On the Difference in Saving Rates

Ben Carlson at MarketWatch has produced interesting data on savings rates in

Opinion: How a slight edge in investing adds up to big money over time.

In his article he starts with a short story from Atul Gawande on how small changes have a big impact in the medical field where people look for big, miraculous changes. As an aside Dr. Gawande is one of my favorite authors and I highly recommend his

The Checklist Manifesto.

So, what is the impact of a small change in the saving rate? Carlson first looks at an example of a household income of $100,000 saving 10%/year and achieving an investment return of 8%. After 10 years this will produce a portfolio value of $132,822. Increasing the saving rate to 11% results in a portfolio of $146,104. He shows portfolio values for 1% incremental returns up to 15% where the portfolio value approaches $200,000.

It is important to note that the period is relatively short in terms of the saving horizon most retirement savers experience. In fact, most savers should be saving over a 30 year plus period!

Carlson also provides an interesting chart showing the impact of marginally increasing your saving rate. He starts, again, with 10% and then increases by 2% to 10.2%.

The big take away is that incremental changes have big impacts over longer periods of time (both in a person's health as well as their retirement program)  but it is difficult to appreciate them because they are barely noticed in the beginning.

I Apologize

I apologize to all those people over the past three years to whom I talked and tried to the best of my ability to get into the stock market. I wish I was more persuasive. We sat together at the table (or Skyped) and looked at the huge amount you had in Certificates of Deposit at .75% or  in  money markets at 0.1% and I pleaded for you to open an account at Schwab (or the discount broker of your choice) and choose a low  fee S&P 500 Index Fund for 60% of the assets.

I argued that the U.S. economy is the most innovative in the world, that products will be forthcoming that neither of us could foresee that would be in demand. We couldn't foresee Fitbits, or driverless trucks, or drones delivering packages. We couldn't foresee virtual reality. But all of it came and is coming big time.

You worried over government shutdowns, a slowing economy, the European Union breaking up and more recently Brexit and Trump. In your thinking you kept going back to the downturn in 2008 despite the fact that you had many years to recover if the market experienced a meltdown in the short run. To no avail I tried to emphasize that such a meltdown is a gift to the long term investor who is accumulating a nest egg for retirement.

The saving grace for me are the many who did invest for the first time and who gained the confidence and knowledge that  put them on the path they need to be on. They  held to a well defined asset allocation and have seen their assets appreciate significantly to return well above the rate of inflation. They learned to manage their own assets and avoid the egregious fees charged by the industry.

They are excellent examples of how straight forward it is to become do-it-yourself investors and participate fully in the free market capitalistic system.

A Great Gift

Recently I received a call from a young man seeking my advisory services. As an advisor my satisfaction comes from helping people get on a path to a successful retirement. This means steering them clear of high priced advisors who underperform, avoiding costly Funds that overcharge, and ensuring that the size of their nest egg will be sufficient to produce the income they need in retirement.

But this young man was a different case than I usually handle. He had just gotten out of prison on drug related charges and while in prison had read "Millionaire Teacher", which he found in the prison library, by Andrew Hallam. By reading the book he had come to understand how people build wealth by saving and investing intelligently. The book inspired him to do the same and he enlisted my services to get going. Full disclosure: I, along with a couple of other advisors, are mentioned in the book.

He related to me how his parents and entire family are poor but he had attained a job and was primed to start investing on a regular basis. To say the least this was one of my most satisfying consultations.

But the bottom line here is receiving the methodology. Admittedly, there are a number of books that describe how to invest in low cost Funds, allocate assets, and rebalance as needed. "Millionaire Teacher" is one and it is a good one. It is well written and can be read in a couple of weekends.

In my opinion it is a great life changing gift, especially for the young couple ( many of whom are financially illiterate) starting out in the professional work world. But many in mid-career find it useful as well.

So, I suggest instead of showing up with the soon to be consumed bottle of wine at the holiday party or putting a DVD of "Deadpool" under the tree consider "Millionaire Teacher".  It is an excellent choice for the budding DIY investor. As this blog and many others have harped on for a long time DIY investing done intelligently can save huge amounts and  increase the size of the nest egg over longer periods of time.

For additional background check out Andrew Hallam's website.

