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Compare 10-Year Projections Using Historical and Forecasted Returns

Thursday, May 17th, 2018

Institutions generally agree that total returns over the next 10 years will be lower than the long-term historical level:

  • 5.42% mean for US large-cap stocks vs 11.92% from January 1987 – April 2018
  • 3.19% mean for Aggregate US bonds vs 6.07% from January 1987 – April 2018.

Forecasted returns used here are averages of forecasts by BlackRock, State Street Global Advisors, JP Morgan, Bank of NewYork/Mellon, Callan Associates (pension consultants) and Research Affiliates.

Considering mean return history or forecasts is not adequate for setting portfolio expectations, because future results have a wide spread of possibilities around the mean due to the impact of volatility (often made worse by investors selling in panic at bottoms and re-entering late in Bulls).

This table shows simulated probabilities for a $1,000,000 bonds or stocks portfolio at the 10th, 25th, 50th, 75th and 90th percentile probabilities (covering 80% of likely outcomes, but still leaving 10% more extreme possibilities at either end of the spectrum undefined).

(click images to view full size)

This table shows four common allocations: 40/60 (conservative balance), 50/50 (allocation Vanguard uses in their target date funds for investors age 65 just beginning retirement), 60/40 (traditional balanced fund allocation) and 70/30 (aggressive balanced allocation).

If the institutions are correct in their assumptions, you should expect lower returns, and lower cumulative values for your portfolio over the next 10 years. The differences in cumulative portfolios per million Dollars of starting capital between simulations based on historical data and forecasted data are in the hundreds of thousands of Dollars.

For example, per $1,000,000 for a 50/50 portfolio allocation at the 50th percentile simulation probability, you should expect an inflation adjusted (real) portfolio value at the end of the next 10 years to be about $624,000 smaller (about 35% less) based on forecasted returns and volatility rather than based on historical returns and volatility. Maximum drawdowns are expected to be similar.

This table shows the actual total returns of US large-cap stocks, US aggregate bonds and nine allocation levels between them over a variety of periods all ending at 12/31/2017.

This table based on daily prices shows the rolling period price returns (not total returns) ending on all market days since the beginning of 1928. All the data is for actual results — no theory or hypotheticals here. There were many very good and very bad rolling period returns.

Bottom line – a simplified look at historical mean returns all ending on a recent day, and not understanding how volatility creates a wide spectrum of possible outcomes and occasional Maximum Drawdowns is not a safe way to look at what may occur in the future. Your allocation decision is critical – more critical than your choice of specific securities – in determining the likely range of return outcomes and the severity of likely Maximum Drawdowns.

Presuming you make reasonable choices of securities and have a diversified portfolio, those decisions will have far less impact on your overall outcomes than your Own / Loan / Reserve allocation decision.

And, whatever your Own / Loan / Reserve allocation decision, the predominate institutional opinion is that returns are likely to be lower over the next 10 years than the last 10, 20 or 30 years.

As you can see in the simulation tables, the lowest projected returns are also paired with the largest Maximum Drawdowns. Minimizing Maximum Drawdown exposure is almost synonymous with maximizing return. Selecting a static allocation is implicitly selecting a likely Maximum Drawdown exposure.

There are two ways to minimize Maximum Drawdowns, not involving derivative products or shorting:

  • Select a more conservative allocation
    • Requires lower overall return expectations
    • Rebalancing maintains risk level, but does not increase return
  • Shift between more aggressive and more conservative allocations as risk levels change
    • Requires a rational signal system for increasing and decreasing risk exposure
      • Trend following approaches are superior to trend prediction approaches
    • Shifting will experience false positives that drag on performance during Bulls
    • Generates tax costs in taxable accounts that reduce return benefit
    • Shifting as risk levels change can avoid the largest part of Maximum Drawdowns
    • Missing the largest part of Maximum Drawdowns can increase returns
    • Requires active oversight and time commitment.

Think about these historical and projected returns, and how you are most comfortable with managing risk levels.

Related Symbols: SPY, IVV, VOO, VFINX,SWPPX, FUSX, PREIX,  AGG, BND, SPAB, SCHZ, VBMFX

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Maximum Drawdown and Allocation Approaches

Sunday, May 6th, 2018
  • Simple Buy & Hold, Strategic Fixed Risk Level Allocation, Strategic Flexible Risk Level Allocation, Dynamic Tactical Risk Level Allocation.
  • 4.5 to 10.5 years time to recover to breakeven associated with 6 example Bears.
  • Our view of suitable allocation within Flexible Strategy.

There are many types of risk when investing. Here are 10 of them:

Credit risk
Interest rate risk
Inflation (real return) risk
Currency risk
Tax risk
Active management risk
Valuation and forecasting error risk
Volatility risk
Maximum drawdown risk
Portfolio longevity in retirement risk

Each of these deserves attention in portfolio construction. In this letter, we examine Maximum Drawdown Risk, which is probably the greatest risk portfolios face over the next couple of years.

Maximum Drawdowns occur infrequently but massively, and it typically takes years to breakeven with the pre-crash portfolio value. In the battle of philosophies between Buy & Hold and Tactical Trend Following, the long recovery time after a Maximum Drawdown is the trend follower’s main argument. We are in the Tactical Trend Following camp for long-term trend reversals. We prefer to take cover in falling markets, by tilting away from equities toward bonds or cash.

Since 1936, US large-cap Bear markets have taken mostly 4 to 6 years from the pre-crash peak to the bottom and back to a breakeven level. Total return recovery from the 2000 Bear took 6.15 years, and from the 2007 Bear it took 4.5 years. Of course, a portfolio diversified with debt assets, experienced a less extensive drawdown and a total return recovery over a shorter period.

This table shows how long it would take for total return breakeven after various levels of portfolio decline, assuming various post-drawdown rates of return:

(click images to enlarge)

Many of us, don’t have the luxury of waiting 4 to 6 years to breakeven with pre-crash levels, particularly if we are making regular withdrawals from our portfolios to support lifestyle.

A young person with only a small portion of future accumulations achieved, engaging in regular periodic investments, can not only ignore most Bear markets, but actually enjoy buying more shares each month at a lower price during a Bear – maybe even increasing the rate of investment during a Bear.

However, for someone, regardless of age, who has completed the process of adding new money to the portfolio, and is relying on the portfolio for sustenance, the Bear presents a threat not an opportunity. Of course, if that person has such a large asset base that withdrawals are less than the investment income (interest and dividends), for that person the Bear is more an annoyance than a threat and may present some attractive asset substitution opportunities.

But for most of you, and for me, the Bear is more of a threat than an opportunity if we lean into it and take it in the face full force.

