Reminder: Check your IRA Beneficiary Designations

iheartroth

According to the stats, you probably funded your Individual Retirement Account (IRA) at the last moment this month (assuming you fund them at all). If we tend to procrastinate about saving, then we also probably put off estate planning. One of the simplest aspects of estate planning is to designate beneficiaries of your IRA.

I am not an estate-planning attorney, but here are some tidbits I picked up from various sources including a review copy of new book The Overtaxed Investor by Phil DeMuth.

Why is this important?

  • The person, trust, charity, or estate that you pick as your beneficiary overrides any will. So if your sole IRA beneficiary is set up as your ex-spouse, and your will says everything goes to your current spouse, then your ex-spouse will still get your IRA (at least without a long legal battle).
  • If you name an individual instead of an estate, the inheritor can space out withdrawals over their (actuarial) lifetimes, prolonging the tax-deferred growth benefits of IRAs. A trust or estate does not get this feature by default (a trust may be carefully constructed to preserve some of these characteristics).
  • You may still want to pick a trust if you have sizable assets and are leaving them to young children. You can then outline rules and a trustee to manage how the money is spent. This route involves extra costs, however.
  • Secondary beneficiaries can also be chosen. If no secondary beneficiaries are named, your assets may pass to your estate – exposing them to the probate process, estate expenses, and creditor claims. In many cases, people pick their spouses as primary and their children as secondary.

How should you do it?

  • Contact your IRA custodian. I use Vanguard, and you can either fill out this paperwork kit or do it all online under Account Maintenance > Beneficiaries. They use some language to simplify the process. For example, I set my primary beneficiary as the “person I am married to at the time of my death” and my secondary beneficiary as “To my descendants who survive me, per stirpes”. I may change this later. Find out what per stirpes means and more with this Vanguard guide.
  • Keep a physical copy in your personal files. Keep copes in your home safe, safety deposit box, and/or digital safe.
  • Tell your beneficiaries where the form is and what is on it. Vanguard won’t contact anyone upon your death, so it is up to your beneficiaries to contact Vanguard. I suspect many other brokerages operate in a similar manner. There are millions of dollars in unclaimed IRAs every year.

Screenshots:

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iraben3

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.

IRA Contribution Stats: Are You a Non-Procrastinating, Consistent Maximizer Unicorn?

iheartrothBesides being the tax return deadline, Monday April 18th, 2016 is also the last day to make a contribution to a Traditional or Roth IRA for the 2015 Tax Year. For both the 2015 and 2016 Tax Years, the maximum annual contribution limits are $5,500 (if under age 50) and $6,500 (if over age 50).

Vanguard has a whitepaper called Are you an IRA superstar? that examines investor behavior when it comes to IRA contributions. Their teaser line was that only 3% of IRA investors contribute consistently over time, maximized their annual contributions, and made their contributions early in the year. Here’s the graphic they provide:

vg_irafunnel

Here’s how I would summarize the results:

  • Out of Vanguard IRA contributors in 2010, roughly half continued to contribute every year for 5 years (2010-2014).
  • Out of those 5-year “consistent” contributors, roughly half contributed the maximum allowable amount every year.
  • Out of those 5-year “consistent maximizer” contributors, only 1 out of 10 contributed early on in the year, every year (by April 30th).

I must admit that even though I have maxed out my IRAs for over a decade, I don’t always contribute early on in the year. I am a procrastinating, consistent maximizer. I was surprised that 9 out of 10 people in a similar situation also waiting for longer than they need to. The contribution window spans from January 1 of the tax year and closes on the following year’s April tax-filing deadline. Are we foolishly and voluntarily giving up money due to a “procrastination penalty“? Our contribution patterns seem to suggest that we do like to wait until the last minute:

vg_irafunnel2

Upon further thought, one possible reason not mentioned in the Vanguard article is that people may not know if they qualify for IRA contributions due to income restrictions, or if they will need to perform a non-deductible Traditional IRA (to later convert to Backdoor Roth IRA). You may not know your modified adjusted gross income until your tax return is done, which might not be until March or April of the following year. To prevent having to undo anything, you might want to wait. Or we’re just lazy. :)

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.

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.

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.)

