By Brad Thomason, CPA
It will not be a surprise to you that most people would like to know how much money they need to retire on. It’s not a surprise, most likely, because you are one of those people.
The good news is it’s a number that we can find. Or at least approximate. But we can’t always do it quickly, and there’s always some uncertainty involved.
To understand why, consider a couple of scenarios involving a bucket of water with a small hole drilled in the bottom.
If I told you how much water was currently in the bucket and the rate at which it was leaking out, you would have little trouble figuring out how long until the bucket was empty.
But what if the bucket were outside, there were rain showers in the area, the neighbor’s dog might stop by for a drink or two, and the hole in the bottom was getting bigger the longer the water was draining out?
Not so straight forward anymore, is it?
In trying to determine how long our retirement money will last, we know that we have to know how much we’re starting with and the rate at which we’ll be spending it down. But we also have to account for the fact that the principal may earn some returns before we spend those particular dollars (i.e. like rain falling to partially refill the bucket). We know that there might be unexpected items to pay for – probably healthcare related, but not necessarily – which can further deplete what we have (i.e. like that pesky dog). Finally, there will be inflation; and the effect of inflation will become ever-greater as time goes on, accelerating the rate of depletion at an ever-accelerating pace (i.e. like a hole in a bucket that magically gets bigger with time).
If we don’t account for all of those factors, our odds of being even close with our estimates are not very good.
We all want simple answers. We’ve usually got other things to do, and even when we don’t we don’t want to spend our time breaking our heads over tedious lines of thought. I get it.
Problem is, whether we want simplicity or not, little is on offer when it comes to retirement planning.
In boxing they have an expression for dealing with unfavorable moments: bite down on your mouthpiece and keep going. There’s nothing wrong with wanting it to be easy. It only becomes a problem when the fact that it isn’t easy stands in the way of us doing it. This is one of those areas in life – like getting hit in the face – where you need to press on in spite of the fact that it isn’t any fun.
If you don’t know your number, you need to. Or at least a range which takes into account some realistic expectations about return levels and longevity.
Precisely hitting projections that are decades away is not a real high-probability activity, even under the best of circumstances. Still, you need to go through the exercise. That’s because what you most need to know about are those scenarios which have little if any chance of succeeding, the ones in which running out early are likely or even inevitable. Preferably you find out about them while you have enough time left on the clock to do something about them. Which, back to the top, is why you need to look now instead of later.
The end of the year is coming up, and that is always a good time for some assessment and thinking. If you don’t know where you stand, why not find out? If you need to make some changes, start thinking them through. And if you need some help putting them in place, give us a shout…though preferably after the first of the year. Looking at my schedule for closing the year out over the next four weeks, it is evident that I’ll need to be biting down on my mouthpiece, too.
By Brad Thomason, CPA
November is national Long-Term Care Awareness Month. From time to time I have conversations with people who have a parent that needs care, and they are thinking about retiring early to be the caregiver.
Today’s post will be short, because I don’t need a lot of space to cover this one.
When a person is working, there are often five key things going on which contribute to a better financial position in retirement:
1. The current paychecks pay this year’s bills
2.Contributions to the 401(k) or similar continue to be funded
3.Employer matching contributions continue
4.The portfolio capital is left alone to compound for another year
5.The total number of years that the retirement savings will have to ultimately pay for is reduced by one year
When a person retires early, all five of these things stop.
Why the person retires does not matter, financially speaking. Whether you have a fantastic reason (like love for a family member) or no reason at all, the dollars are impacted the same.
When a person retires early they are essentially giving their retirement savings a bigger job to do (cover more years’ worth of bills), and demanding that it be done with fewer resources (due primarily to forfeited future investment returns). It’s tough to see how that could be a step in the right direction.
Please be careful if you are contemplating the DIY approach to helping a family member with a care situation. The costs are likely to be much larger than what they appear on the surface to be.
That’s true even before you get into the quality-of-life costs, by the way. Which are by no means insignificant, in their own right. Caring for another person can be demanding and stressful – so much so that it could negatively impact your own health.
