There were 2-3 different "allocation" discussions yesterday. One person at 85-15 equities/bonds, another person switching from 60-40 to 70-30.

This allocation only explains a BRIEF amount of the risk you take. A third person posted a link to a web site which suggested the "equity" position determined **most** of the risk a person takes.

This does not give the full story.

If you put 100% of investments into S&P 500 you are taking on way too much risk. All eggs are in one basket analagy. You will probably "beat" inflation by 5-7%, with a fun roller coaster ride on a day like yesterday.

If you put 100% of investments into bonds (bond index, for example), you have all your eggs in a different basket. Your risk is now centered on interest rates, when rates go up, you will probably lose money, (as rates increase, bond prices drop) and you will only beat inflation by 2-4%... probably.

If a person was 85-15. All 85% in S&P 500, all 15% in bond index, they have less risk than a person with 100% in either or, and the returns would probably be ~8-9% annually (beating inflation by ~5-6%).

If the same 85-15 person took the 85% and divided it amongst S&P 500, large cap value, International, small caps and mid caps, then took the 15% and divided it among REITS, short term bonds and money markets, they would have less risk than any of the previosly mentioned cases.

Which takes me to another point. A person can invest in 100% equities, be divided among large, mid, small and international stocks (funds) and have LESS risk than a person doing 60-40 with only 2-3 funds.

If the person doing 100% equities has TIME, the time reduces the risk they take (they have time to rebound from a day like yesterday).

I don't want to tell anyone to go 100% equity (I am 100% equity), but it's possible the person doing 100% is taking on less risk than the investor which uses only 2-3 funds.

Curious how many sources of income people out there have?

I work my day job, which pays the bills. I train soccer teams at night which nets ~9k a year. This goes to vacations, savings and other frivoulous spending. My wife also works a day job.

How do others supplement their income?

Porfolio allocation helps reduce risk. Time helps reduce risk. Once retired, you no longer have the time to earn back losses, so the risk of retirement funds running out rests squarely on allocation.

Risk (to me) is defined as maintainance of principal balance. I do not want to see account worth $1.5 M in year 1, only to lose 33% and be worth $1 M a year later (even if it could also be worth $2 M a year later).

At retirement I plan to have positions in:

Cash/Bonds (25%)
Large Cap Value (20%)/45
Large Cap Growth (10%)/55
Mid Cap Growth (7%)/62
Mid Cap Value (7%)/69
Small Cap Growth (5%)/74
Small Cap Value (5%)/79
International Large Cap (15%)/94
International small cap (6%)/100

The longer one could keep an allocation like this, the better they will be. As previously stated, the 25% cash and bonds is a retirement position, with ~7 years worth of income. As this gets spend, the portfolio will become "riskier" as cash is reduced. Riskier might become as much as 85%/15% Equity to cash mix.

The way to reduce this risk is to sell off the sections with highest volatility (volatility is change of principal balance). So the International Small Cap and Domestic Small cap positions will be eliminated first.

Then the mid cap positions get reduced.
Then the international large cap positions get reduced.

To point where a 60-40 portfolio looks like:

40% cash/bonds
20% large cap value
10% large cap growth
10% mid/small cap
20% international

The biggest risk to retirement savings is a down year in the stock market within the first 3-4 years of being retired. I believe I read that on a web site (like T Rowe Price). My plan is to hedge this risk with cash.

Issue 1: determine income needed. I like to use 80k as an example.

Issue 2: total porfolio size needs to allow for 4% withdraws. 4% is the most common withdraw percentage used at websites like Vanguard and T Rowe Price. 80/4%=$2 M saved.

Issue 3: Hedge against a down market by putting 7 years in cash instruments. CDs, money markets, I-bonds, bond funds.

7*80k=560k. Meaning I am suggesing 560k of the $2M be put in cash (25% CASH). If a portion of this cash allocation can come from money outside the 401k/Roth IRA accounts, this improves the situation. The remaining $1.5 M is invested in equities (so allocation is about 75% equity and 25% cash/bond)

This is done in the year prior to retiring.

