounts. It covers 457B plans (which have specially rules), as well as 529 plans and both traditional and Roth accounts.

Once you’ve entered the data, OnTrajectory uses both Monte Carlo Analysis as well as historical market returns and inflation data to calculate the chances of retirement success. Finally, you can create and compare multiple retirement scenarios.

Unique Feature: You can change the order of accounts withdrawals are taken during retirement or let OnTrajectory calculate the most tax efficient order.

Try OnTrajectory

4. NetWorthify

NetWorthify is designed for those wanting to retire early, although it works with traditional retirements, too. Simply enter your income, annual savings and total savings, and NetWorthify estimates how long until you can retire. It’s free to use.

NetWorthify early retirement calculator

5. cFIREsim

Another free option that I like a lot is cFIREsim. You enter some basic information such as when you plan to retire, current savings, income, asset allocation of your investments and social security values. cFIREsim then calculates the likelihood of your success.

cFIREsim retirement calculator

Retirement Calculators Worth Considering

The following retirement tools didn’t make are list, but still may be worth checking out. In some cases, I’m continuing to evaluate them, and some make make the “best of” list in the future.

  • FireCalc
  • T. Rowe Price
  • MaxiFi Planner
  • Fidelity Retirement Score
  • Ultimate Retirement Calculator
  • Vanguard Retirement Nest Egg Calculator
  • ESPlanner
  • AARP
  • Fidelity Full View
  • Betterment Retirement Savings Calculator
  • Charles Schwab Retirement Calculator
  • Dave Ramsey’s Retire Inspired Quotient Tool
  • Stash Retirement Calculator
  • The Complete Retirement Planner

Retirement Calculators Not Worth Considering

Here are retirement tools that I believe aren’t worth our time. I list them here to keep a record of what I’ve looked at and so that readers know I’ve considered and rejected these options.

  • Flexible Retirement Planner–Too many ads on the site and planner must either be downloaded (Windows only) or used Java Web Start.

Filed Under: Retirement

3 Ways Early Retirees Can Tap Retirement Accounts Without a 10% Penalty

September 14, 2021 by Rob Berger

Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

  • Summary: In most cases, distributions from a 401k, IRA or other retirement account before the account owner reaches the age of 59.5 are subject to a 10% penalty. There are, however, a number of exceptions. Some of the exceptions are unique to IRAs, while others are unique to 401k and other Workplace Retirement Plans.
  • Hardship Exceptions
    1. Death (401k & IRA)
    2. Total and permanent disability (401k & IRA)
    3. Military: certain distributions to qualified military reservists called to active duty (401k & IRA)
    4. Medical: amount of unreimbursed medical expenses (>10% AGI for 2021, >7.5% AGI; for 2017 – 2020) (401k & IRA)
    5. 401k Loan
      • https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-loans
    6. Divorce: to an alternate payee under a Qualified Domestic Relations Order
    7. Permissive withdrawals from a plan with auto enrollment features (401k only)
      • Must elect to withdrawal the funds within the time allowed by the plan (30 to 90 days)
      • Forfeit any employer matching contributions
      • https://www.irs.gov/retirement-plans/faqs-auto-enrollment-can-an-employee-withdraw-any-automatic-enrollment-contributions-from-the-retirement-plan
  • Invest in Your Future Exceptions (IRAs Only)
    1. Education: qualified higher education expenses
    2. Homebuyers: qualified first-time homebuyers, up to $10,000
  • Early Retirement Exceptions
    1. Equal Payments: series of substantially equal payments (for 401k, cannot work for employer) (401k & IRA)
      • https://www.irs.gov/retirement-plans/substantially-equal-periodic-payments
      • Payments can be based on just one account or multiple accounts
        • https://www.thetaxadviser.com/issues/2008/oct/substantiallyequalperiodicpaymentsfromanira.html
    2. Age 55 (401k Only): the employee separates from service during or after the year the employee reaches age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan)**
    3. Roth IRA Conversion Ladder
      • https://www.madfientist.com/how-to-access-retirement-funds-early/
  • Sources
    • https://www.irs.gov/taxtopics/tc558
    • https://www.irs.gov/pub/irs-tege/early_distributions.pdf
    • https://www.irs.gov/pub/irs-tege/rollover_chart.pdf
    • https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

Filed Under: Retirement

The 60/40 Portfolio for Retirees–Good, Bad or Ugly?