Again, please be careful if you are facing this situation, and appreciate the fact that you are dealing with something that has the ability to do damage to your financial security, by hitting at many different aspects all at once. Being the primary caregiver is probably the wrong answer, even if at first look it appears to be the right one.
By Brad Thomason, CPA
One of obvious aspects of retirement planning is the fact that there’s often a wide degree of difference between the factors which bear upon one case, as compared to those which bear upon another.
What one family would ideally like to do is often very different than what another would like; and this difference exists even before we start getting into things like how much capital is available, where the capital is deployed, what kinds of returns it’s earning, the rate at which it will need to provide income, and so on. None of which is likely to be the same.
Yet in the face of all of these differences, there are also certain similarities. These similarities are not a large enough part of the picture that it becomes reasonable to argue for one-size-fits-all planning. But neither does it mean we are in a land where we have to start completely from scratch each time a new plan starts to come into being.
I think it would be fair to say that most of the work that we do in the field of retirement is based on the idea that understanding is the result of a process, and the process of understanding works best when there are frameworks available for organizing the various pieces of information which are important to the task. Having a place to cognitively put things helps to keep everything straight, and makes the information more useable.
The designers of aircraft, for instance, need to have a basic understanding of whether or not a particular feature is primarily there to create lifting force, or there to absorb the forces associated with returning to the runway, or whatever. Within the larger job of “make it fly,” there are sub-jobs which must act in concert to bring about the general success. Knowing where you are in the big picture, as you move around among the details, is the means by which true knowledge of the whole eventually emerges.
One of the early framework elements we settled on in our work was to make a hard distinction about the job the portfolio needs to do before a person retires, versus the job it needs to do after the person retires. When we point this out to people it gets almost immediate and universal acknowledgment as an important aspect of the landscape.
This, despite the fact that few other voices in the retirement planning discussion seem to be pointing it out very often, if at all.
Another of our framework efforts is in the delineation of the kinds of elements which make up retirement income. We don’t know of many other resources which take the time to go into these in depth. But once you’ve been through them, it is hard to see how a complete understanding of the requirements could have been achieved without having picked them apart.
The key to these frameworks lies in the similarities between cases, not the differences. It may be that one person has a resource base and future needs which differ greatly from what someone else is working with. But it will also be the case that no matter what those variables are, the situation is going to change in analogous ways once they stop working and turn to the portfolio to provide some or all of the monthly cash flow need.
People retire at different ages; though mostly those ages fall within a fairly narrow band of years.
People live to be different ages; but the outer reaches of life expectancy for all of us are pretty well defined (at least they are at this point in time…).
People buy a lot of the same stuff. Inflation affects everyone similarly. Health costs are likely to be a major category of non-budget items when dealing with groups of older persons. Et cetera.
These similarities provide us with the building blocks for creating the frameworks we use to try to help bring order to the planning process.
If you think about it, if we didn’t, then just about all of the questions one could ask about what to do in terms of retirement planning steps would have to be answered with some variant of the response, “Well, it depends…”
A person engaged in planning will eventually get to the point where the unique factors will take over the conversation. It’s just that those unique factors aren’t all there is to talk about, nor do they necessarily have to be talked about first.
So some degree of structure, based on similarities, is preferable. But we have to be careful not to go too far down the path. Though many do.
Unfortunately, there are any number of rules of thumb circulating in the conversation, rules of thumb which are attempts to short-cut what is unfortunately a not-so-simple thing. They seem to dream of a world in which the average retiree is the only we need to provide for.
In twenty five years of doing this stuff I’ve yet to meet the average retiree. If he/she exists, you can’t prove it by way of anything I’ve ever observed.
Rules of thumb usually fail in real-life examples for the simple reason that they are typically attempts to build sameness or framework out of the parts of the equation that actually are different. The effort of building framework should have stopped when the supply of similarities was depleted; but the constructors and advocates of many of the general dictums seem to have not let a little thing like being out of suitable materials get in the way of trying to build the sand castle to greater heights.
This of course flies in the face of that famous admonishment from Einstein, to make things as simple as possible, but not simpler. Frequently, it leads to exactly the outcome you would expect it to.