Those are the reasons that generic advice to someone starting out is to put all assets in stocks, to maximize regular monthly savings, and damn the torpedoes in a Bear market. And, those are the reasons as we achieve more and more of our ultimate accumulation (Financial Capital), and the present value of our future earnings from work (Human Capital) declines, and the number of years we have before beginning to withdraw assets decreases (Time Horizon), that we need to diversify our risk (specifically the correlation of return of the assets we own), to mitigate the damage that a stocks Bear market can have on the ability of our portfolio to support our lifestyle now or in the future (to avoid the Risk of Ruin – outliving our assets – to protect Portfolio Longevity).

Unfortunately, diversification is a bit like insurance. It has a cost, at least it seems that way almost all the time, except in the instance that you need it. You lament the premium you pay for your auto, home or medical insurance, until you have a major claim event. Then you are so glad you had the insurance. Same thing with portfolio risk diversification (diversified asset return correlation), which is predominantly accomplished with high quality debt assets (particularly Treasuries). High quality debt assets do not generate returns over short periods as high as equities do, but they do not experience Maximum Drawdowns as severe as stocks – thus moderating overall portfolio Maximum Drawdown. This picture tells the story:

From the early 1990’s (close to 30 years) the S&P 500 generated a cumulative return over 950%, while the Aggregate Bond market generated a cumulative return of only 265% — and a balanced portfolio of 60% S&P 500 and 40% Aggregate bonds generated a cumulative total return of 630%.

Who would want 265% when they could have 950%? My grandchildren certainly should look to the 950%. But most of you can’t safely deal with Maximum Drawdowns that are likely over 30 years.

Here is how the aggregate bond index helped in the last two Bears (beginning in 2000 and 2007):

The 2000 Bear and the 2007 Bear were back-to-back in a sense, because the October 2007 pre-crash peak was only one year after the S&P 500 reached total return breakeven in October 2006 after the 2000 crash.

This chart shows how the S&P 500 (VFINX) and Intermediate-Term Treasuries (VFITX) worked together in 70/30, 50/50 and 30/70 allocations to moderate the severity of Maximum Drawdown in both Bears through their breakeven points:

Treasuries, unlike corporate bonds have zero credit risk (but like corporate bonds have interest rate risk). In times of panic, no form of debt beats a Treasury, although holding them between Bears is uninspiring. Gold may be helpful in a panic, but its performance is less certain. In times of significantly rising interest rates using ultra-short investment grade variable rate corporate debt, ultra-short Treasuries or money market funds may be best as portfolio risk moderators.

How Do Different Approaches Deal with Maximum Drawdown?

A very simplified view might be that there are 4 general approaches in portfolio risk management (excluding methods involving leverage, shorting, or hedging with futures or options) – let’s give them these names:

  • Simple Buy & Hold
  • Strategic Fixed Risk Level Allocation
  • Strategic Flexible Risk Level Allocation
  • Dynamic Tactical Risk Level Allocation.

Simple Buy & Hold means you own a fixed basket of securities, hopefully cognizant of the risk profile, with the intention of doing nothing thereafter for a long-time. You do not rebalance.

On the positive side, this minimizes taxes, transactions costs, and time commitment.

On the negative side, this basically ensures that the risk profile of the portfolio will move up and down by significant amounts over time – becoming much riskier as stocks outperform debt, and much less risky after stocks crash (and significant portfolio value has gone away).

This method is probably talked about favorably more than it is actually practiced – with many proponents during long Bull markets, but fewer who do not bail out during a crash.

For someone with many investing years ahead, with low assets relative to future additions to savings, making regular periodic investments, Buy & Hold is probably fine. However, for someone without many investing years ahead, with high assets relative to future additions to savings, and certainly those in the withdrawal stage of their investing lives; Buy & Hold of stocks is probably not a good approach, because of it’s exposure to Maximum Drawdown which could take several years to recover. For those in the withdrawal stage taking fixed amounts of money from a declining asset value accelerates the rate of asset depletion, which could be ruinous (your money dies before you do).

Strategic Fixed Risk Level Allocation means you own a selection of assets in a fixed ratio to each other (example: 50% stocks and 50% bonds) with an expected level of risk and return, with the intention to rebalance the mix from time-to-time, or when the ratio of assets held shifts materially, to restore the portfolio to the original allocation to maintain approximately constant risk and return expectations. The assets you choose have diverse return correlations (they don’t all go up or down at the same time in response to the same issues or to the same degree).

On the positive side, this keeps you in the same approximate risk/return exposure that you chose as suitable for you when the market value of your various assets fluctuates up and down. In effect, you sell high and buy low, which is a good thing, because rebalancing back to a fixed allocation level forces a trimming of outperforming assets and augmentation of underperforming assets (typically means trimming the more volatile assets and augmentation of the less volatile assets).

On the negative side, except in tax-free or tax-deferred accounts, trimming outperformers creates a tax cost. There are transaction costs to rebalancing, but those are very low these days and if the size of the taxable gain in the transaction is, let’s say, over $500, then the transaction is probably worth the transaction cost, but not necessarily the tax cost. There is a modest time commitment required to pay attention to the changes in allocation percentages. The lowest time commitment is to rebalance based on the calendar (such as quarterly or yearly). The highest time commitment is to rebalance based on allocations getting out of line with the plan, because that requires weekly or monthly monitoring. Overall, its not much of a time commitment either way, but more than Buy & Hold.

The allocation that is suitable for you changes as you approach retirement – Allocation Glidepath.

Strategic Flexible Risk Allocation, like the Fixed Risk approach to allocation, owns a selection of asset categories chosen for correlation diversification and held in a ratio to each other expected to produce the desired risk and return. And, like the Fixed Risk approach, you rebalance. However, instead of an unchanging allocation, you set Target allocation levels for each asset category, but also Minimum and Maximum allocation levels for each category, allowing you to modulate your risk and return expectations based on objective or subjective criteria as markets unfold or are expected to unfold (example: stocks Target 50%, Minimum 45%, Maximum 55%; and bonds Target 50%, Minimum 45%, Maximum 55%).

On the positive side, you are set up to use rebalancing to keep your expected risk and return at the level you determined was suitable for you, while also allowing you to modulate your allocation within pre-set limits based on changes in your expectations of return or volatility for some or all of your asset categories to maintain your risk exposure; or to modulate your risk exposure. Frankly, it satisfies the common human drive to act, while preventing misjudgment or emotional behavior from possibly creating a big portfolio performance problem.

