AA : willingness, ability, need

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visa890
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AA : willingness, ability, need

Post by visa890 »

I have been reading a bit lately and trying to come up with a suitable AA. Most recommend AA should be based on the ability, willingness and need to take risk. I understand ability and willingness clearly, but having a hard time understanding “need”. The "need" is essentially defined as how much return I need to achieve my objective or my number. I really don’t know my objective clearly. I am in my 30s, so I am not sure what number I should be shooting for. I have no problem going 100% equities, but not sure if I need to do it.

How do you all think about this? Any suggestions?
MotoTrojan
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Re: AA : willingness, ability, need

Post by MotoTrojan »

It’s all based on projections, both on needs and expected returns.

Two people with $1M each make $250K/year and want to spend $200K/year in retirement. One is 30, the other 62; who do you think has more need?

Not exact science but it’s easy to tell roughly what you need.
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Re: AA : willingness, ability, need

Post by jmk »

visa890 wrote: Sun Jun 09, 2019 7:46 pm How do you all think about this? Any suggestions?
You might consider estimating your "funded ratio"by comparing the net present value of your guaranteed income stream and core liability stream year by year from now till you die. Aim to have enough kept safe to bring your funded ratio to 1.2 (in case there's a large crash). That will be hard to estimate when you're 30 and will get more accurate over time but will give you a rough sense of whether you need to be safe with more or less of your future income stream. Ken Steiner has a good free spreadsheet that does a version of this in a user-friendly manner, good "Steiner actuarial approach".

At age 55 I've figured out that as long as I keep $400,000 "safe" now in CDs and bonds (and only use it for liabilities), I don't need to take more risk, but may do so if I choose.

You could also run a monte carlo estimate of different asset allocations (using portfolio visualizer) and see how high a bond allocation you can keep while still having 90% chance of not running out of money.

At age 30 your "need" to take risk isn't a major factor, since you have your maximum human capital ahead of you and plenty of time to catch up if things go awry.
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Re: AA : willingness, ability, need

Post by BogleBoogie »

Take the quiz on the Vanguard website, use as a tool to guide you for now. Adjust later. Savings rate far more important than your AA.
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Re: AA : willingness, ability, need

Post by KlangFool »

visa890 wrote: Sun Jun 09, 2019 7:46 pm I have been reading a bit lately and trying to come up with a suitable AA. Most recommend AA should be based on the ability, willingness and need to take risk. I understand ability and willingness clearly, but having a hard time understanding “need”. The "need" is essentially defined as how much return I need to achieve my objective or my number. I really don’t know my objective clearly. I am in my 30s, so I am not sure what number I should be shooting for. I have no problem going 100% equities, but not sure if I need to do it.

How do you all think about this? Any suggestions?
visa890,

If you do not know your number, you can start with 25 times your current annual expense as the target. You would not know whether you will be fully-employed continuously until the retirement age. Financial Independence is a more proper goal.

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Re: AA : willingness, ability, need

Post by Fallible »

visa890 wrote: Sun Jun 09, 2019 7:46 pm I have been reading a bit lately and trying to come up with a suitable AA. Most recommend AA should be based on the ability, willingness and need to take risk. I understand ability and willingness clearly, but having a hard time understanding “need”. The "need" is essentially defined as how much return I need to achieve my objective or my number. I really don’t know my objective clearly. I am in my 30s, so I am not sure what number I should be shooting for. I have no problem going 100% equities, but not sure if I need to do it. ...
In case you haven't read Larry Swedroe's three-part series on ability, willingness, and need to take risk, here are the links, beginning with the gist of need to take risk, which requires differentiating between real needs and desires, and what to consider in determining your financial objective:
The need to take risk is determined by the rate of return required to achieve financial objectives. The greater the rate of return needed to achieve one's financial objective, the more risks with equities (and/or small and value stocks) one needs to take.

A critical part of the process is differentiating between real needs and desires.