80k in a 1 yr CD (this is next year's income)
80k in a 2 yr CD (this is year two's income)
80k in a 3 yr CD (this is year 3's income)
Put 240k in I bonds. The biggest risk to cash investments is inflation. If inflation hits in next 3 years, you want to hedge this risk with I bonds (or other inflation indexed securities).

The last 80k is flexible. A bond fund, dividend paying stocks or Real estate is my suggestion.

Each year take 1/3 of the I Bonds and convert to a 3 yr CD. This is the income you will spend 3 years later. This system is a 3 yr CD ladder with 6 yrs worth of cash and 7 yrs worth of conservative investments.

Each year take the same amount out of 1.5M invested in market and put into I-bonds.

This automatically increases withdraws in line with inflation (The I-bonds calculate this for you).

The 1.5 M invested needs to generate a 5.3% return to create 80k. It is possible the 1.5M could sustain itself and grow the next 10 years (meaning 1.5 M could swell back to ~$2 M) depending on the market.

The rule I plan to follow is only withdraw 80k in an up year. The next 6 years income is already established. If account increases 8%, 5.3% is put to cash and the other 2.7% is left invested in the market.

Another issue to recognize is as cash is spent down, your risk is increasing (75% equity/25% cash in year 1 might become 80% equity/20% cash by year 3,5 or 7).

To hedge this risk, recognize any of the following:

6 years income was put in cash. That 7th yr is flexible depending on risks investor wants to take, tax law (maybe something presents itself to you), and by yr 5, it's clear to me that will need to be in cash, but maybe yrs 1-4 generate enough dividends to supplement income another way.

Allocating the retirement equity positions will be the next subject.

Generally speaking, you need to save an amount equal to your current income/.04.

If you make $80k per year, divide this by 4% (.04), the result comes out to $2 M.

This $2 M could come from many places

1) SS
2) 401k
3) IRA (Roth preferred)
4) taxable accounts
5) downsizing house to a condo (might create ~150k-200k)

SS:
Of the 80k per year needed, SS might generate around 24k of this. More than likely the SS income would be taxed. (80k is a "significant" income and depending on age, it could be assumed anyone with a significant income in retirement will be subject to SS payments getting taxed).

401k. 401k withdraws will be taxed. 80k is currently in thr 25% tax bracket. meaning tax paid is $8735 (tax owed in 10% and 15% tax brackets, up to $63,000)+ 80,000-63,000=17000*25% is $4250. Federal tax owed each year would be $9285 (there is now 71k you have to pay state taxes and other expenses with).

Roth IRA withdraws are "tax free". If you withdraw 80k from a Roth, you owe no taxes on it. This is why a Roth is the prefferred mechanism for funding retirement, IMO.

Taxable accounts. If you withdraw 80k from a taxable account, you will only owe taxes on the gain (when you sell). If you purchased a security for 20k and sold it for 80k, you have a "capital gain" of 60k. 60k would be taxed at 15% which is $9000 (this is less tax than you paid on same 80k withdrawn from 401k). The 60k gain assumed here is conservative (most gains would be much less than 60k).

So the question remains- which account should you use to fund retirement?

I suggest all types. Contribute to a 401k. It will lower your current tax bill. Because SS still exists, invest the 401k aggressively. Worst case is you collect SS and treat SS like a bond/cash/ annuity type instrument if aggressive investing fails.

A Roth account is the "denser" than any other account. it costs more to put money in a Roth today (because the money going in is taxed before going in). But the tax free withdraws coming out are a key component to retirement income planning.

Taxable accounts. If you become ineligible for a Roth contribution (income greater than 150k for married couples, I believe), then use taxable accounts to allow for cheaper capital gains tax rates in retirement. Taxable accounts should consider using individual stocks as opposed to mutual funds (to avoid intermediate capital gains taxes while accumulating assetts).

Downsize the house if it makes sense. This might reduce the 80k income needed to 75k (lower utilities, property taxes) and create an extra 150k or so you could invest in a taxable account.

You can measure financial success many different ways.

1) No debt
2) Amount of discretionary Income
3) Savings/ Retirement goal
4) Pay off Mortgage
5) Net worth
6) The number of people which ask you for money.

My personal measure of financial success is to pay for a new car in cash.