On the negative side, it has the same negatives as the Fixed Risk approach and introduces the possibility that the reasoning behind deviation from the Targets is faulty. Use of the Minimum and Maximum allocations may produce a lower total return, or higher volatility, or larger Maximum Drawdown than the Fixed Approach. As they say, “it depends”. I find this approach is more appealing to more people than the Fixed Approach. Most people who are not Buy & Hold advocates prefer the idea of some continuing active choices about allocation.

Dynamic Tactical Risk Level Allocation is essentially the opposite of Buy & Hold. It means hold assets while they are doing well and don’t hold them when they are not doing well; and when risk assets are not doing well, hold the money that would otherwise go to them in safe liquid assets such as T-Bills, money market funds or ultra-short-term bond funds.

In practice this could be a full Long / Flat approach (example: 100% S&P 500 and 0% T-Bills, or 0% S&P 500 and 100% T-Bills). Alternatively, it could involve a stepwise movement between 100% and 0% between the asset categories.

The approach could be based on long-term trends (probably the better choice) or short-term trends (probably the less attractive choice) to day-trading (probably the worst choice, unless you are a very special person with very special skills with nerves of steel).

OPINION: If it is your intention to use a Tactical approach, it is probably best in most cases to use it only as a sleeve of your portfolio in combination with Strategic Fixed Risk Level Allocation, where the Strategic portion of your portfolio is an anchor to windward, just in case the Dynamic Tactical Allocations works out less well than planned.

I do believe the evidence shows that a Dynamic Tactical approach (probably more commonly called Trend Following) will underperform the Strategic approach during Bull markets (which could be many years), and if done well, outperform in Bear markets, and thereby outperform in the long-term.

It is not surprising that during the current Correction, we have received numerous calls about whether and when the Bull will end, and whether and how much we should be practicing intermediate-term Trend Following versus long-term Strategic Allocation.

First, if you set out with Strategic Allocation as the plan in the beginning of this Bull market, and now are prepared to cut and run, you never had a Strategic plan in the first place. What you had was a Tactical Allocation plan in hibernation.

A combination of a Strategic Flexible Allocation with a Tactical Allocation sleeve will suit more investors than not.

I believe getting out of the way of a train wreck — as long as an investor is properly prepared to get back on the rails when the wreck is cleared off the tracks. By this I do not mean day-trading or bouncing in and out of risk assets based on headlines, or forecasts, or exiting risk assets within the noise level of volatility (which means at least not within Corrections).

Going full Tactical may sound interesting now, but I doubt that most investors would have a taste for it as a continuing practice. For example, even the best long-term trend indicators generate some false positives. That means by following a tactical system, there will be times that it is wrong. You get “whipsawed”, meaning you exit, the indicator proves wrong and reverses, then you get back in. You may have capital gains taxes because of the exit, and you may get back in at a higher price than your exit. That upsets people, but that is part of tactical methods no matter how good they are.

Example Historical Drawdowns:

A tactical practitioner must accept those costs in exchange for the large payoffs that occur generally many years apart in Bears such as these:

  • Non-US Developed MSCI large-cap + mid-cap stocks
    Down 45% over 1.6 years from 3/1973 – 9/1974
    5.3 years to price breakeven in 7/1998
  • Non-US Developed MSCI large-cap + mid-cap stocks
    Down 58% over 1.3 years from 10/2007 – 2/2009
    10.5 years later (now) not yet reached price breakeven (still down 14%)
  • Emerging markets MSCI large-cap stocks
    down 58% over 3.9 years from 9/1994 – 8/1998
    10.7 years to price breakeven in 10/07
  • USA MSCI large-cap + mid-cap stocks
    Down 48% over 1.8 years from 11/1972 – 9/1974
    7.2 years to price breakeven
  • S&P 500
    down 51% over 2.5 years from 3/2000 intra-day high to 10/2002 intra-day low
    6.1 years to price breakeven in 10/2006
  • S&P 500 Down 57% over 1.4 years from 10/2007 intra-day high to 3/2009 intra-day low
    4.5 years to price breakeven in 4/2012.

I am not willing for my personal portfolio to endure Bears like that, then wait years to breakevenI do believe there is no utility (for other than the early stage investors making regular periodic investments, who may benefit by a stock market crash) to intentionally take the full force of the storm.

Stock market declines of 40% and 50% occur from time-to-time. Once a Bear has clearly arrived for a risk asset, exiting that asset after the Bear has quantitatively revealed itself, is reasonable in my opinion; then re-entering that asset is appropriate when the Bear is dead, and the Bull quantitatively reveals itself.

That is easier said than done, but it is doable to various levels of imperfection. However, an imperfect avoidance of a 50% decline, and an imperfect re-entry, can be better than the full ride down, with a 4 to 6 year or longer wait to breakeven with the pre-Bear portfolio value.

Recommendation (except for early stage investors)

Be allocated in a balanced way in a Strategic Fixed or Flexible Risk Allocation portfolio that is age, wealth and time horizon appropriate (see generic glide-path as a post-script to this letter) and have a Dynamic Tactical Risk Allocation sleeve in that portfolio – a larger sleeve if you think that way and a smaller sleeve if your appetite for a dynamic approach is more limited

Here is my thought about the Strategic Flexible Risk Allocation approach for now:

Keep in mind that major allocation shifts based on expectation of trend reversals is more likely to disappoint than major allocation shifts in response to demonstrated trend reversals.

Expected trend reversal approaches have a much lower batting average than trend reversal recognition approaches. Trends tend to persist, so following a trend whether up or down tends to work. Trend reversals become clear when they break out of the volatility noise area. Trend reversal forecasts tend to be flawed (it is much easier to predict what will happen than when it will happen). Consider fundamentals but rely on trend measurements.

The alternative to a permanent allocation between equities and debt instruments, is a flexible one that shifts toward debt when equity indexes turn down, and that shifts toward equity when equity indexes turn up.

That shifting can be quite moderate, such as moving between a 65% and 75% equity allocation around a target level of 70% in a Strategic Flexible Risk Allocation program, to a more aggressive approach such as 60% to 80% around a 70% target – and all the way to long/flat investors who go from full target equities to 100% Treasury Bills, then back again, based on equity trend conditions.

You need to look deep inside to decide where you belong in the spectrum from Buy & Hold, to Fixed to Flexible Strategic Allocation to partial to full Dynamic Tactical Trend following. For most, some combination of the approaches (effectively in sleeves of the portfolio will be most suitable).

Think about expected returns, return variability, and the likely magnitude of portfolio value change for the allocation you choose during a Correction and a Bear (Maximum Drawdown).