These are very personal decisions, with no right answers. However, the fewer items in the needs column, the lower the need to take risk. Conversely, the more items in the needs column, the more risk one will have to take to meet those needs.

Therefore, regarding your financial objective, carefully consider what economists call the marginal utility of wealth -- how much any potential incremental wealth is worth relative to the risk you must accept to achieve a greater expected return.
https://www.cbsnews.com/news/asset-allo ... -you-need/
https://www.cbsnews.com/news/asset-allo ... -you-take/
https://www.cbsnews.com/news/asset-allo ... tolerance/
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Re: AA : willingness, ability, need

Post by arcticpineapplecorp. »

usually you hit your number when you have 25X your shortfall of income. So let's say you get $25,000 from SS but need $50,000 for annual spending in retirement. Then you have a shortfall of $25,000 per year. Multiply by 25 and you get a needed portfolio of at least $625,000.

So the more income you have in retirement from SS and/or pension, the less you need in savings/investments (and for most people the opposite is true. Because they only get SS, they need much more in savings/retirement than people with pensions).

Other factors apply like will you live in a house where the mortgage is paid off so your largest expense now will be less in retirement, etc?

You're basically trying to figure out what your expenses will be in retirement and what shortfall of income you'll need to cover above and beyond guaranteed sources of income (SS/pension) to cover expenses.

if you're not sure what you're expenses will be in 30 years you could just use a projection of inflation (expecting all else being equal all costs will go up by 3%-4% per year. That's been the case historically speaking). This year inflation was 2.8% and it's been low for many years, but that could change to more historical levels in the future.

Anyway running numbers at an inflation rate of 3% you need twice as much money as todays dollars in 24 years (in excel this shows you what will be needed for every $1 in the future). You'll need $2 for every $1 today in 24 years if inflation grows at 3% per year:
=FV(.03,24,0,1)

You'll need $2 for every $1 today in 20 years if inflation grows at 3.5% per year:
=FV(.035,20,0,1)

You'll need $2 for every $1 today in 18 years if inflation grows at 4% per year:
=FV(,04,18,0,1)

So I'd say plan on needing twice as much in living expenses 30 years from now as you do now (this could change if you have a mortgage now, but won't then. Then your future living costs could go down).

Does that help at all?
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Asset Allocation link

Post by Taylor Larimore »

Take the quiz on the Vanguard website, use as a tool to guide you for now. Adjust later. Savings rate far more important than your AA.
visa890:

This is the link to the Vanguard's quiz:

https://personal.vanguard.com/us/FundsInvQuestionnaire

Best wishes.
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FOGU
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Re: AA : willingness, ability, need

Post by FOGU »

BogleBoogie wrote: Sun Jun 09, 2019 8:21 pm ....Savings rate far more important than your AA.
Amen to this.

80/20, 90/10, 60/40. At age 30ish this is just fiddling with the knobs.

Earn well, live below your means and save, save, save.
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Re: AA : willingness, ability, need

Post by Dandy »

For me it is trying to determine your "number". i.e. what investment asset level do you want to have when you retire. That is pretty hard to do in your 30's. But you can get an idea of what you might accumulate at age 60. Savings rate x a conservative growth rate e.g. 4 or 5%. How does the outcome look? It is a rough guess since lots of things can change over 25 or 30 years e.g. lose your job at 52, a great recession or inflation, etc. But as you age and get a better feel for when you will retire and your likely retirement expenses how much you need to save and your need for equity risk might become a lot clearer.

In retirement the need to take risk is a bit easier to determine. You know or have a good idea of your income (pension, SS), your investment assets, your health and your expenses - and your withdrawal rate needed to support your lifestyle. If your withdrawal rate to support your life style is 3% or less you don't have much need to take a lot of equity risk. If it is more than 4% you might still need to. For many the goal may shift from growth to more asset preservation which is sometimes hard to do if you have been a successful investor for decades. But, is much growth really needed? once you have won the game.
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Re: AA : willingness, ability, need

Post by The Wizard »

The NEED criteria is the difficult one.