My intermediate steps to accomplish this is simple. Each time we buy a new car, we finance it for one year less than we did before.

In 1995 I bought a new Saturn SC2 for 66 months of financing.
In 2000 we bought a new Ford Focus. 4 years of financing.

In 2006 we bought two new cars on the same day (Honda Ridgeline and Honda Accord). We cheated- one car was financed for 4 years and one financed for 3 years. When the cars are paid off the money budgeted for the payment is going to accumulate in the savings account until we need our next car (6 years later).


The next car is a two year payment plan. Bank the payment years 3-10.

The car after that is a one year financing. Bank payment years 2-10.

The next car will be paid in CASH!

I have a chart I use to track retirement savings. It can be easily created in excel.

top row is return percentage (before inflation.

row 1

Column C is 6%
Column E is 7%
Column G is 8%
Column I is 9%
Column K is 10%
Column M is 11%
Column O is 12%

row 2
row underneath is "years to double". 72/%
C=12 (72/6=12)
repeat forumula C2:I2

in cell B3 type in retirement age (68 for me).
in cell C3 type in your income/.04. (80,000/.04) for me= 2,000,000

this means the retirement goal is 2,000,000 at age 68.

in cell B4, subtract C2 from age
in cell C4 divide C3 by 2

meaning X years to double needs half the amount.

repeat. in B5, Subtract C2 years from age in B4. repeat this formula down. In C5, divide C4 by 2. Repeat this formula down.

Columns B and C show age check points for a 6% (conservative) return. If you meet any of the age/amount goals at a young age, you will have smooth sailing to retirement (and could probably retire early).

Repeat this for other return amounts. The goal is to be as far left as young as possible.

For a 12% return, I would be putting 30% in small caps and 50% in international stocks... by 10% I would be much more conventional (40%+ in domestic large caps for example). For 7% return, I would start owning bonds (to preserve amount already accumulated).

The plan is simple.

Create a budget and use the various accounts to set up automatic payments.

4 payments come out of one account (2 IRAs and 2 mortgage payments)

~5 monthly utilities come out of another (all paid electronically or automatically).

~4 bills which will eventually "go away" are paid from another account. When the bills go away, this account starts to accumulate money.

any weekly expense must be paid in cash. If we don't have the money, we do without. We don't need to track every penny we spend, we just need to know how to make $100 in gas money last two weeks.

I drive a full size pickup everywhere we go... so $50 gas/week is not always easy.

We set aside money for retirement prior to doing anything. Right now it's 20% (or close) of gross income. As salary increases, this % goes down (IRA limits favor lower-middle income earners).

Cash accumulates in accounts slowly. Our monthly emergency is the IRA payments. We could stop an IRA payment and save $900 that month. There is always one mortgage payment in bank as well.

Two words "equity income". If you had to choose one mutual fund in your 401k, my suggestion would be either a retirment date fund or an "equity income" fund.

I own T Rowe Price Equity Income (PRFDX) in my Roth IRA and Vanguard Windsor II (VWNFX) in my 401k. My wife has ACGIX in her 401k. All 3 are equity income (large cap value) mutual funds.

Large Cap Value tends to have best returns over time, and is why I make that suggestion.

I believe in assett allocation to reduce risk. As a 34 yo (wife is 33) our target allocation is:

45% domestic large cap
15% domestic mid cap
15% domestic small cap
15% International Large Cap
10% International small cap

This allocation is 75% domestic, 25% international. It is 100% equity "in theory".

For my Roth IRA, I own:

PRFDX (domestic large cap)
PRWCX (domestic mid/large cap value)
RPMGX (domestic Mid Cap)
PRNHX (domestic small cap)
PRIDX (International small cap)
PREDX (junk bonds, emerging market bonds)

My wife's Roth IRA will be

TRIGX (International Large Cap)

as you might see, I prefer T Rowe Price. Low cost funds (all no load), excellent customer service, and offerings in every asset class.