Current Intermediate-Term Trend View for Key Risk Assets:

This is our current intermediate-trend view of major equity indexes, using the QVM Trend Indicator.

A 19 minute video explains this indicator – its rationale, method and results in backtest to 1900.

While stocks are in Correction, the Bull trend has not reversed, but enough cautionary signs exist that a more conservative tilt within equities, or shifting of equity allocation toward the lower end of your allocation policy range may be prudent.

This is a general response to questions many are asking. Lot’s to talk about and think about. The answer to the questions depends on many individually specific facts.

If this responds to a burning question, this commentary may be a good beginning for a personalized discussion.

If you are comfortable with the way you are situated now, including the event of a Bear market sometime within the 2018 – 2020 time frame, that’s great. However, let’s go over your allocation preferences one more time just to make sure as much as we can that what you have is what you need, want and can handle both financially and psychologically when the poop hits the fan.

REDUX:

There are three ways to minimize maximum drawdown that we should evaluate (not involving hedging with short stocks, futures or options):

  • A higher allocation to assets that respond positively to Bears to prepare for a future Bear (Treasuries, high quality medium and short-term corporate debt, and perhaps gold — with ultra-short variable rate debt in times of rapidly rising interest rates)
  • Tactical reduction of risk assets once a Bear is revealed
  • A combination approach.

If you are going to be strategic, recheck your Target Allocations, rebalance if needed, and stay calm.

If you are going to be tactical, do it the better way, not the worse way.

 

post-script (generic glide path):


Bitcoin Bubble Warning Follow-Up

Friday, December 22nd, 2017

We wrote to you on the December 12th warning to stay away from Bitcoin.

We posted that comment on our blog and received some outraged comments from Bitcoin “fanboys”. That is the price of skepticism expressed about any bubble.

We said we can’t be involved in Bitcoin as fiduciaries, and have been recommending to clients that they not become involved on their own.

As Bitcoin went from less than $500 to more than $18,700, our concern was increased, while some people felt we should not have missed the boat.

We are in good company with those who warn about involving in Bitcoin, including the CEO of  JP Morgan; the CEO of the largest hedge fund in the world; the CEO of the largest pure short-only hedge fund, the founder and former CEO of Vanguard; the former CIO of Harvard Endowment, the CEO of the largest money manager in the world, a Nobel Laureate in Economics, and Warren Buffet.

Bitcoin may bounce back to new highs, but it is simply not investable. It may be better than roulette as a fun thing to play, but is not an investable asset.

Maybe just dumb luck, but we did call at least an intermediate top on December 12th. We continue to believe it is not a good idea to own Bitcoin, and advise clients not to see the current decline as a buying opportunity.

Prices that go up vertically (an unsustainable pace) almost always turnaround and go down vertically until the speculative element is washed out.  That appears to be happening now with Bitcoin.

Futures may amplify that process, because now there is a way to be short, whereas before one could only be long.

Our warning post “Clients Ask, Should I Own Bitcoin?” can be found here.

Here is the chart of Bitcoin price on December 12th.

(click images to enlarge)

Here is the chart of Bitcoin today, December 22nd

2016 Year-End Review of ETF’s With Forward Standouts

Monday, January 2nd, 2017

This is a review of all ETF’s at year-end 2016 with a focus on liquidity, intermediate trend condition, and fundamental valuation, excluding commodity, currency and inverse ETF’s.

  • Out of 1605 ETFs, 132 have 2+ years of operations, are liquid, have fundamental data, and are in intermediate-term uptrends
  • Among equity ETFs, 31 have price-to-cash flow rations of 10 or less
  • Among country funds, Russia, Canada and Brazil stand out favorably
  • Among US dividend ETFs, 4 dividend ETFs stand out favorably
  • Among short-term investment grade US bond ETFs, 4 survive the filter
  • Among US junk bond ETFs, 4 survive the filter

Our database has 1605 ETF’s.

Of those, our QVM 4-factor trend indicator identifies 1271 ETF’s with sufficient history (28 months) to be measured. Given the large number of choices we have today with ETF’s, it seems reasonable to require a couple of years of operating history (see explanation of the QVVM 4-factor trend indicator here).

We’d like to look at equity ETF’s, bond ETF’s or hybrid equity bond ETF’s; leaving commodity, currency and inverse ETF’s aside for this review. ETF’s which lack a price-to-book ratio or bond duration virtually eliminates commodity, currency and inverse ETF’s.

Of the 1271 ETF’s, there are 879 for which MorningStar has either a price-to-book ratio, or a bond duration. For ETF’s lacking either of those metrics, we would prefer not to review them further. If MorningStar can’t identify one of those two attributes, there would not be enough information for us to draw a reasonable fundamental conclusion, upon further research.

Of the 879, there are 753 with equity positions, because they have a price-to-book ratio. There are 145 with bond positions, because they have a bond duration attribute. There are 19 ETF’s that have both a price-to-book ratio and a bond duration suggesting they are hybrid funds.

That leaves us with a more than sufficient range of investments to consider.

After the question of some fundamental data being available, comes the question of trading liquidity. It’s very difficult to take position of “size” if the dollar volume of trading activity is low.

For large positions, such as $1 million, high trading volume is appropriate, and the list of suitable ETF’s small. For modest positions, such as $25,000, the list of suitable ETF’s is much larger.

For practical purposes, we think that an ETF should exhibit a per minute Dollar trading volume of at least $15,000 to be useful for modest positions. Therefore, we eliminated all ETF’s with 3-month average per minute trading volume less than $15,000.

Sometimes you will find an interesting sounding ETF, only to discover that it hardly trades at all. At the extreme in our filter today is ONG (Barclays pure beta energy ETN) which averaged $1 (that is one Dollar) trading volume per minute over the last three months. There are 175 ETF’s within the 753 that averaged less than $1,000 per minute trading volume in the last three months. The general proposition is that you probably don’t want to be investing in something that trades only several thousand Dollars per minute.

Using the $15,000 threshold, there are 324 ETF’s of the 879 that have price-to-book ratio or a bond duration.

We then ask which of these 324 ETF’s is in an intermediate-term uptrend. Using our QVM monthly 4-factor trend indicator, we find 205 are in uptrends. However, when we eliminate those that are not hitting on all our trend indicator dimensions only 132 remain.

100 of the ETF’s with an equity component have a trailing 12 month yield of 1% or more.

Of those 100, there are 31 with a price-to-cash flow ratio of 10 or less. Here they are ranked by price to cash flow.

To the extent that you seek a combination of positive intermediate price trend and attractive price-to-cash flow valuation, and at least some dividend income, these equity ETFs provide hunting ground.

