Friday, May 27, 2016

Typical Retirement Portfolios

Some interesting information from Charles Schwab On Investing. Here is how a variety of typical retirement portfolios would have worked over the last 45 years. I don’t see an author listed for this article, but he recommends that you not retire shortly before a market crash. This could be hazardous to your financial well being. Go figure. He also provided me with a new term, sequence-of-returns risk. This refers to permanently damaging your retirement portfolio by withdrawing too much when the market is crashing, another bad idea.

Now I will let you meditate on subjects that will affect your choice of a portfolio such as age, cognitive capacity (think dementia), fear, greed, current income requirements, projected future needs, and the ability not to need the market for extended periods of time. If you can live on dividends, interest income, and a cash cushion for a period of several years, you can ride out most economic storms.

35% Fixed Income
5% Cash Investments
60% Stocks
35% U.S. Large Cap
10% U.S. Small Cap
15% International

Performance: 1970-2015
Average Annual Return: 9.5%
Best Year: 30.9% Worst Year: -20.9%

Moderately Conservative
50% Fixed Income
10% Cash Investments
40% Stocks
25% U.S. Large Cap
5% U.S. Small Cap
10% International

Performance: 1970-2015
Average Annual Return: 8.8%
Best Year: 27.0% Worst Year: -12.5%

50% Fixed Income
30% Cash Investments
20% Stocks
15% U.S. Large Cap
5% International

Performance: 1970-2015
Average Annual Return: 7.7%
Best Year: 22.0% Worst Year: -4.6%

Thursday, May 26, 2016

Retirement Rules of Thumb

For longtime readers of this blog, this will be pretty familiar material. However a recent Bankrate survey of replacement income in retirement indicates that 47 states currently fail to make the grade on replacement income. Only Alaska, Hawaii, and South Carolina get a passing grade. Alaska and Hawaii are peculiar situations involving unconventional life styles, state government programs and large retired military and government employee populations with unusually generous pensions. South Carolina has more folks with pensions than is common in the 48 continental states. When combined with low taxes and a low cost of living, South Carolina comes up a winner. In general high tax/high cost of living states appear at the bottom of the list and low tax/low cost of living states come closer to a passing grade. However, there are some surprises in the list.

Bankrate study: Seniors' incomes in 47 states don't go far enough

One of the retirement rules of thumb can be termed the 70% solution. Most financial advisors believe that in order to maintain your pre-retirement standard of living you will require at least 70% of your pre-retirement income. People do spend less in retirement, but not all that much less. Some experts think 80% is safer, but that is a pretty difficult goal for most of us to achieve. Shoot for 70% and then adjust your lifestyle to match your income.

Pensions, once the most important leg of the famous three legged stool of retirement income are almost a thing of the past. The military, government employees, and a few remaining union workers still get a pension, but state and local governments around the country are facing pension bills they can no longer continue to pay and today one of the Teamsters largest pension funds is on the verge of bankruptcy. Many other bankrupt union pension funds are now paid by The Pension Benefit Guaranty Corporation, an independent agency of the United States government. The recipients of these funds are only receiving a small fraction of what they were promised.

The good news is most of us still have a pension, Social Security, once the second leg of the stool. Let’s assume that a family earning a combined income of $85,000 a year can collect a total of $3,000 a month in Social Security benefits.

$85,000 dollars/year divided by 12 months/year multiplied by 70% = $4,958.33

In this simplistic example our couple still needs to replace $1,958.33 every month for the rest of their lives. Where is that money going to come from? The answer is retirement savings and home equity, the third leg of the stool that was once pretty much reserved for cruises to the Caribbean, membership dues at the country club, and trips to Europe. Today, most retirees will need that money for everyday expenses.

This brings up the second retirement rule of thumb, termed the 4% solution. Endless numbers of academic studies indicate that given an investment portfolio of 50% bonds, cash, and CDs combined with 50% in equities, a retiree can safely withdraw a number equal to 4% of the original amount adjusted for inflation in subsequent years and never outlive their money.

This means in order safely withdraw $1,958.33 every month our hypothetical couple requires an initial retirement nest egg equal to $587,499.