Market Reaction to Trump

This from Yahoo Finance, "How Wall Street is trying to make sense of the stunning stock market rally" 

Stock prices crashed as it became clear that Donald Trump would be elected the next President of the United States. And then they did a complete reversal to actually rally during the first trading day after the votes were counted.Just when you thought the stock market was starting to make sense, it goes ahead and does the exact opposite.The markets were supposed to get crushedAhead of Election Day, Wall Street’s stock market experts were in broad agreement that a surprise victory by Republican candidate Donald Trump would be met by a sharp sell-off, ranging somewhere between -3% to -15%. Yahoo Finance reported on this multiple times.

This is another example of the futility of trying to time the market. There also is some "recency bias" apparently going on. This is where investors give weight to what has happened in similar situations in the recent past. On this front not long ago investors saw the head fake from the Brexit situation whereby stocks dropped and then reversed sharply. 

Market time at your own risk.

Is This an Accumulator or a Decumulator Market?

In the simplistic world of financial planning you fall into one of three categories: an accumulator building a nest egg, a decumulator drawing down your nest egg and a live for today, borrow and spend type who will worry about retirement when it gets here. For the record there are too many in this latter category.

All three show up on the investment manager/financial planner's doorstep and the fact is only the first two can be helped unless the live for today person has had a revelation and has years to go before they want to build a nest egg or happily has been the beneficiary of an inheritance, won the lottery etc.

So what about the market for the accumulator and decumulator categories? Here are some market indices as reported by Schwab in their performance module. The returns are thru the close of business on 10/14/2016:

Market Index        3 months     YTD     1 year     5 years
S&P 500               -0.9              6.17       9.30       14.15
MSCI EAFE          1.22           -.47        -1.05        5.56
Russell 2000          1.21           8.01        8.25       12.77
Barclay's Bond     -0.50           5.08        3.84         3.10
Citi 3-mo. TB        0.07           0.20        0.21         0.08
S&P GSCI             1.60           7.72     -11.53      -13.54

Note that the 5 year number is an average annualized return. The S&P GSCI is an index of commodities produced by Goldman Sachs. The Citi 3-mo. TB (Treasury bill) return is a proxy for cash equivalent investments.

From one perspective the returns have been good for both the accumulator and the decumulator. They have been good for the accumulator because positive returns keep people in the market. On the other hand positive returns means the market is getting more pricey and sometimes gets investors to take more risk than they should. Accumulators would actually be better off if the returns were negative because then they could pick up shares at a lower price and the probability of strong returns going forward would be greater.

Decumulators should be more than satisfied with these returns as long as they stayed away from commodities, didn't park their retirement assets in cash and followed a well conceived asset allocation/drawdown strategy. Most decumulators are retirees. The behavior of markets for the first several years of retirement are critical. The 65 year old who retired 5 years ago is today 70 years old - by the "rule of 72" the annualized 14.15% return on equities has doubled money in the stock market. A retiree could hardly ask for more! Most will find that they took a nice drawdown and today have more than they started with 5 years ago and yet are 5 years closer to the grim reaper.

What more could they ask for?

A Proposal - Summary

This proposal's purpose is to give everyone at least a framework of how to go about building a nest egg for retirement, as presented in the previous 4 posts. Like many areas we have gone 90% of the way to handling a problem but then stop just short of wrapping it up.

The 401(k) and similar qualified plans are excellent for getting people to a successful retirement. The problem is many don't know how to use it. The purpose of the proposal is to fix that. As mentioned in previous posts if you know how to invest or have a different approach then go for it. Again, a caveat, if you are hell bent on beating the market by picking stocks or active Funds or timing the market all I can say is "good luck". The odds are against you.

Begin by emphasizing the importance of starting early and putting away at least 10% of every paycheck.

So, the proposal: start with an appropriate target date/life cycle/retirement date Fund . How to do this will be presented in a 15 minute video when you take your job. Secondly, once you reach $60,000 or so in your 401(k) switch to low cost index Funds with an appropriate asset allocation. Typically this would be somewhere around 70% stocks/30% bonds. Finally, when you reach the point where you are thinking of generating an income off of your portfolio consider creating a dividend stream by using bonds Funds and Dividend Funds and even individual dividend stocks.

The first two steps require very little time. The third is a bit more time consuming.

As explained in the previous 4 posts there is no need to switch at various points. If you have no interest and just want to stick with the life cycle approach you can do that. Or you can stay with the low cost, index Funds. The only reason to switch at various times is to lower the costs a bit. It is worth noting that directly investing in the dividend stocks can potentially be the most rewarding because you have opportunities for tax loss harvesting, judicially increasing yields oner time etc.

