If you read about investing in stocks and bonds, there is a lot of discussion about rebalancing your portfolio. Should you rebalance? When? How often? How much? Carl Ozeck contributes his thoughts on the Vanguard Blog article Capital gains are a good thing. However, sometimes you just like to see what the professionals actually settle on.

In Vanguard Personal Advisor Services®, we use a “time-and-threshold” blend for our rebalancing strategy. We review the portfolio quarterly and rebalance if its asset allocation has deviated by 5 percentage points or more. Blending these triggers results in a more complex strategy, but it has merit. If we use this strategy on a 60% stock, 40% bond portfolio, the average portfolio turnover would be about 1.95%2 and average Sharpe ratio about 0.51. This shows that rebalancing can help you mitigate your risk while spreading out rebalancing events over time.

Vanguard Personal Advisor Services (my review) is an add-on service where they actually manage your portfolio and perform the trades on your behalf. The cost is 0.30% of assets annually. Their paid service performs a quarterly check-in, and rebalances if a 5% threshold band is exceeded. I think this is a good rule to save as a “default” and then adjust as needed for your own circumstances.

For our portfolio, I also perform quarterly check-ins and then rebalance with the free cash from dividends and interest. If possible, investments from work income are also directed in a manner to help rebalance. I only rebalance further if a 5% threshold has still been exceeded after all that for at least two quarterly check-ins.

While poking around the Bogleheads investing forum, I came across a thread discussing a 2015 ETF.com interview with the late Jack Bogle that touches on the topic of mailbox money in retirement. First, a nice dose of Bogle common sense:

If anybody were to give you a blueprint, I would say put your hand over your wallet. There are no blueprints. There is common sense, and the obvious principle here is to be more conservative and more protective when you’re older than when you’re younger. When you’re young, you have a small amount of capital, you can take more risk, you’ve got years to recoup, and you don’t care about income. When you’re older you want to protect what you have; if you’re wrong, you don’t have a lot of time to recoup, and on balance you want more income.

Bogle on the idea of Social Security and stock dividends as mailbox money:

But you ought to think about all sources of your retirement income. Having said that, when you own an equity portfolio, don’t get into it for market reasons, get into it for income reasons. Oversimplifying, what you want to do when you retire is walk out to the mailbox on Social Security day and on dividend payment day for the funds—assuming they’re the same day—and make sure you have two envelopes out there. One is your fund dividend and the other is your Social Security check. The Social Security will keep up with inflation year after year, and dividends are likely to increase year after year. They have been going up. Every once in a while there is an interruption, such as the Great Depression of the early 1930s. And many bank stocks eliminated their dividends in 2008, so there was obviously a drop. But it has long since recovered, and then some.

Bet on the dividends, and not on the market price. You’ve got those two envelopes and that’s your retirement. If you have a pension plan (one that is not likely to go bankrupt—and a lot of them are likely to) that is a third envelope. You want to be concerned about whether you have enough income to pay utility bills, pay for your food, pay your rent or your mortgage, whatever it might be, every month. You want income to help you pay those bills. And in the retirement stage, that’s what investing should be about—regular checks from dividends and/or from Social Security and/or from a pension account.

The problem is that the yield on the Vanguard Total US Stock Market (VTSAX) or S&P 500 Index fund is only about 2%. That’s a lot less income than most people would like out of their portfolio. Here’s Bogle on a high-dividend stock strategy:

If you really need the dividend income, I see nothing wrong with overweighting high-dividend stocks, knowing you’re taking a small risk of falling significantly behind the total market. But you can own blue chip stocks, and you’re going to get a higher dividend, a situation I think would be attractive to an awful lot of investors. But once you depart from the market portfolio, you’re taking on extra risk. Any strategy may have done very well in the past, but in this business, the past is not prologue.

The draw here is that the low-cost Vanguard High Dividend Yield Index Fund (VHYAX) sends out bigger income “checks”, currently an SEC yield of 3.37% as of 5/31/19. However, roughly speaking, the dividend payout from high-dividend stocks is going to be more likely to drop with poor market conditions.

Alternative #1: Low-cost Value funds. While not from this interview, Bogle has said elsewhere that he thinks that Large-Cap Growth and Large-Cap Value stocks will have roughly the same average returns over the long run. The difference is that in Value you’ll get a slightly bigger share of returns in the form of dividends and a little less in share price appreciation. Growth is the opposite – less dividends and more price appreciation. Therefore, if you wanted to create a little more “mailbox money” than the S&P 500, you may consider buying the Vanguard Value Index Fund (VVIAX) or Vanguard Value ETF (VTV) with a current SEC yield of about 2.8%.

