Higher Savings Rate vs. Higher Risk Portfolio

An article on the Vanguard Advisors Blog discussed the trade-offs involved in adjusting an investor’s savings rate and the risk level of their portfolio – Investor success: Measured in dollars, not (per)cents.

A portfolio’s value can grow through both capital contributions and return on capital, but only capital contributions can grow wealth reliably. Saving is our contribution to our own investment success and, importantly, unlike the investment returns we seek, its benefits are both more certain and within our control.

The chart below shows projected outcomes based on savings rate (4% or 6%) and portfolio risk level (conservative, moderate, or aggressive). You can see visually that the combination of 6% savings rate and moderate risk (50% stocks/50% bonds) has both a higher average outcome and fewer poor outcomes than the combination of 4% savings rate and aggressive risk (80% stocks/20% bonds)

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Part of this should be expected – you’re saving 50% more in dollars when going from a 4% to 6% savings rate. But on an absolute level, perhaps that amount of dollars is something you can swing.

Vanguard did a similar study called Penny saved, Penny earned back in 2011 that compared three levers: savings rate, portfolio asset allocation, and also starting to save earlier. Take the following baseline scenario:

  • Investor begins working at 25, but starts saving at age 35.
  • 12% savings rate
  • Moderate asset allocation (50% stocks and 50% bonds)
  • Salary starts at $30,000 but increases with age

Now, here are three ways in which a worker could increase their final savings balance at retirement (age 65).

  • Option #1. Invest more aggressively with an asset allocation of 80% stocks and 20% bonds, while keeping your 12% savings rate and starting age of 35.
  • Option #2. Raise your savings rate to 15%, while keeping your starting age of 35 and 50/50 asset allocation.
  • Option #3. Start saving at age 25 instead of 35. while keeping your 12% savings rate and and 50/50 asset allocation.

Which single option do you think has the most impact? The results are based the median balance found after running Monte Carlo computer simulations based on 10,000 possible future scenarios for each option.

Scenario Median Balance at age 65 % Increase vs. Baseline
Baseline $474,461
Option #1
(Aggressive asset allocation)
$577,133 22%
Option #2
(Raise savings rate)
$593,077 25%
Option #3
(Start saving earlier)
$718,437 51%

 

Between the three “levers” you could pull, starting to save earlier wins by a significant margin, which is an important truth but minus a time machine today is the earliest we can start saving more. After that, a higher savings rate is a more reliable path to improving your odds for success. Investing with significantly more risk performs somewhat similarly on a median basis, but actual results will vary the most widely.

I suppose my version of this is that an investor should keep working hard to maximize their savings rate, but only work hard to find a “good” asset allocation once and then let it be. My definition of “good” asset allocation is one that considers your financial needs, your knowledge, and as a result is something that you can keep forever. Don’t look for the “perfect” asset allocation, as these can only be known after the fact and are constantly changing. Too often, they are based on data mining and recent performance. Look at any asset allocation with growing popularity, and the asset classes that make it hot have probably done well in the past decade. You can quote “long-term” numbers from long periods like 1970 to 2015, but these numbers are still strongly influenced by recent past performance.

Early Retirement Portfolio Income Update, April 2016

dividendmono225I like the idea of living off dividend and interest income. Who doesn’t? The problem is that you can’t just buy stocks with the absolute highest dividend yields and junk bonds with the highest interest rates without giving up something in return. There are many bad investments lurking out there for desperate retirees looking only at income. My goal is to generate reliable portfolio income by not reaching too far for yield.

A quick and dirty way to see how much income (dividends and interest) your portfolio is generating is to take the “TTM Yield” or “12 Mo. Yield” from Morningstar quote pages. Trailing 12 Month Yield is the sum of a fund’s total trailing 12-month interest and dividend payments divided by the last month’s ending share price (NAV) plus any capital gains distributed over the same period. SEC yield is another alternative, but I like TTM because it is based on actual distributions (SEC vs. TTM yield article).

Below is a close approximation of my most recent portfolio update. I have changed my asset allocation slightly to 60% stocks and 40% bonds because I believe that will be my permanent allocation upon early retirement.

