Sunday, July 31, 2011

More Rules for Retirees

The decision as to when to retire and how much to draw from savings and investments is a large looming part of my life. I have read so much on the subject I am growing tired of the whole business. The traditional 4% rule of thumb was first proposed by William Bengen in a landmark article published in the Journal of Financial Planning in 1994. Since then numerous authors have tweaked this number up or down or suggested methods of adjusting a hard and fast rule to the realities of current market conditions. The long and the short of all these statistical analyses are; the more optimistic advisors say 5% is OK; the pessimists say, “Nah, your better off at 3%.”

All the following discussions assume a portfolio of 60% stocks and 40% bonds.

In an article entitled, How to Inflation-Adjust Your Retirement-Portfolio Withdrawls, Christine Benz reports on a new method based on the 4% rule. Let us imagine a retirement portfolio valued at $1,000,000. In the first year, the retiree is allowed to withdrawal 4% or $40,000. Simple enough, but how to adjust for inflation in the second year? The author proposes adding a percentage based on the Consumer Price Index. Hence if inflation in the first year of this example was running at 4%, the retiree would withdrawal $40,000 + 0.04 ($40,000) or $41,600.

I see a lot of problems with this method. It is assuming that the market moves with inflation. How about the stagflation of the 1970s, years when the market was flat and inflation was running wild? In such a situation this method would wipe out that $1,000,000 nest egg in short order. In boom years with relatively low inflation, say 1985 to 1999, the retirees could find themselves living on dog food, so their heirs could buy SUVs and vacation condos.

Benz notes, “Others, such as financial expert Michael Kitces, have argued in favor of a flexible withdrawal rate that takes market valuations into account.”

Read this article when you have the time. It is long and somewhat arcane but it will give you a lot to think about (as if I need that). Here are his key findings.

Kitces believes that the withdrawal rate should be keyed to the Market’s Price Earnings Ratio (P/E). If the P/E ratio is over 20, history indicates that the market is overvalued. In such circumstance the author recommends not exceeding a 4.5% base rate for withdrawals. If the P/E ratio is between 12 and 20, the historic norm, Kitces believes the retiree can safely bump their withdrawal rate to 5%. If the P/E ratio is below 12%, history indicates the market is about to experience a significant increase. In such a situation a retiree could safely withdraw 5.5%.

By the way, at the time the article was written, May 2008, the P/E ratio for the S&P was 24.2. History has proven Kitces’s proposal was correct, at least in this instance. The market was wildly overvalued. In October of that year, it fell from the sky like a wounded duck.

Sunday, July 24, 2011

Only 90 Miles From Washington, DC

Luray is only 90 miles from Washington, DC but it is part of an entirely different world. My wife and I were looking for a quiet place to rest for a week or so somewhere nearby. So, we ended up renting a cabin out in the Page County countryside near Luray, Virginia.

Page County is exceptionally rural given its proximity to our nation’s capital. The population density is listed at only 74 per square mile. Page County is located in the Northern end of the Shenandoah Valley, bordered on the East by the mountains of the Shenandoah National Park and on the West by the Mountains of the George Washington National Forest. It is easy to see why early settlers chose to live here, on gently rolling hillsides and prime bottom land, safely sheltered between two mountain ranges. Even today it is a world unto itself. Only two major roads and no Interstates disturb the tranquility of the landscape. Once you turn off one of these main roads you will soon hear the crunch of gravel beneath your tire. There are still a lot of farms in Page County. They seem unusually neat and clean. The corn and other crops grow in straight carefully tended rows under the hot July sunshine. There is some light industry in the County, but nothing major. I was surprised to discover a Wrangler Jeans plant still operates in Luray. The once thriving American garment industry is nearly dead.

To reach the cabin we rented, it is necessary to turn off the paved road and descend into a valley inside the valley. The road drops 100 feet or more into the Shenandoah River bottom. Across the gently meandering stream, a steep hill, almost a cliff, rises up from the water’s edge. Along a ¼ mile of dirt road that runs parallel to the river, folks have built 12 or more cabins and built semi-permanent hookups for half that number of trailers. Some of the cabins are little more than fishermen’s shacks. Some, like the one we rented are pretty nice. On the weekends, there is a fair amount of activity down by the river. Kids are out playing, riding their bicycles, and setting off firecrackers. During the week, it gets pretty quiet. In the morning I would read out on the deck. The only sounds were the songs of cicadas and the river.

