Performance - 1st Quarter 2013

Source: Capital Pixel

My favorite investment chart is the BlackRock 20-year sector performance.  It details the relative ranking of asset classes as well as the performance of an easily replicated low-cost diversified portfolio comprised of 65% stocks, 35% bonds.  The portfolio returned 12.2% over the 12 months ended 12/31/2012 and 7.9% on an average annualized basis over the past 20 years.

The diversified portfolio allocation is an appropriate benchmark for individuals in their 40s and even early 50s, depending on risk tolerance.  The table contains sufficient data, however, to construct a benchmark for any specific allocation and, in fact, the allocation can be changed over time--as it should be as the individual ages.

Voluminous data from unbiased academic studies have been presented over the years showing that a diversified portfolio of low-cost funds outperforms upwards of 70% of active managers over the longer term after all costs are taken into account.  These studies cover various time periods, countries, asset classes, and investment methodologies.  In line with this data, the low-cost diversified approach warrants consideration as a benchmark for investors.  It shouldn't go unnoticed that the approach economizes on the investor's time.

Here is an update showing the approximate performance of the diversified portfolio for the 1st quarter of 2013:

Weight	Fund	Return (%) 3 months ended 3/31/2013	Expense Ratio
35	AGG  (Barclay’s Aggregate Bond Index)	-0.11	.08
10	EFA (EAFE Index)	5.11	.34
10	IWM (Russell 2000)	12.39	.23
22.5	IWF (Russell 1000 Growth)	9.49	.20
22.5	IWD (Russell 3000)	12.22	.20

The overall return of the diversified portfolio was approximately +6.5% over the first 3 months of the year.

Disclosure:  This post is intended for educational purposes only.  Past performance is not indicative of future performance.  Individuals should consult a professional or do their own research before making investment decisions.

The Tricky Part of Investing

Like many endeavors, investing is comprised of two very different parts:  first, setting out a strategy and sticking to the strategy and secondly, putting the strategy in place.  The second part is a hurdle for many investors.

The strategy I recommend, at least for 90% of investable assets, is pretty straight forward and comes endorsed by the likes of John Bogle, Burton Malkiel, Charles Ellis, and many other stalwarts in the investment field.  It is comprised of 3 parts:  get an appropriate asset allocation (i.e., percentage of stocks and bonds), use low-cost, well-diversified funds, and monitor and rebalance.  These 3 steps have been described in numerous posts here as well as by those mentioned above.

The DIY investor who can put this strategy into effect can save investment management fees which, in turn, typically run between 1% and 2% of AUM (assets under management)!  Over the longer term, these fees can subtract meaningfully from the nest egg.

But getting to the point of being able to implement the strategy effectively can be tricky in some cases. Take a typical example.  Dan, a DIY investor wannabe, has numerous accounts including a brokerage account, a 401(k), a couple of IRAs (including a Roth).  Dan's wife has a 403(b) and a traditional IRA. Thus, they have several providers, a number of different mutual funds (of various fund classes), and typically have lost sight of their overall asset allocation.  Dan and his wife may own company stock and may be contemplating changing jobs.

It is at this point that a knowledgeable investment person typically can add considerable value by  discussing such things as the location of investments, the special way to handle rolling over  company stock, and even the appropriate funds to choose in the company 401(k) plan.  In some cases, an evaluation of a 401(k) may dictate that contributions be minimized.

What Dan and his wife needs is a knowledgeable person who will charge by the hour or manage
assets over a short period of time.  In the interview process, they need to stress that they have a philosophy they want to follow.  More times than not, an advisor will try to convince them that they are great stock pickers, can choose the best high-priced mutual funds, or even are great market timers.  But with a little work, by choosing the right advisor, they will be on their way with a clearly-defined investment philosophy which minimizes costs and prospers through the ups and downs of the market.

Benzinga - Market Data Source

Most market watchers have a routine they go through each morning to get up to speed on overnight market action and important events for the day ahead.  When I first started in the investment management business, my day started by reading The Wall Street Journal, followed by several phone calls to get market color.  In all, it typically took over an hour to get a feel for how the market day was likely to shape up.  Today, it is literally a matter of minutes.