What all of this means, in the end, is that your retirement plan will need to be tailored for you. Your specifics will play out differently than what other people will experience. But you can nonetheless follow the same process of putting the plan together that others have followed. Because just as there are profound differences, there are also some basic similarities. If you use those similarities to create a sense of order, you will be in a much better place to contemplate and understand the range of possible outcomes offered by the remaining differences. Just be mindful of where the line between the two is, by among other things, being very careful about how willing you are to follow rules of thumb or follow the guidance of those who suggest that the task in front of you is a simple one.
Because it isn’t. But neither is it completely uncharted territory.
By Brad Thomason, CPA
There’s nothing like a drop in stock prices to remind everyone what they already know: that stock prices can fall.
Lots of people are paying attention to changing market levels right now, and wondering if they should take some action as a result of them. You can hardly blame them. But in some respects that’s like wondering if you should have fire insurance after you see the flames.
In principle, we like the idea that the stay-or-go question ought to be tied to whether or not you’ve achieved the amount of money you need to retire on. When you have, it’s fair to ask if any of your at-risk investments should remain a part of your portfolio. Once accumulation reaches the level of an apparent win, the argument to get off the field becomes much stronger. In other words, it’s ideally a decision which is best made without reference to whether the market closed up or down on a particular day.
In practice that means you may exit a rising stock market. Which as far as it goes, doesn’t sound appealing. The obvious problem though is that you won’t know until after-the-fact whether it really was a rising market, or one which had reached its peak ahead of a reversal.
The market today is more or less exactly where it was at the beginning of the year. I can tell you from long experience that if you had been discussing reallocation back in January with a retired person with investments in stocks and funds, it would have been the most common thing in the world for that person to express resistance on the grounds that doing so could cause him/her to miss the next run-up.
Well, guess what? If they are still holding stocks and funds today they DID miss that next run-up. They have spent 10 months in the market with nothing to show for it, at least as of today. If prices rise from here, then maybe they catch the next run-up. But the one they stayed in for back in January is now gone forever. And looking at the future from the perch of today, there’s no way to know if there actually will be a next run-up anytime soon. Nor, if there is, that it won’t eventually reverse and dissolve right before our eyes just like the recent run-ups of 2018 just have.
You can hopefully see that there is a certain merry-go-round aspect to this whole thing, making it possible for a given investor to get caught up in this giveth and taketh cycle for quite some time.
People who aren’t retiring for awhile can probably ride out any fluctuations. Historically, that has been the case. Whether or not that’s the best course of action is a different story. But the indications are that it is at least doable.
People who have already retired should have already made the assessment of whether or not assets of that type were consistent with their goals and needs. If they haven’t, they should make that assessment now. Not because the market is falling. But because it’s something that is a critical step in a secure retirement.
On a final note, a word of caution to those of you who were working to “a number,” almost got there, but are now just a little bit short of it because the market didn’t keep going up. There is a temptation to stay until you achieve that number. It is often phrased as, “Well, now I can’t afford to sell.” I’d like to invite you to sit down in a quiet place, perhaps with a nice cup of coffee, or maybe something stronger, and work through the logic of that position. Or rather I should say try to work through the logic of it.
Warren Buffett has stated that a key realization for him was the fact that a person who loses money doing activity #1 is not obligated to continue with activity #1 in pursuit of making it back. You can make it back with any number of other activities, many, and maybe all of which may be a much better prospect than activity #1.
If you don’t like the idea that you were at 99% of your goal, but now you’re at 97%, how are you going to feel if you wake up two or three months from now at 90% (or 80%...) all because you tried to make back that 2% the same way you lost it?
Thinking that one can fully ignore the market when making investment decisions is not that realistic. I’ve read plenty of articles on why people should. But I’ve met few actual people who do. That said, the broader point here is that your decisions to invest or not invest in anything should ideally be made in consultation with the progress and needs of your plans, and not any particular move in prices.
