Jonathan Clements's Blog, page 267
September 8, 2021
Wheel Deal
I���VE BEEN KNOWN to overanalyze decisions, especially financial ones. When faced with a money question, often my first thought is to create a spreadsheet. While this brings groans from family and friends, I find them a great way to clarify my thinking and gain insights. Sometimes the resulting insights are glaringly obvious, and I get to laugh at myself.
My wife and I were looking to replace her nine-year-old SUV. We had read and heard that new car inventory was the biggest problem we���d face, and boy was that right. Even tried-and-true cars that have been around for decades were tough to find.
The dealer we went to had three of our desired SUV, each with a different trimline. One was the version we were interested in, but not the color we preferred. There was no negotiating on price. We test drove the model we were interested in, but took a day to decide whether we could live with the color. I called and asked for a price.
The dealer sent me a link to a great website, which showed the detailed pricing, our trade-in value and final cost. The site also had several tools to allow us to investigate financing or leasing the car. We could evaluate different lease periods and mileage allowances. Based on our inputs, the site told us the monthly payment and residual car value. The residual value is the price we���d have to pay if we wanted to purchase the car at the end of the lease.
I understand many people pick a car based on what they can afford per month and structure the purchase or lease accordingly. But me being me, I had to evaluate all the options to see which was the best deal. The three options I considered were: buy the car for cash, finance some of the cost, or lease the car for three years and then purchase it. So off to Excel I went.
It seemed like a pretty straightforward series of present value (PV) calculations. These involve turning all costs into a single price that���s expressed in today���s dollars. PV calculations are based on the notion that, given a choice, we���d rather pay $1 later than $1 today, because in the meantime we could use the money to earn interest. Excel makes it easy to do PV calculations.
The manufacturer was offering 0% financing for 48 months. To evaluate the financing option, I added the money we���d put down, plus the trade-in value, to the PV of the 48 monthly payments. This total could then be compared directly to the cash price.
Evaluating a lease is a bit more complex. I took the money due at signing (again, including the trade-in value) and added it to the PV of the monthly lease payments. To make the three options consistent, I assumed we���d buy the car at the end of the lease, so I also calculated the PV of the residual car value. The total of these present values could then be stacked up against the cash option and the financing option. My goal: Find the lowest PV.
As expected, the lease was the worst deal. The PV of that option was about $2,100 more than the cash option. The financing option was the best. Its PV was $253 less than the cash option. In retrospect, this should have been obvious. Free financing, with no hidden fees, is always better than tying up your own money.
After running the numbers on the three scenarios, I realized there was a fourth option to consider. In the scenarios above, you ended up owning the car. But many people lease a car and then turn it back in at the end of the lease. Why? Their employer might be paying for the vehicle, or perhaps they couldn���t afford to pay the residual value, or maybe they just like having a new car every few years.
In this fourth scenario, figuring out the cost of the lease is easy���you once again just add the money due at signing to the PV of the series of lease payments. But since you aren���t buying the car, this isn���t an apples-to-apples comparison to the first three scenarios. After thinking about this, I realized that instead of owning the car at the end of the lease, what you have is the money you didn���t spend buying the car. That, in effect, gives you the same PV as the leasing-and-then-buying scenario. My conclusion: The extra $2,100 you pay is for the privilege of leasing for three years and then having the choice to buy or not buy.
For those currently nearing the end of their car���s lease, that flexibility might be more valuable than usual. My sister-in-law's high-end SUV just came to the end of its lease. She had intended to lease a newer version of the same vehicle but couldn���t find one that was available. That prompted her to look at buying her current SUV for its residual value. It turns out that the car���s current market price was significantly higher than the residual value, so she went ahead and bought it.�� What if it���s the reverse situation���and used car prices have softened? A friend told me that several years ago he was able to negotiate $2,500 off the residual value when there was a large supply of his model on the used car market.
Still, most of the time, leasing will likely be the least attractive option. In running the present value calculations, I assumed a discounting interest rate of 0.4%, which is the current rate on my FDIC-insured online savings account. If I can find a higher safe return for this money, the financing option looks even better. What would it take for the lease option to look better than the cash option? I���d need to be able to invest my cash at a safe 4% a year���an impossibility these days.
Richard Connor is��a semi-retired aerospace engineer with a keen interest in finance. He��enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter��@RConnor609��and check out his earlier articles.
My wife and I were looking to replace her nine-year-old SUV. We had read and heard that new car inventory was the biggest problem we���d face, and boy was that right. Even tried-and-true cars that have been around for decades were tough to find.
The dealer we went to had three of our desired SUV, each with a different trimline. One was the version we were interested in, but not the color we preferred. There was no negotiating on price. We test drove the model we were interested in, but took a day to decide whether we could live with the color. I called and asked for a price.
The dealer sent me a link to a great website, which showed the detailed pricing, our trade-in value and final cost. The site also had several tools to allow us to investigate financing or leasing the car. We could evaluate different lease periods and mileage allowances. Based on our inputs, the site told us the monthly payment and residual car value. The residual value is the price we���d have to pay if we wanted to purchase the car at the end of the lease.
I understand many people pick a car based on what they can afford per month and structure the purchase or lease accordingly. But me being me, I had to evaluate all the options to see which was the best deal. The three options I considered were: buy the car for cash, finance some of the cost, or lease the car for three years and then purchase it. So off to Excel I went.
It seemed like a pretty straightforward series of present value (PV) calculations. These involve turning all costs into a single price that���s expressed in today���s dollars. PV calculations are based on the notion that, given a choice, we���d rather pay $1 later than $1 today, because in the meantime we could use the money to earn interest. Excel makes it easy to do PV calculations.
The manufacturer was offering 0% financing for 48 months. To evaluate the financing option, I added the money we���d put down, plus the trade-in value, to the PV of the 48 monthly payments. This total could then be compared directly to the cash price.
Evaluating a lease is a bit more complex. I took the money due at signing (again, including the trade-in value) and added it to the PV of the monthly lease payments. To make the three options consistent, I assumed we���d buy the car at the end of the lease, so I also calculated the PV of the residual car value. The total of these present values could then be stacked up against the cash option and the financing option. My goal: Find the lowest PV.
As expected, the lease was the worst deal. The PV of that option was about $2,100 more than the cash option. The financing option was the best. Its PV was $253 less than the cash option. In retrospect, this should have been obvious. Free financing, with no hidden fees, is always better than tying up your own money.
After running the numbers on the three scenarios, I realized there was a fourth option to consider. In the scenarios above, you ended up owning the car. But many people lease a car and then turn it back in at the end of the lease. Why? Their employer might be paying for the vehicle, or perhaps they couldn���t afford to pay the residual value, or maybe they just like having a new car every few years.