The bottom line is that this proposal provides a way to emphasize to workers that by following some very basic steps they can end up enjoying a nice retirement.

Average Joe on the Path to Retirement

According to Census Bureau data, the real median income of a household 10 years ago was $65,000.  This is where we 'll start our average Joe. Today, Joe's household income, adjusted for inflation, again from median Census Bureau data, is approximately $67,141.

The following simple exercise shows how Joe has done on the path to retirement if he followed some basic guidelines.

Tables from the book Your Money Ratios by Charles Farrell show that a 40-year-old on track to achieve an 80% income replacement at age 65 should have a nest egg of 2.4 times his income.  In average Joe's case, this amounted to 2.4 * $65,000 = $156,000.  This is what his nest egg should have been 10 years ago.

Farrell's tables also show that Joe should have been saving roughly 12% of income or $7,800/year (.12 * $65,000).  In case you're interested, Farrell also says that Joe's mortgage should have been 1.8 * $65,000  = $117,000 and his household education debt should have been zero.  Given these stipulations, at 40 years old, Joe would have been on a path for a successful retirement.

But how is Joe doing today at 50 years old given market performance over the past 10 years?  Most studies show that the average investor underperforms the market by a significant amount.  This is because the average investor jumps in aggressively when prices are high and panics when prices are low.  For our purpose, we'll assume that average Joe isn't like the average investor.  Instead we'll assume Joe invests in low-cost, well-diversified index funds.

For our performance data, we will use the chart produced by BlackRock.  The chart shows annual performance for a diversified portfolio comprised basically of 65% stocks and 35% bonds.  This is the portfolio whose performance we update each quarter.

For the purpose of the analysis, I used $7,800 as the amount Joe saved each year.  This amount would ratchet up according to plan because Joe's salary increased but also because Farrell suggests the saving rate be ramped up to 15% at age 45. I  kept it simplistic at $7,800/year.

Joe's goal, as given by Farrell's tables, is to have 5.2 * $67,141 = $349,133 to be on plan at age 50.  The following table shows the year-by-year results:

Start of Year	Amount  in Nest  Egg	Diversified Portfolio Performance	Annual Saving
1/1/2005	$156,000	+5.4%	$7,800
1/1/2006	$172,425	+13.0	$7,800
1/1/2007	$203,117	+6.0%	$7,800
1/1/2008	$223,327	-23.0% *	$7,800
1/1/2009	$177,967	+20% *	$7,800
1/1/2010	$222,087	+13.0%	$7,800
1/1/2011	$259,236	+1.8%	$7,800
1/1/2012	$271,770	+12.2%	$7,800
1/1/2013	$313,174	+20.0%	$7,800
1/1/2014	$384,335	+8.1%	$7,800
1/1/2015	$423,566

The results in the table were obtained using a bankrate calculator.  I used the calculator to calculate year-by-year returns assuming Joe contributed $300/week to a qualified, 401(k) type plan.  The calculator doesn't handle negative investment performance or returns exceeding 20%.  For those years, I used rough estimates to calculate by hand.  The performance numbers came from the aforementioned BlackRock chart obtainable from the link above.

The diversified portfolio is weighted as follows:  35% Barclay's Aggregate bond index, 10% MSCI EAFE index, 10% Russell 2000 index, 22.5% Russell 1000 growth index, 22.5% Russell 1000 value index.

The bottom line is that Joe is not doing badly, with a portfolio above target by approximately $73,000. In fact, Joe would have probably done better because most 40-year-olds would be more aggressively invested than with a 65% stocks/35% bonds portfolio.

Disclaimer:  info here is for educational purposes only.  Individuals should consult a professional and do their own research before making financial decisions.

Are Men or Women Better Investors?

Here's a cute piece on data from SigFig which aggregated and anonymized (whatever that means!) 2.5 MILLION PORTFOLIOS  "Is your Valentine a better stock picker than you?" by Eric Cheni.
Total assets amounted to $350 billion, and the bottom line was women had a return of 4.7% and men had a return of 4.1%. The finding that women tend to perform better as investors is fairly consistent because they trade less and generally are more patient. Plus they don't have an exaggerated opinion of their investment prowess!