$1,958.33 dollars/month X 12 months/year divided by 0.04 = $587,499

If you can’t make 70%, there are other options. The most common is moving from a high cost/high tax state like Maryland to a low cost/low tax state like South Carolina. If the total cost of living in your new state is only 75% of the cost of living in your old state, your 70% replacement income is going to look a lot more like 93%. Maryland wanted me to go away, making room for somebody younger who can pay those high taxes for the next 30 years. South Carolina welcomed me with open arms, warmer weather, lower taxes, and much less traffic.

So how are you doing?

Danko and Stanley, authors of The Millionaire Next Door, have proposed a simple formula to calculate a reasonable value for net worth at a particular age with a given income. This formula produces bizarre results for people in their twenties. However for ages over forty, the results are pretty realistic when compared with actual averages.

Net worth = Age X Pretax Income ÷ 10


A couple about 50 years old earning a combined family income of $65,000 a year should have a net worth in the neighborhood of $325,000. If they have been paying on a mortgage for over 20 years and have been contributing to their 401K, this is fairly reasonable as an average number.

If you are near this target, you are considered by the authors as an average accumulator of wealth.

If your net worth is less than half your target, you are viewed as an under-accumulator of wealth.

If you have more than double this target, you are considered a prodigious accumulator of wealth and I tip my hat to you, sir.

While you should have started saving for retirement at age 22, all is not lost if you happened to get a late start. Whatever your age or financial situation, you can make decisions that will move you closer to financial freedom. Once the kids are out of the house and the mortgage is paid off, you are likely to be earning the highest income of your life at a time when your expenses have declined. Go into savings overdrive. You will be amazed at what you can accomplish in the next ten years.

Monday, May 23, 2016

Talents or Minas, It Don't Matter

For nearly two years, I have been managing my father’s affairs. I make decisions concerning both the type of care and the medical treatments he receives. I pay his bills and choose how to invest his money. I am somewhat amazed at the breadth of the authority given to me by our family’s legal documents. Even though I have the power to use this money almost as though it was my money, it isn’t my money. It is my father’s money. My relationship to his money is fiduciary in nature. This means I must manage my father’s affairs for his benefit, not for my benefit. In addition, I believe that I should manage his money as he and my mother would have managed their money if they were both alive and competent. As a result of this decision, I take fewer risks with my father’s money than I do with my own money. I have the authority to pay myself a salary for these sometimes time consuming and emotionally stressful tasks, but I haven’t done that. It just doesn’t seem right. After all, it is my father’s money.

What is generally called the Parable of the Talents appears twice in the New Testament. There are slight differences in Luke’s telling of the story and that offered by Matthew, as they were given at different times and in different locations. However, they both tell the story of a nobleman who goes off on a long journey. In Matthew, the master gives three of his servants varying amounts of money to invest in his absence. In this version the servants receive 5 talents, 2 talents, and 1 talent respectively. A talent is a serious sum, worth perhaps $500,000 in today’s money. In the other version each of ten servants receives a much smaller investment, ten minas. There are 60 minas to a talent, so we are talking, maybe $83,000. When the master returns, he asks for an accounting of his investments. The servants who have used their master’s money wisely, either doubling the net worth of their holdings or in one case increasing the amount by 50% receive praise and rewards. The servants who have not increased the master’s money in his absence are cursed and punished.

How long was the journey? No time is given, but in today’s world where the return on equities over long time periods is roughly 7%, the Rule of 72 tells us we might be talking ten years. The time necessary to double your money is the rate of return multiplied by the number of years required to equal 72. In the ancient world, long journeys were measured in years.

In the Bible, we are instructed that the money we have been given by God to manage on his behalf isn’t our money. It is our Father’s money. Instead of using the term, fiduciary relationship, Christians typically use the stewardship metaphor. In the middle ages, a nobleman had a steward, a trusted servant who possessed Power of Attorney over the nobleman’s financial affairs. Due to the importance of this position, the steward received a generous salary. Typically he would be the second richest man in the realm after the nobleman in charge. As my investments grew, I reached a point where I realized God hadn’t trusted me with all this money so I could waste it on loose women, fast cars, and cocaine. I had been given significant responsibility and someday I would have to answer for how I managed my Father’s money. It was a sobering realization.