In this fourth scenario, figuring out the cost of the lease is easy���you once again just add the money due at signing to the PV of the series of lease payments. But since you aren���t buying the car, this isn���t an apples-to-apples comparison to the first three scenarios. After thinking about this, I realized that instead of owning the car at the end of the lease, what you have is the money you didn���t spend buying the car. That, in effect, gives you the same PV as the leasing-and-then-buying scenario. My conclusion: The extra $2,100 you pay is for the privilege of leasing for three years and then having the choice to buy or not buy.
For those currently nearing the end of their car���s lease, that flexibility might be more valuable than usual. My sister-in-law's high-end SUV just came to the end of its lease. She had intended to lease a newer version of the same vehicle but couldn���t find one that was available. That prompted her to look at buying her current SUV for its residual value. It turns out that the car���s current market price was significantly higher than the residual value, so she went ahead and bought it.�� What if it���s the reverse situation���and used car prices have softened? A friend told me that several years ago he was able to negotiate $2,500 off the residual value when there was a large supply of his model on the used car market.
Still, most of the time, leasing will likely be the least attractive option. In running the present value calculations, I assumed a discounting interest rate of 0.4%, which is the current rate on my FDIC-insured online savings account. If I can find a higher safe return for this money, the financing option looks even better. What would it take for the lease option to look better than the cash option? I���d need to be able to invest my cash at a safe 4% a year���an impossibility these days.
Richard Connor is��a semi-retired aerospace engineer with a keen interest in finance. He��enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter��@RConnor609��and check out his earlier articles.The post Wheel Deal appeared first on HumbleDollar.
September 7, 2021
Take a Chance?
IS THERE AN EASY way to solve our financial problems? I doubt it, but that doesn���t stop people from trying. Initial public offerings, cryptocurrencies and hot stock tips come to mind. But they seem insignificant in popularity compared to lotteries.
My state currently offers 11 different draw lotteries and 63 scratch-off games. Several cost between $10 and $30 each to play. I consider lotteries an insidious tax, mostly on Americans who can���t afford it.
According to a 2018 Bankrate study, households in the lowest income bracket���those earning under $30,000���spent 13% of their annual income on lottery tickets. The highest earners, by contrast, devoted just 1% of their annual household income to playing the lottery.
Long-run investing has a much surer chance of paying off than do scratch-offs from the corner store. Yet people are so poor at probability that they believe a winning ticket may fall into their hands. One survey found 59% of millennials said winning a lottery jackpot is a reasonable way to fund retirement. Pure fantasy. The odds of winning the top Powerball prize are 1 in 292,201,338. The chance of being attacked by a shark is far greater, at 1 in 3,700,000 for Americans living near oceans.
The chance of winning a fortune from a scratch-off game is remote as well. Many of these games run for years. You could buy a scratch-off ticket not knowing that the top prize was awarded years before. Still, 60% to 70% of the $70 billion spent on state lotteries in 2014 was for scratch-off tickets.
Not that I���m entirely rational about all of this. I used to buy one ticket a week in three different games. Since then, I stopped playing all but one game, whose top prize rarely exceeds $5 million. For two bucks a week, I can dream.
The post Take a Chance? appeared first on HumbleDollar.
No Green Light
MORE AND MORE investors are using environmental, social and governance (ESG) criteria to direct their investment dollars toward companies fighting climate change. An obvious question: Do companies that deliver ���green��� innovations earn high ESG scores?
It seems not. The authors of a recent study from the European Corporate Governance Institute found that:
Companies with lower ESG scores are producing more and higher-quality innovations designed to mitigate climate change.
A sizable percentage of recent U.S. green patents have been issued not to highly rated ESG firms, but to those typically shunned by ESG funds.
The green patents granted to energy-producing firms���which usually don���t score well on ESG criteria���are significantly higher quality, as measured by the number of times these patents are cited by others and by the number that are considered ���blockbuster��� patents.
Compared to other industries, the energy sector is nearly three times more focused on green innovation, based on the number of green patents received relative to total patents received.
Out of the top 50 green patent producers, 14% are energy firms typically excluded from ESG funds. These firms include Exxon Mobil, Royal Dutch Shell, BP, ConocoPhillips and Chevron, which produced 6,969 green patents as of 2017. Despite this, energy firms receive much lower ESG scores, minimizing or eliminating their representation in portfolios driven by ESG factors.
That brings us to a second obvious question: If the idea of ESG investing is to reward those companies that are striving to arrest or reverse climate change, how much progress will we make if we minimize investments in those companies coming up with the most innovative ideas?
It seems not. The authors of a recent study from the European Corporate Governance Institute found that:
Companies with lower ESG scores are producing more and higher-quality innovations designed to mitigate climate change.
A sizable percentage of recent U.S. green patents have been issued not to highly rated ESG firms, but to those typically shunned by ESG funds.
The green patents granted to energy-producing firms���which usually don���t score well on ESG criteria���are significantly higher quality, as measured by the number of times these patents are cited by others and by the number that are considered ���blockbuster��� patents.
Compared to other industries, the energy sector is nearly three times more focused on green innovation, based on the number of green patents received relative to total patents received.
Out of the top 50 green patent producers, 14% are energy firms typically excluded from ESG funds. These firms include Exxon Mobil, Royal Dutch Shell, BP, ConocoPhillips and Chevron, which produced 6,969 green patents as of 2017. Despite this, energy firms receive much lower ESG scores, minimizing or eliminating their representation in portfolios driven by ESG factors.
That brings us to a second obvious question: If the idea of ESG investing is to reward those companies that are striving to arrest or reverse climate change, how much progress will we make if we minimize investments in those companies coming up with the most innovative ideas?
The post No Green Light appeared first on HumbleDollar.
Reclaiming My Life
A STRANGE THING is happening in corporate America right now.
The job market is booming, and companies are offering bonuses and salary increases to find and keep good people. Yet experienced workers are leaving their jobs in droves. The Labor Department reported that a record number of Americans have recently quit their jobs, part of what pundits are calling ���the Great Resignation.���
I���m one of them. After 30 years leading global communications and public relations programs for multi-billion-dollar technology companies, I���m stepping down as PR chief for a large financial technology corporation. Next up: I���m driving to Colorado to spend a month with my son. I don���t have anything lined up other than hiking, flyfishing, fall foliage watching and working on the novel I���ve been trying to get to for months.
What���s going on?