The first evening there, an outdoor wedding was held in a little pavilion overlooking the water next to our cabin. The minister and the wedding party were sheltered but the guests sat in folding chairs out on the grass. It was strange to look down on a wedding from a second storey viewpoint. A middle aged woman, clearly in charge, checked a piece of paper from time to time. Then she snapped out orders, making certain that all the participants performed their proper roles at the proper time. I was surprised by how quickly it was all over. Something that will generate so many long term consequences ought to take longer.

Unemployment in Page County stands at 9.3%, just a bit over the national average of 9.2%, but noticeably higher than some nearby counties. It is a little sad that some place so beautiful and peaceful can’t generate enough jobs for it citizens. One of the local businessmen told me Luray has its rush hour at 3:30 in the morning. Local men carpool to construction jobs in the Washington metropolitan area, leaving in the middle of the night and returning in the afternoon. There is a surprisingly well used Park and Ride lot in Luray. It is hard to imagine commuting that far every day. Main Street is in pretty good shape. Obviously, as in the rest of the country, the family owned stores that built the town center have been replaced by Walmart and the other chain stores that one finds out on what could be described as the bypass. However, the menswear store, the five and dime, and the local jeweler have been replaced by antique shops, accountants, and an art gallery. The owner of the local used book store, retired to Luray, buying an extremely well made three storey building for a pittance. The first two stories hold his bookstore and he rents out the top floor as an apartment. In his retirement he has become something of a commercial real estate mogul. Perhaps I should study his example.

I was particularly pleased by the restaurants in Luray. They provide large portions of surprisingly good food at very reasonable prices. We were particularly blown away by a little soft ice cream stand that operates out of a trailer in the back corner of a gas station near the Walmart. I had an ice cream sundae that mixed chunks of cheese cake into the ice cream. It was covered with whipped cream and real blueberries cooked into syrupy goo. Yum!

I knew right away what kind of people live in Luray when early in my visit I pulled up behind a pickup truck at a red light. It displayed bumper stickers for the local high school football team and the United States Marine Corp, my kind of America. Subsequent interactions with local folks confirmed my intuition, kind friendly people earning an honest living in a good land.

Saturday, July 23, 2011

When the Going gets Tough, The Tough Change the Rules

The Ferengi are a strange little gnome like race of aliens who appear from time to time on Star Trek. They are obsessed with profits, living under a religious code based on the sacred “Rules of Acquisition.” Because they avoid war, racism, revenge, and dictatorships they consider themselves morally superior to humans even though they cheat and engage in every possible sort of fraud to maximize their profits.

I really like rule #78. “When the going gets tough, the tough change the rules.”

Isn’t that what the Bank of America did during the recent unpleasantness? The rules of the game said they were bankrupt, a ward of the Federal Deposit Insurance Corporation, but they used their connections in the Federal Reserve Bank and the Department of Treasury to change the rules of the game. Now their profits are the property of the bank’s executives. Any losses belong to the American middle class taxpayer. Talk about the tough changing the rules.

I don’t have enough power to change all the rules that affect me and my profits, but I can change some of the rules some of the time. We lend our money to the bank. If we are lucky, they will give us 0.5% interest. Then they encourage us to borrow our own money by means of their credit cards at 18%. I don’t like the rules of this game, so I change the rules. I pay off my credit card every month. I get to use my money for free. I like those rules.

What rules can you change?

Just Do It! (Addendum)

I would like to add a little something to the previous post. You can tell if someone is a writer, they write. It doesn’t matter if the are good writers or Paula Nancy Millstone Jennings of Sussex, the worst poet in the universe. If they write they are writers. If they read about the theory of writing and discuss writing with their friends they may be sensitive souls but they are not writers.

The other day I discussed my latest market insights with a friend at work. Neither one of us are likely to ever be interviewed by Jim Cramer. But, you know what? We are both investors. By nature he is a trader. I am a buy and hold kind of a guy. We study the market, make our decisions, and invest some money. Sometimes we make good decisions. Sometimes they don’t work out so well.

You can become an investor. It is really pretty simple. Decide how much risk you can tolerate and then, make your move. Put $2,000 in an index fund. Buy your first shares of a common stock. Buy a beat up used car, fix it up, and sell it to a high school student. Take your kid to a coin shop and let her buy a Silver Eagle with her own money. Now your 6th grader is an investor.

George Washington Plunkitt of Tammany Hall, a corrupt politician famous for differentiating between honest graft and dishonest graft, while discussing his start in politics with a reporter observed, “I had a cousin, a young man who didn’t take any particular interest in politics. I went to him and said: “Tommy, I’m goin’ to be a politician, and I want to get a followin’: Can I count on you?” He said: “Sure George.” That’s how I started in business. I got a marketable commodity-one vote. Then I went to the district leader and told him I could command two votes on election day, Tommy’s and my own. He smiled on me and told me to go ahead. If I had offered him a speech or bookful of learnin’, he would have said, “Oh forget it!”