But what about the most patient, non-stock-picking approach of all?  Pull out again the BlackRock chart and find that, in 2014, the Diversified Portfolio achieved a return of 8.1%!  This portfolio is 35% Barclay's Aggregate Bond Index, 10% MSCI EAFE Index, 10% Russel 2000 Index, 22.5% Russell 1000 Growth Index, and 22.5% Russell 1000 Value Index.  This portfolio is easily replicated.  In fact, it could have been set up on 1/1/2014 and you could have enjoyed the rest of year leaving the stock picking and market timing to those with the big egos!

Update on Morning Routine

Source: Capital Pixel

I'm primarily an indexer and passive dividend stock investor.  Thus, I don't hunger after economic data during the course of the market day or breathlessly wait for the next pundit coming up on CNBC.  But I do like to feel like I know what is going on in the market and  like I understand the major influences.  To that end, I begin my day gathering data.

I go to MarketWatch and begin at the data source shown:

Source: MarketWatch

I first record the yield on the 10-year Treasury Note (1.79) and the German 10-year Bund yield (.32) and then calculate the difference.  That difference, as shown, is now 1.47%.  So, even though the U.S. rate is anemic, it is considerably higher than the German rate as well as most of the other yields shown in the table.  Other things equal, U.S. rates are enticing to many in the global markets.

Next I click "FX" and record  "WSJ $ Idx, a basket of currencies, as well as the euro.  Both of these have moved higher.  On January 14, for example, the WSJ Idx and the euro stood at 84.02 and 1.18, respectively.  Today they are at 85.40 and 1.12, respectively.  The bottom line is U.S. Notes and Bonds look very attractive to global investors both on a yield level basis and dollar appreciation basis.  This was the major factor confounding prognosticators in their prediction that rates would rise in 2014!

I next click "Futures" and record both the price of oil and gold.  In reading Barron's "Roundtable," I have gotten chuckles, as I'm sure some of you have, over the hand-wringing by participants of the failure to foresee the collapse in oil prices.  Some of the participants seem to question the whole pundit/prediction exercise!

One final data point I started picking up recently was the yield on the S&P 500 which, itself, has gone above the yield on the 10-year Treasury.  I get it by going to Yahoo! Finance and looking at the yield on SPY, the ETF tracking the S&P 500:

Source: Yahoo

As shown, the yield is 1.87%.

All of this takes less than 10 minutes in the morning and gives me a good feel for how markets are behaving.

A couple of years from now, I will surely be tracking different indicators.  That's the nature of markets - what is important at various times changes.  There was a time when the P/E ratio on internet stocks was a driving factor.  At another time, it was the rate on adjustable rate mortgages.  Today it happens to be the spread between U.S. interest rates and global rates along with the value of the dollar.

Since some of you may go to the MarketWatch site, it is a good time to tout the "RetireMentors" which can be found by clicking the "retirement" link at the top of the homepage.  IMHO, this is the best ongoing collection of articles online for people interested in retirement.

Robo Advisor or Full Service Advisor?

Put your info online and, for a reasonable fee, a robo advisor (see picture) will come back with a recommended asset allocation and specific funds to invest in.  Also, you'll typically get a lot of personalized reporting on your investments letting you know how much you should be saving, where you can expect to be several years from now, etc.

What's not to like?

Well, a lot, if you listen to full service advisors.  They argue that investments need to be part of the whole financial picture.  And they are more than glad to explain how the whole financial picture can be complicated.  You need advice on when to take Social Security, how to choose a 529 plan, whether to do a Roth, estate planning questions, etc. I nvestments need to fit into this bigger picture and that makes the 1 - 2% fee they charge reasonable for managing your investments, they say.

Actually, there is a third way:  forget the full service advisor and forget the robo advisor and learn how to do the whole thing yourself.  This, in fact, is doable for most people by reading a relevant book, three of which are constantly touted here:

Millionaire Teacher by Andrew Hallam,

Your Money Ratios by Charles Farrell,

The Smartest Money Book You'll Ever Read by Dan Solin.

Each of these books is easy to read - two weekends at the most - and you'll come away a lot smarter after reading them.  In fact, you'll come away knowing exactly how to invest after reading them. Furthermore, you'll know how to decide how much insurance you need, what you should seek in the way of estate planning, and even how big a mortgage you can reasonably carry.  Every family should have someone who knows and understands the information in these books.

As a motivation, you should know that understanding the information in these books will save you a huge chunk of your nest egg over your lifetime.