Asset Class / Fund % of Portfolio Trailing 12-Month Yield (Taken 4/14/15) Yield Contribution
US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)
24% 1.94% 0.46%
US Small Value
WisdomTree SmallCap Dividend ETF (DES)
3% 2.80% 0.09%
International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX)
24% 2.82% 0.66%
Emerging Markets Small Value
WisdomTree Emerging Markets SmallCap Dividend ETF (DGS)
3% 3.03% 0.10%
US Real Estate
Vanguard REIT Index Fund (VNQ, VGSLX)
6% 4.21% 0.24%
Intermediate-Term High Quality Bonds
Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX)
20% 2.90% 0.60%
Inflation-Linked Treasury Bonds
Vanguard Inflation-Protected Securities Fund (VAIPX)
20% 0.82% 0.26%
Totals 100% 2.31%

 

The total weighted 12-month yield was 2.31%. This means that if I had a $1,000,000 portfolio balance today, it would have generated $23,100 in interest and dividends over the last 12 months. Now, that is significantly lower than the 4% withdrawal rate often quoted for 65-year-old retirees with 30-year spending horizons, and is even lower than the 3% withdrawal rate that I have previously used as a rough benchmark. I’ll note that the muni bond interest in my portfolio is exempt from federal income taxes.

Given the volatility of stock returns, the associated sequence of returns risk, and current high valuations, I still like the income yield measuring stick. I feel that the income yield number does a rough job of compensating for market valuations (valuations go up probably means dividend yield go down) as well as interest rates (low interest rates now, probably low bond returns in future). With 60% stocks, I am hoping that the overall income will keep up with inflation and that I will never have to “touch the principal”. Over the last 15 years or so, the annual growth rate of the S&P 500 dividend averaged about 5%.

As noted previously, a simple benchmark for this portfolio is Vanguard LifeStrategy Moderate Growth Fund (VSMGX) which is an all-in-one fund that is also 60% stocks and 40% bonds. That fund has a trailing 12-month yield of 2.12%. Taken 4/14/2016.

So how am I doing? Staying invested throughout the last 10 years has been good to me. Using the 2.31% income yield, the combination of ongoing savings and recent market gains have us at 88% of the way to matching our annual household spending target. Consider that if all your portfolio did was keep up with inflation each year (0% real returns), you could still spend 2% a year for 50 years. From that perspective, a 2% spending rate seems like a conservative number, even with the many current predictions of modest future returns.

Early Retirement Portfolio Asset Allocation Update, April 2016

portpiegenericIt has been a while, so here is a 2016 First Quarter update on my investment portfolio holdings. This includes tax-deferred accounts like 401ks, IRAs, and taxable brokerage holdings, but excludes things like our primary home and cash reserves (emergency fund). The purpose of this portfolio is to create enough income to cover household expenses.

Target Asset Allocation

aa_updated2015

I try to pick asset classes that will provide long-term returns above inflation, distribute income via dividends and interest, and finally offer some historical tendencies to balance each other out. I don’t hold commodities futures or gold as they don’t provide any income and I don’t believe they’ll outpace inflation significantly. In addition, I have doubt that I would hold them through an extended period of underperformance (i.e. don’t buy what you don’t can’t stick with).

Our current target ratio is 70% stocks and 30% bonds within our investment strategy of buy, hold, and rebalance. With a self-directed portfolio of low-cost funds and low turnover, we minimize management fees, commissions, and tax drag.

Actual Asset Allocation and Holdings

1604_portpie

Stock Holdings
Vanguard Total Stock Market Fund (VTI, VTSMX, VTSAX)
Vanguard Total International Stock Market Fund (VXUS, VGTSX, VTIAX)
WisdomTree SmallCap Dividend ETF (DES)
WisdomTree Emerging Markets SmallCap Dividend ETF (DGS)
Vanguard REIT Index Fund (VNQ, VGSIX, VGSLX)

Bond Holdings
Vanguard Limited-Term Tax-Exempt Fund (VMLTX, VMLUX)
Vanguard Intermediate-Term Tax-Exempt Fund (VWITX, VWIUX)
Vanguard High-Yield Tax-Exempt Fund (VWAHX, VWALX)
Vanguard Inflation-Protected Securities Fund (VIPSX, VAIPX)
iShares Barclays TIPS Bond ETF (TIP)
Individual TIPS securities
U.S. Savings Bonds (Series I)