Experts say the global pandemic is causing people across all walks of life to reassess what���s important in their lives and careers. Personally, I suspect there���s more at work here than a health crisis. I think a lot of people are just plain burned out.
In the wake of the Great Recession of 2007-09, more Americans than ever before went to work for large companies. When the global financial system is melting down and other firms are laying off, there���s security in riding the back of a corporate leviathan. Big companies also have the leverage to negotiate richer medical plans and benefit packages on behalf of their employees. For anyone with a family, those benefits are gold at times of uncertainty.
Fast forward to 2021 and things look a lot different, both for employers and their workers. Whatever fat was on the bones of the corporate leviathans is long gone. Over the past decade, big public companies have methodically pruned their operations to lean perfection. They���re now desperately searching for new revenue opportunities to bring those savings to the bottom line and meet relentless shareholder expectations.
Workers, too, are in a different situation. Many have used the past decade to scrub up their own personal balance sheets. Debt is down, cash balances are up and, with the stock market setting fresh records, those who invested regularly during the economic downturn are sitting on sizable 401(k)s and brokerage accounts.
Now, with the job market on fire, workers are in the driver���s seat. They have more luxury to pick and choose where, how and when they want to work. Many are making career choices based on lifestyle, not just financial necessity.
Let���s face it: While the past decade-plus of belt-tightening has been good for corporate balance sheets, it���s been rough on the typical large company employee. Workloads and job purviews have steadily grown. Laptops, smartphones and lightning-fast internet connections have blurred the lines between work and home. When I started in the corporate world, work ended when you drove away from the office at the end of the day. Today, our homes have become our workplaces. There���s no escape, no driving away.
The pandemic has only accelerated these trends. I���ve put in more hours working remotely over the past 18 months than I used to in the days when I was making those horrid 45-minute commutes to the office. As for vacations���forget it. Even if we could go somewhere during the pandemic, who has the time? Every year, I've left unused vacation and personal time on the table. There���s simply too much to do and no one else to do it.
And it isn���t just vacation days that we���re missing out on. Also missing is the time needed to pursue personal passions and interests.
One of my passions is writing fiction. When I started working in the corporate world, I was able to consistently carve out an hour or two of writing time each morning before heading off to work. But as I moved up the corporate ladder and began managing a global team, those early morning writing sessions fell away. I still got up at the same godawful early hour, but by 7 a.m. I was online dealing with all the issues that come with a large global organization.
All of this comes with the territory, and I���m not complaining. I am forever grateful to the companies where I���ve worked for the opportunities that they���ve given me to learn and grow, while also allowing me to raise my kids and enjoy a good standard of living.
But it wears on you after a while. And then suddenly you���re in the middle of a once-in-a-generation pandemic. You���re seeing people on respirators, and you become keenly aware of life's fragility. The close proximity of death and illness has a way of doing that.
Is it any wonder so many workers, especially older ones, are opting to leave pressure-cooker jobs for something else?
I believe we are witnessing a bit of generational awakening today.��On the way to accumulating the greatest wealth ever amassed by a generation in American history, baby boomers and Gen Xers are seeing the toll that their work-above-everything-else mindset has created in terms of their mental health, not to mention in the health of the planet.
They are choosing differently. They���re downsizing, cutting back, choosing different work situations���whatever they can to get their time and schedules back.
That���s where I���m at, at least. Over the past two years, I���ve lost my father and a couple of dear friends. As a cancer survivor, I���m keenly aware of the preciousness of life and the fact that my clock is ticking away. So, when my kids were out of college, I sold the big house, paid off my debts, invested and saved as best as I was able. Financially, I���m as prepared as I���m ever going to be. Why not reach for that brass ring of freedom while I can?
Tick, tick, tick. Every moment that we spend responding to emails is a moment we could be doing something else. It���s a calculus we all have to make.
As for me, I���m driving to Colorado in my new 30-foot Keystone Passport trailer. I have dreams burning a hole in my chest and I���m going after them while I still have the time and the health.
James Kerr led global communications, public relations and social media for a number of Fortune 500 technology firms before leaving the corporate world to pursue his passion for writing and storytelling. His book, ���The Long Walk Home: How I Lost My Job as a Corporate Remora Fish and Rediscovered My Life���s Purpose,��� is forthcoming in early 2022 from Blydyn Square Books.��Check out his blog at
PeaceableMan.com
.
The job market is booming, and companies are offering bonuses and salary increases to find and keep good people. Yet experienced workers are leaving their jobs in droves. The Labor Department reported that a record number of Americans have recently quit their jobs, part of what pundits are calling ���the Great Resignation.���
I���m one of them. After 30 years leading global communications and public relations programs for multi-billion-dollar technology companies, I���m stepping down as PR chief for a large financial technology corporation. Next up: I���m driving to Colorado to spend a month with my son. I don���t have anything lined up other than hiking, flyfishing, fall foliage watching and working on the novel I���ve been trying to get to for months.
What���s going on?
Experts say the global pandemic is causing people across all walks of life to reassess what���s important in their lives and careers. Personally, I suspect there���s more at work here than a health crisis. I think a lot of people are just plain burned out.
In the wake of the Great Recession of 2007-09, more Americans than ever before went to work for large companies. When the global financial system is melting down and other firms are laying off, there���s security in riding the back of a corporate leviathan. Big companies also have the leverage to negotiate richer medical plans and benefit packages on behalf of their employees. For anyone with a family, those benefits are gold at times of uncertainty.
Fast forward to 2021 and things look a lot different, both for employers and their workers. Whatever fat was on the bones of the corporate leviathans is long gone. Over the past decade, big public companies have methodically pruned their operations to lean perfection. They���re now desperately searching for new revenue opportunities to bring those savings to the bottom line and meet relentless shareholder expectations.
Workers, too, are in a different situation. Many have used the past decade to scrub up their own personal balance sheets. Debt is down, cash balances are up and, with the stock market setting fresh records, those who invested regularly during the economic downturn are sitting on sizable 401(k)s and brokerage accounts.
Now, with the job market on fire, workers are in the driver���s seat. They have more luxury to pick and choose where, how and when they want to work. Many are making career choices based on lifestyle, not just financial necessity.
Let���s face it: While the past decade-plus of belt-tightening has been good for corporate balance sheets, it���s been rough on the typical large company employee. Workloads and job purviews have steadily grown. Laptops, smartphones and lightning-fast internet connections have blurred the lines between work and home. When I started in the corporate world, work ended when you drove away from the office at the end of the day. Today, our homes have become our workplaces. There���s no escape, no driving away.
