Asset Allocation When You Have Enough

When we are asked whether it is a good time to invest or to sell, or which assets a person should hold, we typically answer, “it depends”.  General information can be useful, but it may not be applicable to your specific situation.

In this article we focus specifically on the investor that has already reached their target, or is on track to do so. The approach taken for such an investor may be very different from someone starting out.

If you have enough to meet your goals and objectives with contingencies, the approach may be more focused on asset preservation, beating inflation and covering your income needs. Thereafter, you might consider what you would like to achieve with the additional assets. Investors in this situation may consider estate planning, intergenerational support, legacy planning, and other such factors.

In a recent article, Morningstar described a case study for asset management and financial planning for a client that has reached their goals and that ‘has enough’.

First, Cover the Basics and make sure you do have enough

A good place to start is looking at spending from the bottom up. what your spending looks like in a typical month, including costs for housing, food, medical care, insurance, clothing, charitable donations, and taxes. This gives you a baseline for estimating annual expenses. Then you can add in discretionary spending, such as travel, entertainment, major purchases, and add a buffer for unexpected expenses.

Having worked out what you need to live on each year, we can convert that to a capital amount that is required to generate that level of income, adjusted each year for inflation, for the rest of your life. Good financial planning will take into account whether you wish to live only on the returns from your portfolio so you never erode the capital base, or whether you will amortise that over time.

Scenario 1: Legacy Focus

If you don’t anticipate needing to draw down assets outside of the core retirement portfolio, it can be helpful to think of the additional assets as a separate “bucket” for asset-allocation purposes. How to allocate these assets depends mainly on your individual goals. If you want to prioritize leaving assets for your family members, you might be comfortable with a higher equity allocation, which should allow for continued growth while the assets are still in your portfolio. The table below illustrates what this might look like.

Note the figures are for illustrative purposes only and are not a reference to amounts needed for retirement.

With a higher equity allocation for the “extra” assets, the combined portfolio ends up with an asset mix of about 66% stocks and 34% bonds.

Scenario 2: Capital Preservation Focus

Investors who aren’t as focused on asset growth for eventual bequests to charity or family members might be more comfortable prioritizing safety instead. Tilting the “extra” portfolio toward defensive assets provides more of a buffer against equity market downturns at the opportunity cost of potentially higher growth in the long term and should lead to a more stable portfolio value from year to year. The position taken here follows the argument that there’s no need to take on additional risk if you’ve already saved enough to meet your financial goals. As shown below, the combined portfolio would end up with a significantly more conservative asset mix, which could provide more peace of mind for investors who value safety and aren’t worried about asset growth.

Of course, the two scenarios illustrated above are just a starting point. Ani investor in this situation might end up deciding on a portfolio allocation somewhere in between, or decide to carve out additional buckets, such as a separate bucket for charitable donations during their lifetime or another bucket for “fun money” to enjoy the fruits of a lifetime of work and saving.

Other Considerations

Even for investors comfortable with a higher equity allocation, it’s prudent to reduce exposure to individual stocks if they’re significantly overvalued or consume a large percentage of the portfolio (5% or more is a rough guideline).

Conclusion

There is no “right” answer to creating an asset-allocation mix. It comes down to an individual’s level of risk tolerance, portfolio size, time frame, and anticipated spending needs. But investors who have enough assets to cover their planned spending during retirement - and then some - have more flexibility to create a customized asset mix that reflects their goals and priorities.

Speak with us about your long-term financial plans and how to best manage your assets. Contact us at info@blackswancapital.eu.