Commentary
In terms of the big picture, very little has changed. I did not accomplish my plan of relocating my holdings of WisdomTree SmallCap Dividend ETF (DES) and WisdomTree Emerging Markets SmallCap Dividend ETF (DGS) into tax-deferred accounts. I pretty much left them where they have been, inside a taxable brokerage account. I am currently leaning towards simply selling them completely and making my overall portfolio more simple. I would just have Total US, Total International, and US REITs for stocks. I would technically still hold a “small value tilt” on my holding in my kid’s 529 college saving plan asset allocation.

As for bonds, I’m still somewhat underweight in TIPS mostly due to lack of tax-deferred space as I really don’t want to hold them in a taxable account. (I noticed that shares of TIP are actually up 4% this year, less than 4 months in). My taxable bonds are split roughly evenly between the three Vanguard muni funds. The average duration across all of them is roughly 4-5 years.

A simple benchmark for my portfolio is 50% Vanguard LifeStrategy Growth Fund (VASGX) and 50% Vanguard LifeStrategy Moderate Growth Fund (VSMGX), one is 60/40 and one is 80/20 so it also works out to 70% stocks and 30% bonds. That benchmark would have a total return of -0.87% for 2015 and +1.42% YTD (as of 3/31/16).

I like tracking my dividend and interest income more than overall market movements. In a separate post, I will update the amount of income that I am deriving from this portfolio along with how that compares to my expenses.

Under Armour, Nike, and Owning The Haystack

haystacknikeIf you’re a basketball fan, you may have read this ESPN article about how Under Armour beat out Nike to get an endorsement deal for Stephen Curry. As one of the hottest athletes in the world, this single deal could shift billions of dollars towards Under Armour, especially if the Warriors win 73 games and defend their NBA championship. All for a company that just starting making shoes 10 years ago.

Under Armour (UA) is currently worth about $10 billion (at a very high P/E ratio), just 10% of Nike (NKE) at roughly $100 billion. What will things look like in another 10 or 20 years? Will they maintain their momentum? Athletic apparel is a huge and growing industry, but fashion moves quickly and I am only getting older! Under Armour didn’t even exist when I was begging my parents for Nike Air Jordans in high school.

I see myself as an investor in these companies through the Vanguard Total Stock Market Index Fund. I know that as a market-cap weighted fund, the amount of each stock held is directly proportional to the total market value of the company. Right now, I own roughly 10 shares of Nike stock to every 1 share of Under Armour stock. If the current trends continue, I could one day be owning 10 shares of UA stock for every share of NKE. All without having to pay attention to trends, comb through any financial statements, or trade a single share of stock.

In the future, I will own shares of the company selling whatever kinds of clothing and shoes all the kids covet, be it Nike or Under Armour or something being sketched right now in a garage somewhere. (My own athletic wear logos are dependent on what is on sale under $10 at Ross…) I’ve repeated this well-known quote from Vanguard founder Jack Bogle before:

Don’t look for the needle in the haystack. Buy the entire haystack.

In the end, I sleep better at night because I know that I will own the haystack. I will own all the winners in relative amounts. In exchange, I will give up the opportunity to earn a very high return from betting on the top winner, I will give up the risk of picking the losers, and I won’t have to pay anyone to pick them for me.

The New Financial Bundle: Checking + Savings + Credit Card + Brokerage + Retirement Advice

allytk

Last week, Ally Financial announced that they are acquiring TradeKing. What made this interesting was that they didn’t refer to TradeKing as a discount brokerage firm, but a “digital wealth management company”. This another move from independent start-up (TradeKing merged with Zecco earlier) to big, corporate “bundle”. The traditional communications bundle includes TV, home internet, home phone, cellular phone, and cellular data. The new financial bundle will include:

  • Checking account – Daily cash management, paycheck target, online bill payment, ATM access, debit cards.
  • Savings account – Liquid savings, higher interest rate.
  • Credit card – Easily-accessed credit line.
  • Self-directed brokerage account – DIY investments including individual stocks, options trading.
  • Professional portfolio management – Managed accounts including advice regarding asset allocation, taxes, retirement income, and more. Both lower-cost robo-advisor and higher-touch human advisor platforms.