Alternative #2: Low-cost Dividend Appreciation fund. I can’t find any Bogle commentary on this strategy, but you could also buy into the Vanguard Dividend Appreciation ETF (VIG), which invests in companies with at least ten consecutive years of increasing dividends. This fund also has a ~2% yield similar to the S&P 500, but historically they offer a more stable and steadily growing income stream without sacrificing too much in total return.

In the end, treating your dividend checks as retirement income is not all that different than taking out about conservative 3% a year from your portfolio. If you really wanted to make your income checks equal 3%, you can do some tweaks like going with the Vanguard Value Index fund and the Vanguard Total Bond fund and get very close without “reaching for yield” with junk bonds or niche investments. My portfolio is different and yet the income still gets close to 3% when I track the dividends and interest every 3 months.

Bogle would also remind you to make sure you are investing in low-cost, passive funds so you aren’t giving away 1% off the top to a fund manager. If you have a DIY mindset, you also avoid paying a financial advisor taking out another 1%. Paying both of those and you’ll be missing 2/3rds of your potential mailbox money.

Vanguard has a blog post about their Target Retirement 20XX funds (TDFs) with a few interesting stats (via Abnormal Returns):

• 97% of all Vanguard retirement plan participants had a target-date fund as an available investment option.
• 77% of all Vanguard retirement plan participants owned a target-date fund.
• 52% of all Vanguard retirement plan participants owned a target-date fund as their sole investment.

These all-in-one funds are getting more and more popular. So what is the effect of owning these TDFs as compared to the old method where you had to do your own mixing and matching of various funds? In general, the effect was to nudge younger investors to own more stocks. Here’s their chart comparing asset allocation holdings by age in 2004 and 2018. (The earliest TDFs were born in 2003 and still had a small percentage of assets in 2004.)

I find the 2004 “hump” curve to be interesting. The average young investor in 2014 was risk-averse and increased their stock holding up until the peak at about age 40, gradually going back to owning more bonds after that. The youngest investors (under 25) used to only hold 55% stocks on average, as opposed to 88% stocks today (90% stocks is the what the current Vanguard target-date funds own at that age). On an individual level, did most of them hold a 50/50 split or were half of them 100% stocks and the other half 100% cash?

I have recommended the Vanguard Target Retirement Funds to my own family members for its low costs and broad diversification. Vanguard obviously thinks this modern glide path is an improvement, but I hope that young people will keep holding onto the fund during the next bear market. That’s the true test of whether this new system is better.

Annuities have a rather mixed reputation, which I think is mostly deserved. Some are amazingly complex and expensive (the word “Indexed” can be bad in this world). Then there are simple, straightforward ones that are worth consideration, including single premium immediate annuities (SPIA). The most basic version lets you convert a lump-sum payment into a regular stream of income payments that is guaranteed and doesn’t ever vary, period.

Michael Edesess has an article Are Annuities the Best Strategy to Fund One’s Retirement?. The article is on a site meant for financial advisors, so it’s got a lot of jargon inside. However, I do like that it provided some hard numbers to consider.

Here are current market rates:

In other words, a 65-year-old male hands over $100,000 and will get $6,720 per year ($560 per month), every year, for the rest of his life. Putting up $1,000,000 will get you $67,200 per year ($5,600 per month). Whether he lives to 68 or 108, he will end up with zero dollars. A female would get a bit less due to a longer average lifespan, and a joint annuity even less than that as the likelihood of at least one person living a long time is higher.

The article then compared the annuity payout against the “safe withdrawal rate” as calculated by popular industry methods. The Bengen method has a fixed payout percentage every month, adjusted annually for inflation. The HWS strategy uses a variable payout with a floor rate and allows a higher payout if the portfolio has high returns. I’ll just share one of them.

As you can see, the immediate annuity offers a higher annual payout in almost all cases. This is good.

However, you are giving up certain things in exchange for this higher income. Once you die, there is nothing left for heirs or charity. Thus, part of your return is simply them giving your own money back to you (return of principal). You have lost permanent control of that money, with no liquidity if for any reason you had a big expense. Finally, unless you buy a special inflation-adjusted annuity with a much lower initial payout, your monthly payment will buy less and less as inflation eats away at it over time.

I would also read about your applicable state guaranty limits and always stay under them. It is rare for an insurance company to fail, but it has happened. Read about the Executive Life Insurance Company. The state guaranty association system is not as good as FDIC insurance, but being within the limits is much better than being above the limits!

Bottom line. I would research single-premium immediate annuities as a source of retirement income once your reach age 59.5. I would avoid any annuity that is linked or “indexed” to the stock market. Personally, I am thinking of annuitizing a fraction of my portfolio (less than 10%) once I reach a certain age, but only if it remains under state guaranty limits.