Let's say you're 20 years from when you want to retire and don't have much saved for it. So does this mean your NEED is high and you should go 90% stock funds to catch up?
I'm not sure; that could backfire.

Or in case of a retiree with ample income streams who doesn't NEED regular portfolio withdrawals to sustain their lifestyle. So where should that person be with his/her AA?

This latter case allows one to ignore the need criteria entirely, which is sort of what I'm doing...
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Re: AA : willingness, ability, need

Post by Sandtrap »

Here is an allocation chart from Vanguard that may be helpful.
Note that there is not much difference between various ranges of allocations.

VANGUARD PORTFOLIO ALLOCATION MODELS
https://personal.vanguard.com/us/insig ... locations
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Re: AA : willingness, ability, need

Post by Sandtrap »

The Wizard wrote: Mon Jun 10, 2019 7:47 am The NEED criteria is the difficult one.

Let's say you're 20 years from when you want to retire and don't have much saved for it. So does this mean your NEED is high and you should go 90% stock funds to catch up?
I'm not sure; that could backfire.

Or in case of a retiree with ample income streams who doesn't NEED regular portfolio withdrawals to sustain their lifestyle. So where should that person be with his/her AA?

This latter case allows one to ignore the need criteria entirely, which is sort of what I'm doing...
+1

Even if one has an "ability" to take risk, if there's less of a "need" to because of other income streams or asset size, then "willingness" is all about being realistic and prudent.
The more one has to lose than to gain by and aggressive allocation, then question, why?

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Re: AA : willingness, ability, need

Post by azanon »

visa890 wrote: Sun Jun 09, 2019 7:46 pm I have been reading a bit lately and trying to come up with a suitable AA. Most recommend AA should be based on the ability, willingness and need to take risk. I understand ability and willingness clearly, but having a hard time understanding “need”. The "need" is essentially defined as how much return I need to achieve my objective or my number. I really don’t know my objective clearly. I am in my 30s, so I am not sure what number I should be shooting for. I have no problem going 100% equities, but not sure if I need to do it.

How do you all think about this? Any suggestions?
The amount of $$ you need to save at 30% equities is approximately the same as the worst case outcome of 100% equities. So from a certain point of view, you never actually need anything close to 100% equities if you save enough.

My preference is saving at least 20% of gross income (and preferably higher), and using a low(er) equity percentage, instead of forcing my portfolio to do all of the heavy lifting. You just have to decide what you prefer.
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Re: AA : willingness, ability, need

Post by Phineas J. Whoopee »

This is what I did, and a couple of years later I answered some questions about it.

For the record, I think an age-based asset allocation approach will be far more practical for most investors to commit to and carry out.

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Re: AA : willingness, ability, need

Post by willthrill81 »

The Wizard wrote: Mon Jun 10, 2019 7:47 am The NEED criteria is the difficult one.

Let's say you're 20 years from when you want to retire and don't have much saved for it. So does this mean your NEED is high and you should go 90% stock funds to catch up?
I'm not sure; that could backfire.

Or in case of a retiree with ample income streams who doesn't NEED regular portfolio withdrawals to sustain their lifestyle. So where should that person be with his/her AA?

This latter case allows one to ignore the need criteria entirely, which is sort of what I'm doing...
I agree. If you're willing to take on risk and able to do so, then 'need' is irrelevant.
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Re: AA : willingness, ability, need

Post by ThrustVectoring »

The need part is pretty straightforward to me: taking on equity risk earns a premium, and you need money. All the "need" portion says - to me at least - is that you should take on as much equity risk as you can afford to, given your future cash flow needs and emotional fortitude. With a long enough timeline, the best approach IMO is to protect the money you'll expect to need (emergency fund etc), and take whatever risks pay well enough with the money you know you won't need (100% equity is fine here).