Here’s my opinionated rundown on some of the bigger firms in this new area. Some of the “pros” aren’t that strong, and some of the “cons” aren’t that bad, but it helps organize my thoughts.

Ally Financial / TradeKing

  • Pros: Competitive interest rates on checking and savings, ATM fee reimbursements, $5 brokerage trades.
  • Cons: No physical branches. No credit cards (yet). Robo-advisor program is still relatively small and new.

Bank of America

  • Pros: Huge physical branch and in-house ATM footprint. Merrill Edge commission-free trades starting at $25k minimum asset balance, $6.95 trades otherwise. Credit card rewards bonus with minimum asset balance.
  • Cons: Low interest rates on banking products. Merrill Lynch advisor network is big and uses traditional fee system, so I’m not a huge fan but others may like it. No robo-advisor program (yet).

Fidelity

  • Pros: Decent cash management account with ATM fee reimbursements, selected commission-free ETFs, somewhat limited but low-cost index fund selection, $7.95 trades otherwise, 2% cash back credit card.
  • Cons: Low interest rates on banking products, human-based Portfolio Advice is relatively expensive and pushes expensive actively-managed funds. Lower-cost robo-advisor is probably coming soon, but yet released.

Schwab

  • Pros: Decent cash management account with ATM fee reimbursements, commission-free Schwab ETF trades with low-cost index options, $8.95 trades otherwise, 1.5% cash back American Express, low-cost robo-advisor via Intelligent Portfolios.
  • Cons: Low interest rates on banking products.

Vanguard

  • Pros: Large selection of low-cost funds and ETFs, commission-free Vanguard ETF trades for all, $7 non-Vanguard ETF/stock trades (or less based on asset level). Portfolio advice includes robo-component plus available human representative.
  • Cons: Limited availability and features on banking accounts. Limited portfolio support for buying non-Vanguard products. No credit cards.

I still believe that the self-directed investor is best off picking individual products a la carte, but it will be interesting to see how things change in the coming years. Each financial mega-institution will likely improve upon their weaknesses, and offer significant perks and discounts for keeping all your money with them.

New Rules on Fiduciary Duty for Retirement Account Advice

dol_logo

The Department of Labor has released their final rule on reducing conflicts of interest on retirement savings advice. As expected, the new rule now requires any person who provides investment advice on retirement accounts like 401(k) or IRAs to act as fiduciaries and put their client’s best interest first. The goals are to save investor money otherwise directed to hidden fees and commissions, while helping even the playing field for the financial advisors have been acting as fiduciaries all along.

Commentary. Lots of people have most of their retirement savings in 401k plans, which are often eventually rolled over into IRAs. There are entire firms of salespeople who try to capture this money and skim off huge commissions, and now they will have to act as fiduciaries.

While it can be touted as an overall “win” for consumers, there are still plenty of grey areas. The final rule requires firms to be compliant on several broader provisions by April 2017 and fully compliant by Jan. 1, 2018. Existing investments are grandfathered in. Small 401(k) plans are exempt from some of the rules. Firms can still technically sell you things like high fee variable and indexed annuities in IRAs and brokers can continue to recommend proprietary products, there just has to be a believable shred of reason behind it.

I’m going to be honest, I read about 20 articles on this subject and my head hurt with all the little details. This rule could have really blown up large parts of the industry, but you can tell they really tried not to disrupt anything significant. Try reading some for yourself:

Department of Labor Official Page
Department of Labor Press Release Fact Sheet
White House Fact Sheet [PDF]
NY Times 1, NY Times 2
WSJ 1, WSJ 2

In other words, the nastiest stuff with the highest hidden fees and commissions will probably go away. So it’s a win around the edges. For the savvy DIY investor or the person with their money with a trustworthy registered investment advisor (RIA) that was already a fiduciary, the effect will likely be small if anything.

Hopefully, if you decide to have someone help you manage your investments, they are already a fiduciary, have been for a while, and don’t need someone to tell them to act in your best interest.