(click images to enlarge)

2016-12-31_etfa

 

Only eight bond funds survived the trend criterion filter. Here they are — you can see that they are floating-rate, short-term, or high-yield:

2016-12-31_etfb

 

None of the hybrid equity/bond funds made it through the trend criterion filter.

If you are looking for country funds to diversify from a heavy US concentration, Russia (RSX), Canada (EWC) and Brazil (EWZ) are among the ETFs that survived the filter — each heavily depend on natural resource exports (not the least of which is oil).  Here is how they look on a monthly basis versus the S&P 500 (SPY) — they outperformed the S&P 500 over the past year.

2016-12-31_etfc

These three countries also have attractive CAPE ratios (Shiller 10-year inflation adjusted P/E ratios relative to their own long-term history) — meaning they seem to have good long-term mean reversion potential.

Here is a spider web chart showing the position of the CAPE ratio of 28 country indexes to their own long-term history.   Values in the red areas have negative mean reversion potential.  Those in the green areas have positive mean reversion potential.  Values between the dashed black lines represent the middle quintile of positions (the likely fair value area).  You will also notice that the US is very expensive relative to other countries by this measure.

2016-12-31_etfg

 

Looking toward above average dividend yield, these four ETFs made it through the filter – they outperformed the S&P 500 over the past year (SPHD, SDOG, DVY, FDL):

2016-12-31_etfh

The sector weightings for dividend funds tend to be quite different than the broad market, as defined by the S&P 500, but the weightings vary greatly from dividend index to the other.  This table shows the sector weightings and weighting ratios to the S&P 500 for the 4 dividend ETF’ that made it through our filter:

2016-12-31_etfx

 

Here are comparative performance charts for the short-term investment grade bond ETFs, and for the high yield bond ETFs – first the investment grade bond funds, then the junk bond funds

The short-term investments grade bonds were steady performers (except for BSJI which zoomed for reasons we have not explored) and turned in a respectable performance for low duration versus the Aggregate Bond index (FLOT, GSY, NEAR, BSJI):

2016-12-31_etfe

The junk bonds outperformed the Aggregate Bond index and were pretty steady in their performance (HYS, SHYG, SJNK, HYG).

2016-12-31_etff

 

Overall the 39 funds in the tables above may provide some interesting ETF selections for the intermediate-term, or longer.

 

ETF’s highlighted in this post:  RSX, EWC, EWZ, SPHD, SDOG, DVY, FDL, FLOT, GSY, BSJI, HYS, SHYG, SJUNK, HYG

Stocks With Strong Potential Earnings Boost From Trump Tax Plan

Friday, December 9th, 2016
  • Companies that have low effective tax rates due to current “tax loop holes” may find their effective tax rate rise (and profits decline), even if nominal corporate tax rates decline, because “tax loop holes” may be closed to pay for the tax rate change
  • Companies that have effective tax rates near the nominal rates, would likely see their effective tax rate fall (and profits rise), if nominal corporate tax rates decline
  • Searching for companies that may benefit from a tax rate decline, and are otherwise potentially attractive is a useful exercise
  • We found 22 stocks among all listed with favorable yield and valuation attributes that may provide interesting Trump tax plan return potential
  • We found 100 stocks in the S&P 500 with effective tax rates from 30% to 35% that would like benefit significantly from a corporate tax reduction
  • 34 of those 100 S&P 500 stocks are in current up trends.

Our search for stocks with favorable yield and valuation was of all listed US stocks, for those with these characteristics:

  • 7-year cumulative effective tax rate greater than 30% and less than 36%
  • 12-mo trailing dividend yield greater than 2%
  • PEG ratio less than 2
  • 12-mo trailing shareholder yield (dividend yield + buyback yield) is no less than dividend yield (no share issuance).

There are companies with tax rates  much higher than the nominal rates.  Those cases are too complicated for this simple search, and that is why we limited the effective tax range to less than 36%.   The 30% minimum is to find those with a substantial potential benefit from a corporate tax rate reduction.

These are the 22 companies that came through the filter criteria:

DE Deere & Company
HMC Honda Motor Co Ltd (ADR)
ETH Ethan Allen Interiors Inc.
PII Polaris Industries Inc.
HOG Harley-Davidson Inc
AFL AFLAC Incorporated
LM Legg Mason Inc
PDCO Patterson Companies, Inc.
IPG Interpublic Group of Companies
TEO Telecom Argentina SA (ADR)
AMX America Movil SAB de CV (ADR)
HRB H & R Block Inc
GATX GATX Corporation
IX ORIX Corporation (ADR)
AEO American Eagle Outfitters
M Macy’s Inc
PAG Penske Automotive Group, Inc.
BBY Best Buy Co Inc
NVEC NVE Corp
MINI Mobile Mini Inc
NSC Norfolk Southern Corp.
CPPL Columbia Pipeline Partners LP

These are the metrics for each company, along with the Standard and Poor’s Capital IQ ratings for 12-months forward (“stars”) and fair value:

(click image to enlarge)

 

 

20161209_2

 

This table presents the trend condition of those 22 stocks, using the QVM 4 Factor monthly trend indicator.

A rating of 100 is for the leading end of the major trend line moving up.  A rating of zero is for the leading end of the major trend moving down. A rating of 50 is for the leading end of the major trend line in transition between trend directions.  At the bottom of this article, there is an explanation of how the QVM 4 Factor indicator works.

20161209_1

 

The median tax rate among S&P 500 stocks that have positive 7-year cumulative tax rates is 30%, and the average is 24%.

Our search among S&P 500 stocks simply eliminated those with 7-year cumulative effective tax rates below 30% and greater than 35%.  We found 100 such stocks shown in this table:

20161209_3

Thirty-four of those 100 stocks are currently in up trends as measured by the QVM 4 Factor monthly trend indicator, as follows

20161209_4

 

Companies currently with effective tax rates below the 20% rate that is often mentioned in Washington for the next Congress, may find their effective tax rate rising and profits declining, if the “tax loopholes” they have relied upon are repealed to pay for a new lower corporate tax rate.  Companies with rather full effective tax rates (such as those in between 30% and 35%) in our filter, would likely find their effective tax rate dropping and profits increasing under a new lower corporate tax rate.

Currently low effective tax rate companies with high valuation multiples would possibly see the double effect of declining profits and declining valuation multiples.

Currently high effective tax rate companies with high valuation multiples may see support for their multiples as their profits increase as their taxes decline.

If a company with a current 35% tax rate (with a 65% after-tax income rate) goes to a 20% tax rate (with an 80% after-tax income rate), that would be a 23% increase in profits.  That profits increase could offset a similar decline in valuation multiple, that might be triggered by a general multiple contraction in the broad market.