The pandemic has only accelerated these trends. I���ve put in more hours working remotely over the past 18 months than I used to in the days when I was making those horrid 45-minute commutes to the office. As for vacations���forget it. Even if we could go somewhere during the pandemic, who has the time? Every year, I've left unused vacation and personal time on the table. There���s simply too much to do and no one else to do it.
And it isn���t just vacation days that we���re missing out on. Also missing is the time needed to pursue personal passions and interests.
One of my passions is writing fiction. When I started working in the corporate world, I was able to consistently carve out an hour or two of writing time each morning before heading off to work. But as I moved up the corporate ladder and began managing a global team, those early morning writing sessions fell away. I still got up at the same godawful early hour, but by 7 a.m. I was online dealing with all the issues that come with a large global organization.
All of this comes with the territory, and I���m not complaining. I am forever grateful to the companies where I���ve worked for the opportunities that they���ve given me to learn and grow, while also allowing me to raise my kids and enjoy a good standard of living.
But it wears on you after a while. And then suddenly you���re in the middle of a once-in-a-generation pandemic. You���re seeing people on respirators, and you become keenly aware of life's fragility. The close proximity of death and illness has a way of doing that.
Is it any wonder so many workers, especially older ones, are opting to leave pressure-cooker jobs for something else?
I believe we are witnessing a bit of generational awakening today.��On the way to accumulating the greatest wealth ever amassed by a generation in American history, baby boomers and Gen Xers are seeing the toll that their work-above-everything-else mindset has created in terms of their mental health, not to mention in the health of the planet.
They are choosing differently. They���re downsizing, cutting back, choosing different work situations���whatever they can to get their time and schedules back.
That���s where I���m at, at least. Over the past two years, I���ve lost my father and a couple of dear friends. As a cancer survivor, I���m keenly aware of the preciousness of life and the fact that my clock is ticking away. So, when my kids were out of college, I sold the big house, paid off my debts, invested and saved as best as I was able. Financially, I���m as prepared as I���m ever going to be. Why not reach for that brass ring of freedom while I can?
Tick, tick, tick. Every moment that we spend responding to emails is a moment we could be doing something else. It���s a calculus we all have to make.
As for me, I���m driving to Colorado in my new 30-foot Keystone Passport trailer. I have dreams burning a hole in my chest and I���m going after them while I still have the time and the health.
James Kerr led global communications, public relations and social media for a number of Fortune 500 technology firms before leaving the corporate world to pursue his passion for writing and storytelling. His book, ���The Long Walk Home: How I Lost My Job as a Corporate Remora Fish and Rediscovered My Life���s Purpose,��� is forthcoming in early 2022 from Blydyn Square Books.��Check out his blog at
PeaceableMan.com
.The post Reclaiming My Life appeared first on HumbleDollar.
September 6, 2021
An Age-Old Puzzle
ONE OF THE GREAT mysteries in finance is the reluctance of retirees to annuitize more of their portfolio. Annuities���and here I���m referring to plain-vanilla income annuities���provide a guaranteed income stream for life. Examples include Social Security and company pensions. Income annuities can also be purchased from insurance companies. When you buy an immediate-fixed annuity from an insurer, you exchange a lump sum for a guaranteed, monthly payout for the remainder of your life and, in some cases, the life of your spouse as well.
There are many benefits to annuitizing a portion of our retirement savings. Annuities reduce longevity risk���the risk that we���ll outlive our nest egg. They also lower sequence-of-return risk, which is the risk that poor market returns early in retirement will do permanent damage to a portfolio, even if subsequent market returns are generous.
In addition, annuities can generate higher income than bonds. This is accomplished by pooling risk and leveraging mortality credits. The term ���mortality credits��� is a euphemism for the money left over when those who annuitize die earlier than expected. In essence, they fund the payouts to the lucky annuitants who live much longer than average. In fact, it is precisely this fear���the fear of getting hit by a bus on the way home after purchasing an annuity���that plagues the minds of would-be annuity buyers.
Income annuities simplify life for retirees. Rather than worry about the optimal asset allocation or adjusting spending based on portfolio returns, annuity owners simply receive a monthly check in the mail and get on with life. Having guaranteed income���in the form of Social Security, a pension or an annuity, or a combination thereof���to cover fixed expenses can be a huge boon in retirement. This simplicity is particularly valuable late in life, when waning mental faculties or, worse yet, dementia become increasing realities.
Given the many benefits of income annuities, it���s long puzzled financial experts and academicians that so few Americans purchase them. In fact, this conundrum has a name: the annuity puzzle. A recent paper by David Blanchett and Michael Finke highlights a major downside of the annuity puzzle, which is the tendency of retirees to significantly underspend when their savings are tied up in traditional assets such as stocks and bonds. As they put it, ���Retirees will spend twice as much each year in retirement if they shift investment assets into guaranteed income wealth������in other words, into annuities.
There are many benefits to annuitizing a portion of our retirement savings. Annuities reduce longevity risk���the risk that we���ll outlive our nest egg. They also lower sequence-of-return risk, which is the risk that poor market returns early in retirement will do permanent damage to a portfolio, even if subsequent market returns are generous.
In addition, annuities can generate higher income than bonds. This is accomplished by pooling risk and leveraging mortality credits. The term ���mortality credits��� is a euphemism for the money left over when those who annuitize die earlier than expected. In essence, they fund the payouts to the lucky annuitants who live much longer than average. In fact, it is precisely this fear���the fear of getting hit by a bus on the way home after purchasing an annuity���that plagues the minds of would-be annuity buyers.
Income annuities simplify life for retirees. Rather than worry about the optimal asset allocation or adjusting spending based on portfolio returns, annuity owners simply receive a monthly check in the mail and get on with life. Having guaranteed income���in the form of Social Security, a pension or an annuity, or a combination thereof���to cover fixed expenses can be a huge boon in retirement. This simplicity is particularly valuable late in life, when waning mental faculties or, worse yet, dementia become increasing realities.
Given the many benefits of income annuities, it���s long puzzled financial experts and academicians that so few Americans purchase them. In fact, this conundrum has a name: the annuity puzzle. A recent paper by David Blanchett and Michael Finke highlights a major downside of the annuity puzzle, which is the tendency of retirees to significantly underspend when their savings are tied up in traditional assets such as stocks and bonds. As they put it, ���Retirees will spend twice as much each year in retirement if they shift investment assets into guaranteed income wealth������in other words, into annuities.
The post An Age-Old Puzzle appeared first on HumbleDollar.
Similar but Not
U.S. AND FOREIGN STOCKS are highly correlated, with monthly returns that move in the same direction��almost all the time. Because of this, some have argued that there's scant reason to diversify internationally.