If it makes more sense to protect what you already have than it does to risk it in the hopes of maybe making more (especially if you don’t need more), then that probably tells you a lot of what you need to know about what to do next. And looking at where the market closes this afternoon really shouldn’t add much to the equation.
By Brad Thomason, CPA
When we go looking for an investment advisor or new fund, a common step is to ask about the track record, the past performance of the thing we’re thinking about getting involved with.
Now, we’ve all heard the endless warnings about past performance not being a guarantee of future results. And we get it. Sort of. Yet it still seems like we ought to find out something about the past before we get involved. That’s part of “due diligence,” right?
Let me point out a few things you might want to keep in mind.
First, the context of the track record matters. You often hear people say things like, “My guy’s done a real good job for me the last few years.” But what does that really mean? If the market was up 20%, and your account went up 20%, how much of that is really attributable to “your guy.” To simply know the degree of movement doesn’t tell you much. A far more important measure is the degree of movement after taking out the part that the market naturally gave to everyone who just showed up.
Or is it? The second thing to remember is that market returns don’t repeat. Like, ever. If you look at twenty years of annual returns, from any period in US history, you are unlikely to see the same rate of return for any two years in the data set. Probably you are going to have twenty different numbers. If the historical record all but proves that the results are going to be different year to year, and the market return has a big impact on the return you experience, how much insight about what you will earn in the future can you really discern from looking at the past? Moreover, to get back to the point made above, even if your return in one year really was meaningfully helped by the actions of the advisor or fund manager, how does that imply that a repeat is coming?
Which brings me to my final point. Understand that track record comparisons in the investing world are fundamentally different than what we do when we look at stats and win/loss records for athletes. Why? Because there is a sameness to sporting events which doesn’t translate into the world of the market.
In a baseball game, for instance, while it may be the case that you have different people playing the positions, different order of pitches, different weather conditions, and other unique features from one game to the next, at the structural level, at the rules level, one game of baseball is exactly like every other one.
The variances are minor, and exist within a rigid framework; meaning that the possible permutations and the range of variance are essentially fixed. This stable environment, in turn, makes it possible to draw some meaningful comparisons. When we look at the batting averages of two players, for instance, we can get some insight as to how each player may perform when presented with essentially identical circumstances in the future. As a measure of relative performance, it really can tell us which guy is the better hitter.
But if we get into a land where the events are not repeating, this mode of analysis loses its ability to tell us much of anything about what to expect.
Now, to be clear, markets are not brand new inventions each new day. There is some sameness from one day to the next. But unfortunately the small amount of sameness has a tendency to draw our attention away from the far more expansive degrees of difference.
The paradox is that markets are always just the composite of people buying or selling. So at the broadest level they seem like an unchanging, rather simple, thing. The problem though is the vast range of possibilities for why people transact, when they transact, and in what quantities. Those ranges are so much broader than steal second/don’t steal second that the variances become the drivers, and the sameness loses most of its meaning. They keep the market from attaining the kind of stable environment status that we wish it had. Instead, it’s just an accumulation of historical events.
Historical events simply don’t repeat themselves in a way that makes standard measures of probability suitable for gaining insight. There was only one Waterloo, and there will only ever be one Waterloo, because Napoleon and Wellington are never going to relive that day again. The ever-changing aspect of global political and economic events, combined with the ever-changing cast of market participants who happen to show up on a particular day, make a day in the life of the market much more similar to Waterloo than just another baseball game.
So before you spend too much time comparing and considering track records, make sure you understand what you are really looking at and what value (if any) it can really offer.
I’ll leave you with this thought, which you may find instructive. Professional traders often look at past studies of various strategies in order to try to gain a sense of how they will perform in the future. But the best traders understand the inherent limitations of this approach, and proceed accordingly.
Many ask the rather simple and general question, “Does this event happen more often than not?” They want to know, is there something to indicate that a particular set up or indicator identifies a greater than or less than 50% proposition? If it does, they often stop the analysis right there and turn their attention to how they will manage the position: when to get in, when to take profit, when to stop out.