All-in-all that suggests to us that overweighting stocks of companies that would most strongly benefit by a corporate tax rate reduction, and a underweighting stocks whos effective tax rates might increase as a result changes in the tax law is a reasonable idea.

Within these two lists, there should be good hunting ground for strong Trump tax plan beneficiaries, that may be suitable for you.

Post Script: How the QVM 4 Factor Trend Indicator:

A quick summary is in the graphics below.  A more expanded discussion is at this link.

4-factor-explanation-14-factor-explanation-2

Rational Risk Retirement Withdrawal Strategies – Part One of Three

Thursday, October 13th, 2016

[ this is a letter we sent to clients on September 9.  It discusses a retirement issue important enough that it should be shared with the investing public ]

In our September 8th post, we discussed the outlook for lower portfolio returns over the next 10-20 years due to reversion to the mean from the above mean returns of recent years – a factor that has particular importance to those near or in retirement.

We promised to discuss withdrawal strategies in follow-up communications. We begin that discussion here.

Most people will be surprised to learn how much money they will need in their portfolio at retirement to provide a retirement lifetime of financial support for their lifestyle in a rising cost environment. That will become clear as you read this letter.

This letter is Part One of three letters on retirement portfolio withdrawal strategies.

  • This letter examines the “4% Rule”, probably the most widely known rule-of-thumb for safe maximum retirement withdrawal, and an X% derivative of the rule.
  • Part Two will examine other withdrawal strategies, including variations of the 4% rule; and examine a portfolio of mixed taxable and tax deferred accounts and tax-exempt income.
  • Part Three will discuss retirement asset allocation strategies during the withdrawal stage of financial life.

Key Factors in Success or Failure of a Retirement Withdrawal Strategy:

  • Life expectancy (number of years of needed withdrawals)
  • Changes in cost of living
  • Withdrawal rate
  • Expected portfolio mean return
  • Expected portfolio volatility
  • Portfolio asset allocation
  • Taxable status of portfolio and withdrawals.

All of these will come under consideration over the three letters.

LIFE EXPECTANCY

Typically an uncomfortable subject, but life expectancy is an integral part of retirement withdrawal strategy selection and design. So let’s quickly put some broad parameters on that and move on to the next factor.

There are differences in life expectancy based on age, gender, lifestyle, family history, and current health/disease profile as examples. However, for the purposes of this discussion, let’s start with the Social Security Administration national tables that merely consider attained age and gender. An extract from that table with round numbers for attained ages in 5-year increments from 50 – 75 as the starting ages for retirement is as follows:

FIGURE 1:

(click images to enlarge)

2016-09-10_fig1

From this it appears that strategies that last from roughly 10 to 35 years may be needed in retirement.

The problem is those life expectancies are means, and you may not be average. Not everybody dies in their 80’s. There is a distribution of shorter lives and longer lives around those means. Some people live into their 90’s. It may well be appropriate to plan on living to 95, just in case – so you do not live longer than your portfolio.

Just imagine setting up a plan that is expected to work until age 85 – and it does work until 85 with $1 left in the portfolio – then you live 10 more years (on family or state assistance).

When thinking about “safe maximum withdrawal”, death at age 95 is a better choice than a population level life expectancy table.

The IRS is more practical that way, because for their Required Minimum Distributions (RMDs), which begin at age 70, they start the distribution of your IRA assets with withdrawals at a 27-year rate (to age 97).

As a rule-of-thumb, assuming life to age 95 is probably a good idea. So, based on your age at retirement, these are good starting points for modeling a portfolio and withdrawal strategy:

FIGURE 2:

2016-09-10_fig2

Let’s be square about it. The longer you assume you may live, the less you can withdraw per year to avoid the “risk of ruin” (outliving your assets), but part of a “safe maximum” withdrawal rate is assuming a maximum life expectancy.

THE 4% RULE

The 4% Rule is probably the most widely suggested withdrawal strategy. It was popularized after a 1994 article by William Bengen in the Journal of Financial Planning.

The Rule: The retiree in the first year of retirement would withdraw a fixed amount equal to 4% of the portfolio assets (e.g. $40,000 from a $1 million portfolio). Each subsequent year, the retiree would increase the fixed amount withdrawal by the rate of inflation of the preceding year; and never take less than the prior year withdrawal amount.

Bengen based the rule on this set of assumptions:

  • age 65 retirement
  • 30 year withdrawal period to age 95
  • withdrawals from a tax deferred retirement (non-taxable rebalancing; and ordinary tax on distributions)
  • no transaction or management fees
  • assets allocated 50/50 between US stocks (S&P 500) and bonds (US 10-year Treasury bonds)
  • the 10 year bonds were purchased at the beginning of each year, sold at the end, followed by the purchase of new bonds for the next year.

Example: with a $1 million portfolio, withdraw $40,000 (4%) in the first year, and then if inflation were 3%, withdraw $40,000 X 1.03 ($41,200) in the second year; and so on with inflation adjustments throughout retirement. In the 30th year, the withdrawal would be $94,263 (inflation raises needed income to 2.36 times original withdrawal amount) . So the portfolio has to perform to support the growth in withdrawals.

The portfolio must have growth components to maintain spending power. For various life expectancies with the long-term average 3% inflation (the approximate long-term average) the terminal withdrawals would be these multiples of the initial withdrawal amount:

  • 10-years: 1.30 X
  • 15-years: 1.51 X
  • 20-years: 1.75 X
  • 25-years: 2.03 X
  • 30-years: 2.36 X
  • 35-years: 2.73 X
  • 40-years: 3.67 X

With the 4% Rule there is an approximate 93% chance of success, meaning the portfolio lasting throughout the 30 years (7% chance of failure, portfolio being exhausted before 30 years).

Note well, that all of the calculations in this letter are before investment costs. It is critical that the sum of transaction costs, fund expenses and advisory fees are kept as low as possible. If effect, they are part of your cost of living and reduce the sustainable amounts you can withdraw from your portfolio in retirement.

You may retire at a different age, have a different tax status of your assets, and a different portfolio allocation; which may justify or require a different percentage than 4%.

We will examine variations in length of withdrawal, stock/bond allocation and beginning percentage withdrawal in the next section (the X% Rule).

X% RULE – BASED ON ACTUAL HISTORICAL RETURNS

Let’s generalize from the 4% rule, and acknowledge that for different circumstances and investment assumptions, different percentages could be applied to the same logic structure as the 4% rule: an inflation indexed, fixed amount withdrawal, beginning with a certain percentage of the beginning portfolio.