I'll probably revisit my asset allocation when I've got 10 years of expenses saved up or so.
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Re: AA : willingness, ability, need

Post by willthrill81 »

ThrustVectoring wrote: Mon Jun 10, 2019 2:21 pm The need part is pretty straightforward to me: taking on equity risk earns a premium, and you need money. All the "need" portion says - to me at least - is that you should take on as much equity risk as you can afford to, given your future cash flow needs and emotional fortitude. With a long enough timeline, the best approach IMO is to protect the money you'll expect to need (emergency fund etc), and take whatever risks pay well enough with the money you know you won't need (100% equity is fine here).

I'll probably revisit my asset allocation when I've got 10 years of expenses saved up or so.
So does a 60 year old with $10 million and annual expenses of $200k 'need' any equity exposure at all? If this person is willing and able to invest in equities, should s/he not since they have no 'need'?
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Re: AA : willingness, ability, need

Post by Phineas J. Whoopee »

willthrill81 wrote: Mon Jun 10, 2019 2:31 pm
ThrustVectoring wrote: Mon Jun 10, 2019 2:21 pm The need part is pretty straightforward to me: taking on equity risk earns a premium, and you need money. All the "need" portion says - to me at least - is that you should take on as much equity risk as you can afford to, given your future cash flow needs and emotional fortitude. With a long enough timeline, the best approach IMO is to protect the money you'll expect to need (emergency fund etc), and take whatever risks pay well enough with the money you know you won't need (100% equity is fine here).

I'll probably revisit my asset allocation when I've got 10 years of expenses saved up or so.
So does a 60 year old with $10 million and annual expenses of $200k 'need' any equity exposure at all? If this person is willing and able to invest in equities, should s/he not since they have no 'need'?
Ain't no matter of should nor shouldn't. At that level the person's individual preferences take over. Ability, willingness, and need is founded upon scarce resources, not abundant ones, just like most of the rest of economics.

I could make up any fictional story I want, too, but I see no point.

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Re: AA : willingness, ability, need

Post by pkcrafter »

visa890 wrote: Sun Jun 09, 2019 7:46 pm I have been reading a bit lately and trying to come up with a suitable AA. Most recommend AA should be based on the ability, willingness and need to take risk. I understand ability and willingness clearly, but having a hard time understanding “need”. The "need" is essentially defined as how much return I need to achieve my objective or my number. I really don’t know my objective clearly. I am in my 30s, so I am not sure what number I should be shooting for. I have no problem going 100% equities, but not sure if I need to do it.

How do you all think about this? Any suggestions?
No, you don't need to be 100% stock, and you should consider the potential downside of being all in equity. Also, all stocks leaves you out of two major asset classes - bonds and cash. When starting out, savings/investing percentage is what is going to get you off to a great start. Twelve to 15% savings rate is recommended. You do need to put money into stocks for long term accumulation, but 75-80% max is suggested by most members.

Read this and then decide on an asset allocation:

https://finpage.blog/2019/06/01/choosin ... l-aspects/


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Re: AA : willingness, ability, need

Post by willthrill81 »

Phineas J. Whoopee wrote: Mon Jun 10, 2019 2:44 pm
willthrill81 wrote: Mon Jun 10, 2019 2:31 pm
ThrustVectoring wrote: Mon Jun 10, 2019 2:21 pm The need part is pretty straightforward to me: taking on equity risk earns a premium, and you need money. All the "need" portion says - to me at least - is that you should take on as much equity risk as you can afford to, given your future cash flow needs and emotional fortitude. With a long enough timeline, the best approach IMO is to protect the money you'll expect to need (emergency fund etc), and take whatever risks pay well enough with the money you know you won't need (100% equity is fine here).

I'll probably revisit my asset allocation when I've got 10 years of expenses saved up or so.
So does a 60 year old with $10 million and annual expenses of $200k 'need' any equity exposure at all? If this person is willing and able to invest in equities, should s/he not since they have no 'need'?
Ain't no matter of should nor shouldn't. At that level the person's individual preferences take over. Ability, willingness, and need is founded upon scarce resources, not abundant ones, just like most of the rest of economics.

