A Simple Rebalancing Example

It is that time of the year where many investors look to rebalance their portfolio to a specific asset allocation. Here is a simple example, using Schwab online resources.

Schwab has 6 different asset allocation models to choose from, to fit an investor's risk tolerance, ranging from 0% stocks to 95% stocks.

This client is close to retirement and, thus, has chosen the model with 60% stocks/40% Fixed Income + Cash Investments.

Source: Charles Schwab

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The table shows the difference for each asset class relative to the target percentage.  Each time you buy or sell a security or a fund, Schwab automatically adjusts the percentages and enables you to see how you are positioned relative to your targeted allocation.

The investor has a choice on when to rebalance.  He or she can choose a percentage difference - for example, rebalance when the difference is 2% or more or once or twice a year on a given date.

It is important to note that, if you are paying a commission, you want to buy or sell enough shares to make it economical.  Here I use Schwab shares which have zero commission and don't have to worry about the number of shares.

Note also the link "View Table in $."  Let's click on this and make our life easy:

Source: Charles Schwab

This shows we need to sell $4,593 in the "Large Cap Equity" sector.

 If you don't invest frequently, you might not recall the ticker symbol for the Schwab ETF that tracks the large cap sector.  Not a problem.  In the quote box at the bottom left on any Schwab page, put in SCH and look what you get:

Here you have a list of Schwab ETFs, and you can see that SCHX is the ticker symbol for large cap.  Note also the ticker symbols for small cap and international (you'll need these to complete the homework assignment).

Here we have the quote for SCHX at 43.92.  To figure out the number of shares to sell, just divide 4593 by 43.92 and get 104.  Thus, selling 100 shares of SCHX will get the large cap position pretty close to the target.

With some sectors over-allocated, there is another sector or sectors under-allocated.  In this case, it happens to be "Fixed Income."  To take care of this, you'll have to google Schwab bond ETFs or use other ETFs.  Again, if you use other ETFs, like AGG or HYS, etc., there will be a small commission.  To find Schwab bond ETFs or other fixed ETFS, just google the relevant phrase or look at the last post on this site.

All in all, the whole process takes less than 30 minutes.  And, THE BEST PART has historically outperformed most market timers and stock pickers over the long term after all expenses.

ENJOY THE NEW YEAR!

Bond ETF Fund Performance (Update)

I last reported on bond ETF performance on 7/7.  Here is an update on the performance of funds I follow based on Morningstar performance data.

Allocating the fixed income portion of invested assets has been a challenge, to put it mildly, for investors over the past few years.  Not long ago, investors could put the bulk of fixed income assets in an index fund tracking the Barclay's Aggregate Index and then go to thinking about the stock portion of assets.  Not true in 2013 and not true as we look ahead to 2014.

As you can see, the returns vary widely and the funds are quite different.  For what it's worth, you'll find that most 401(k)s do not offer a decent selection of bond funds - you are forced to select from a couple.  On the other hand, if you have an IRA, you have the selection available below as well as many others - another reason on the side of rolling over 401(k)s.

In general, you want to limit, to the extent it makes sense,  the bond exposure of your investable assets  in your taxable accounts where they will get hit with your marginal tax rate as ordinary income.

Generally, as you can see in the table, the shorter duration or shorter maturity funds performed best as would be expected in a rising yield environment where the yield curve steepens.  This impact can be seen by comparing IEI (-2.57%) versus IEF (-5.75%).  The table also shows the poor performance of emerging markets and international in general.

The bogey in the bond market is AGG, the Barclay's Aggregate Bond Index - it is to the bond market what the S&P 500 is to stocks. 

Disclosure:  this post is for educational purposes.  Individuals should do their own research or consult a professional before making financial transactions.

ETF	YTD RET.	DESCRIPTION
HYG	5.33	HIGH YIELD
AGG	-1.43	TOTAL MARKET
SCHZ	-1.26	TOTAL MARKET
MBB	-1.13	MBS
CSJ	1.07	1-3 YR. CORP.
IEI	-0.59	3-7 YR. TREAS.
IEF	-4.08	7-10 YR. TREAS.
EMB	-8.05	EMERGING MKT.
BKLN	3.46	BANK LOANS
IHY	5.83	INT'L. HIGH YLD.
PFF	0.33	PREFERRED STK.
FLOT	0.48	FLOATING RATE
BSJF	5.44	2015 HIGH YLD.
LQD	-2.21	INVEST GRADE CORP.
BAB	-4.53	BUILD AMER.
BOND	-0.56	PIMCO TOTAL RET.
HYS	7.16	0-5 YR. HIGH YLD.
VCIT	-1.47	INTERM. CORP.

Are Stocks Overvalued?