July 21, 2021 by Rob Berger

Some of the links in this article may be affiliate links, meaning at no cost to you I earn a commission if you click through and make a purchase or open an account. I only recommend products or services that I (1) believe in and (2) would recommend to my mom. Advertisers have had no control, influence, or input on this article, and they never will.

The 60/40 portfolio has powered retirements for decades. With 60% stocks and 40% bonds, this balanced fund offers equity-fueled growth and fixed income stability.

Today, however, many are calling into question the sustainability of the 60/40 portfolio. Some even argue that it’s dead and that retirees need take on more risk if they want to avoid outliving their retirement savings.

In this article we’ll take a deep dive into the 60/40 portfolio and whether it’s still a viable approach to investing for retirees.

Table of contents

  • A Brief History of the 60/40 Portfolio
  • Arguments that 60/40 Portfolio is Dead
    • Argument #1: Bond yields are at all-time lows
    • Argument #2: The 40-Year Bull Market in Bonds Is Over
    • Argument #3: Equity Valuations are High (and must fall significantly)
    • Argument #4: Negative Correlation May be Over
  • Arguments that 60/40 Portfolio is Still Solid
    • Argument #1: Retirees are long-term investors
    • Argument #2: The 60/40 Portfolio has Worked Since 1871
    • Argument #3: The 60/40 portfolio offers growth and stability
    • Argument #4: Retirees can stick with a 60/40 portfolio
    • Argument #5: The 60/40 portfolio survived rising rates and inflation
  • Building a 60/40 Portfolio
  • Final Thoughts

A Brief History of the 60/40 Portfolio

Dating back to 1926, the 60/40 portfolio has enjoyed an annualized return of 9.1% (Source: Vanguard). Its best year, 1993, saw returns of 36.7%, while its worst year, 1931, experienced a loss of 26.6%. Over those 95 years, 22 saw the portfolio decline in value. The returns combined with relative stability have made the balanced portfolio ideal for retirees.

More recent returns show similar results. From 1972 to 2021 a 60/40 portfolio consisting of an S&P 500 index for stocks and intermediate term Treasuries for bonds has returned 9.61% with a standard deviation of 9.51% (via Portfolio Visualizer). The combination of solid returns with less volatility has been ideal for retirees.

In his 1994 paper, certified financial planner Bill Bengen gave us what is now known as the 4% Rule. In brief, the 4% Rule states the following:

  • A retiree can spend 4% of their investments in the first year of retirement;
  • In subsequent years, the retiree can adjust the prior year’s distribution by the rate of inflation; and
  • Following this approach, the retiree should not outlive their money.

Why do we care about the 4% rule? We care because the 60/40 portfolio fits in the sweet spot of the 4% Rule. Bengen found that retirees should hold somewhere between 50% and 75% in equities. In a later book, he identified 60/40 as the ideal portfolio in retirement to avoid outliving a nest egg. Other papers evaluating safe withdrawal rates have reached similar conclusions (as we’ll see in a minute). Some have even evaluated its performance back to 1871!

Notwithstanding the 60/40 portfolio’s stellar history dating back to the post-Civil War era, many are now calling into question its future.

Arguments that 60/40 Portfolio is Dead

There have been several arguments put forth that the 60/40 portfolio is no longer ideal for retirees. All of the arguments stem from the unprecedented financial times we are currently in.

Argument #1: Bond yields are at all-time lows

The yield on the 10-year Treasury sunk to its lowest in 2020 and remains at historic lows. When viewed on a yearly basis, the yield sunk below 2% back in 1941 (1.95% to be precise). Apart from that one year, it remained above 2.00% until 2012 (Source: Shiller). It’s currently at about 1.30%.

During much of the 20th century, the yield was significantly higher. It reached over 14% in 1982. At today’s low yields, many question how a 60/40 portfolio could survive a 30-year retirement.

From Money (4/21/21):

“I think the 60/40 portfolio is antiquated,” says Keith Singer of Singer Wealth Advisors in Boca Raton, Florida. “When bonds used to pay 6-8% and interest rates were falling, the 60/40 model worked great. But as they say, past performance is no guarantee of future results, and that is especially true with the 60/40 portfolio.” (Source: Money).

Argument #2: The 40-Year Bull Market in Bonds Is Over

The second argument relates to the fall of yields over the past 40 years. They hit a high in 1982, and then steadily dropped to their historic lows today. As bond yields fall, the value of existing bonds go up. As such, retirees have benefited from falling interest rates. Unless rates go negative, however, most believe the bull market in bonds is over

If the bond bull market is over, and rates begin to rise, the value of existing bonds will fall. Rising rates can also lead to lower asset values on everything from stocks to real estate, which brings us to the third argument.

Argument #3: Equity Valuations are High (and must fall significantly)

Many point to the richly valued S&P 500. The Shiller PE, which measures price-to-earnings over 10-year periods, is at one of its highest levels.

Shiller PE
Source: https://www.multpl.com/shiller-pe

The argument here is simple. Lofty valuations suggest that stock returns over the next decade will be much lower than historical averages.

At the same time, many argue that the 60/40 portfolio should shift to a greater allocation in stocks. The reason is that while stocks are expensive, the additional long-term returns are needed to offset the paltry returns expected from bonds.

A recent report from Goldman Sachs framed the issue as follows:

The beneficial role of bonds in balanced portfolios has more recently been in doubt given that bond yields close to the zero lower bound offer a diminished returns buffer during “risk-off” periods. These doubts have only increased alongside concerns that an accelerating economic recovery from the pandemic-induced recession, amplified by historically large US fiscal stimulus, could lead to a strong rise in inflation and, in turn, the start of a prolonged bond bear market. During most historical bond bear markets, equities have outperformed bonds and have delivered positive real returns. This has been especially the case over the last 20 years, during which bond bear markets tended to be short and shallow.

Source: https://www.goldmansachs.com/insights/pages/gs-research/reflation-risk/report.pdf

Argument #4: Negative Correlation May be Over

Finally, many believe the negative correlation that stocks and bonds have enjoyed over the past two decades may be over. In a report entitled The End of 60/40, Bank of America analysts warn that bonds may no longer provide the diversification investors have come to expect.

60/40 portfolio diversification

The authors explain,

The core premise of every 60/40 portfolio is that bonds can hedge against risks to growth and equities can hedge against inflation; their returns are negatively correlated,” Woodard and Harris added. “But this assumption was only true over the past two decades and was mostly false over the prior 65 years. The big risk is that the correlation could flip, and now the longest period of negative correlation in history is coming to an end as policy makers jolt markets with attempts to boost growth.

In short, there’s no place to hide.

Arguments that 60/40 Portfolio is Still Solid

All of the above arguments identify real and significant challenges to the capital markets. Interest rates are at historic yields. The 40-year bull market in bonds does appear to be over. And stock valuations are extremely high.

Nevertheless, I believe the 60/40 portfolio is still ideal for retirees. It’s not the only reasonably allocation in retirement, but it will continue to support a retiree for 30 years or more who relies on the 4% Rule. Here’s why I believe this.

Argument #1: Retirees are long-term investors

Those who retire at a traditional age are long-term investors. For a 65-year-old couple, there is a 1-in-4 chance of at least one spouse living past 97 and a 1-in-10 chance of at least one spouse living to 100 (Source: BofA). Retirees could be in the market 35 years or longer. To put that number in perspective, 35 years ago Ronald Reagan was President and Boy George and Mr. T were filing an episode of The A-Team.

The point is that while both equities and bonds may underperform over the next several years, or decade, retirees must consider a much longer time horizon.

Of course, the first ten to 15 years of retirement are critical. Due to the sequence of returns and inflation risk, a devastating market in the first decade of retirement could spell disaster. And that brings us to the second point.

Argument #2: The 60/40 Portfolio has Worked Since 1871

No, that’s not a typo. Researchers have tested the 60/40 portfolio against the 4% Rule with markets dating back to just after the Civil War. It’s never failed.

Michael Kitces, CFP, published a paper showing the maximum initial withdrawal rate one could have taken in the first year of retirement without running out of money over a 30-year retirement. His research tested retirements beginning in 1871.

Initial safe withdrawal rate by year
Source: https://www.genesiswealthmanagement.com/files/documents/SafeWithdrawalRate%20%28Kitces%29.pdf

The lowest initial withdrawal rate was 4.4% in 1966. Some years could have seen an initial withdrawal rate of over 10%. The point is that a 60/40 portfolio has sustained a 30-year retirement through the aftermath of the Civil War, the Panic of 1893, WWI, the Great Depression, WWII, the stagflation of the 1970s, the tech bubble, 9/11, the Great Recession, and the ongoing Covid pandemic.

Argument #3: The 60/40 portfolio offers growth and stability

When compared to a portfolio heavily weighted in stocks, the 60/40 portfolio stands out for its excellent growth and muted volatility. That’s not to say it’s not volatile, but its up and downs are significantly less than a 100% stock portfolio. And that’s precisely what many retirees need.

Since 1972, a 60/40 portfolio has returned an annual compound rate of 9.61%. These returns are lower than a 100% stock portfolio, which returned 10.75% over the same period. What’s notable, however, is the volatility. The standard deviation of a 60/40 portfolio was just 9.51%, while the stock portfolio came in at 15.25%.

To put these differences in perspective, the worst year for a 100% stock portfolio during this period was -37.45%, compared to just -16.88% of the 60/40 portfolio. At the same time, the worst maximum drawdown for the stock portfolio was nearly -51%, compared to -28% for the balanced portfolio.

The increased volatility that comes with 100% stocks brings us to the next argument.

Argument #4: Retirees can stick with a 60/40 portfolio

Studies have shown that investors are not adept at timing the market. Called the investor gap, studies have documented the gap between an investment’s return and an investor’s return. Because investors tend to buy high when stocks are rising and to sell low in a panic when investments fall, they consistently underperform the very investments where they place their money.

One Morningstar study found that investors lost on average 45 basis points due to market timing. There was, however, one bright spot. The study found that investors in less volatile investments performed better. From the study,

When we broke down funds within asset classes based on their standard deviation, we found that funds in the least-volatile quintiles consistently had higher investor returns than those in more-volatile quintiles. This suggests that “boring” funds work well because they aren’t as likely to inspire fear or greed.

A portfolio with more stocks may perform better over the long-term. Investors in retirement, however, need to ask whether they can handle the ride.

Argument #5: The 60/40 portfolio survived rising rates and inflation

No two time periods are identical. Today we face challenges the U.S. and world have never faced. We can, however, look back at similar times to gain an understanding of how the 60/40 portfolio might perform when interest rates and inflation rise. Here I’m thinking of the period from 1941 to 1982.

The yield on the 10-year Treasury stood at 1.95% at the start of 1941. In 1982 it began the year north of 14%. Over the decade leading up to 1982, the U.S. experienced double-digit inflation, with low growth, giving way to the term stagflation.

During this time how did the 60/40 portfolio perform for retirees? Just fine. To be sure, this period is why we have the 4% rule. It represents the low water mark on a safe initial withdrawal rate. But that rate still stands at 4 to 4.5%.

The 60/40 portfolio also performed well more recently when rates began to rise earlier this year. The first quarter of 2021 was the worst for U.S. investment-grade bonds in the last two decades. The 60/40 portfolio did just fine:

“The first quarter of 2021 showed that even the worst quarter for U.S. investment-grade bonds in the last 20 years wasn’t enough to derail the classic 60/40 portfolio”, says Jason Kephart.

So what’s the take for investors. As long as the correlation between traditional asset classes doesn’t shift dramatically and the portfolio continues to rise over time, then holding a 60/40 portfolio still makes sense.

That doesn’t mean investors shouldn’t consider some alternative mixes but perhaps hold those on the margins and keep your core in stocks and bonds. Although, instead of holding broad indexes, they might want to consider diversifying by adding buckets of individual stocks and bonds.

At the end of the day, the most important risk any investor should always think about is the permanent loss of capital and the loss of purchasing power. The 60/40 portfolio still offers the best defence. And even it if did seem to veer off course at one point, it could have been by design.

Source: https://www.morningstar.ca/ca/news/213154/does-the-60%2F40-portfolio-still-make-sense.aspx

Building a 60/40 Portfolio

So far we haven’t discussed the stock and bond investments that make up a 60/40 portfolio. Most of the studies on a balanced portfolio use an S&P 500 index for stocks and intermediate term U.S. bond fund for fixed income. Given current economic challenges faced by retirees, should we further diversify our asset classes?

Warren Buffett would likely say no. The Warren Buffett portfolio he recommends consists of just two asset classes: S&P 500 index and short term U.S. government bonds. He’s bullish on the future of the United States.

At the same time, the U.S. faces significant hurdles. Its population is aging, reducing the workforce while increasing the cost of social programs for senior citizens. The country’s debt to GDP ratio skyrocketed as a result of the pandemic and now stands at more than 125% (Source: The Fed). And our politicians in Washington seem willing to continue borrowing at unprecedented levels indefinitely. Eventually we’ll have to pay for all of this spending.

As a result, some financial advisors recommend moving beyond U.S. stocks and Treasuries. Bob Rice, the Chief Investment Strategist for Tangent Capital made such an argument when he spoke at the fifth annual Investment News conference for alternative investments.

“You cannot invest in one future anymore; you have to invest in multiple futures,” Rice said. “The things that drove 60/40 portfolios to work are broken. The old 60/40 portfolio did the things that clients wanted, but those two asset classes alone cannot provide that anymore. It was convenient, it was easy, and it’s over. We don’t trust stocks and bonds completely to do the job of providing income, growth, inflation protection, and downside protection anymore.”

Source: https://www.investopedia.com/articles/financial-advisors/011916/why-6040-portfolio-no-longer-good-enough.asp

While I don’t share his pessimistic views of the 60/40 portfolio, diversifying to international equities seems reasonable. This could include both developed countries and emerging markets. Other diversification opportunities could include real estate (REITs) and commodities. For bonds, some argue that retirees should take on more credit risk through high-yield bonds and emerging market debt.

Having said that, there’s no guarantee that diversifying the portfolio will lead to better results. A well diversified portfolio has significantly underperformed a basic 60/40 portfolio over the last 15 years (commodities data wasn’t available before 2007 in Portfolio Visualizer).

diversified 60/40 portfolio

At the same time, if we remove commodities and add the 5% allocation back into the S&P 500, we extended the data to 1999 AND see that the greater diversification paid off.

60/40 diversification

Of course, this time period saw the tech bubble burst, 9/11 and the Great Recession, all of which had significant affects on the S&P 500. And that really is the point. While diversification is generally a sound approach to investing, it’s not a guarantee of higher returns.

Final Thoughts

The 60/40 portfolio is certainly not the only reasonable approach to investing in retirement. Yet for many retirees, it has stood the test of time. It offers both growth and stability, which retirees need for their money to last 30 years or more.

Nobody knows the future. Is it possible that we could see unprecedented economic conditions that could wreck havoc on retirees? Of course we could. Although if that happens, one wonders if any asset allocation would save us.

Filed Under: Investing, Retirement

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