Figure 3 is based on applying the X% rules (from 3% to 7%) to the actual annual returns of 11 different allocations between the S&P 500 (or large-cap precursors) and US 10-year Treasury bonds from 1928 through 2015 (88 years of actual annual returns).

This period included the Great Depression, WWII, periods of high and low inflation, the period of steeply rising interest rates into the early 1980’s and the declining interest rates since then, and the DotCom crash and the 2008-2009 stock market crash.

You can see that a 3% rule worked for a 40 year retirement for all allocations, except the 100% bonds allocation, and a 4% allocation worked for 30 years for all allocations except either 100% bonds or 100% stocks.

A stock/bond allocation of between 50/50 and 80/20 gave the best results.

FIGURE 3:

2016-09-10_fig3

Figure 4 from 1972 -2015 (44 years) was selected to ignore the Great Depression and WWII, and to specifically experience the huge run up in interest rates to the early 1980’s and the long period of declining interest rates to the end of 2015.

A 3% initial withdrawal rate worked for a 40 year retirement for all of the asset allocations. A 4% initial withdrawal rate worked for a 30 year retirement for all asset allocations except 100% bonds, and 10% stocks/90% bonds.

FIGURE 4:

2016-09-10_fig4

X% RULE – BASED ON MONTE CARLO SIMULATION

Let’s see how the X% rule might be expected to work using Monte Carlo simulation based on historical return and inflation data from 1972 to 2015 (44 years).

Monte Carlo will be described below, but for the moment understand that it is a method to explore thousands of plausible portfolio returns to test how withdrawal strategies might work.

We examine the general method of the 4% Rule, but with variations at 3%, 3.5%, 4%, 4.5%, 5%, 5.5% 6.0% . 6.5% and 7.0%; and tested all of those initial withdrawal rates ability to survive without complete portfolio exhaustion over multiple periods of 15, 20, 25, 30, 35, and 40 years – 9 different withdrawal rates tested over 6 different periods of years (54 scenarios).

What the results suggest is that if you want nearly 100% confidence (based on history) of not outliving assets over 30 years, 3% initial withdrawal is about as far as you should go. If you want to toss the dice a bit, and possibly have a 7% chance of outliving your portfolio (a 93% success rate) then 4% could be attempted. If you are totally ill-advised and chose to withdrawal 6.5%, you have less than a 50% chance of success.

The table further shows that the shorter the number of years the portfolio is expected to last, or the lower the initial withdrawal rate, the lower the “risk of ruin” (outliving the portfolio).

Some people have commented that these data are silly, because they believe they know of people who have been retired for years and taken out a lot more than 4% indexed for inflation and have done well, and their portfolios are larger than when they started. Maybe so and maybe not, but not with these or similar core assets. We would bet that if all the facts are known, few if any people beat these odds. We will discuss asset allocation in Part Three.

FIGURE 5:

2016-09-10_fig5

WHAT IS MONTE CARLO SIMULATION?

Monte Carlo Simulation is a computerized method of using random selection of returns to construct huge numbers of plausible portfolio outcomes (instances), and then to see the frequency distribution of results of those portfolio instanced to understand what is most likely, and how far from the mean some results may end up.

Specifically in the case of the table above in Figure 5, the computer created 10,000 instances of the 50/50 portfolio for each of the 54 scenarios in the table above (540,000 portfolio instances)

Because there were 44 annual returns for each of stocks and bonds from 1972-2015, the computer could randomly chose between 1,936 possible stock and bond return combinations for each of the years in each instance of each scenario. And, because there were also 44 possible inflation values to choose at random each year in each instance of a scenario, there are 85,184 possibilities results per instance.

In all the computer made over 30 million random selections of individual annual returns and inflation levels for portfolio assets to assemble the probabilities in the table in Figure 5.

The 10,000 portfolio simulations of each scenario were compiled in a statistical distribution to determine success probabilities. From practical experience with the software, repeating simulations over and over seldom resulted in a different success rate, and when it did a few times, the variance was only 1 percentage point.

Suffice is to say for now, that Monte Carlo simulation is a well-established method of attempting to examine risk and opportunity.

Here are the annual returns data used in the random selection of stock and bond returns for the portfolio simulation:

FIGURE 6:

2016-09-10_fig6

And here are the inflation data points in the random selection for the annual increase in the withdrawal:

FIGURE 7:

2016-09-10_fig7

If you care to look more into Monte Carlo simulation, a good place to start is Wikipedia.

Before moving on to see how the X% Rule might work in the lower expected return world of the next couple of decades, let’s look at more of the data that came out of the simulation of the 4% Rule over 30 years with a 50/50 portfolio.

WHAT DO THE 10,000 OUTCOMES PER INSTANCE LOOK LIKE?

First, for the 4% rule, although 7% (700 of 10,000 iterations) of the portfolio failed to work (portfolio did not last 30 years with a positive balance), 93% did last.

Specifically, 75% of instances began with $1 million, took out an inflation indexed $40,000 (initial 4%) and ended up with at least $2.3 million after 30 years; and 25% ended up with more than $8.8 million; and 50% ended up with more than about $5 million.

So why not take out a lot more than 4%. You could, but let me quote Clint Eastwood in the 1971 movie “Dirty Harry” pointing his Smith & Wesson 0.44 magnum revolver at a bad guy (that is the metaphor for betting that you will not be in the 7% who outlived their assets): “Do you feel lucky? Well Do ya?” That is the question.

By the way, if you are old enough to remember the movie, you are probably old enough to retire. If not, you probably have years to go before this is a big issue for you, but this data can give you good clues to how much you need to accumulate to have the retirement you desire.

FIGURE 8:

2016-09-10_fig8

When Does the 4% Rule Begin To Fail in a 50/50 Portfolio Based on Historical Data?

This chart of failure points shows the 4% rules in a 50/50 portfolio working well through about 20 years, but then more and more instances failing until it reaches 700 failures (7% failure, or 93% success).

FIGURE 9:

2016-09-10_fig9

What Is The Distribution of Return Outcomes In This Instance?

While the median outcome is around a $5 million ending portfolio, the range is $0 to $21 million; but there are very many more zero outcomes than very high ones (7% at zero)

FIGURE 10:

2016-09-10_fig10

What is the Distribution of Maximum Drawdowns in this Instance?

Definition: A maximum drawdown is the maximum portfolio value change from a peak to a trough of a portfolio, before a new peak is attained.

It looks like a good 5% or so of the outcomes could have maximum drawdowns in the negative mid-30%, with the average maximum drawdown of about 26% and the median drawdown about 17%. However, note that around 5% also drawdown to zero (presumably, those near the end of the portfolio life for those 7% that do not last as long at 30 years).