Morningstar Individual Investor Conference 2016

mornconfMorningstar is holding a free online event this Saturday, April 2nd called the Individual Investor Conference. Starting at 9am Central, according the full agenda there will be six live streaming video sessions from their staff. You can chat with other attendees during the video stream, or also send in your own questions to miic@morningstar.com with the subject line “MIIC 2016: My Investing Question”. Here are the sessions that interest me:

10:00–10:50 a.m. CST “Securing Your Retirement: A Conversation with Christine Benz and Harold Evensky”

As pension plans wane and Social Security faces long-term cutbacks, more and more of individuals’ retirement security is in their own hands. How do they make it work? In this one-on-one interview, Morningstar director of personal finance Christine Benz and noted financial planner Harold Evensky (a pioneer of the “bucket approach” to retirement income) will discuss the key pillars to retirement security for individuals in every life stage–from early-career savers to those already in retirement.

1:30–2:20 p.m. CST “Portfolio Planning: Make a Lean, Mean, Tax-Efficient Machine”

Because we investors don’t know what headwinds will come, it makes sense to streamline everything else we can control–and that includes minimizing the drag caused by unnecessary tax exposure. In this presentation, Morningstar director of personal finance Christine Benz will help you craft a solid plan for tax efficiency–that means maximizing tax shelters, optimizing taxable portfolios, finding the best tax-smart investments, and building a tax-savvy retirement-drawdown plan.

It doesn’t look like are required to register or anything, just show up. These are relatively long sessions, so hopefully it will be a compilation of their “best stuff” on the given subjects.

Top 10 Financial Advisor Firms With Highest Misconduct Rate

misconduct0

There is a famous quote that Charlie Munger uses as an example of the inversion technique:

Tell me where I’m going to die, so I won’t go there.

Instead of focusing on things we should to help us, we can also simply avoid doing things that will hurt us. Don’t do drugs. Don’t gamble.

I can’t provide a clear roadmap to finding a great financial advisor. But after reading through the SSRN research paper The Market for Financial Adviser Misconduct mentioned yesterday, I certainly know what to avoid. Here’s my version of the Munger quote:

Tell me where I’m most likely to be mistreated financially, and I won’t put my money there.

These are the top 10 firms ranked according to the percentage of advisors who been disciplined for misconduct, as based on the FINRA BrokerCheck database. This list is restricted to firms with at least 1,000 advsiors.

  • 20% Oppenheimer & Co.
  • 18% First Allied Securities, Inc.
  • 15% Wells Fargo Advisors Financial Network, LLC
  • 15% UBS Financial Services
  • 14% Cetera Advisors, LLC
  • 14% Securities America, Inc.
  • 14% National Planning Corporation
  • 14% Raymond James & Associates, Inc.
  • 13% Stifel, Nicolaus & Company, Inc.
  • 13% Janney Montgomery Scott, LLC

Yes, you read that right, 1 in 5 advisors employed by Oppenheimer & Co have at least one misconduct-related disclosure in the their files. All of these firms above have incident rates roughly double that of the overall advisor population. Mix in the information we learned previously about the high likelihood of being repeat offenders, and it’s quite simple to avoid putting your hard-earned money anywhere near these firms.

Source screenshot:

misconduct1

They May Not All Be, But Your Financial Advisor Should Be a Fiduciary

dol_logoRight now, there is a big debate in Congress about whether the fiduciary standard should be required for all financial advisors that manage retirement accounts. A fiduciary requirement would include the following:

  • They must exercise best efforts to act in the best interests of the client.
  • They must provide disclosure of any conflicts of interest.
  • They must clearly explain how they make their money (upfront fees, asset-based fees, commissions, etc.)

Most people probably think “Wait, don’t they do this already”? Nope. Even so, many still violate the current lower standards! Barry Ritholtz has some scary numbers in his Bloomberg article Brokers Behaving Badly:

  • 1 in 13 brokers have committed misconduct that resulted in disciplinary action.
  • Half of those brokers are fired, but nearly half simply move on to work for another firm within a year.
  • About a third of brokers are repeat offenders (multiple events of misconduct).

(Use the FINRA Broker Check tool to look up regulatory actions, violations or complaints for a specific person or firm.)

The worst part is that much of the financial industry continues to fight against the fiduciary standard. Even popular “guru” Dave Ramsey opposes the fiduciary proposal, and has been called out on Twitter for it. They claim it will “limit middle-class access to financial advice”, which roughly translates in my mind to “if we can no longer suck huge 8% commissions from small accounts, then we might not bother anymore”.

I enjoy managing my own investments. I also believe that hiring a good financial advisor would work well for many people. A “good” financial advisor needs to have hard knowledge, soft communication skills, and the proper alignment of interests.

Whoever wins this political fight, you as an individual still have the right to demand that your financial advisor be a fiduciary. Those letters after people’s name don’t all have the same value. Certain designations like Registered Investment Advisor (RIA) include a fiduciary standard component. You may also show them this Fiduciary Pledge and see how they respond. Being a fiduciary alone is not enough to find an appropriate advisor, but it does serve as a very simple and basic filter.

Index Funds vs. Hedge Funds: Buffett $1,000,000 Bet Update 2016

chips

We are now 8 years in on the 10-year bet between Warren Buffett and a successful hedge fund manager. In 2007, Warren Buffett challenged any hedge fund to a long-term bet against the S&P 500. He found a taker.

Fortune magazine announced “Buffett’s Big Bet”, where $1,000,000 would go to the charity chosen by the winner. The bet would run from 2008 to 2018. Buffett would take the S&P 500, represented by the Vanguard S&P 500 index fund (Admiral shares). Protégé Partners would stand behind hedge funds, represented by the average return of five hand-picked hedge funds.

Carol Loomis has just posted the 2016 update in Fortune. The hedge funds made up a little bit of ground in 2015, but overall still lag significantly:

  • Last year (2015) the S&P 500 index fund went up 1.36%, but the hedge funds went up 1.7%.
  • Since inception (2008 through 2015), the S&P 500 index fund is up 66%. The hedge funds went up 22%. The performance gap is over 40%.

Here are the historical annual breakdowns:

protege2016

An important aspect of this bet is that we are comparing performance after fees. Hedge funds may employ some bright minds but also charge hefty fees of roughly 2% of assets annually + 20% of any gains. That is like running into a heavy and persistent headwind. Meanwhile, the Admiral shares of the Vanguard 500 Index Fund charge only a flat 0.05% annually.

Another important lesson that it is easy to point on good performance in retrospect. It is MUCH harder to pick out winning managers ahead of time (and harder on those managers when everyone is looking and there is too much money to deploy). At the start of the bet, the past performance of the hedge funds were excellent – from inception in July 2002 through the end of 2007, the Protégé fund gained 95% (after all fees), soundly beating the Vanguard S&P 500 index fund’s 64%.

Finally, my last point is that it is hard to know when to drop a winning strategy gone sour. The handpicked hedge funds have some serious catching up to do. But there are two years left in the bet, so technically it is still anyone’s game. If you were invested in these hedge funds, would you stick it out or cut your losses?

Read the full terms of the bet and each side’s opening arguments at LongBets.org. See my original 2008 blog post and halfway 5-year update here.

Vanguard Target Date Retirement Funds: Embrace Your Inner Ronco Rotisserie Oven!

ronco200b

I’m a fan of the Vanguard Target Retirement 20XX Funds. These Target Date Funds (TDFs) may not be perfect, but they are a low-cost, broadly-diversified, “set-it-and-forget-it” fund that I feel are consistently under-appreciated and easily maligned due to their inherent “one-size-fits-most” nature.

In a recent Vanguard blog post titled “TDF investors are not rotisserie ovens”, senior product manager John Croke felt the “set it and forget it” description “fuels the misperception that many investors in TDF strategies are disengaged, disinterested, and generally unaware of what they’re invested in.”

The subsequent points he makes are certainly valid, but I happen to think the rotisserie oven analogy should be worn as a badge of honor! As Jason Zweig writes in the WSJ article “Radical Investing Advice: Do Nothing, Nada, Zilch, Zippo”:

Target-date investors, says Jeff Holt, an analyst at Morningstar, “are less prone to take matters into their own hands and move their assets around when markets are gyrating.”

[…] research by Financial Engines found that participants with little or no money in target-date funds underperform them by an average of 2.1 percentage points annually.