But it isn't just about do-it-yourself investing.  Most important of all, you'll come away with an understanding of when you need an advisor.  It may be in your 50s when you really want to hone in on whether you are saving enough to get your  nest egg where it should be by the time you reach your retirement date.  It may be that you want a formal outside opinion on your investments or even a formal analysis of the best time to take Social Security.  It may be that you have stock options you need to exercise in a tax-efficient way.

The bottom line is that there are times you need to pay up for advisory services and there are times when it isn't necessary, and knowing the difference can affect your pocket book greatly.  Again, the readings will help.  At the very least, they will help you understand what questions to ask and enable you to participate meaningfully in the advisor conversation - a conversation that some find intimidating.

Investment Seminar Announcement

I will be giving a seminar/ workshop at the Miller Library in Columbia, Maryland on Thursday, November 13 starting at 7 pm. The presentation will go over two approaches to investing :  (1) low-cost index investing as touted by John Bogle, Warren Buffett, and Burton Malkiel ( author of A Random Walk Down Wall Street) as well as many other knowledgeable investors, and (2) dividend stock investing for investors seeking to develop an income stream in a low interest rate environment.  Also, we will go over a worksheet to determine how to pinpoint whether we are on the right track for retirement.

So bring a friend, bring a neighbor, or suggest it to a co-worker who has expressed confusion on the whole topic of whether they are doing the right approach with their investments.  We live in a world where we are responsible for our own retirement.  This is something many people are getting wrong-- possibly including your neighbors, your co-workers, and your friends.  Get it right and your 65-year-old self will thank you.

I hope to see you there!

Here is a link for the registration : Seminar/Workshop .

Is "Buy-and-Hold Dead"?

Is "Buy-and-Hold" in Here?

I quite often hear the phrase "buy-and-hold is dead."  In fact, two years ago a money manager stood in front of the American Association of Individual Investors in Baltimore and proclaimed the demise of buy and hold.  He was promoting tactical allocation, of which he is a practitioner and would be glad to tactically allocate your assets for 1.50% of your assets annually.  Perhaps not as remembered by some in the group, there was a member who pressed the speaker on his current allocation.  He responded that his tactical allocation indicators had him heavily into cash.

Given how adamant he was about his style and the hindsight we now have for the past 2 years, I often wondered how he did.

It is hard to get performance data on specific managers, for good reason:  managing for individuals presents unique cases in every instance.  For example, some clients come in with load funds and stocks that have large capital gains, etc., requiring careful management from a tax efficiency perspective.  As a result, it is not easy to tell if a given money manager is doing a good job.  Furthermore, you can't ask clients because many clients don't know.  I've had people tell me their investment manager did great last year because he made them $18,000.  Think about that for a moment.  It actually tells you nothing.

I follow up by asking what their return was.  Typically, they have no idea.  At that point, it is useless to go the next step and ask about risk.

So it is difficult to assess how investment managers perform.

But what do we know?  We know that a well-diversified, low-cost indexed portfolio achieved a return of approximately 8%/year over the past 20 years - a rate that doubles your money every 9 years and, therefore, more than quadruples assets over two decades.  We know it achieved this performance over a period that was extremely difficult at times.

We also know that Warren Buffett, the most successful investor of our era,  is a proponent of buy-and-hold.

Here are some further thoughts on buy-and-hold:

THOUGHTS ON BUY-AND-HOLD



The bottom line is each investor has to decide on their own whether active trading, tactical allocation, market timing or buy-and-hold is the way to go .

Presentation Preview

Millionaire Teacher Andrew Hallam

Tonight I give a wrap-up talk for the online discussion of Millionaire Teacher by Andrew Hallam conducted via the Howard County Library System in Howard County, Maryland.  As one part of the presentation, I will give the following overview that hopefully will help people as they think about saving for retirement.

How to Invest

• Asset Allocation - Percentage in Stocks/Bonds/Cash. Most important decision for investors. Pick asset allocation and stick with it.
• Low Cost Index Funds - forget market timing and stock picking. Understand the cost of the funds you use and minimize those. Use index funds. 
• Monitor - keep track of performance. Performance should be close to market returns. Understand that, in accumulating assets, declining markets are your friends.
• 10% Max Play Money - You are introduced to 3D printing and want to invest. You eat at Chilpolte's and want to invest. Limit these investments to your "10% play money."