Real World IRA Asset Allocations vs. “Age in Bonds”

As a follow-up to my last post on 100% stocks forever, the referenced NYT article had some neat data that I hadn’t seen anywhere else. This chart shows how the overall asset allocation of IRAs held by Vanguard change according to the age of the investor. The glide path of Vanguard Target Retirement mutual funds is also included for comparison.

nyt_100stocks_glide

Eyeballing things, it appears that past age 65, Traditional IRAs settle at roughly 58% stocks, while Roth IRAs settle at roughly 67% stocks. This “real world glide path” declines much more gradually than ones from the major all-in-one fund providers, and also stays flat from retirement age onward. For comparison, here are additional glide paths for Fidelity, T. Rowe Price, Blackrock, and American Century, taken from a Morningstar paper. (For this chart, retirement age would be roughly 2015.)

target1_full

I don’t know any studies that have found the real reason behind the “real world” numbers. I would suggest as a possible explanation that the average percentage must be asset-weighted, and “rich” people have more assets in aggregate. The “rich” don’t need to make big withdrawals (unless required by law), and so they don’t need to spend every penny before they die. They will leave a chunk of money to heirs and thus have a long time horizon. In turn, this longer time horizon would support the holding of more stocks. Roth IRAs are especially useful as an inheritance vehicle as they don’t have required minimum distributions (RMDs), which could also explain why they are even more strongly weighted in stocks.

Meanwhile, if you need to spend down your assets during retirement, then the asset allocation suggested by Vanguard Target Retirement funds (and all the other major target-date funds) would make more sense. But it’s certainly a good point that these one-size-for-all solutions will not apply to everyone.

If you like low costs, diversification, and simplicity but want more control, I would suggest the option of switching to a Vanguard LifeStrategy all-in-one fund that stays fixed at 40%, 60% or 80% stocks. I use the 60/40 LifeStrategy Moderate Growth Fund (VSMGX) as a benchmark for my own long-term portfolio asset allocation.

Best Asset Allocation Plan: 100% Stocks, Forever?

The NY Times had a provocative two-part series on portfolio asset allocation by David A. Levine, former chief economist at Sanford C. Bernstein & Company:

I enjoyed reading his opinions, but didn’t agree with all of his points. The heart of my argument is that when the writer says “most people”, he seems to be talking about his Wall Street peers with multi-million dollar retirement portfolios, where most of it will eventually be passed onto heirs or charity. Instead, “most people” are actually trying to make something like a $200,000 nest egg last as long as it possibly can.

Time horizon vs. asset size. The first article brings up the topic of “time horizon”:

This consensus view, though, rests on a fallacy: the belief that as people grow older, their investment horizon shortens and, therefore, their ability to withstand volatility diminishes considerably.

I would argue, instead, that there is an insufficient appreciation of just how apt the metaphor of the “investment horizon” is. Just as a sailor sees but never reaches the horizon, the same is true for nearly all investors.

[…] But what if there’s a bear market? “No big deal,” I say. As long as you don’t panic and sell most of your holdings at the worst times, your annual withdrawals are limited. As a result, you should not really worry about fluctuations in the stock market.

A rule of thumb is that stocks can drop 50% in any given year. Again, let say all you have is $200,000 and you’re withdrawing 4% of that ($670 a month) to supplement your Social Security and/or pension income. If your balance drops to $100,000 due to a economic crisis, and you still need that $670 a month to pay the bills, yes you are going to panic.

If you have a $10 million portfolio, and a market crash means that you simply reign in some of your discretionary purchases, then your stress level is going to be lower. As my own portfolio has grown, I now only hold 70% stocks but also worry less about the stock portion as I know can ride out a bad sequence of returns.

As Josh Brown reports on The Reformed Broker:

Having worked directly and indirectly with investors from all walks of life and every region of the country over the last 18 years, I can promise you that almost no one can endure – emotionally speaking – the volatility and drawdowns that an all-equity portfolio brings to the table.

Long-term performance vs. asset allocation. The second article makes the point that the historical long-term performance of stocks has been higher than all types of bonds, over many different holding periods:

nyt_100stocks_bonds

In my opinion, the logical conclusion from such tables as above is limited to saying that if you are going to invest in stocks, you need to hold them for 20+ years. So if your portfolio is 60% stocks, keep that portion in stocks for 20+ years. The table doesn’t take into account withdrawals or timing risks where you are forced to take out money to meet spending needs during a period of negative returns.