You won’t see Vanguard Target Retirement funds being touted very much in the financial media. Their returns are rarely at the top since they are index-based, so magazines and newsletters won’t write about them. Most advisors are supposedly charging you for their “expert” advice, so they will of course recommend something more complicated. Even index fund enthusiasts like myself often don’t invest in them because we like to fine-tune and tinker (sometimes to our detriment). They never seem to be the “best” move, just something you settle for when you can’t think of anything better. I think this cartoon describes the situation well (found via @michaelbatnick):

ronco_truth

It is an unpleasant truth that most people would be better off just focusing their energy on savings rate and leaving the investing to a Vanguard Target Retirement Fund. Another example of the power of inaction: A person who bought the 30 largest US companies back in 1935 and did absolutely nothing after that would have outperformed the S&P 500 over the last 40 years.

Now, I should throw in a few quick points from the Vanguard blog post about what investors shouldn’t forget about:

  • TDFs will continue to hold a certain amount of stock risk after you reach your target retirement age.
  • Along the same lines, TDFs do not provide guaranteed income in retirement.

To summarize, don’t be insulted when being compared to a Ronco rotisserie oven. Be proud to “Set it and forget it”. Vanguard Target Retirement Funds even perform the chore of rebalancing between stocks and bonds for you automatically. Perhaps Vanguard could even use some tips from Ron Popeil about marketing their low, low pricing 😉

Making Your Nest Egg Last: Safe Withdrawal Rates vs. Sustainable Withdrawal Rates

eggosReading Warren Buffett’s Annual Letter always reminds me that stocks are not just some numbers that bop up and down, but are shares of real businesses with land, factories, knowledge, and hard-working people. This helps reassure me that the value of those companies taken together will never go to zero, and will eventually rebound and grow over the long term. At the same time, once you stop working and start selling shares, the prospect of going to zero is real. If you combine a prolonged bear market and forced withdrawals at depressed prices, you risk permanently impairing your portfolio.

According to a Merrill Lynch survey of wealthy families with $5+ million (not just people on the street!), 39% of them thought you could spend 6% or more from your portfolio indefinitely. The reality is closer to 3%.

When you see the term safe withdrawal rate, it almost always refers to how much money you can safely withdraw from an investment portfolio each year without running out of money. Usually, this number is set during the first year, and is adjusted annually for inflation. The key phrase is “without running out of money”. You could start out with a $800,000 dollars, but as long as you end with at least $1 and never drop below zero, you’re considered “safe”. In the real world, having your portfolio nosedive while you’re still relatively young may cause you to panic prematurely.

pc_panic

Since I last mentioned PortfolioCharts.com, the creator Tyler has released a new tool called the Withdrawal Rates Calculator. It is quite cool, at least for an asset allocation geek like myself. You can enter your own custom asset allocation, and it will show both the historical safe withdrawal rate and the sustainable withdrawal rate. As defined there, a sustainable withdrawal rate is one where you must end the period with your initial principal amount, for example you must both start and end with $800,000 dollars.

Here are the results for the Classic 60/40 portfolio:

60% Total US Stock Market
40% Total US Bond Market

pc_6040

Here are the results for the Swensen Portfolio, on which my portfolio is loosely based:

30% Total US Stock Market
15% International Developed
5% Emerging Markets
15% 5 Year US Treasuries
15% US TIPS
20% US REIT

pc_swensen

For the Classic 60/40 portfolio, the rough numbers for a 40-year period are 4% for Safe WR and 3.4% for Sustainable WR. For the Swensen portfolio, the rough numbers for a 40-year period are 4.6% for Safe WR and 4.2% for Sustainable WR. If you were to focus on the sustainable numbers, that’s a surprising result of 24% higher withdrawals with the Swensen portfolio (and other asset allocations do even better!)

Can you depend on these historical differences to persist into the future? I would be careful about looking at things too finely, as correlations are always shifting. However, I do prefer using the sustainable withdrawal rate number for my own early retirement planning, and I am thankful to have this tool to tinker with.

(You may also be interested to know that a 100% US stock portfolio, despite its higher historical average returns, has a slightly lower 30-year sustainable withdrawal rate that either of the options above.)