Money Magazine puts out an annual "Professional User's Guide."  This year they have a "best of" section, and one of the items (p. 78)  is "Best New Way to ...Tell If Stocks are Overvalued."  It is based on Robert Shiller's (recent Nobel Prize Economics recipient) work on average inflation adjusted price-earnings ratios (CAPE ratio) and subsequent stock market returns.  Shiller uses the 10-year average of past earnings.

The Leuthold Group has done further research and found better predictions come from using 5 years of past average adjusted P/E data.

They found that, if 5-year adjusted P/Es start at below 10, then 10-year annualized returns average 11.9%.  If P/E is in 10 to 14.9, average return over 10 years is 9.8%, 15 -19.9 gives 6%, 20.0 to 24.9 gives 3.3%, and 25 and higher produces -0.6%.

At the time of the article, the Shiller 5-year P/E stood at 21.3.  Thus, if historical data holds, we can expect 3.3% annualized over the next 10 years.  Not good, right?

Obviously it is not great; but still, in a world where money market rates are practically zero, the 10-year Treasury yield is approximately 2.80%, and most inflation numbers are less than 2%, a 3.3% annualized return is not something to necessarily thumb our noses at.  Throw in the fact that most Central Banks are like deer caught in the headlights when they contemplate the possibility of deflation.

If you accept the Leuthold Group findings of 3.3% annualized returns, you may, however, want to revisit your financial plan and revise some numbers.  Most plans predictive of retirement nest eggs are based on anticipated stock market returns of 8 - 10%.

Disclosure: T his post is for educational purposes only.  Investors should do their own research or consult an investment professional before making investment decisions.

Calculating the Required Minimum Distribution

As IRA and 401(k) holders approach their 70s, they need to start thinking about required minimum distributions.  Inherited IRA holders need to know the RMD as well.  Get it wrong, and there is a hefty tax penalty!  Here is the IRS link with the questions typically asked about the subject:  Retirement Plans FAQs regarding Required Minimum Distributions.

Before doing the calculation, first check your online broker site.  The amount you need to withdraw may be there.  For example, with Schwab, just click "Balances" and scroll to the bottom to find:

Source: Schwab

Done!  At least for this account.

Because this is the first RMD, it doesn't have to be taken until 4/1/2014; but next year's RMD will need to be taken by 12/31/14.

Note the footnote link to a calculator for distributions required from inherited IRAs!

An easy-to-use calculator for the DIYer is provided by FINRA.  Only 2 inputs required: previous year balance and age.

Source: FINRA

The results then are shown as:

Source: FINRA

Think in Real Terms

Back in '73-'74, OPEC, at a time when  the U.S. was a big importer of oil with our gas guzzlers and wasteful energy practices, quadrupled the price of oil overnight.  Economists, in thinking through this type of event, tend to get away from prices and dollars and think in real terms.  Thus, in effect pre-embargo, we would trade x number of autos versus a given number of barrels of oil and after the embargo OPEC wanted 4 times as many autos for the same number of barrels!  Putting the oil price rise in these terms clearly shows the extent of the problem.  Specifically, it showed that something would have to give:  either the U'S. economy would get pounded or OPEC would be paid in funny money as inflation pushed the value of the dollar lower.

In fact, in 1980 OPEC doubled the price of oil again a;nd the U.S. experienced spiraling double-digit inflation that led to Volcker slamming the brakes and throwing the economy into a severe downturn. Anyone remember the WIN buttons?

This technique of putting dollars in real terms is useful in financial planning.  For example, sometimes the decision is to take Social Security today or wait 2 years and get $150/month more.  Many people would think that $150/ month extra, on the face of it, isn't worth waiting for and opt for the payments to start today.  But, in real terms, we might observe that $150/month provides a really nice dinner (wine included) monthly for a couple as long as they live.  Perhaps put in these terms the decision might be worth reconsidering!  Or, more broadly, looking at the payments over a 12-month period shows an amount that could go a long ways towards funding an annual trip.

The technique also works the other way.  Working with annuity payouts typically involve higher payments if there are no survivor benefits.  Allowing, for example, for survivor benefits of, say, 90% may lower the monthly payment by $100/month.  Would you give up a monthly eating dinner out to have the peace of mind that the payments will continue to the spouse as long as she is a survivor?  Again, thinking of the payments in terms of real sacrifices can help in the decision process.

Obviously, I like to eat; but the decision can be framed in terms of rounds of golf, traveling to see friends, time between buying a new car, or whatever.  Framing the decision in terms of what you can gain or have to give up can sometimes be a big help in making the right decision.  This is also useful for young people thinking about saving.  What do they get 30 years down the road, in real terms, by saving a relatively small amount today?