In other words, they use the track record to gain a small bit of insight. But they don’t try to take it much further than that. Because they realize there isn’t much more it can tell them. Just because the particular thing happened 63.7% of the time during the test period, doesn’t imply that the same results will be repeated. It just confirms that the thing did in fact happen more than half the time. With that out of the way, they turn their attention to the practical matters of what they will do if the investment works out the way they hope, and what they will do if it doesn’t.
If the pros allocate their time and attention in that manner, well that probably says something worth hearing about the way other investors should approach the matter, too.
By Brad Thomason, CPA
Do you want to be directly responsible for making sure that your money is both safe and earning a return for the rest of your life?
It’s actually a pretty big job. Maybe a bigger job than you want to tackle. And even if you want to, keep in mind that at some point in the future you may have health issues which make it impossible to continue doing so.
One way to address this is to hire an investment advisor to keep an eye on your money for you. While this is a popular solution, it may not be optimal. RIAs charge fees which can grow to significant sums over time.
Please note that I am in no way suggesting that the fees are unfair, nor am I saying anything at all negative about that profession. I’m merely pointing out the price tag.
If you have a million dollars with an RIA you could easily expect to spend $250,000+ in fees over the next twenty years. Moreover, the lost earnings on that money could be worth another $200,000 to $300,000 over the same period (in other words, when you write the check for the fees, that money stops being investment capital; and if it isn’t investment capital it can’t earn any future returns). I think it’s fair to say that half a million bucks qualifies as “real money” for just about everyone.
There is also the matter of risk. Having someone watch your money is probably better than ignoring it. But as long as it remains invested it remains at risk, and if there is a negative event the account owner (i.e. you) still bears responsibility for the loss. The advisor isn’t going to pay you back for investment- related losses. Not only is that not what they agreed to do, it would also be illegal.
As boring as it may sound to many of you, the only way to shift the burden of risk, and the responsibility for earning returns, to someone else, is to transact with an insurance company.
The whole reason the insurance industry exists is to allow risk to be shifted from one party to another. That’s what they do. And they’re the only ones – by law – who can.
Insurance gets a bad rap because there are higher theoretical rates of return available in other places you could put your money; and candidly, because a lot of the people who sell insurance are doofuses.
Sorry, but they are.
But if you look past the messengers to the message itself, I think the case becomes a lot stronger. Insurance companies have the ability to take on that risk, and have an extraordinarily solid track-record for absorbing the hits and delivering what they promised. They are also dramatically cheaper in terms of the fees they charge for tending to your principal.
Are insurance products a means to maximum returns? Probably not, although certain types of contracts pay substantially more than what you might expect. But still, I don’t think anyone would categorize them as the best way to make your money.
But there’s a difference between making money and storing it for later use. That which may not be such a great deal for the 40 year old might be exactly the right solution when she gets to be 70.
More and more I’ve come to view the ultimate goal of personal finance as a condition in which a person has enough money to cover what they are likely to need for the rest of their life, AND do it with little to no remaining exposure to investment risk. Why? Because that’s about the most conservative position I can envision in the midst of a situation that will never lose all of its aspects of chaos or unpredictability.
If a person wants to be able to say, “I did everything I could think of to secure my financial future,” isn’t that where they would necessarily have to end up?
There are many roads to building enough money. But when things approach the endgame, there are relatively few options for truly getting the money out of harm’s way. Banks and Treasury bonds probably deserve a place in that discussion. But the protection they afford comes at the expense of accepting the lowest return rates out there.
So if we take all of the at-risk stuff off the board, and we allocate to banks and Treasury bonds the maximum that we can tolerate on the return front, what’s left? The various offerings of the insurance industry.
They’ve had decades to design a host of products which deal quite directly with virtually all of the issues a retiree with money needs to address. They already know what your issues are going to be, even before you do, because they’ve already been through the various scenarios millions of times with past customers. Retiring may be new to you. But it sure isn’t new to them.
True, the contracts are often detailed and complex. But given that they are trying to defend against a vast spectrum of real world threats, I’m not sure why it would be expected that they would be anything but.
Insurance solutions are far from perfect. It’s just that everything else, in the end, may be even farther away. Winston Churchill said, “Democracy is the worst form of government, except for all those other forms which have been tried.” Perhaps there’s an analog here. Just because something isn’t perfect doesn’t keep it from being preferable to the other choices.
If you think you can do the job all by yourself, so be it. But most people are going to need help. Paid advisors may have a role to play, but they are expensive and can’t take the burden of risk from you. The insurance industry was the original retirement industry, and even though they get out-marketed by their flashier cousins over on the investment side, you shouldn’t assume that the substance isn’t there. There are things that insurance companies have a legal mandate to do that no fund company, broker/dealer or investment advisor can come close to matching.
So, if you are in need of what they excel at – low risk, with modest returns - doesn’t it make sense to include them as one of the options under consideration for your next rebalance?
By Brad Thomason, CPA
If you’ve ever slipped a canoe into a stream you found out pretty quickly which way the current was going. Canoeing on a stream is essentially an exercise in starting here with the intent of ending up there.
When performing investment analysis, it is often the case that the focus is simply on what the opportunity looks like today. But for an asset which will be held any length of time, looking at the future picture is an important part of really knowing what you’re getting into. It’s important to get a sense of what things might look like once you get downstream.
A popular newsletter advocates the idea of buying stocks of companies with a habit of increasing their dividends every quarter. Why? Because, that 6% yield you are buying today could morph into an 8% yield within a couple of years if everything goes well. And if you get really lucky, that higher yield could also lead to an increase in value (i.e. because more people want the bigger dividend and buying pressure causes the price to rise). So you’ll be earning more dividend income on your original investment and you’ll have an unrealized capital gain, too. Smart idea, and good when it works.
Contrast this with something like a CD or a bond. The terms you agree to are the ones you are going to have for the life of the investment. Well, if the issuer runs into problems you may get less than you were expecting. But you aren’t likely to get more. There’s simply nothing about the structure of those assets which would lead to that sort of changing situation.
Now, it is fair to point out that technically, investing on the basis of something which could develop is not without risks. It is in fact the very definition of speculation. You can take anything too far, and this is certainly something to be careful about. Venture capital (VC) investments are maybe the ultimate expression of investing in a situation today which you hope will be different tomorrow. VC investors write-off a lot of situations that never go anywhere at all, in the process of booking the relative few that actually take off. They are used to it and plan for it. Us mere mortals usually find losses harder to stomach, and should invest accordingly.
One downstream investment which we’ve had some involvement with is an office complex owned by one of our clients. The rental rates were initially set below market, in order to attract tenants and give the place a vibe of activity. Ghost towns are harder to lease, you know. This was possible because they got a good price on acquisition, and even with the lower rate the offices still made money for them.
Fast forward a couple of years and occupancy was over 90% and open space didn’t sit very long. So they started edging up the rates. Overall return levels rose because the future picture was different than the picture on the day they bought it. It was all just part of the plan, but the point is that they might not have done the deal in the first place if they’d only looked at the situation when it was empty space with no revenue.
Another one we like: buying a rental house and putting a mortgage on it. Even if the rents never go up and even if the property never appreciates, it can make more money in the future than in the present. How? Because the tenant is paying off the debt. That decreases the interest expenses that are hitting earnings, and improves the owner’s equity position at the same time. A double win. Best of all, the initial rents are often a higher yield than the investor was getting on bonds or other investments, and at least a portion of the income may be tax-preferenced, due to the depreciation deduction. You start out with a winning return and improve from there. Hire a pro to manage it, and it’s no harder to own than something which pays a much smaller yield.
Investing analysis has to look at the merits of the investment on the day of acquisition. Anything which may or may not happen in the future has to be understood as merely a maybe. But that said, if you don’t look into the paths the future could take, you may not have a full appreciation of what you are investing in. Ending up with a nice surprise is certainly not something to be too worried about. But passing on an opportunity because your analysis is too one-dimensional is probably not where you want to be.
By Brad Thomason, CPA
It’s quite possible that here lately you have been asking yourself whether the market will go up or go down from present levels.
Today I’d like to suggest a different question for you to consider.
If you go ahead and assume that the market falls significantly from here, what would you do about that?