But there's a small problem with this argument: Just because investments move in the same direction doesn't mean they generate the same return. For proof, consider the past 20 calendar years.
Over that stretch, there were only three years when U.S. and foreign developed market stocks didn't��head in the same direction, either both rising or both falling. That would seem to suggest that foreign stocks didn't provide much diversification benefit���plus, in each of the three anomalous years, it turns out that U.S. stocks rose, while foreign stocks fell.
Case closed? Maybe not. Next, consider the gap in annual performance. In 17 of the past 20 years, the gap between the total return of U.S. and foreign stocks was six percentage points or greater. In other words, almost every year, there's a sharp difference in performance. In those years, if you'd owned just U.S. stocks or just foreign stocks, the "no diversification benefit" argument wouldn't have seemed so convincing. Moreover, these big return differences often persist for a decade or more. U.S. shares have dominated during the most recent decade, while foreign stocks���especially emerging markets���outperformed during the decade before.
How are we doing in 2021? As of Friday's market close, Vanguard Group's S&P 500��fund had gained 21.9%, while its international developed markets fund was up 14.1%���yet another year with a sizable performance gap.
But there's a small problem with this argument: Just because investments move in the same direction doesn't mean they generate the same return. For proof, consider the past 20 calendar years.
Over that stretch, there were only three years when U.S. and foreign developed market stocks didn't��head in the same direction, either both rising or both falling. That would seem to suggest that foreign stocks didn't provide much diversification benefit���plus, in each of the three anomalous years, it turns out that U.S. stocks rose, while foreign stocks fell.
Case closed? Maybe not. Next, consider the gap in annual performance. In 17 of the past 20 years, the gap between the total return of U.S. and foreign stocks was six percentage points or greater. In other words, almost every year, there's a sharp difference in performance. In those years, if you'd owned just U.S. stocks or just foreign stocks, the "no diversification benefit" argument wouldn't have seemed so convincing. Moreover, these big return differences often persist for a decade or more. U.S. shares have dominated during the most recent decade, while foreign stocks���especially emerging markets���outperformed during the decade before.
How are we doing in 2021? As of Friday's market close, Vanguard Group's S&P 500��fund had gained 21.9%, while its international developed markets fund was up 14.1%���yet another year with a sizable performance gap.
The post Similar but Not appeared first on HumbleDollar.
Falling Short
I SERVED ON a scholarship committee for a local foundation. We offered awards to college students entering their sophomore year. Our coordinator had the unhappy job of explaining to some students and parents that, even though their students had a full freshman schedule and passed all their classes, they didn���t actually have sophomore standing. How can this be? The answer is remediation.
Almost 24% of entering college freshmen at Ohio universities required remediation in English or math and 6% needed both. What this means is that the student must take remediation classes (and pay tuition for them) and yet get no college credits. The need for remediation is a key indicator that students are less likely to complete their college degree.
Simply put, these students didn���t learn in high school what was minimally necessary to enroll in freshman English or math. After spending several years on a small town���s school board, I���m still trying to figure this out. Who do we hold responsible? There���s no shortage of suspects. I can make a case that it���s the school district���s responsibility, but I also recall the enthusiasm and creativity we saw in our teaching and administrative staffs.
We could blame the victim: You can send a student to school, but you can���t make him or her learn. The students are not (choose your adjective) ���motivated,��� ���disciplined,��� ���responsible��� or ���engaged.���
And I certainly have strong feelings about the mandates from the state regarding curriculum, standardized testing, school choice and school ���report cards,��� which suck up administrative time and attention while detracting from educating students.
In management class, we learn that if something is everyone���s responsibility then it's effectively no one���s responsibility���and it doesn���t get done. In the end, I put the primary responsibility on parents. An investment truism is that no one cares as much about your money as you do. The same can be said for your children. If you want them to succeed in college, you don���t delegate that responsibility to someone else. Schools have students six hours a day, 180 days per year starting at age six. Parents are there from birth and during all those non-school hours. They also set the priority and expectations for learning. Ways to do this include:
Fill your house with books and turn off the screens.
Ask questions and show interest in what���s going on academically.
Find outside enrichment activities to build on school learning.
Support the authority of the teacher.
Volunteer in the school.
Prioritize academics over sports and extracurriculars.
Prioritize school attendance over allowing absences for convenience or vacations.
Parents should be warned: This is clearly a ���pay now or pay later��� scenario. If parents don���t focus on their child���s performance in kindergarten through 12th grade, they risk paying for it in additional college tuition or, worse, no college degree at all.
Almost 24% of entering college freshmen at Ohio universities required remediation in English or math and 6% needed both. What this means is that the student must take remediation classes (and pay tuition for them) and yet get no college credits. The need for remediation is a key indicator that students are less likely to complete their college degree.
Simply put, these students didn���t learn in high school what was minimally necessary to enroll in freshman English or math. After spending several years on a small town���s school board, I���m still trying to figure this out. Who do we hold responsible? There���s no shortage of suspects. I can make a case that it���s the school district���s responsibility, but I also recall the enthusiasm and creativity we saw in our teaching and administrative staffs.
We could blame the victim: You can send a student to school, but you can���t make him or her learn. The students are not (choose your adjective) ���motivated,��� ���disciplined,��� ���responsible��� or ���engaged.���
And I certainly have strong feelings about the mandates from the state regarding curriculum, standardized testing, school choice and school ���report cards,��� which suck up administrative time and attention while detracting from educating students.
In management class, we learn that if something is everyone���s responsibility then it's effectively no one���s responsibility���and it doesn���t get done. In the end, I put the primary responsibility on parents. An investment truism is that no one cares as much about your money as you do. The same can be said for your children. If you want them to succeed in college, you don���t delegate that responsibility to someone else. Schools have students six hours a day, 180 days per year starting at age six. Parents are there from birth and during all those non-school hours. They also set the priority and expectations for learning. Ways to do this include:
Fill your house with books and turn off the screens.
Ask questions and show interest in what���s going on academically.
Find outside enrichment activities to build on school learning.
Support the authority of the teacher.
Volunteer in the school.
Prioritize academics over sports and extracurriculars.
Prioritize school attendance over allowing absences for convenience or vacations.
Parents should be warned: This is clearly a ���pay now or pay later��� scenario. If parents don���t focus on their child���s performance in kindergarten through 12th grade, they risk paying for it in additional college tuition or, worse, no college degree at all.
The post Falling Short appeared first on HumbleDollar.
Ignoring the Experts
I���M NOT A RULE breaker. In the nearly 40 years I���ve had a driver���s license, I���ve received just one traffic citation. I follow all the laboratory safety rules when I���m at work. When I fly, I���m the person who removes the card from the seatback pocket and follows along with the flight attendants as they do their safety briefing.