Organize 

• Taxable, Qualified (401k, 403b, TSP, IRA), Roths - Put accounts statements in this order. This, by the way, is generally the order you'll spend in retirement.
• Consolidate - Many people have accounts with several brokers and banks. Simplify as much as possible. It helps in getting the big picture and monitoring the overall results.
• Bonds in Qualified Accounts and Roths/Stocks in Taxable and Qualified Accounts-Two tax rules:  defer taxes and pay as little as possible. Understanding the idea behind location of investments helps along these lines.

How Much to Save and Invest?

• Add Social Security + Pension + Nest Egg * .04 + Other Income - The idea is to estimate potential income  when you stop drawing a paycheck. Online calculators will help you with this by putting in estimates of inflation and market returns.
• Income should typically  = 80% to 110% of current lifestyle expenses - Estimate living expenses at retirement and get within the range. 

What Can Upset the Apple Cart?

• Lose Breadwinner Income - Carry term insurance. 
• Health - Think about long-term care insurance.
• Lawsuit - Carry umbrella insurance.

This outline is intended to get the wheels turning.  People need wills and trusts.  People need to consider what it would cost to replace a homemaker.  People need to understand how to rollover 401ks and educate their heirs how to title inherited IRAs.  This outline isn't intended to suggest that dotting all the i's and crossing all the t's is easy but, hopefully, get people started on the right path. Reading the Millionaire Teacher goes a long way down this road.

Create an Income Stream Versus an Annuity

An ongoing conundrum in the financial community is why single premium immediate pay annuities (SPIA) aren't more widely accepted?  After all, they go a long way towards avoiding running out of money in old age (the number one fear of retirees), no matter what the market does.  Furthermore, used intelligently, SPIAs can be used to enable a retiree to take on a bit more risk in the other assets they own.

So what's not to like?  First off, retirees lose control of the money.  For example, suppose the retiree comes home and finds a leak in the attic crawl space?  The roofer guy is going to come out and tell the retiree he or she needs a new roof!  Where do you get the money from?  Hint:  not the annuity. Secondly, though useful, today the timing may not be right with interest rates close to historically low levels.  With the yield on the 10-year Treasury note at 2.50% and the Federal Reserve printing money akin to Anatasios Arnaouti on steroids, many feel that higher yields will be available down the road. Thirdly, most people would rather wallow in their own fear of a market collapse than talk to a silver-tongued insurance agent who has been trained to sell you products that will destroy a retirement portfolio faster than you can get out a high-powered electronic microscope to read the fine print.

So, does it leave the retiree at the mercy of the usual portfolio approach trying to beat the market?  Not necessarily.  Some are constructing a sort of hybrid portfolio whereby the allocation to fixed income is replaced partially with high dividend stocks.  This is not a couch potato approach in that it does require some time on the part of the DIYer but could pay high dividends (sorry, couldn't help it) if done correctly. And, as a matter of fact, a whole industry of bloggers (see below)  has arisen to help the DIYer in this endeavor.

 DIVIDEND PORTFOLIO EXAMPLE

To see one way to approach this, let's look at an account I recently set up.  We began with the usual important first step of doing an asset allocation.  This is for a couple in their 60s.  Income will become important to them shortly.  The allocation was 50/50 stocks/fixed income.  The stocks portion was invested in low-cost diversified index funds.

The twist came with the bond portion.  Instead of bond funds, the fixed income portion was invested in dividend stocks that have a dividend of 3% or greater.  It was decided that the dividend stock positions would be less than 5% of the overall exposure in the dividend sector, making each position less than 2.5% of total assets.  Importantly, it was agreed to carefully look at diversification - the last thing you want is to load up on bank stocks, energy stocks, etc.

With these specifications, here is a partial listing of the  portfolio that was constructed:

Source: Schwab

CLICK TO ENLARGE
You'll notice that NLY is in for a lesser amount.  It is a riskier issue with a yield in excess of 11%.  Its purpose is to juice up the yield of the portfolio a bit with the understanding that its dividend is considerably less secure compared to the other holdings.


The thing to get your head around is that, in one sense, you really don't care about the prices of the stocks.  After all, if you had put the money in an annuity, you would be dealing with an income stream!

Having said this, if prices move higher and this is a taxable account (which, in this case, it is), you have some options.  You can realize long-term gains if you find better replacements and can actually take advantage of tax-harvesting by capturing losses.

