Retirement Portfolio Spending Strategy – Withdrawal Order Flowchart


According to research from the Vanguard Group, another area where a skilled financial advisor is supposed to able to add value is helping retirees manage withdrawals from their portfolios in order to minimize taxes. According to their paper:

Advisors who implement informed withdrawal-order strategies can minimize the total taxes paid over the course of their clients’ retirement, thereby increasing their clients’ wealth and the longevity of their portfolios. This process alone could represent the entire value proposition for the fee-based advisor.

The paper goes on to show how correct ordering can improve returns by up to 0.70% annually versus people with multiple different account types withdrawing in the wrong order. The thing is, ordering your withdrawals properly isn’t all that complicated. Most of it is summarized in this flowchart:


  • RMDs stand for required minimum distributions. In general, these are forced withdrawals from pre-tax “traditional” IRAs (including SEP and SIMPLE IRAs) and pre-tax workplace defined-contribution plans (including 401(k) and 403(b) plans) once you reach age 70.5. Since it is mandatory and taxed at ordinary income rates, you may as well spend them first.
  • Next, taxable flows include things like interest, dividends, and capital gains distributions that are already being “spun off” from your taxable portfolio. These are also going to be taxed no matter what anyway.
  • Next, spend your taxable portfolio itself by selling shares and paying any capital gains taxes that may be due. Sell investments with the lowest gains first to minimize taxes. Don’t sell if you don’t need the money.
  • What you have left are tax-deferred or tax-free (Roth) accounts. Do you want to pay taxes now, or later? If you think your marginal tax bracket will be higher in the future, then you should pay taxes now (withdraw first from tax-deferred account). If you think your marginal tax bracket will be lower in the future, then you should pay taxes later (withdraw first from Roth accounts). You could make your decision differently each year depending on your current situation.

How Good Portfolio Management Can Improve Real-World Returns


Vanguard has released a research paper called Putting a value on your value: Quantifying Vanguard Advisor’s Alpha, which provides the data and methodology behind its previous statement that a good financial advisor should be able to affect the performance of client’s portfolio by about three percentage points. The areas where good management can add value are summarized in the graphic below:


As a DIY investor, this chart also provides suggestions for areas to focus your energy. The biggest single “value-add” appears to be in the area of behavioral coaching. This basically boils down to convincing the client/investor not to abandon their previous plans during times of extreme greed (bull market) or fear (bear market). In other words, do nothing. In my previous post, I posed that a simple Vanguard Target Date Retirement fund would provide both low expense ratios and regular rebalancing – no advisor required. It turns out that if you can buy one of these Target funds and leave it alone for a long time, you’ll do even better…

Vanguard analyzed the performance of 58,168 self-directed Vanguard IRA investors from 1/1/2008 to 12/31/2012, a 5-year period which includes both the financial crisis and subsequent recovery. These self-directed investors were compared with an appropriate Target Date fund benchmark. The authors even state “For the purpose of our example, we are assuming that Vanguard target-date funds provide some of the structure and guidance that an advisor might have provided.”

An investor who made at least one buy/sell exchange between fund over the entire five-year period trailed the applicable Vanguard target-date fund benchmark by 1.5% annually on average. Investors who made no exchange lagged the benchmark by only 0.19%. The chart supplied is a little tricky to read, but illustrates the performance gap.


(You want more “area under the curve” on the positive excess return side, and less “area under the curve” on the negative excess return side.)

I agree a good financial advisor can add value. Many people are doing none of the strategies listed above. However, a motivated DIY investor can implement most of not all of these strategies themselves. If you can buy a Vanguard Target Retirement fund and leave it alone (easier said than done), you can get much of the way there without an advisor. The problem is that you may have to go through an extreme market cycle to know if you can actually do it. Excerpted from the paper’s conclusion:

This 3% increase in potential net returns should not be viewed as an annual value-add, but is likely to be intermittent, as some of the most significant opportunities to add value occur during periods of market duress or euphoria when clients are tempted to abandon their well-thought-out investment plan.