But when it comes to finances, I don���t always follow the rules laid down by accountants, financial planners and other money experts. While I respect their suggestions for improving my financial life, I sometimes choose not to abide by the guidance they offer.
Rule No. 1: Don���t buy a house unless you plan to stay put for at least five to seven years.
I took this one to heart when I got divorced almost a decade ago. I didn���t know what my future held so I opted to rent a small, one-bedroom apartment rather than purchase a home. But when I decided to remarry three years ago, owning a home became a necessity. My husband-to-be and I had four dogs and finding a landlord who would rent to us was impossible.
Because of our retirement plans, I doubted we���d live in any home for the recommended five-to-seven-year timeframe, so I was hesitant to take the plunge. I worried being a short-term homeowner would mean not accumulating enough equity to cover the cost of real-estate agent fees and other closing costs when we sold.
Over the past year, I���ve become much more comfortable with our decision. Real estate values in our area have soared to record heights. The average home stays on the market for just five days and often sells for more than the asking price. Of course, I���m also aware of the housing market���s fickleness and know values could decline by the time we���re ready to move. Still, for the time being, I feel confident we���ll walk away with a substantial profit when we sell.
Rule No. 2: Save at least 10 times your salary before retiring.
I���m not retired���yet. If I continue to work until my full retirement age, it���s possible I might reach the goal of amassing savings equal to 10 times my annual salary. At age 54, I have just over $455,000 in my various retirement accounts. I also have a small pension that, if I chose, would pay me a lump sum benefit of $55,000 in a couple of years. Those figures put my savings at seven times my salary. That���s about where I should be at age 55���but I doubt I���ll hit the goal of 10 times salary before I leave fulltime work behind.
The fact is, my husband is already retired. Three years ago, he left his decades-long career in law enforcement. I���m looking forward to spending more time with him and together enjoying the various activities we participate in.
To be sure, if the stock market continues to grow at a reasonable rate over the next decade, it���s possible I���ll reach my mid-60s with 10 times my final salary sitting in my retirement accounts. But it���s also possible a stock market crash could leave me with significantly less retirement savings than recommended. But either way, I���m not going to let the ���10 times salary��� rule determine when I retire.
Rule No. 3: Delay taking Social Security for as long as possible.
I���m still eight years away from being eligible for Social Security benefits. But if my retirement plan goes as I think it might, I���ll likely claim benefits well before age 70. My own work record should provide me with approximately $1,300 a month if I take the benefit starting at age 62. My husband, whose work record is both longer than mine and with a much higher average salary, is planning to delay taking his own Social Security until age 70. I���ll receive his benefit as a survivor benefit, assuming he predeceases me, at which point the size of my benefit will no longer matter.
My hope: By taking my own Social Security benefit early, I���ll be able to let my 403(b), annuity and pension accounts continue to grow for several years before tapping them for income. And who knows? Maybe my investment accounts will end up at 10 times my salary���but it���ll likely be some years after I quit the workforce.
Kristine Hayes is a departmental manager at a small, liberal arts college. She��enjoys competitive pistol shooting and hanging out with her husband and their dogs. Check out Kristine's earlier articles.
But when it comes to finances, I don���t always follow the rules laid down by accountants, financial planners and other money experts. While I respect their suggestions for improving my financial life, I sometimes choose not to abide by the guidance they offer.
Rule No. 1: Don���t buy a house unless you plan to stay put for at least five to seven years.
I took this one to heart when I got divorced almost a decade ago. I didn���t know what my future held so I opted to rent a small, one-bedroom apartment rather than purchase a home. But when I decided to remarry three years ago, owning a home became a necessity. My husband-to-be and I had four dogs and finding a landlord who would rent to us was impossible.
Because of our retirement plans, I doubted we���d live in any home for the recommended five-to-seven-year timeframe, so I was hesitant to take the plunge. I worried being a short-term homeowner would mean not accumulating enough equity to cover the cost of real-estate agent fees and other closing costs when we sold.
Over the past year, I���ve become much more comfortable with our decision. Real estate values in our area have soared to record heights. The average home stays on the market for just five days and often sells for more than the asking price. Of course, I���m also aware of the housing market���s fickleness and know values could decline by the time we���re ready to move. Still, for the time being, I feel confident we���ll walk away with a substantial profit when we sell.
Rule No. 2: Save at least 10 times your salary before retiring.
I���m not retired���yet. If I continue to work until my full retirement age, it���s possible I might reach the goal of amassing savings equal to 10 times my annual salary. At age 54, I have just over $455,000 in my various retirement accounts. I also have a small pension that, if I chose, would pay me a lump sum benefit of $55,000 in a couple of years. Those figures put my savings at seven times my salary. That���s about where I should be at age 55���but I doubt I���ll hit the goal of 10 times salary before I leave fulltime work behind.
The fact is, my husband is already retired. Three years ago, he left his decades-long career in law enforcement. I���m looking forward to spending more time with him and together enjoying the various activities we participate in.
To be sure, if the stock market continues to grow at a reasonable rate over the next decade, it���s possible I���ll reach my mid-60s with 10 times my final salary sitting in my retirement accounts. But it���s also possible a stock market crash could leave me with significantly less retirement savings than recommended. But either way, I���m not going to let the ���10 times salary��� rule determine when I retire.
Rule No. 3: Delay taking Social Security for as long as possible.
I���m still eight years away from being eligible for Social Security benefits. But if my retirement plan goes as I think it might, I���ll likely claim benefits well before age 70. My own work record should provide me with approximately $1,300 a month if I take the benefit starting at age 62. My husband, whose work record is both longer than mine and with a much higher average salary, is planning to delay taking his own Social Security until age 70. I���ll receive his benefit as a survivor benefit, assuming he predeceases me, at which point the size of my benefit will no longer matter.
My hope: By taking my own Social Security benefit early, I���ll be able to let my 403(b), annuity and pension accounts continue to grow for several years before tapping them for income. And who knows? Maybe my investment accounts will end up at 10 times my salary���but it���ll likely be some years after I quit the workforce.
Kristine Hayes is a departmental manager at a small, liberal arts college. She��enjoys competitive pistol shooting and hanging out with her husband and their dogs. Check out Kristine's earlier articles.The post Ignoring the Experts appeared first on HumbleDollar.
September 5, 2021
All That Glitters
TEN YEARS AGO, I recall sitting in a meeting at a local financial planning firm. We hadn't heard of cryptocurrencies. The term ���FAANG stocks��� hadn���t yet been coined. On the minds of many individual investors was a different hot asset: gold.