I’m not saying I think it will. I’m just asking you to imagine what you would do about it if it did.
The first thing to make note of I think, is that the implications are different for someone who hasn’t retired yet retired, than they are for someone who has.
If you haven’t retired, the answer is that you probably wouldn’t do much of anything. It’s not so much that you aren’t impacted; but it probably doesn’t have any immediate effect on you. And once the price decline bottoms out and starts going back the other way, new money put into the market during such periods typically does pretty well.
It’s potentially a whole other story though for someone who has already retired, though.
We do not believe that it is a foregone conclusion, no matter who you are, that you have to have a stock allocation, at all. Stocks aren’t the only way to deploy capital in pursuit of meaningful returns. We further believe that if you have already retired, there’s a pretty good argument that you shouldn’t have a stock allocation. We’ve articulated this viewpoint in any number of past blogs and presentations, spanning a period of many years.
That said, if you are going to have stocks in the mix after retirement, you have an engineering issue to deal with: how you will handle “the V.”
The V is the dip in the price chart that takes places any time there’s a major market downturn. It’s the period of time from start of the fall, until the price eventually makes it back up to its former level.
The V associated with the Tech Bubble lasted from the summer of 2000 until the spring of 2007 (about 7 years).
The V associated with the Financial Crisis lasted from about August 2007 to November of 2012 (a bit over 5 years).
The V is extremely significant for those who are already relying on their portfolio/savings to fund monthly income. That’s because anything you withdraw during the entire run of the V will never have a chance to recover its lost value (at least not all of it).
So not only will the block of capital associated with your stock allocation not earn anything for a period of months or years, without some sort of per-planned means of coping with it, the V will force you to lock in some losses as well. A true case of adding insult to injury (or maybe just adding injury to other injury).
There are two broad approaches for dealing with a V. If you remain invested in stocks, the goal becomes to diminish the effect of the V. This can be accomplished by taking steps (whether through active management, derivatives, etc) to either shorten the duration of your personal version of the V, lessen the degree of your V’s decline, or some combination of the two. A briefer V decreases the number of months that the withdrawals should ideally be put on hold; a shallower V means that the losses you book are not (quite…) as serious. But do note that under any of these scenarios you don’t come out unscathed. Maybe just less injured.
The other approach is to diversify to other asset classes, and use those other allocations to supply income until the V is over. If all of your money is in stocks, waiting it out probably isn’t an option. If most of your money is elsewhere, it might be possible. It might even be easy. Just depends on how much of the capital is outside of stocks (prior to the beginning of the V) and what it’s earning.
As you might expect, none of these workarounds just happen. They require thought, planning , and most of all, action. Once you figure out what you ought to do, you still have to do it.
While everyone is attracted to the idea of seeing their money grow because the market keeps inching higher, there’s no getting around the fact that making money is not the only important consideration. Making it and then losing it yields no benefit; and is actually harder on a person, psychologically speaking, than never having had the money in the first place.
So while it is natural to have some preoccupation with the question of whether or not the market will go up from here, a more useful question to focus on may be what you are going to have to do if it goes down. That second question may give you much clearer guidance on what your next step ought to be, than the first one.
By Brad Thomason, CPA
According to the models we use for forecasting interest rate moves, three clear possibilities have emerged. We see them rising, falling or staying pretty much the same.
Sorry. That was funnier in my head.
Someone told me a long time ago that trying to guess where interest rates are headed is a sucker bet. They were probably right. Most of the people I have met over the years who were the most certain about where rates were headed have been almost universally wrong. It’s like the more convinced you are, the less likely the powers-that-be are to give you what you want.
Still, interest rates are important, a lot of people watch them, and it therefore becomes impossible not to speculate a little. Or at least wonder.
A gauge that I have always found interesting is the relationship between rates for junk bonds versus other more mainstream types of debt. The theory is that since the lower-rated bonds have a higher likelihood of default (which is why they have the lower rating…), then you have to pay a higher rate to get investors to take the risk.
Which is sound logic at all times; yet what “higher” means fluctuates rather widely from one year to the next.