FIGURE 11:

2016-09-10_fig11

COMPARISON OF 20-YEAR REQUIRED PORTFOLIO LIFE USING DIFFERENT HISTORICAL DATA SETS, AND FORWARD VIEW OF ASSET PERFORMANCE

Now let’s look at a 20-year time horizon. That is the longest period for which we can find future return expectations from a recognized institutional source. This will create some informational value for those with a 20-year horizon — those 75 years old, or perhaps those with illnesses that make a 30 year horizon unrealistic. Primarily, however, a 20-year horizon allows us to compare a future view of lower returns with actual historical periods when using the X% rule.

The tables in Figure 12 examine the success rate of inflation indexed fixed dollar amount withdrawals over 20 years representing the 5 generic allocations. Those 5 allocations circumscribe the mostly likely range of most retirement portfolios (30% stock/ 70% bonds, 40/60, 50/50, 60/40 and 70/30). They are generic because they involve only two US assets; S&P 500 and 10-year US Treasury bonds. Other asset selections may be more appropriate for specific retirees, but these generic portfolios are useful to study the withdrawal strategy. Part Three of this letter series will discuss asset allocation choices.

The rows of each table present Monte Carlo simulations based on different historical periods of time ranging from 94 years from 1928-2015 to 10 years from 2006-2015; and simulations based on the 20-year forward view of returns published by McKinsey Global Institute, “Why Investors May Need to Lower Their Sights” (April 2016). We presented information about the McKinsey 20-year forward view (along with other essentially corroborating institutional view) in our September 5th letter.

The conclusion we draw is that lower expected returns, also means lower safe withdrawal rates in retirement.

The columns of each table present the success rate (not outliving assets) for each withdrawal rate (from initial 3% to 7%) for simulations based on different historical asset performance periods, and one future 20-year period of expected asset returns (the McKinsey view). The bottom row of each table is based on the McKinsey forward view of lower return from 2016-2036.

What do we see?

  • 3% works well (100% to 99% — dark green shaded) for all historical allocations; and for the McKinsey lower return future for the 30/70/ 40/60 and 50/50 allocations, but slightly less than well (97% to 98% – light green shaded) for the 60/40 and 70/30 allocations for the McKinsey lower future returns
  • 3.5% works well for almost all of the historical allocations, but slightly less than well for all of the McKinsey lower return future allocations.
  • 4% mostly works mostly well for the 30/70, 40/60 and 50/50 historical allocations, but slightly less than well for the 60/40 and 70/30 historical allocations; and works slightly less than well for all of the allocations for the McKinsey lower future returns
  • 4.5% works mostly slightly less than well for all of the historical allocations, except for the 70/30 where is works only moderately in great part (lower 90’s, shaded yellow); and it works poorly (less than 90%, shaded in degrees of pink to red) for all of the allocations for the McKinsey lower return futures
  • 5% works mostly moderately for historical allocations, except for the 70/30 which tends toward poorly; and poorly for McKinsey lower return futures.
  • 5.5% and greater allocations, run into success rate problems pretty much across the spectrum of history and allocations

The 4% rule essentially holds up under Monte Carlo simulation with historical data, but the comfortable success probabilities drop back to 3.5% if the McKinsey lower return futures discussed in our September 8th materialize.

FIGURE 12:

2016-09-10_fig12

DATA PARAMETERS FOR FIGURE 12

For 1972-2015, the actual annual returns were the possible random choices (see Figures 6 and 7).

For the other historical periods and the McKinsey forward view, only the return and standard deviation parameters were provided; and the computer randomly generate returns with a mean equal to the specified mean and with a standard deviation equal to the specified standard deviation as shown in Figure 13 below. The inflation rate was constant as listed in Figure 13.

FIGURE 13:

2016-09-10_fig13

CONCLUSION

Best to bet your survival on the workable withdrawal rates from a tested strategy (such as in this letter), and hope that the markets are generous leaving a large estate to your beneficiaries. Also, just as we are told these days to think of multiple jobs or careers, maybe we should think of multiple retirements.

Joyously, if the markets are so generous that our portfolios are growing substantially, perhaps “re-retiring” every 5 years or so, could rationally allow for an upward adjustment. And sadly, it the markets are punishing, we may have to consider “re-retiring” at a lower withdrawal rate than our initial retirement rate; or foregoing some of the inflation increases to our withdrawals.

So, how much money do you need to retire?

In really rough terms, if all of your money was in tax deferred accounts, and you expected to need a 20 to 30 year retirement, you would need portfolio assets in the neighborhood of 25 to 33 times the annual pre-tax income you require from the portfolio. That multiple will vary based on different facts, including the mix of taxable and tax deferred assets and tax exempt income; and the specific assets you hold, But as a yardstick, first cut, back of the envelope form of retirement readiness testing – ask yourself how much pre-tax equivalent income you need from the portfolio and multiply that by 25 to 33 to get a rough idea of needed investment assets. You either have to save and invest until you reach a good multiple, or scale back spending expectations.

For the young investor, keep the 25 to 33 multiple in front of you as you lay out your plans and execute your savings and investment.

In Part Two, we will look at other withdrawal strategies, and discuss the significance of taxable and tax deferred accounts (and RMDs), and tax exempt income in the withdrawal strategies; and in Part Three, we will look at retirement asset allocation strategies for retirement.

SECURITIES RELATING TO THIS POST

The models in this post are based on portfolios consisting exclusively of the S&P 500 and 10 year Treasury bonds — not a recommendation, just the basis of most safe retirement withdrawal models.

The bonds can be purchased directly from the Treasury or from a broker, but are sold through a broker.

The three leading ETFs for the S&P 500 along with their expense ratios are:  IVV, expense ratio 4 basis points; VOO, expense ratio 5 basis  points; and SPY, expense ratio 9.5 basis points.

There are, almost unbelievably, load mutual funds out there charging a 5% front sales commission load with annual expenses of 150 basis points (typically with a 25 basis point annual payment to the sales person).  First, you would have to be nuts to purchase one of those when you could purchase IVV, VOO or SPY with costs approaching zero.  If anyone ever proposes you buy a load S&P 500 fund or one with a large expense ratio, run do not walk from that, and assume that the balance of their ideas are equally not good for you (but great for them).  Second, you could not come even close to the withdrawal rates in this post if you owned such funds.

Remember the sum of fund expenses and advisor fees are effectively part of the cost of living in retirement.  Those are a direct take-away from the amount you can withdraw reasonably safely.