Gold is the butt of many jokes in the financial blogosphere these days. Who can blame them? The shiny metal is flat over the past decade���and, of course, has produced no dividends in that time���while the S&P 500���s total return is more than 370%. Even relatively weak foreign stocks have climbed 100%.
But a decade ago, investors who were clamoring for gold didn���t know such a dismal period was in store. After all, CNBC headlines at the time were a constant flow of bullish sentiment. The world���s biggest ETF was SPDR Gold Shares (symbol: GLD) and the price of an ounce of gold had been higher in each of the 10 years leading up to September 2011. The precious metal had returned nearly 600% from September 2001 up until that meeting.
Meanwhile, at the time, stocks were experiencing a correction, plus longer-term returns had been lousy since March 2000. The preceding decade had seen gains of just 25% for S&P 500 investors. ���The lost decade,��� it was dubbed.
What was the meeting about? The lead financial planner wanted our take on gold because so many clients were asking for it. I recall arguing that, after a decade of outstanding performance, another string of strong annual returns was unlikely. Also, stocks were cheap, with the S&P 500 trading at a price-earnings ratio of just 13.5.
What is today's asset that everyone feels they must own, but which likely won't produce impressive profits over the next 10 years? I���m sure you have a few in mind. But I���d cast my vote for mega-cap technology stocks and most cryptocurrencies.
Gold is the butt of many jokes in the financial blogosphere these days. Who can blame them? The shiny metal is flat over the past decade���and, of course, has produced no dividends in that time���while the S&P 500���s total return is more than 370%. Even relatively weak foreign stocks have climbed 100%.
But a decade ago, investors who were clamoring for gold didn���t know such a dismal period was in store. After all, CNBC headlines at the time were a constant flow of bullish sentiment. The world���s biggest ETF was SPDR Gold Shares (symbol: GLD) and the price of an ounce of gold had been higher in each of the 10 years leading up to September 2011. The precious metal had returned nearly 600% from September 2001 up until that meeting.
Meanwhile, at the time, stocks were experiencing a correction, plus longer-term returns had been lousy since March 2000. The preceding decade had seen gains of just 25% for S&P 500 investors. ���The lost decade,��� it was dubbed.
What was the meeting about? The lead financial planner wanted our take on gold because so many clients were asking for it. I recall arguing that, after a decade of outstanding performance, another string of strong annual returns was unlikely. Also, stocks were cheap, with the S&P 500 trading at a price-earnings ratio of just 13.5.
What is today's asset that everyone feels they must own, but which likely won't produce impressive profits over the next 10 years? I���m sure you have a few in mind. But I���d cast my vote for mega-cap technology stocks and most cryptocurrencies.
The post All That Glitters appeared first on HumbleDollar.
Containing the Issue
THE MUCH-DEBATED 4% rule���which I wrote about back in July���is a popular way to think about portfolio withdrawals in retirement. But it isn���t the only way. Another approach, called the bucket system, is also worth understanding. Below is some background.
What is the bucket system? As its name suggests, an investor divides his or her portfolio into multiple containers. Each container, or bucket, is then assigned a different role.
The most popular implementation of the bucket system involves three containers: The first is earmarked for a year or two of spending and is held entirely in cash. The second is earmarked for another five to 10 years of expenses. Because of the longer time horizon, this can be invested with somewhat more risk���in high-quality bonds, for example. Finally, the third bucket is earmarked for expenses beyond 10 years. Because of that, it can be invested entirely in stocks.
What���s the purpose of all this? In constructing a portfolio, retirees face a fundamental dilemma: If a portfolio is too conservative, meaning it holds too little in stocks, inflation can erode its buying power over time. On the other hand, if it���s too aggressive, with too��much��in stocks, there���s the risk of a large, sudden loss.
The bucket approach is designed to help balance these risks. The first two buckets���the more conservative ones���won���t provide much long-term growth, but they protect against short-term stock market risk. That, in turn, allows the investor to take lots of risk with the third bucket. Result: The bucket system helps an investor thread the needle between too much and too little risk.
The bucket strategy is a lot like the asset-liability matching system used by insurance companies. To cover future claims, insurers also set aside funds using buckets. As I���ve��noted before, this has contributed to making insurance companies very durable.
What are the benefits? The bucket system can help retirees sleep at night. This is especially true when the market drops. Retirees who have, say, a year of spending money in cash, plus another seven years in bonds, will have a much greater ability to tune out the bad financial news because they know that they can survive a multi-year stock market downturn.
Buckets can be particularly helpful in those early retirement years, when sequence-of-returns risk is greatest. Because funds are earmarked so clearly, new retirees need not worry about a nightmare scenario in which they retire on Monday and the stock market drops on Tuesday. With buckets, that kind of scenario might be unnerving, but it wouldn���t derail a new retiree���s plans.
What are the disadvantages? Critics cite two drawbacks. First, the system can be complicated to manage. If you��search online��for illustrations of the bucket strategy, you���ll see they involve a fair amount of maintenance. Interest and dividends need to be moved periodically from bucket Nos. 2 and 3 to bucket No. 1. A retiree also needs to monitor the market to determine which bucket to draw from and which to refill. During periods of extreme market volatility, like last year, the bucket system can send retirees scrambling as they work to maintain their buckets.
Another potential issue with the bucket system: Some studies have found that bucket portfolios, on average, might underperform. Why? A��2014 paper��identified a key weakness in bucket portfolios: They don���t enforce rebalancing. Specifically, there���s nothing in the bucket system that would lead an investor to buy more stocks when the market is down. By contrast, a traditional investor, following rebalancing rules,��would��buy more stocks when the market drops.
Take last year. When the market fell more than 30%, a bucket investor would have simply been withdrawing from his or her cash bucket, but not necessarily adding to stocks. A traditional investor, on the other hand, would have been rebalancing and adding to stocks when they were on sale. That would have resulted in a performance boost as the market recovered. More recently, another��study��came to the same conclusion���that bucket portfolios may have a performance disadvantage. The difference isn���t dramatic, but it���s measurable.
On balance, is the bucket system a good idea? Yes and no. If you���re trying to decide on an asset allocation, I think the bucket idea provides an excellent��place to begin. Suppose you���re heading into retirement with a $4 million portfolio and plan to withdraw $100,000 a year for expenses. Under the bucket system, you might set aside eight years of spending, or $800,000, in bonds and cash. That would translate to an asset allocation of 20% in bonds and cash ($800,000������$4 million), and hence 80% in stocks.