At present the spread between junk bonds and Treasuries has dipped to less than four percentage points (400 basis points, if you want to get all fancy). Compare that to a historical average of probably between 6% and 7% (depending on how far back you look).
The St Louis Fed has a nice chart, if you want to take a look.
In simple terms, this means that bond buyers are willing to take a smaller amount of additional interest for their risk, than usual. Why they might do that, perhaps, provides some clues as to what they think is on the horizon for interest rates.
One theory would be that they wouldn’t lock up money for a long time if they thought a rise in rates was coming any time soon. They have to park the money somewhere, and if the current rate is as good as they are likely to get for the foreseeable future, then earning something is better than earning nothing sitting in cash.
Another theory is that they wouldn’t pay such a high premium, unless they could pick up a profit doing so. What would lead to such a profit? A drop in interest rates. If Treasury rates drop, that spread widens, and the value of the junk bonds would go up. In theory. A nice trader’s play.
There’s no real way to know which theory drove the action that got us to this point on the spread differential. And even if we did know why they acted, there’s no guarantee they guessed right and will get the win they are after.
But what’s interesting to me about both possibilities is what they aren’t: neither is a vote for the idea that rates are going higher.
People who think rates are rising stay in cash to get the higher rate later, and duck the capital losses that come from being long bonds when the prices are falling (remember that rates and prices move in opposite directions in the bond market). They don’t buy now. And they sure don’t pay extra.
I hear growing talk that higher rates are coming. Maybe they are. But based on the spreads in the junk bond world, it doesn’t appear that those folks think so.
Recall also that for interest to get high and stay high, someone has to agree to pay the actual interest. That little consumer-centric fact is almost always left out of the discussion when investment people start talking. But it’s not a minor point. Individuals, businesses and the real estate community all have a lot of financing options these days, and no one seems to be eager to pay a lot more for the use of that capital.
An additional bit of commentary which may be meaningful is the trend in Treasury yields over the last few months. Since the beginning of the year, short term Treasury yields are up. but the the 30 year is basically right where it started the year (i.e. the yield curve has "flattened" over the course of the last 6 months).
So, I don’t know where rates are headed. But if you think that it is a foregone conclusion that they are headed dramatically higher, it might be worth considering why some of your fellow market participants – ones who control an awful lot of capital – apparently think otherwise. Because somebody is going to end up being wrong.
By Brad Thomason, CPA
The year is half over. How has it been going?
Today I’ll describe a quick way to tell, a mid-year check-up of sorts.
Look back to your statements from a year ago. Total them up. Multiply by 1.07.
Take the product and compare it to your current balances.
Which is bigger, the number you calculated or the current size of your portfolio?
In other words, is your portfolio 7% larger (or more) than it was twelve months ago?
As we’ve discussed in detail a number of times, there’s a whole lot more to the world of retirement income than just what your portfolio earns. That said, every one of those other parts is easier to deal with if your capital is doing its job: producing more capital.
I suppose we should differentiate this question for those who have versus have not retired. If you are already drawing money out of your portfolio, you can add those amounts back before you compare your balance to the bogey. If you are not retired, and still making contributions (as to a 401(k), etc) then you need to deduct those amounts. No credit on the earnings front for new principal.
But big picture this is just straight math. Either you beat the hurdle or you didn’t.
While there’s nothing magical about 7%, per se, it does represent what I think of as sort of being in the lower end of the range for a portfolio that’s really doing its job. Languishing capital can be OK for awhile, especially if there are risk or asset selection issues. But over the long run it needs to be deployed and working. Otherwise, the lost potential that it represents is insanely expensive – maybe more so than you can afford.
I’ll close with a couple of obvious conclusions. First, this is a useful test to run any time, not just at midyear. Second, if your capital isn’t producing where it is, maybe you want to consider moving it around. There are risk concerns to take into account, as well as matters related to diversification and timing of cash flows (especially if you’ve already retired). Don’t just reallocate willy-nilly without giving it some thought.
But yea, if it isn’t producing, do give it some thought; probably followed by some sort of prudent action.