My day begins with a report on the clock radio from a local broker typically giving an update on futures along with a couple of headlines - the day's first indication if stocks are likely to open higher or lower.

Once I get a little cereal and coffee in me, I go online and check out Yahoo! Finance and Bloomberg. More recently, I have come across Benzinga, a site I  recommend, especially if you don't have much time but want a comprehensive overview.  Let's take a look.

Benzinga Market Primer

The Market Primer is where you want to go:

You'll find it begins with a short summary of the main story of the day.  Today that's Cyprus.  It then follows with other "Top News."  Today this includes items such as foreign direct investment in China, Quantitative Easing in Japan, the value of the Euro, and S&P 500 futures.  The movement in the yields on 10-year Spanish and Italian bonds overnight, the most widely watched indicators of the impact of developments in the Euro zone by market watchers, is included as well.

Next there is a paragraph about Asian Markets, followed by paragraphs on:

• European Markets
• Commodities
• Currencies
• Pre-Market Movers (Stocks affected by overnight news)
• Earnings
• Economics

The site includes much, much more--especially if you are looking for investment ideas.  Check it out - I think you'll like it!

Should I Rebalance?

New DIY investors are really interested in the process of rebalancing.  How often should I rebalance?  How often do I need to check the allocation?  Is there a rule I can follow?

Actually there are no set rules.  It is up to the individual and, in fact, in most cases there is very little activity once the allocation is set up for the index investor.  For those who have a need to be in and out of the market, I suggest a small trading account on the side.

Let's take a look at an actual allocation to see what we're talking about:

Source: Schwab

As you can see, this allocation is based on one of Schwab's models.  There are many others out there as well.  The basic idea is simple:  target a given percentage for the various asset classes.  More conservative investors should target a greater percentage in "Fixed Income" and "Cash Investments."

Most people would want to follow their asset allocation for all of their assets combined, including brokerage accounts, IRAs, 401(k)s, etc.  You can do this the old school way, using an Excel spread sheet, or with online services like Personal Capital that collect account information from various sources.

In looking at the Schwab allocation above, you want to eyeball the "Difference" column.  This tells you when to rebalance.  Note that "Fixed Income, in this example, is under allocated by 2%.  If this is your rule (i.e., to rebalance at 2% difference), then the sector needs to be bolstered by 2%.  As it turns out in this case, this increase can be met by reducing "Cash Investments" which happen to be over invested by 1.8%.

You probably have noticed the "View Table in $" link at the top of the table.  If you click, you'll see the dollar amount to be invested.  Divide by the fund to be purchased and you have the number of shares to buy.  It's that simple.  Inside of 5 minutes, you are done.

Keep in mind that, if you are using commission-free funds (most major providers today - Fidelity, Schwab, Vanguard etc.- offer them ), the number of shares to be bought or sold doesn't matter.  If the commission is approximately $10/trade, then you want to buy sufficient size so that commissions are not having a material impact.

Is the Market a Giant Casino?

How many times have you heard people exclaim, "the stock market is nothing but a giant casino"?  And, you can bet, more times than not, these people are out of the market--invested in money market funds or Treasury bills--and have probably been hit pretty badly in the past.  Some got caught up in the internet bubble.  Others got carried away as the market hit new highs in 2007.  They buy high, sell low, and distort the data significantly--showing that individual investors perform poorly.

Sadly, these very same people will likely come back in as the market hits new highs.  After all, in their minds, the slot machines, everyone knows (I think) that the house/casino wins.

The stock market couldn't be more different, at least from the perspective of an investor.  The stock market consists of incredible businesses comprising the global economy.  A global economy that is striving to create enormous wealth.  The ability to participate as company owners is viewed as an opportunity by investors.

But investors don't just go in and jump on the hottest sector.  Investors study the research on diversification and how to manage fees to participate in long-term growth.  Investors understand the market will go up and down and that asset allocation is important.

I've reached the point pretty much where, when I hear someone proclaim the market is a casino, I walk away thinking they are better off just keeping their money in a money market fund or CDs.  In my mind, most are like the hapless miners seeking an easy way to get rich whenever there is a gold strike.

Jeremy Grantham on Charlie Rose

Jeremy Grantham, a smart, successful investor, gives a lot to think about in interview with Charlie Rose:

http://www.charlierose.com/view/content/12812

A Teaching Moment-Record Dow Jones

Teaching moments don't come along every day.  They have to be taken advantage of when they do arrive.

The Dow Jones Industrial Average hit an all-time high yesterday.  So, should we release the balloons and celebrate?  Actually, it depends.  If you are retired, go ahead and sip some champagne and let the balloons go.  Otherwise, take it in stride.  In particular, if you are building a nest egg, record highs are not what you want to see. You could very well be buying at prices that, in retrospect, will be high.  WHAT YOU CARE ABOUT IS WHERE THE MARKET IS WHEN YOU START DRAWING A PAYCHECK OFF OF YOUR NEST EGG!

It actually would be better for you, the dollar cost averager, if the market was down 20%!  Hopefully I didn't totally take away your warm, fuzzy feeling.

Looking Back

To gain some insight, let's take a step back 12 months and ask what we would have done if we knew some of the things that would happen over the ensuing 12 months.  Suppose we knew the government would continue its dysfunctionality, pushing to the fiscal cliff up until the last minute and actually going through with the sequester.  Assume we knew that the growth rate of the economy would remain anemic with only slight improvement on the job front.  Assume we knew the Italians would have a 3-ring circus of an election and bring the European malaise back to the forefront, not to mention the huge questions arising out of China.

Actually a lot of professionals saw these events unfolding and did what you would expect - they reduced stock exposure and took actions to take "risk off," as they like to say.  Consider, though, the following real world graph of the value of a portfolio positioned with 60% stocks and 40% bonds + cash, comprised of low-cost, exchange-traded funds managed on a "buy and hold" basis, carefully tracking the 60/40 agreed upon asset allocation.

Source: Schwab

 CLICK TO ENLARGE  The arrows show dysfunctional government events.  From left to right, you have the debt ceiling debacle, the fiscal cliff, and the sequester.  One after another, professionals and politicians on CNBC ranted and raved about the likely impact on the market.  In fact, the downturn initially (before the immunity built up?) was reason enough for market timers to exit the market.

What seems to have gone unappreciated by many has been the impact of Ben Bernanke on pushing investors into risky assets.  Simply, avoiding risk is very costly these days with short-term rates at zero and the 10-year Treasury note below 2%.  Investors figured out that taking risk byscarfing up dividend payers was the better choice.

Hopefully, your account has participated in the run up.  If it hasn't. you may want to ask questions.  It could be a teaching moment on how your retirement assets are managed.

Disclosure:  Past returns are not indicative of future performance.  This post is for educational purposes only.  Investors should do their own research or consult a professional before making investment decisions.

Bengen's 4% Withdrawal Rule

Here is a nice summary article by Kelly Greene of The Wall Street Journal on William Bengen's 4% rule:  "Say Goodbye To the 4% Rule."

This well-known, widely bandied about rule is based on research analyzing 30-year periods going back prior to the Great Depression. Its key finding was that 4% was the withdrawal rate, adjusted for inflation, that would have ensured one's nest egg wasn't depleted. The study encompassed widely varying and challenging markets.

Just for the record, the number one fear of retirees is running out of money.  Typically they don't.  But many do have to adjust life style considerably below what was anticipated. 

More recently, of course, markets have experienced considerable volatility and two sharp downturns over a relatively short period.  Furthermore, individuals have had ever increasing responsibility for managing their retirement assets over this period as defined benefit plans go the way of the dinosaur. Careful management of the so-called nest egg is the order of the day.

Humans seek to simplify complex problems.  That's what we do.  Coming up with a single, one-size-fits-all withdrawal rate is a prime example.  Think about it--and you quickly come to realize that the withdrawal problem has a number of unknowns beyond the retiree's control; and coming up with a single simplistic rate is just, well, too simplistic.  There's inflation and market returns.  The big unknown, however, is how long the retiree will live.  Reflect on these unknowns, and you come away with an appreciation of the need to be careful in coming up with a single withdrawal rate number or even a simple process.  Flexibility is the order of the day.

Interpretation can also be a bit tricky.  In the article noted above, data from TRowe Price was cited for a retirement in the year 2000.  They concluded that using the 4% rule "...you would be left with only a 29% chance of making it through three decades..."  This was after the 3 years at the start of the decade. This interests me because this is a period analysts like to put forward to show that the 4% rule falls apart.

I don't have TRowe's data at hand, but I wanted to check it out myself.  I used data put out by BlackRock for a portfolio comprised of 65% stocks/35% bonds (TRowe used 55%stocks/45%bonds).  I used the 3% inflation assumed by TRowe (note:  forgoing the inflation adjustment in down markets can make a difference!).  I also assumed that the withdrawal was taken on 1/1 of each year; they assumed monthly withdrawals.

Here's my Table, extended through the end of 2012:

YEAR	65%stocks/35%Bonds	Withdrawal	Amount	Value
2000	0.989	4,000	96,000	94944
2001	0.952	4,120	90,824	86464
2002	0.902	4,244	82,221	74163
2003	1.235	4,371	69,792	86193
2004	1.105	4,502	81,691	90269
2005	1.054	4,637	85,632	90256
2006	1.13	4,776	85,480	96592
2007	1.06	4,919	91,673	97173
2008	0.772	5,067	92,106	71106
2009	1.208	5,219	65,887	79591
2010	1.13	5,376	74,216	83864
2011	1.018	5,537	78,327	79737
2012	1.122	5,703	74,033	83066

This period encompasses two sharp downturns.  In fact, the retiree is met with 3 down years at the start of retirement.  Later, the worst crisis since the 1930s hit.  And still, at the end of the period, the portfolio still retains greater than 80% of its value.  At this point, a 65-year-old retiree would be in his early 70s!

The bottom line for me is that you have to go in with a strategy.  Understand that markets go up and they go down.  Those who don't get this should stay on the sidelines.  Think about this.  This is what life is about.  You can have a great financial plan; but ,if you experience 2 serious illnesses within the next 5 years, any plan is stressed.  It's about handling the uncertainty appropriately which, admittedly, isn't easy.

The absolute worst thing is to get in, see the portfolio drop, and then abandon ship.  Many are on the sidelines today, having jumped ship in 2009 and wondering whether they should get back in.

Kitces on Spending and Retirement

For those who don't know, Michael Kitces is a rarity - the smart financial planner and an original thinker.  Most financial planners I know are really good at learning complex rules for all the various situations that come up in the financial arena but not so much at questioning the consensus view.

Here is a piece, "Retirement success is about spending, not saving," he recently wrote for MarketWatch in which he looks at the simple notion of  saving a given percentage of income starting at a young age and exploiting compounded returns to get a six-figure nest egg.  Many readily accept this as the simple key to building a sufficient nest egg.

Kitces finds two caveats with this.  First off, the simplistic analysis actually assumes the nest egg will double in the last 10 years (in the real world, sequence of returns is important whereas people like to simplify and just use averages).  Think about this:  if we assume we're compounding at 8%/year, then we are assuming that the fund doubles in the last 9 years (think rule of 72).  Over that 9-year period, the fund appreciates, for example, from $500,000 to $1.0 million.

It doesn't necessarily work out like this in the real world.  Not a good thing to realize on your 65th birthday!

Another problem is that saving a fixed amount may not keep up with lifestyle.  Consider an extreme example, where you make $40,000/year and then in the last 10 years you make $400,000/year.  Saving 10% of income/year will leave you woefully short of financincing the lifestyle you've enjoyed your last 10 years of work.  Kitces emphasizes it's not just about saving but is about spending as well.

The whole business of how much needs to be saved, and even how much can be safely spent in retirement, is tricky.  In fact, it amounts to a Rubik's cube.  We don't know how long we will live, how the markets will treat us, or what inflation will be.  Spin the cube and the results can change meaningfully.  Only the minority will come close to realizing their goals.  The rest of us will be forced to ramp down lifestyle or kick the bucket with much more left over than we would like.  We will either have to take less trips, and eat at Hardee's more, or end up so that we would have preferred more weeks at Sanibel and more creme brulees than we had.

Still, Kitces's observations point up, at least to me, the importance of ongoing financial planning.  At least twice/year plans should be revisited (even if just using TRowe's free online calculator or a similar calculator) to even have a shot at getting the process halfway right.