Would that be the right asset allocation? In my view, that would be aggressive for someone entering retirement, but it isn���t totally unreasonable. It is, at a minimum, a good starting point for discussion���and better, I think, than starting with an arbitrary allocation, such as 50% stocks-50% bonds, which doesn���t have any relationship to the investor���s spending needs. That���s why, in setting asset allocations, I always start with a calculation like this. In that sense, buckets are a useful idea.
Still, I���m not sure I���d 100% follow the bucket system. That���s because the ongoing maintenance of buckets takes work. Instead of managing a single portfolio, a bucket investor effectively needs to manage three. It���s much simpler, in my opinion, to manage a portfolio the traditional way���with assigned percentages for each asset class. In addition, I see a lot of value in rebalancing and agree with the research cited above, which calls this out as a weakness of the bucket system.
For these reasons, I don���t recommend strict adherence to the bucket system. But I don���t want to be too critical. Conceptually, I see a lot of value in the way the bucket system uses an investor���s spending needs as the all-important yardstick. For risk management, I see no better way to assess a portfolio than to measure an investor���s withdrawal needs against a portfolio���s holdings of bonds and cash.
The upshot: I recommend a hybrid approach. Use bucket calculations to help settle on an asset allocation, but then translate those calculations into percentages that you use to monitor and rebalance your portfolio. That way, you can enjoy the peace-of-mind benefit of buckets, while also benefitting from the simplicity and potential performance benefit of a traditionally managed portfolio.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on Twitter @AdamMGrossman��and check out his earlier articles.
What is the bucket system? As its name suggests, an investor divides his or her portfolio into multiple containers. Each container, or bucket, is then assigned a different role.
The most popular implementation of the bucket system involves three containers: The first is earmarked for a year or two of spending and is held entirely in cash. The second is earmarked for another five to 10 years of expenses. Because of the longer time horizon, this can be invested with somewhat more risk���in high-quality bonds, for example. Finally, the third bucket is earmarked for expenses beyond 10 years. Because of that, it can be invested entirely in stocks.
What���s the purpose of all this? In constructing a portfolio, retirees face a fundamental dilemma: If a portfolio is too conservative, meaning it holds too little in stocks, inflation can erode its buying power over time. On the other hand, if it���s too aggressive, with too��much��in stocks, there���s the risk of a large, sudden loss.
The bucket approach is designed to help balance these risks. The first two buckets���the more conservative ones���won���t provide much long-term growth, but they protect against short-term stock market risk. That, in turn, allows the investor to take lots of risk with the third bucket. Result: The bucket system helps an investor thread the needle between too much and too little risk.
The bucket strategy is a lot like the asset-liability matching system used by insurance companies. To cover future claims, insurers also set aside funds using buckets. As I���ve��noted before, this has contributed to making insurance companies very durable.
What are the benefits? The bucket system can help retirees sleep at night. This is especially true when the market drops. Retirees who have, say, a year of spending money in cash, plus another seven years in bonds, will have a much greater ability to tune out the bad financial news because they know that they can survive a multi-year stock market downturn.
Buckets can be particularly helpful in those early retirement years, when sequence-of-returns risk is greatest. Because funds are earmarked so clearly, new retirees need not worry about a nightmare scenario in which they retire on Monday and the stock market drops on Tuesday. With buckets, that kind of scenario might be unnerving, but it wouldn���t derail a new retiree���s plans.
What are the disadvantages? Critics cite two drawbacks. First, the system can be complicated to manage. If you��search online��for illustrations of the bucket strategy, you���ll see they involve a fair amount of maintenance. Interest and dividends need to be moved periodically from bucket Nos. 2 and 3 to bucket No. 1. A retiree also needs to monitor the market to determine which bucket to draw from and which to refill. During periods of extreme market volatility, like last year, the bucket system can send retirees scrambling as they work to maintain their buckets.
Another potential issue with the bucket system: Some studies have found that bucket portfolios, on average, might underperform. Why? A��2014 paper��identified a key weakness in bucket portfolios: They don���t enforce rebalancing. Specifically, there���s nothing in the bucket system that would lead an investor to buy more stocks when the market is down. By contrast, a traditional investor, following rebalancing rules,��would��buy more stocks when the market drops.
Take last year. When the market fell more than 30%, a bucket investor would have simply been withdrawing from his or her cash bucket, but not necessarily adding to stocks. A traditional investor, on the other hand, would have been rebalancing and adding to stocks when they were on sale. That would have resulted in a performance boost as the market recovered. More recently, another��study��came to the same conclusion���that bucket portfolios may have a performance disadvantage. The difference isn���t dramatic, but it���s measurable.
On balance, is the bucket system a good idea? Yes and no. If you���re trying to decide on an asset allocation, I think the bucket idea provides an excellent��place to begin. Suppose you���re heading into retirement with a $4 million portfolio and plan to withdraw $100,000 a year for expenses. Under the bucket system, you might set aside eight years of spending, or $800,000, in bonds and cash. That would translate to an asset allocation of 20% in bonds and cash ($800,000������$4 million), and hence 80% in stocks.
Would that be the right asset allocation? In my view, that would be aggressive for someone entering retirement, but it isn���t totally unreasonable. It is, at a minimum, a good starting point for discussion���and better, I think, than starting with an arbitrary allocation, such as 50% stocks-50% bonds, which doesn���t have any relationship to the investor���s spending needs. That���s why, in setting asset allocations, I always start with a calculation like this. In that sense, buckets are a useful idea.
Still, I���m not sure I���d 100% follow the bucket system. That���s because the ongoing maintenance of buckets takes work. Instead of managing a single portfolio, a bucket investor effectively needs to manage three. It���s much simpler, in my opinion, to manage a portfolio the traditional way���with assigned percentages for each asset class. In addition, I see a lot of value in rebalancing and agree with the research cited above, which calls this out as a weakness of the bucket system.
For these reasons, I don���t recommend strict adherence to the bucket system. But I don���t want to be too critical. Conceptually, I see a lot of value in the way the bucket system uses an investor���s spending needs as the all-important yardstick. For risk management, I see no better way to assess a portfolio than to measure an investor���s withdrawal needs against a portfolio���s holdings of bonds and cash.
The upshot: I recommend a hybrid approach. Use bucket calculations to help settle on an asset allocation, but then translate those calculations into percentages that you use to monitor and rebalance your portfolio. That way, you can enjoy the peace-of-mind benefit of buckets, while also benefitting from the simplicity and potential performance benefit of a traditionally managed portfolio.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on Twitter @AdamMGrossman��and check out his earlier articles.The post Containing the Issue appeared first on HumbleDollar.