In my 401k, I own:
VFINX (Vanguard 500 index) 20% large cap
VWNFX (Vanguard Windsor II) 25% large cap
VEXMX (Vanguard Explorer) 10% small cap
VEXPX (Vanguard Extended Market Index) 10% mid/small cap
RYTFX 14.30 +0.11 (Royce Total Return) 10% small/micro cap
VTRIX (Vanguard International Value) 25%


In my wife's 401k, we own:

REREX International Large Cap 25%
RGAEX Domestic Large Cap 20%
ACGIX Domestic Large Cap 25%
SSVSX Domestic Mid Cap 20%

we also own 10% company stock in her 401k.

We duplicate allocations, with IRS's being the "core". As we change jobs, we don't have to repick funds, just pick the best 401k funds to meet part of this allocation. If in doubt, we overweight large cap value (if no better 401k choices exist).

I contribute 10% to 401k (increases 1% each year automatically)
Wife contributes 6% to her 401k.
I max out my Roth (4k each year)
2007 will be first year my wife has a Roth IRA.

My emphasis in our house (between my wife and me) is to keep spending on budget.

There are 2 or 3 things which influence the budget and how I do things.

First is multiple bank accounts are a good thing. We have 4 bank accounts (at two different banks). Checking and Savings Accounts used for various reasons (more on this later).

Second is debit cards are BAD things. Cash rules.

Third, over budget and under pay to create a minimal cash buffer.

We look at out bills and organize them-
long term debt (mortgages), permanent monthly expenses (like IRA's), permanent monthly bills (like electric, gas, cell phones, insurance, home phone, satellite dish), mid term monthly expenses (car payments) and permanent monthly CASH expenses (gas for cars, grocery, hair appointments).

Long term debt and permanent monthly expenses come out of one SAVINGS account. In our case this budget is $1660 for 1st mortgage, $430 for second mortgage, $480 for escrow (prop taxes and insurance), $625/month for my Roth IRA and $350 for my wife's Roth IRA. The $625 maxes out IRA for me in June, the remaining months this is accumulating a cash buffer in this account.

Permanent monthly bills come out of a checking account. We overbudget as much as possible (gas/electric bill budget is $300/mo, we don't come close to this 6 months a year in Ohio). There is no debit card for this account, so this money accumulates "slowly".

We have a second SAVINGS account for mid term monthly bills (our two car payments). We also have our cell phone coming out of this account... When a car gets paid off, this account accumulates money.

We have a second checking account which is for cash expenses. Groceries, Gas and hair salon are cash expenses. This account zeros out the day we withdraw the cash.

We have two incomes.

I get paid twice a month. $1700 from each of my paychecks get put into account for the mortgage and IRAs. The rest is in the checking account we pay monthly bills out of.

My wife gets paid biweekly. This complicates calculations... if you look at our spread sheet for a given month we may run one account at a deficit (until we hit that month where she gets 3 pay checks). But trash bill comes once every 3 months, as does sewer/water... so it evens out over course of year- not to mention electric bill is not as high as we budget. But it's important to look at this at both weekly/monthly/yearly expenses relative to paydays.

We calculate how much cash we need for groceries ($75/week), hair ($20/week) and gas ($100/week), then make sure $390 from each of my wife's paychecks is put into the checking account. We withdraw it all in CASH. It must last two weeks. My wife gets her hair done 6-8X per year, so that $20 adds up to the real $90 hair appointment for her and $10 hair cut for me.

Conventional wisdom suggests you want 2-4 months "cash" for expenses in event of emergency (loss of job, other emergency).

This is good advice... my advice suggests that the "cash" portion of this can be better utilized within a budget.

Goal #1 is create a budget
Goal #1a is save 10% as part of that budget.
Goal #2 is remove debt. There is no "good debt". There is bad debt, worse debt and "I can't believe I financed that" debt.
Goal

everything else depends on the budget.

Be good at what you do. Most people which are financially successful are not successful simply because they saved and/or invested.

They are good at what they do, first and foremost. They then take a portion of what they make and set it aside.

My suggestion is to save 10% into a 401k or similar plan. This makes retirement savings easier (you will need less because you trained yourself to live on less).

If you can save more than 10%, GREAT, but any realistic savings plan needs to account for at least 10% of gross pay.

The more you make, the higher this percentage needs to be, 10% is the base amount for starters.