In addition, Warren Buffett is used as an example because he stipulated 90% S&P 500 stocks and 10% Treasury Bills for his wife’s trust upon his passing. Buffett is worried about the long-term returns, not the risk of his wife running out of money. Do you think her withdrawal rate will be anywhere near 4%? It’s going to be a tiny fraction of 1%. I’d bet big bucks that Buffett would not have set the same asset allocation if she only had $500,000 to live on.

In the end, I guess what I am saying is that your asset allocation also depends on your asset size. Your time horizon matters, but also how close you are to missing a rent payment matters too. Products like target-date retirement funds don’t adjust based on if your balance is $10 million or $10,000. Nor should they really, as they don’t know your future spending needs either. Investors themselves (or their advisors) need to take both of these factors into account.

Of course, it would be great not to have to worry about keeping a balance greater than zero. With a big asset base and modest spending levels, you could indeed have an indefinite time horizon and keep 60% in stocks forever, much like a traditional pension plan. I’d require some enormous amount like $10+ million to be 100% stocks forever, though.

Investment Returns By Asset Class, 2015 Year-End Review

yearendreview

The problem with a lot of good advice is that you really don’t understand it without experience. For example, Jack Bogle always says “Stay the course”. I was lucky enough to trust in that advice, but it took me a while to really appreciate the power of investing in productive assets and then treating them with what I call beneficial neglect. That is, I make the most money when I fight off the urge to take action.

I managed again to do as very little during the hiccups, tantrums, seizures, or other bodily functions the markets had in 2015. As the year ends, we all like to take look back and assess the situation. Here are the trailing 1-year returns for select asset classes as benchmarked by passive mutual funds and ETFs. Return data was taken from Morningstar after market close 12/31/15.

2015annualret2

2015annualret1

Stocks. The Total US Stock Market (VTI) ended up mostly flat, while the rest of the world’s markets (VXUS) dropped a little bit (~4%). Emerging Markets (VWO) did the worst, with a -15% total return. US REITs (VNQ) were up a little bit (~2%). If you were like most people and owned mostly US stocks with perhaps a little international exposure, you were probably close to breaking even.

Bonds. The Total US Bond Market (BND) and short-Term Treasuries (SHY) went up a little bit. Long-Term Treasuries (TLT) and Inflation-linked Treasuries (TIP) went the other way, going down a little bit instead. There were no huge moves, despite all the talk about interest rates.

Gold dropped around 10%, joining the other industrially-useful commodities in having a down year.

Another year, another batch of predictions into the shredder. How many people were saying that oil prices, already said to be “too low” at $50, would drop another 30% in value? Did anyone listen to me when I said not to speculate with the USO ETF? A funny book that came out this year was The Devil’s Financial Dictionary by Jason Zweig. Here’s how he defines forecasting:

Forecasting (n.) The attempt to predict the unknowable by measuring the irrelevant; a task that, in one way or another, employs most people on Wall Street.

Most people who owned a diversified portfolio in 2015 had their money go nowhere or perhaps lost a little bit of money. The 2015 total return of my personal investment portfolio was roughly -1.5%, right in that “meh” range. I imagine the people who like to focus on dividends, interest, and rental income collected them happily and went about their lives. That sort of mental framework is becoming increasingly appealing to me.

Bogle 10-Year Stock and Bond Return Forecasts, December 2015

As a follow-up to Vanguard founder Jack Bogle’s 2015 stock market prediction paper and related Morningstar article, here are a few selected slides from the presentation deck by Jack Bogle at the Bogleheads XIV conference in October 2015.

bogle2015_1

bogle2015_2

The formula for predicting future stock market returns is:

Future stock returns = Current dividend yield + Predicted earnings growth ± (Reversion to long-term average P/E ratio)

The formula for predicting future bond market returns is:

Future bond returns = Current yield to maturity

At 6% nominal for stocks and 3% nominal for bonds, both 10-year numbers are below long-term averages. However, the 10-year breakeven inflation rate based on TIPS and Treasury yields is roughly 1.5% as of now (late 2015). Using those inflation numbers would result in 4.5% real returns for stocks and 1.5% real returns for bonds, a brighter picture than that painted by other forecasts.

Admittedly it is not a large sample size, but here is a plot of how the 10-year predictions have done so far (1990-2014):

bogle2015_3

As noted previously, I like to keep track of these forecasts along with those provided by: