One reader left two good questions that I thought I would try to tackle.First up was a question about this article in the WSJ about widening the parameters for Monte Carlo simulations to include a greater probability for 50% declines than is typically used now.
Some folks like to use Monte Carlo simulations and some do not. I tend to come at this completely differently. A 50 year old could get a result from a simulation that then ends up "not working" for good or bad.
When you need to start drawing on the portfolio it will be worth X. It may or may not be what you need it to be regardless of what things looked like at any point in the past. If you don't have enough money when the time does come then something will have to give; mostly likely you get a job, draw less than you "need" or you run out of money.
Another point I have made in this context before and of which there is no convincing me otherwise is that there is more risk to financial plans from human behavior, mostly regarding spending habits, than poor results in the stock market. One extravagant purchase, and I realize the word extravagant can be subjective, right before a year like 2008 can wreak havoc on the likelihood for a plan working out. And often this extravagant purchase may not be on that person's radar ten years before they retire.
The amount you have when you retire will be your reality. If you keep it to a 4% withdrawal rate (more practically 1% per quarter) the odds are good you won't run out of money. Planning for a $2 million retirement but then only having $800,000 means, repeated for emphasis, something will have to give.
This is not to say you shouldn't have a plan and know how you are doing versus that plan but if you come up short then that is what matters.
The other question was about activist investing and whether I care about wrongdoing by corporate boards. The reader reasons that I as someone who believes in living below my means would be disturbed by "the excesses we have witnessed."
Disturbed is the wrong word. I have no emotional response to these things. If management creates a reason, IMO, to sell then I sell. This has not happened very often with stocks I own. The one that comes since I have been writing the blog is my sale of Bank of America immediately after news of the merger broke. As I wrote about at the time I did not agree with the merger from a big picture standpoint and I did not like the details of the merger so I just sold the stock. It was the only domestic financial stock I owned, figured I'd own it forever but did not think twice about selling it when I disagreed with a big decision.
I tend to not really understand when I hear or read an active manager talk about what they think the management of their long time holding needs to do to turn things around. How many people have you heard from one way or another in this capacity about Citigroup? It seems like they are willing to ride the thing all the way down to zero (I said on CNBC a few months ago I did not think it was going to zero, have not changed my mind, but that is not a reason to buy). Maybe it's just me but one good time to sell might be when the CEO gets fired in some sort of disgrace surrounded in controversy.
I view my job as a combo of growing assets and then protecting them. That does not including solving the world's problems. Perhaps that is an ugly answer but it is also my perception of reality.
How cool is the picture? Joellyn took it from our porch on Wednesday night.
25 comments:
Talking about simulations, I noticed early this year a reasonable correlation between banks' TARP funds needs and their 12 month CD rate. So:
Citi 2.25%
Bofa 2.00%
WF 1.90%
Chase 1.75%
For reference, ING Direct is at 1.50%.
WF is a little suprising.
CA
Good read by Mauldin...
http://www.frontlinethoughts.com/pdf/mwo050109.pdf
Roger:
What is the ticker on the Virtnam fund you have mentioned before?
Vietnam!
Thanks for tackling my questions Roger. I could have done a better job asking my corporate governance question, but I appreciate you sharing your views.
At a 4% withdrawal rate, one will never run out of money per se. Zeno's paradox. Whether the real purchasing power is diminished or not is the main question. Isn't this after all what retirement planning is all about?
Anon 6:02, great observation!
Interesting comments in the WSJ from Buffett and Munger at BRK's annual meeting:
Mr. Buffett on complex calculations used to value purchases: “If you need to use a computer or a calculator to make the calculation, you shouldn’t buy it.”
Mr. Munger on the same theme: “Some of the worst business decisions I’ve ever seen are those with future projections and discounts back. It seems like the higher mathematics with more false precision should help you but it doesn’t. They teach that in business schools because, well, they’ve got to do something. ”
VCVOF
I think you're being a little hard on the Monte Carlo guys, Roger. Used properly, it's another tool that can be helpful in structuring a portfolio and helping investors understand the consequences of living too high on the hog. It's only right that the parameters of the tool should be adjusted.
On the other hand, following it (or anything/anyone) out the window can be hazardous to your financial health. Ditto for MPT, Buffett, and Swenson. Your advice to study, learn, and borrow makes a great deal of practical sense.
For instance, I was intrigued by the Stein/DeMuth lazy portfolio for retirees. In 2006, they concluded that a portfolio of 50% RWR and 50% DVY only had a 1 in 10,000 chance of running out of money in 30 years with a 4% withdrawal rate, and that was in year 29. I'd LOVE to see those simulations updated, but for now I'm glad that I didn't follow their advice beyond incorporating more dividend payers into my portfolio.
while i think 50% DVY and 50% RWR is nuts other than a research context the odds of it working starting on May 4 2009 are much better than May 4 2007 or whenever stein and demuth offered it up.
If nothing else, a Monte Carlo simulator can show people who confuse their recent luck with skill what can happen when they ask the question everyone should ask, "What if I'm wrong?" It would be like a behavioral finance truth serum.
I believe ING Direct's parent (ABN Amro? I can't remember) has received significant funding from the EU.
Also, I'd like to point out that while Buffet makes for interesting quotes, he's not doing the calculations he uses to value a company in his head.
I like the Owl.
Monte Carlo Simulation! LOL.
It is mathematically impossible to measure the correlation between 2 stocks!! Go back to school and learn proper math and science.
Stop with the fake psuedo math you learned in business school.
"he's not doing the calculations he uses to value a company in his head."
Actually he is, you don't know much about Buffett and proper investing do you?
More good stuff to help us baby boomers. My friends and relatives are always asking what's the number? Meaning what is the asset value needed before retirement. After trying Monte Carlo and variety of other tools we are back to a basic spreadsheet. We have spending on one side and income and assets on the other. A number of the tools out there are good and many have helped us add entries to our own tool. The best use is we are always playing "what-if". Most recently we took our stock holdings way down to see what the impact would be from this down market. Our goal has always been to have enough money for us to reach 100. Our basic assumptions we use, 4% avg. return on investment, 3% avg.increase on SS, and 3% increase per yr. on spending. A couple of other things that work well. We started to live on fixed income 4 yrs. before retirement to test our spending amount and we do not include the value of our home in our assets. Living below our means has been key. We lost money in the dotcom bust, got active portfolio help, made some mistakes along the way, but today take comfort in knowing "our number" and living comfortable with it. I would appreciate any comments on our assumption percentages.
11:02 I think what you say makes a lot of sense.
The thing I would offer up for you to think about is the lumpiness of certain types of expenses (mostly medical and other surprises like car repairs).
A thoughtful and conservative approach, anon 11:02. For WIW, here's some thoughts from another retiree.
I love the idea of testing your ability to live on a fixed income before you actually have to do so, though I always considered my salary "fixed" until I got a raise. We had mortgage expenses, of course, and college debt for the kids, but otherwise tried to limit our obligations to what the salary would bear. Like you, we now budget a 3% increase in expenses, just to cover inflation.
We're very close to SS and debating whether to take it before the system goes kaput or hold off because we're in good health. I think your 3% annual increase might be a tad high right now, but if inflation ramps up, it could average out in the long run. That's one variable I worry Congress might reduce or eliminate altogether in order to extend the longevity of the program.
Finally, I'm sure you've discovered that Roger is right about the lumpiness of expenses. I worry that investment returns are equally lumpy now. I hope your 4% bogey proves conservative; a portfolio that includes stocks as well as fixed income should get you 7% over time without excessive risk, in my opinion. I think Hussman, among others, believes the market is currently priced to deliver 10% returns over time.
Good luck. Let's talk again when we're both 100.
According to GMO's 7 year forecast, U.S. equities should have a real return around 7.5%, and government bonds around .2%. For a 50/50 portfolio 3.85% real return or about 6.85% nominal. I cite GMO, because they have been very consistent and on-target in their long-range forecasts for many years. They are forecasting higher returns for international equities of about 10% real. I'm not sure that I would buy into 10% return going forward. I think 4% withdrawal is too high.
Anon 11:02 that seems a sensible approach but along with the issue of potentially lumpy expenses your assumption of equivalent 3% increases in SS and spending per year seems dependent on official measures of inflation -- COLA on SS accurately tracking living expenses -- but how confident are you that your actual living expenses reflect the CPI basket?
BLS’s answer to the question, "Does the CPI measure my experience with price change?” is “Not necessarily. ...BLS bases the market baskets and pricing procedures ...of the relevant average household, not of any specific family or individual. It is unlikely that your experience will correspond precisely with either the national indexes or the indexes for specific cities or regions."
It might be a useful exercise to review the BLS methodology and see if there some areas where adjustments to SS could vary significantly from your actual costs of living.
I'm not ready for SS either but in my own planning I do make some fairly severe 'what if' projections to assess impact and that includes flattened or falling SS payments; e.g., the SS trust is structurally and administratively separate from the federal budget (never mind the so-called unified budget) and cannot 'run out' even over absurdly long projected horizons but funding lapses seems possible, deflation as measured by CPI possible also and, frankly, who knows what games they’ll play in Washington DC over the next few decades regardless.
See y'all at the century mark (I hope).
Roger. Off topic, but maybe useful in a general sense, given our current economy. US Shipping Partners (USSPQ.PK) filed for chapter 11 bankruptcy protection on 4/30/09, stating that current shares will be discontinued and worth nothing; however, current shares, per Yahoo! Finance are trading at $0.04, which is down only 1/3 from their previous day's price. Seems to me these shares should be worth 0, given the filing. Could the positive value be due to speculation that the bankruptcy judge will provide some relief for the current share holders? Or, some other reason?
Thanks,
JCarr
assuming that info about four cents is correct might be a bad assumption. if that data is correct; people love to speculate with these things even if their fate is sealed also there can be short covering as well.
an "immediate annunity" for a 65 year old man pays 8.5 percent a year forever - if you are in the position of not having a "big enough" nest egg to live off 4% withdraws - this seems like a no brainer. I am not personally a fan - but having twice as much money to live off of is hard to ignore - and the percentage chance of success is virtually 100% - the insurer has to go bankrupt and even then the governement steps in some.
I would appreciate you thoughts on that some time
Anon 1:39
The tradeoff with an immediate annuity is diminished purchasing power. You really won't have twice as much to live off indefinitely since inflation will take its toll over time. No free lunch with annuities, but they have their place for many people.
2 comments:
1. Way cool picture !
2. random's celts live to play another round, somewhere red is enjoying a cigar...
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