Once set up, the next step, which takes all of 30 minutes, is to do an Excel sheet showing dividends received:

The portfolio will be comprised of approximately 20 stocks.  The bottom line is to seek to have income increase over time.  This, of course, won't happen with a bond.  Buy the 10-year Treasury note and you'll get a fixed interest payment every 6 months for the next 10 years.

Here's the bottom of the Excel spread sheet:

The arrows show that already the dividends have increased and, in fact, they will increase this month with the final payment due in.  The goal is to see them double approximately over the next several years.

Obviously, unlike the annuity situation, the investor has control over the assets.  If  the roof leaks or Aunt Maude in Stuttgart Germany kicks the bucket, the investor can sell assets to pay the roofer guy (or gal) or get on an airplane to Stuttgart.  A DOWNSIDE IS THAT THE YIELD WILL BE LESS THAN WITH AN ANNUITY, AT LEAST AT THE BEGINNING!  This is because, with an annuity, you are receiving an actuarial rate based on a group's mortality.

The newbie DIYer should be able to find on his or her brokerage site a history link that shows all cash flows that come into an account.  This is a convenient place to track your dividend receipts to put into your Excel spreadsheet.  In Schwab, it looks like this:

If this intrigues you in the least bit, you should realize you can go at it at whatever size you want.  For example, if your asset allocation calls for 40% fixed income, you could consider putting 20% of your fixed income allocation in dividend stocks and think of the allocation as your personal annuity!

The obvious question is how do you find good dividend-paying stocks without having to spend an inordinate amount of research effort? Actually, today this is easy because there are several really good blogs dedicated to finding good dividend payers.  Here are a few:

DIVIDEND GROWTH INVESTOR , DIVIDEND MANTRA, DIVIDENDS4LIFE .

Disclosure:  This post is for educational purposes only.  Individuals should do their own research or consult a professional before making investment decisions.

Comment on Risk Tolerance Questionnaires

Here is a good, short article from the online Financial Planning site on risk tolerance questionnaires by Alan S. Roth:  Why Risk Tolerance Questionnaires Don't Work.  For those who might not know, risk tolerance questionnaire are a favorite tool of the financial planning crowd, frequently presented with an aura of scientific precision.

But this scientific precision is too simple.  In fact, at the extreme, some people are taking unnecessary risk!

In the article, William Bernstein (author of The Four Pillars of  Investing) poses the question: “if you’ve won the game, why keep playing?”

This question is especially relevant today with the S&P 500 and other indices at all-time highs.  It takes me back to the year 2000 when I attended an event for investment professionals and a young investment professional was bragging about his $3.0 million portfolio of internet stocks.  Someone asked why he didn't sell and take a profit, and his response was "with a portfolio going up $50,000/month, why would anyone take a profit?"

This young man was hardly the exception.  Back then, many had a portfolio they could have retired on comfortably at a young age but let ride. 

Later, someone told me he eventually finally sold out after the portfolio had dropped to $150,000.

The same behavior frequently occurs with state pension funds where they become fully funded, or close to fully funded, as markets rise but then become more aggressive with their asset allocation.  All of this points out the astute observation, made in the article, that risk tolerance isn't some stable magnitude that can be measured by a risk tolerance questionnaire.  Instead risk tolerance changes as markets change.

I would add that there is a difference between a highly volatile market that is trending upwards versus a highly volatile market trending downward!

What is the Cost of Investment Management? (Update)

This post is an update of a post published 4/26/2011.  It looks at market performance from the perspective of investment management cost over 20 years from 1/1/1993 to 2012.  The previous post covered 20 years ended 12/31/2009.

If you are a typical investor using an investment advisor, you probably have wondered at some point exactly what  it is costing.  On the surface, it looks rather small - the typical advisor charges between 1% and 2% of the market value of assets managed. 

Throw into the mix, however, the mountains of evidence which show that, over the long run, 3 out of 4 managers who try to beat the market and charge high fees for their services underperform--and the question becomes really interesting.

Keep in mind that financial planning and investment management are two different endeavors.  You could get a sophisticated financial plan done by a financial planner, and it could be well worth the cost. Understand, however, that FINANCIAL PLANNING AND INVESTMENT MANAGEMENT ARE TWO VERY DIFFERENT SKILL SETS!

There is considerable confusion on this topic in the blogosphere.  Let me be clear:  for many people, a well-done financial plan is worth paying for and, in fact, I've seen costly financial plans pay for themselves as the planner spots profitable attractive tax savings, etc.

What we are  looking at here is solely investment management.  Specifically, we'll think about how much could be saved managing your own assets and just matching market performance.  Bottom line: the savings are huge - this isn't the old "change your own oil" tactic from graduate school days.  This is meaningful savings.  It is the difference between being able to retire comfortably and not.

Regular readers of this blog know I like periodic tables of investment returns because they readily enable analyses of this type.  Here is the link to the Table put out by BlackRock for the 20-year period ended 2012:

Source:BlackRock

CLICK TO ENLARGE  Granted there are many paths we could have gone down over the past 20 years, but this is one path we did travel. The table shows the value of diversifying, why not to chase hot sectors, and the biggest ups and downs of the past 20 years.  It also shows the performance of a diversified portfolio (white box) and, thereby, gives us what we need to calculate the cost of investment management for a basic diversified portfolio. But first, let's back up and review what we are considering.

Google "wealth managers" along with your zip code, and you'll find at least 10 wealth managers within 25 miles, say, of where you live (unless you're in the Amazon jungle or the North Pole).  Call the 10 wealth managers and tell them you have $1.0 million in assets and you need help managing it.

To make a long story short, they will gladly manage it for you at a fee of between 1% and 2% of the market value of assets.  Thus, the first year fee on your $1.0 million will be approximately $10,000.

The question we are interested in is the cost of professional management if we had gone back 20 years ago to 1993.  What would have been the impact on the portfolio of professional management at 1% versus managing it ourselves?  Keep in mind that assets typically need to be managed over much longer periods, so we are actually looking at a short time frame - maybe for someone in their mid-40s with a couple of rollover IRAs and 20 years to retirement.

Again, most professionals (and individuals who try to pick stocks and time the market), after fees, underperform markets over the long term.  If you need evidence of this,  please do not hesitate to contact me.  For our analysis, we assume that the investment manager achieves the returns of the diversified portfolio in the BlackRock table.

We'll also assume that the investment manager gets paid at the end of the year.  In the real world, investment managers are paid at least quarterly.

Using the returns provided by BlackRock produces the following results :

Column1	Column2	Column3	Column4	Column5	Column6
	PORTFOLIO (T)	RETURN		FEE	PORT-FEE
1993	1,000,000	1.133	1133000	11,330	46192
1994	1,121,670	0.997	1118305	11,183	45730
1995	1,107,122	1.274	1410473	14,105	40350
1996	1,396,369	1.136	1586275	15,863	44820
1997	1,570,412	1.206	1893917	18,939	44372
1998	1,874,978	1.17	2193724	21,937	43928
1999	2,171,787	1.137	2469321	24,693	43489
2000	2,444,628	0.989	2417737	24,177	43054
2001	2,393,560	0.952	2278669	22,787	42623
2002	2,255,882	0.902	2034806	20,348	42197
2003	2,014,458	1.235	2487855	24,879	41775
2004	2,462,977	1.105	2721589	27,216	41357
2005	2,694,374	1.054	2839870	28,399	40944
2006	2,811,471	1.13	3176962	31,770	40534
2007	3,145,193	1.06	3333904	33,339	40129
2008	3,300,565	0.772	2548036	25,480	39728
2009	2,522,556	1.208	3047248	30,472	39330
2010	3,016,775	1.13	3408956	34,090	38937
2011	3,374,866	1.018	3435614	34,356	38548
2012	3,401,258	1.122	3816211	38,162	38162
	6.02%			386,917	836196

For those who may not be mathematically adept, the 13% return shown for the diversified portfolio in 1993 in the BlackRock table is put in the spread sheet above as 1.13 because $100 will grow to $113 at the end of the year.  The portfolio grew to $1,133,000.  The fee then would be .01* 1,133,000 or 11,300.  As another example, in 1994, the diversified portfolio declined by -0.3%; so the return number is .997 in the table.  Each dollar fell to $.997.  Thus the portfolio dropped, and the fee went down accordingly.

If you can need some practice, work through 1998 which saw the largest drop in the market.

The totals are what we are interested in.  Over the 20-year period, $386,917 went in to the pockets of the investment manager.  If, instead, the yearly amounts had remained in the portfolio and achieved the ensuing market returns, the total amounts to $836,196!  No wonder Fred Schwed stood on the docks at the end of Wall Street looking at the broker yachts and wondered where the customer yachts were!


Disclosure:  This post is intended solely for educational purposes.  Individuals should do their own analysis and/or consult with an advisor before investing.