Vanguard Managed Payout Funds and Safe Withdrawal Rate Strategy


paycheckreplaceA key component of retirement planning is figuring out how to draw an income from all that money you’ve invested. “Create your own paycheck.” The trick is figuring out how to take a stable amount out every year without running out of money.

This has led to a debate about “safe withdrawal rates”. The 4% number has been thrown around a lot, where for example if you retired with $1,000,000 in a balanced portfolio of stocks and bonds you might take out $40,000 a year (increasing with inflation) for 30 years with confidence. The problem is that if you simply take out 4% of your starting balance and then keep taking that number out every year robotically then your outcome depends a lot on sequence of returns. If you hit a prolonged bear market just a couple years into retirement (i.e. value drops to $700,000), your nest egg is much less likely to survive. On the other hand, if you hit a bull market for the first 10-15 years and only experience the bear market afterward, then you may die with more money than you started with.

This is why many experts encourage a more flexible “dynamic” withdrawal strategy that adjusts withdrawals based on portfolio performance. There are an infinite number of ways to implement this, so I looked for an industry example and found it in the Vanguard Managed Payout Fund (VPGDX)*. This all-in-one fund uses a 4% target distribution rate and with regular, monthly distributions that you can indeed treat like a (somewhat variable) paycheck. The fund is actively managed for total return, although a majority of its components are passive index funds.

How does the Vanguard Managed Payout fund calculate how much you can spend each year? Reading through the prospectus, we find that the monthly payout is calculated on January 1st every year, then kept constant for the next 12 months, and then reset again the next January 1st. If you started January 1st, 2014 with a $1,000,000 in this fund you would get a payout every month of 2014 for $2,995 ($35,940 a year). Why isn’t it 4% or $40,000?

The fund’s dynamic spending approach uses a “smoothing” method that keeps the monthly payout from changing too dramatically from year to year. Specifically, the 4% withdrawal rate is based on a 3-year rolling average of hypothetical past account value (assumes you spend the monthly distributions, but reinvest any year-end capital gains and dividends). Screenshot from prospectus:


So since the average of the past 3 years is lower than the current value, you’re getting 4% of a smaller number. As you can see, with smoothing your annual income from this fund can vary significantly over time. A starting portfolio size of $1,000,000 might get you an annual distribution varying from less than $36,000 or more than $44,000. Other smoothing methods include setting a maximum ceiling or minimum floor value, but this fund does not do that. Ideally, you would use the income from this fund to supplement other income from more reliable sources like Social Security, pensions, or guaranteed income annuities. That way your overall income will vary even less, and you’ll only have to cut back a little during down years.

(* Previously, Vanguard had three different Managed Payout funds with three different target spending rates of 3%, 5%, and 7%. I think this was confusing for many investors who didn’t really understand that the 7% fund would most likely experience a significant loss of principal over time. This is only speculation on my part, but the 7% payout fund did gather 8 times the assets as the 3% payout fund, even though 3% is a more realistic number for most folks. Vanguard now says that 4% is best for the “typical retirement period of 20–30 years”.)

The Power of Compound Interest Shown in a Single Chart


It’s not just how much you save, it’s when you save that matters. The best time to start is now. This is the power of compounding returns, which this single chart will help you visualize:


  • Susan (grey) invests $5,000 per year from age 25 to 35 ($50,000 over 10 years) and stops.
  • Bill (green) invests $5,000 per year from ages 35 to 65 ($150,000 over 30 years).
  • Chris (blue) invests $5,000 per year from ages 25 to 65 ($200,000 over 40 years).

You’ll note that Susan still ends up with more money than Bill, even though he invests three times as much money over 30 years, all because Bill starts late. Susan and Chris start out the same, except that Susan stops after 10 years while Chris keeps going. Chris only invests $100,000 more than Susan, but ends up with $500,000 more money in the end. A 7% annual return is assumed.

The chart is from a JP Morgan slide deck for their asset managers, via Business Insider.

I’m also reminded of Warren Buffett and his Snowball biography – “Life is like a snowball. The important thing is finding wet snow and a really long hill.”

