Retirement Planning Bugaboos

There were a couple of interesting articles that although the topics were different, tied in with each other in an important way. The first was a writeup by Rob Arnott and John West at IndexUniverse that updated the active passive debate.

According to the article a 60/40 mix, with the proxies being SPY and AGG was only down 22% in 2008 compared to a 21% decline for Hedge Fund Research Institute's Hedge Fund of Funds Composite which the authors described as the ultimate active management vehicle. Perhaps their conclusion that the lack of value added by most active managers will send more people to passive investing will be correct but it is not clear to me that a hedge fund index should be compared to a 60/40 portfolio. As Aaron Pressman recently noted a 70/30 mix was down 25%. The greater the equity exposure the greater the decline and while I do not know whether a hedge fund index is best compared to a 90/10 mix or something else I do not think 60/40 is the correct comparison.

The article got me to look at the price action and dividend payouts of three different bond ETFs; AGG, MUB and GBF. Other than a violent spasm last fall in which many ETFs moved sharply away from their respective net asset values the price action was pretty steady in those three, that's good. However the dividends, all three are monthly pays, have gone down considerably for AGG and GBF. I'm not sure that a reduced payout can be factored in to the down 22% number cited in the article but if in the simplest world possible you had 40% in AGG and the dividend dropped 17.5% that could have a big impact if the portfolio was used to generate income.

With individual bonds treasuries and agencies have probably done OK but other parts may have declined in price depending on what was held and so the value of a 60/40 portfolio could be worse than down 22%. But that would not be an indexed bond portfolio an indexer would say. While that is true it has been pretty easy to beat generic bond indexes for most of this decade and so looking at a longer period of time might be constructive than cherry picking the worst year for the market since the plague set upon Europe.

On a related noted there was another article by Robert Huebscher that dissected the 4% withdrawal rule for people living off of their portfolio. The take away is that depending on the rate of inflation, retirees can take more than 4% out and still be safe. He makes all sorts of assumptions that I would not make but he does tell readers that he is making those assumptions and why he's making them. Fair enough.

Personally I am not on board with assuming inflation will remain at a certain level or that a state cannot default (think muni bond holders), not that he was advocating wild risks in a portfolio, just relying on a few things for his numbers. It is definitely worth reading.

My take all along has been to take 4% of what ever you have per year (more specifically 1% per quarter) and not increase the amount for inflation. Hopefully a balanced portfolio will keep up with inflation (the last 12 years notwithstanding). There is another element to this that I have touched on before but do not see addressed often enough that threatens even 4%; one off events.

This month we had a $254 vet bill (Tater's teeth cleaning and shots for Trixie) and needed to replace our kitchen faucet for $117 which I replaced myself (very easy project), in February we spent about $100 at Home Depot, last fall we had $1300 worth of work done on our 4-runner (nine years old but this was cheaper than a new SUV), last summer we needed tires for the pick up, about a year ago we needed a new vacuum; you can see where I am going and those are only the things that I can remember. It would be easy to have $5000 worth of one-offs every year. That can be a significant number depending on the income level. Even someone who has to work hard to live on $100,000 per year could have trouble covering $5000 worth of surprises.

These things cannot be accurately budgeted for (god forbid this is the month you need to buy ink cartridges), do not decrease in retirement and can come from anywhere. Any time I have a client ask me something about this subject I always say the same thing, "you have to do what you have to do, it is better for you to spend as little as possible doing it."

All of the work anyone does with their investing, the sacrifice they make with their saving and their willingness to work one way or another during retirement is about increasing their odds of not running out of money. There are obstacles with all of these. The biggest obstacle to investing is the human emotions that cause people to want to sell low and buy high. The biggest obstacle to saving is spending habits which is a tough one to overcome as very few people actually think they spend too much (there would be no telling Joellyn and me to not have dogs). There are two obstacle to working longer; some folks are unable and some others simply don't want to.

Overcoming these obstacles, and any others I am not thinking of, guarantees nothing but it does increase the odds for success.