I could make up any fictional story I want, too, but I see no point.

PJW
It's a relevant hypothetical because it illustrates that whether one actually 'needs' to take on equity risk is a very subjective and contextual decision, so much so that I see no purpose in including it in such a framework.
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Re: AA : willingness, ability, need

Post by ThrustVectoring »

willthrill81 wrote: Mon Jun 10, 2019 2:31 pm
ThrustVectoring wrote: Mon Jun 10, 2019 2:21 pm The need part is pretty straightforward to me: taking on equity risk earns a premium, and you need money. All the "need" portion says - to me at least - is that you should take on as much equity risk as you can afford to, given your future cash flow needs and emotional fortitude. With a long enough timeline, the best approach IMO is to protect the money you'll expect to need (emergency fund etc), and take whatever risks pay well enough with the money you know you won't need (100% equity is fine here).

I'll probably revisit my asset allocation when I've got 10 years of expenses saved up or so.
So does a 60 year old with $10 million and annual expenses of $200k 'need' any equity exposure at all? If this person is willing and able to invest in equities, should s/he not since they have no 'need'?
Everyone "needs" more money, because having more money later is better than not having more money. Having saved more than 50 times your annual expenses makes you a prime candidate for considering an extremely heavy equity allocation, regardless of age.
Current portfolio: 60% VTI / 40% VXUS
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Re: AA : willingness, ability, need

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ThrustVectoring wrote: Mon Jun 10, 2019 3:04 pm
willthrill81 wrote: Mon Jun 10, 2019 2:31 pm
ThrustVectoring wrote: Mon Jun 10, 2019 2:21 pm The need part is pretty straightforward to me: taking on equity risk earns a premium, and you need money. All the "need" portion says - to me at least - is that you should take on as much equity risk as you can afford to, given your future cash flow needs and emotional fortitude. With a long enough timeline, the best approach IMO is to protect the money you'll expect to need (emergency fund etc), and take whatever risks pay well enough with the money you know you won't need (100% equity is fine here).

I'll probably revisit my asset allocation when I've got 10 years of expenses saved up or so.
So does a 60 year old with $10 million and annual expenses of $200k 'need' any equity exposure at all? If this person is willing and able to invest in equities, should s/he not since they have no 'need'?
Everyone "needs" more money, because having more money later is better than not having more money. Having saved more than 50 times your annual expenses makes you a prime candidate for considering an extremely heavy equity allocation, regardless of age.
Actually, it makes you a prime candidate for both an extremely heavy equity allocation or an extremely low one. When you're 'overfunded', more options become plausible than otherwise.
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visa890
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Re: AA : willingness, ability, need

Post by visa890 »

Thanks for the replies.

I took that VG quiz and it says 100% equities.

The 25-33x annual spend seems like a reasonable number

What are your thoughts on increasing bonds and making the equities portion more aggressive? Example would be instead of doing 100% equities split into US/Int'l 50/50, one can opt for 80/20 stocks/bonds but have that 80% allocated to 50% SCV
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Re: AA : willingness, ability, need

Post by MotoTrojan »

visa890 wrote: Mon Jun 10, 2019 9:01 pm Thanks for the replies.

I took that VG quiz and it says 100% equities.

The 25-33x annual spend seems like a reasonable number

What are your thoughts on increasing bonds and making the equities portion more aggressive? Example would be instead of doing 100% equities split into US/Int'l 50/50, one can opt for 80/20 stocks/bonds but have that 80% allocated to 50% SCV
The Larry Portfolio is more like 30% equity but all in SCV for just this reason. If I did this I’d want the 20% in long treasuries. I believe equity is the most efficient way to increase returns though and if that’s what you want I’d do 100/0 first, and even then consider adding SCV or leverage.
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