Barron’s Best Online Broker Rankings 2014


barron2014Weekly business newspaper Barron’s just released their 2014 annual broker survey rankings. Here’s a snippet about their criteria (emphasis mine):

Our evaluation criteria focus on the needs of wealthy, active traders. We looked at eight categories of service, examining what can be traded online, how the tools work together across platforms, the design and capabilities of mobile platforms, educational offerings and customer service, as well as the nuts and bolts of placing and executing a trade. We closely scrutinized the various tools available for finding appropriate trades, including scanners and charts. When examining costs, we considered stock and options commissions as well as platform or maintenance fees, margin debt, and charges for transferring an account out.

Their overall winner was again Interactive Brokers, a broker designed for highly-active traders with an extensive feature set, low commissions, and low margin rates. However, IB also has a minimum opening balance of $10,000, a minimum monthly fee of $10 even if you don’t trade at all, and customer service that does not cater to casual investors. They recently starting waiving the $10 minimum monthly fee if your account value is at least $100,000.

I am not an active trader, but I still like having real-time quotes, a clean user interface, and helpful customer service when I need it. Thankfully, Barron’s again ranked the brokers for the rest of us:

Top 5 Brokers for Novice Investors

  1. TD Ameritrade. Performed well in customer service & education, research tools, and mobile offerings. Improved desktop site and mobile apps integration. Free real-time quotes from NYSE, AMEX, and NASDAQ Level 1 and 2.
  2. Fidelity
  3. E-Trade
  4. Charles Schwab
  5. Capital One Sharebuilder

Top 5 Brokers for Long-Term Investing

  1. TD Ameritrade. The only broker to provide a wide range of commission-free ETFs from various providers (not just their own in-house ETFs).
  2. Fidelity
  3. Charles Schwab
  4. Merrill Edge
  5. E-Trade

Top 5 Brokers for In-Person Service

  1. Scottrade. Scottrade has over 500 physical branches across US, so that when you call you reach a human in that local branch. Free in-person educational seminars are offered as well.
  2. Merrill Edge
  3. Charles Schwab
  4. Fidelity
  5. TD Ameritrade

Reading through the entire article, most of the brokers made a few incremental changes (better mobile app, new options tools) but nothing game-changing. So it shouldn’t come as a surprise that for the three niche rankings above, the Top 5 ended up exactly the same as the 2013 rankings. Again, Vanguard’s brokerage declined to participate and thus was not eligible for the rankings.

Bogle on Predicting Future Long-Term Bond Returns


Jack Bogle is best known as the founder of Vanguard index funds, but he also dispenses great common sense advice about investing. I’ve written previously about his long-term stock return methodology including this prediction for stock returns for 2010-2020.

He also has a simple method to predicting future long-term bond returns, which is by simply taking the current bond yield. For example, the current yield of 10-year Treasuries is 2.7%, so roughly 3% is likely the future 10-year return.

This is explained further in this recent WSJ article (via Abnormal Returns). This chart shows it best:


Since 1926, he notes, the entry yield on the 10-year Treasury explains 92% of the annualized return an investor would have earned over the subsequent decade had he or she held the bond to maturity and reinvested the coupon payments at prevailing rates.

Similarly, the entry yield on the Barclays U.S. Aggregate Bond index (of investment-grade U.S. bonds) explains 90% of its 10-year returns for the years 1976 to 2012, says Tony Crescenzi, a portfolio manager and strategist at Pacific Investment Management Co.

The Vanguard Total Bond Market ETF (BND) which tracks the Barclays U.S. Aggregate Bond index currently has an SEC yield of 2.2%, which doesn’t seem like a very exciting number to look forward to. While this shows that our expectations should be very modest, it’s still important to remember that we hold bonds as a counterbalance to stock price volatility. As long as we hold them together, the overall picture is much more tolerable.