By the time Plunkitt had three followers, the district leader would light his cigar. You will be surprised how few trades it takes or how small a portfolio is required to attract the attention of a brokerage firm. After all, they don’t know. Maybe you will be the next Warren Buffet.

Sunday, July 17, 2011

Just Do It!

Last week while on vacation, I read most of a scholarly volume on the wisdom books of the Bible written by Robert Alter. For the first time I noticed something in Chapter 11 of Ecclesiastes that I overlooked in my previous readings. These verses are frequently quoted by Christian personal finance authors (including yours truly) as a scriptural instruction on diversification.

1 Ship your grain across the sea;
after many days you may receive a return.
2 Invest in seven ventures, yes, in eight;
you do not know what disaster may come upon the land.

A pretty obvious and easy to understand insight from Solomon, the richest and wisest of Israel’s kings.

But I have never heard mention of a later passage from the same chapter.

4 Whoever watches the wind will not plant; whoever looks at the clouds will not reap.

5 As you do not know the path of the wind, or how the body is formed in a mother’s womb, so you cannot understand the work of God, the Maker of all things.

6 Sow your seed in the morning, and at evening let your hands not be idle,for you do not know which will succeed, whether this or that, or whether both will do equally well.

Lately, I haven’t done much other than continue my usual contribution to the government equivalent of a 401K. I have been planning several possible moves, but I thought the market seemed a little high. I was watching the wind and the clouds. I was waiting for the perfect moment to plant my crop instead of sewing and reaping in the appropriate season, while trusting the Lord for the increase. So, taking some instruction from the master, I pulled the trigger on two moves this weekend. On Monday, during regular business hours, I will find out how to pull the trigger on a third move I have been contemplating for several quarters, cashing out an old unproductive Roth IRA. Some of those funds will go into some bathroom and kitchen renovations. I have some ideas what I might do with any left over money, but that’s enough activity for a Sunday afternoon.

Sunday, July 3, 2011

Dave Ramsey The Great Misunderstanding (Class 13 of 13)

The thirteenth and final chapter of Financial Peace University deals with giving from a traditional conservative Protestant viewpoint. Dave Ramsey believes that if the student follows the instructions found in his class materials, they will generate a surplus of wealth. He also believes that the Bible teaches a family with surplus wealth has a sacred responsibility to give generously, not just to their church, but in all their dealings. Dave Ramsey considers generosity the final key to financial peace.

Dave Ramsey, as a Christian, believes that God owns everything. He is just a steward of the wealth that God has chosen to let him manage. He believes that God is a generous giver, so generous he was willing to give us his only begotten Son. In giving we are reminded we are not the owners, in giving we praise and worship our God, in giving to God we are engaging in spiritual warfare in heavenly places.

Dave Ramsey believes that the tithe is the basic Biblical instruction for giving. Dave Ramsey defines the tithe as 10% of gross income given to the local church. He considers that anything over that can be given to other worthy causes but it is an offering, not a part of the tithe. Of course he uses the standard arguments that the tithe is pre-law, Abraham’s gift to Melchizedek. He uses all the standard scriptures to support his teaching on the tithe. However, he does allow that other interpretations are allowed to exist within the pale of Christian orthodoxy.

More interestingly, Dave Ramsey encourages his viewer to engage in random acts of kindness whenever the opportunity presents itself. Leave $100 tip to the waitress working on Christmas day. Help someone with their college expenses. Change a tire for some stranded motorist. This presentation is littered with stories of men and women who found opportunities to perform amazing charitable acts.

The Clay Walker song, The Chain of Love, sums it up nicely. Sorry you have to cut and paste. I still can't figure out how to put a hot link into these posts.


1 Corinthians 13:3 (NASB)

“And if I give all my possessions to feed the poor, and if I surrender my body to be burned, but do not have love, it profits me nothing.”

Leviticus 27:30 (NKJV)

“And all the tithe of the land, whether of the seed of the land or of the fruit of the tree, is the Lord’s. It is holy to the Lord.”

Deuteronomy 14:22 (NKJV)

“You shall truly tithe all the increase of your grain that the field produces year by year.”

Malachi 3:10 (NKJV)

“Bring all the tithes into the storehouse, that there may be food in
My house, and try Me now in this,’ says the Lord of hosts,
If I will not open for you the windows of heaven and pour out for you such blessing that there will not be room enough to receive it.”