WiseBanyan: Free Automated Portfolio Management?


wblogoReady for another start-up? WiseBanyan wants to offer free online investment advisory services. That’s right, they will take your money, help you buy a portfolio of ETFs, manage dividends, rebalance, all that for free with no minimum balance (you’ll still pay the underlying ETF expense ratios). Sounds like Betterment minus their fees. WiseBanyan CEO Herbert Moore outlined his vision for the future in the Medium article You Will Be Investing For Free In 5 Years. Here’s my take:

Fund management fees are going to zero. The Vanguard Stock Market ETF (VTI) already holds over a basket of over 3,600 stocks and charges just 0.05%, or $5 a year for each $10,000 invested. Supposedly with short-term securities lending, ETF expense ratios could be zero or even negative (investors get paid).

Securities lending is complex, but for ETF sponsors it means being able to lend out the underlying securities of the ETF for a fee — iShares has a good description of it here. In fact, iShares is already able to offset much of its management fee with securities lending revenues?—?for example, iShares Small Cap US Equity ETF IWM has an expense ratio of 0.20% but earned 0.20% in securities lending in 2013, meaning that the effective fee was zero.

Vanguard’s head of retail Investments, Nick Blake, has also weighed in on this, saying that “In theory, we could pay investors to invest in us [as] stock lending can [create] a negative TER [total expense ratio] …There will always be a fixed cost in there, but if volume is big, the total expense ratio can come right down.”

Stock and ETF trading commissions are going to zero. Zecco offered a bunch of free trades several years ago before the financial crisis, but ended up back at $4.95 a trade. But sometime this year is supposed to start up a lean online brokerage offering free trades. I agree that the marginal cost of a trade may be zero, but you have to first overcome sizeable fixed costs. This is why even super-lean brokers for active traders like Interactive Brokers still charge a base minimum of $20 month.

Management fees for a portfolio of stocks and ETFs… are going to zero. Surprise! This is where Wisebanyan comes in. They want to extend the online investment advisory business and use automation to make it free as well. It appears they will be using the “freemium” model where you can pay extra for added features:

WiseBanyan plans to introduce paid investing and client services to complement our free managed portfolios. Two examples include tax-loss harvesting and a product we’re tentatively calling “financial concierge.”

I’m always skeptical when something that requires a certain level of customer service tries to be completely free. Of course, I still signed up on their early access waitlist (use my link and supposedly I’ll move up in line just like with Robinhood). Is it really just a race to the bottom? Gotta remember to check back in 5 years.

Vanguard Index Fund Expense Ratio Changes 2014


When you invest in a mutual fund or ETF, the fund company charges you a fee for managing that basket of stocks or bonds. These expenses are taken out via small reductions in the funds’ net asset value (NAV), and while the numbers can seem small they will compound quietly and relentlessly over time. Here are two illustrations from the Vanguard website:

Each percentage point in an expense ratio represents an annual charge of $100 against every $10,000 you invest in that fund. In other words, if you have $10,000 in a hypothetical fund with a 0.50% expense ratio, you’re charged $50 each year. So, a 0.15% expense reduction would save you $15, while a 0.15% increase would cost you an extra $15.


Vanguard consistently drops what they charge to investors as their own costs drop. I’m using this post to keep track of their 2014 expense ratio change announcements, highlighting the more popular index funds that I watch for use in my own portfolio.

Fund Name Expense Ratio (Jan 2014) New Expense Ratio (Feb 2014)
Total International Stock ETF (VXUS) 0.16% 0.14%
FTSE Emerging Markets ETF (VWO) 0.18% 0.15%
Total World Stock ETF (VT) 0.19% 0.18%
Global ex-U.S. Real Estate ETF (VNQI) 0.32% 0.27%
FTSE All-World ex-US Small-Cap ETF (VSS) 0.25% 0.20%
Total US Stock ETF (VTI) 0.05% 0.05% (nc)
REIT ETF (VNQ) 0.10% 0.10% (nc)

Also note that ETF expense ratios usually match the Admiral shares of the respective mutual fund.

February 2014
January 2014
December 2013

Buffett’s Simple Investment Advice to Wife After His Death

The popular Berkshire Hathaway (BRK) Annual Letter to Shareholders by Warren Buffett is now available to the public. Download it here [pdf].

I’ve been haltingly working on making preparations for my family in case of my premature demise. I’ve done a number of things, but I’m still not sure if my wife can manage our investments when I’m gone. Should I try to teach her, even if she has little interest? Should I find an advisor? Should I hire him/her now, even though I am a control freak? Interestingly, Buffett addresses this issue partially in his letter.

First, Buffett repeats his advice that while he doesn’t believe in efficient markets, he does believe that non-professionals should invest their money in low-cost index funds.

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.

Of course, I’m sure the sum set aside would be enough even if kept 100% in cash. But index funds were still a surprise to me given how many smart money managers Buffett knows. At the minimum, I figured he’d leave a big ole’ pile of BRK shares (managed by some of those smart people that he already hired). But I forgot that Buffett has already committed his BRK shares to charity.

Buffett’s simple advice made me think about my plans again. I would also leave my wife a relatively simple index fund portfolio and a paid-off house. My casual advice given to her so far is that she can spend 2-3% of the total balance each year without worrying about the money running out. With the life insurance proceeds, that 2%-withdrawal value is a bit more than what we spend now, so it shouldn’t be too hard.

If she needs help, she can contact the Certified Financial Planner that Vanguard offers clients ($50k in assets gets you access to a discounted plan from a CFP). I figure that even the cookie-cutter portfolios that they may recommend won’t be too bad in the big picture. I know this is not a complete plan, but well, I also don’t want my wife going to a high-fee manager.

Late Brokerage 1099 Forms & IRS Mailing Deadlines


I never file my tax returns too early. The last time I did so, I had to file an extra amended return as my stock brokerage sent me a late corrected 1099 form shortly afterward. What a hassle. It seems that every year one of these forms shows up in my mailbox in March. Indeed, TD Ameritrade just send me an e-mail today (2/25) that a corrected 1099 is on its way. Why?

IRS mailing deadlines
The official IRS mailing deadline for 1099-B forms (reporting sales from brokerage firms and mutual fund companies) is normally February 15th. This is 15 days later than the mailing deadline for most other tax forms like W-2s. However, this year February 15th falls on a Saturday and Presidents Day is Monday, February 17th. This results in the adjusted mailing deadline being Monday, February 18th, 2014.

So how can they arrive even later?
Many brokerage firms will only send a “preliminary” 1099 by this date to satisfy the IRS requirement. Because some securities (commonly certain REITs or foreign stocks) may not report their numbers to the broker in time, brokers often delay sending out their corrected or “final” 1099 until a month or more later. So while I start preparing my return ahead of time, I usually wait to file until I’m confident that all my 1099 forms are finalized.

In my case, it was the Vanguard REIT ETF (VNQ) that caused my corrected 1099 form. $1,000 Outgoing Account Transfer Fee


Update: “Sunlight is the best disinfectant” – Louis Brandeis. :) A few hours after my post…

Online portfolio managers are a hot area right now, and is one that promises “we do everything for you” simplicity combined with relatively low costs when compared with a human advisor. Recently, a reader named RSG left a comment on my Betterment Review post:

In the updated user agreement, Betterment will charge a fee of up to $1000 for an in-kind transfer! That’s absurd and way higher than industry standard for other broker-dealers.

An in-kind transfer, also referred to as a full Automated Customer Account Transfer (ACAT) transfer, is where all of your holdings are transferred to another broker-dealer. Since you don’t sell any positions, any potential tax complications are avoided. I agree that this fee is around $75 at most brokers, so naturally I wanted to verify this claim.

I could not locate any notice of this fee anywhere on the website, even on their “pricing details” pages. The only place I could find it mentioned it is buried on page 59 of their 139-page customer agreement [pdf] last revised on 1/15/2014.

23. Transfer of Assets. Client may request transfer of Assets to an account Client has established with another broker-dealer. [...] The fee provisions of the Brokerage Agreement and Advisory Agreement notwithstanding, Betterment Securities may charge a fee of up to $1000 for transferring assets to another broker-dealer.

I opened a $1,000 test account with Betterment myself and I admit that I totally missed this fee. (I better not move it as I’d be left with nothing!) I also verified this by contacting Betterment support staff, and here was their response:

Unfortunately this is not something that Betterment supports right now so we would bring in a third party to do an ACAT transfer. This process costs a fee of $1,000. Again, simply liquidating the funds is completely free.

I appreciate the explanation for why the fee is so high (although they have been around for a few years now), but potential customers should be aware of this potential exit fee. While it is indeed “free” to sell all your positions, be aware that you may trigger a sizable tax bill on any investment gains. Some brokers offer ACAT fee rebates if you transfer over enough assets, but many of them cap it at $100-$150.

Tax Guide 2013 for LendingClub and Prosper 1099 Forms


Updated 2014. I’ve gotten a few tax-filing questions regarding P2P lenders Prosper Lending and Lending Club. For tax year 2013, LendingClub provided individual investors extra guidance with their Tax Guide for Retail Investors [pdf]. Using this information, I have updated this post.

Don’t file too early. My first recommendation is to not print out or download any of your 1099s until mid-March. Both Prosper and LendingClub seem to regularly issue corrected and/or amended 1099 forms with new numbers late in February. If you already printed them out earlier, go back and make sure they haven’t been changed. After having to file an amended return a few years ago, I always wait until after mid-March to gather all my tax documents.

Where to find your tax documents. I don’t think either Prosper or Lendingclub sends you 1099 forms in the mail. The easiest way for me to direct you to these documents is for you to cut-and-paste the following URLs into your web browser and then log into your accounts. Here are screenshots of what the pages should look like for Prosper and LendingClub.

Tax disclaimer. I am not a tax professional. The following is based on my best attempt at understanding the fuzzy world of P2P lending taxes. I am simply sharing how I’m going to do my personal tax return, but you should consult a tax professional for an expert opinion. You may not get all or most of these forms.


LendingClub 1099-OID. OID stands for original issue discount. The total of Box 1 is basically what LendingClub is reporting as the interest earned on your loans, net of fees. This interest should be reported on Schedule B and taxed as ordinary interest income (similar to interest from bank accounts).

LendingClub 1099-B (Recoveries for Charge-offs). If you had any loans charged-off*, but they still recovered some money later on, that will be reported here. It should be broken down into either short-term or long-term capital gains. Because it already tells me short-term or long-term, I will simply report the totals with acquisition and sell date(s) as “various”.

LendingClub 1099-B (Folio secondary market). If you sold any loans on the secondary Folio market, then the sales should be reported here. It should also be broken down into either short-term or long-term gains or losses. I will simply report the totals on Schedule D, using my acquisition and sell date(s) as “various”.

LendingClub 1099-MISC. I would just type this form into TurboTax box-by-box or submit directly to your accountant, usually under “Other Income”. Box 7 amounts will be subject to self-employment taxes, Box 3 amounts will not.

Prosper Lending

Prosper 1099-OID. Similar story to the LendingClub 1099-OID above, except they just give you the total from all your loans. Again, I have all zeros except for Box 1, which I will report as ordinary interest income on Schedule B.

Prosper 1099-B (Recoveries for Charge-offs). Again, anything listed here should be broken down into either short-term or long-term capital gains/losses and recorded on Schedule D. Prosper includes loan charge-offs on this form.

Prosper 1099-B (Folio secondary market). Again, anything listed here should also be broken down into either short-term or long-term gains or losses.

Prosper 1099-MISC. I would just type this form into TurboTax box-by-box or submit directly to your accountant, and it should be pretty straightforward. Box 7 amounts will be subject to self-employment taxes, Box 3 amounts will not.

*Reporting Charge-offs

If you have loans that were charged-off in 2013 (loan is very late and attempts to collect have failed, so they give up), you can write them off as a non-business bad debt. You can find these in either your year-end statements (LendingClub) or your 1099-B form (Prosper). These are all treated as short-term capital losses, which you can use to offset short-term capital gains from other investments or you can deduct against up to $3,000 in ordinary income per year (with the balance carrying forward to the next year).

More resources: Let me also recommend Peter Renton’s post at LendAcademy, the follow-up comments on that post, and this forum post by AmCap as good references for an intelligent discussion on the topic. Also see the LendingClub and Prosper tax pages, even though they aren’t especially helpful.