I am responsible for investing and increasing the money that has been entrusted to my care, by my heavenly Father. I am also responsible for distributing this money in a sensible manner, both in this world and after my passing to those who will follow in my footsteps.

Obviously the first place I give is to my local church. If you don’t want to give to your church, you should probably find another church. I also support three other ministries on a regular basis. In each case I know who and what is involved and how they are using the money. I have a great deal of confidence that the men who are expending these funds are using them wisely and well.

Lending or giving money to individuals is a lot harder than giving to a well understood ministry. In some instances helping can hurt. As a young Christian, I watched my church attempt to help an individual who suffered from mental illness. For some time he played the leadership like a fiddle. Eventually, they realized that helping this man with money wasn’t improving the situation. While he was still treated like a brother, the gravy train ended. I don’t remember what happened in this particular case, but over time I have discovered that these people tend to move from church to church looking for handouts, as they recite their tale of woe. At one point in our marriage, we gave a small amount of money to a friend with substance abuse problems. A few months later she asked for what at that time seemed a rather large loan for car repairs. I told my wife we would never see that money again. We agreed that if we made the loan and it wasn’t repaid, this person would never get another dime from our checkbook. Needless to say, we never saw a penny, but this person did try and hit us up for more money on at least two subsequent occasions.

On the other hand, I have found that a well timed gift or interest free loan can really change a life. It is a great joy to know that something you have done pulled one of God’s children out of a mud hole and put them back on a paved road leading to greater success and an opportunity to become a blessing to others who you will never meet in this world.

Whether you currently have been given one mina or one hundred talents by the Master, you are responsible for how you manage His money in this world. While this is a fiduciary relationship, for the Master’s benefit, not your benefit, He has given me authority to pay myself a salary for these sometimes time consuming and emotionally stressful tasks.

He is generous and He is good.

Tuesday, May 17, 2016

A Tale of Two Women

Therefore all things whatsoever ye would that men should do to you, do ye even so to them; for this is the law and the prophets.
Jesus of Nazareth

The Golden Rule, or the law of reciprocity not only sums up the law and prophets on the subject of human interaction, but it is also the bedrock of ethical capitalism. If you want to have more money, learn how to become a greater blessing to your neighbor. Whether you are a crooked billionaire hedge fund manager or an impoverished disability cheat, the way of the skimmer or the scammer will not ultimately lead you to the blessings of God.

There is another dimension to this teaching. Often you don’t know the person on the other end of the deal. He might be a leg breaker for the mob. Do you think it would be a good idea to try and scam one of Tony Soprano’s associates? You also don’t know what the future might hold. The poor helpless person of today might well be your boss tomorrow. The fact is—you just don’t know.

About the time I turned 50, I decided to start learning about investments. My CPA at the time, may her name be blessed, recommended I open a Roth IRA with some of my refund money. When I asked if she knew any brokers, she recommended a certain woman. I contacted this person and she sold me shares in a mutual fund. They did badly. The next year I bought some more shares in the same fund. It hadn’t been a good year for stocks. Even back then I understood the value of patience. Shortly afterwards, I was far enough up the learning curve to discover that she sold me shares in something that was listed as one of the 50 worst mutual funds sold in America. It was loaded with high sales commissions, management fees, and even execrable 12B-1 fees. It was a very good product for the salesperson, but a very bad product for the investor. By the way, if anyone attempts to sell you anything with a 12B-1 fee, run away. They are not your friend.

I told my CPA about my experience. She was genuinely upset and apologetic. I doubt that she ever recommended that woman to any other customer. This woman earned a sales commission on a few thousand dollars from a novice investor. As a result, I decided that if I was going to lose my money, I wasn’t going to pay anyone to lose it for me. I decided that mutual funds and the people who sold them were to be avoided and went on to learn the basics of value investing. I also learned that low cost index funds, such as those offered by Vanguard, are just fine for the small time investor. They aren’t sold by commission saleswomen, their management fees are triflingly small, and you will never pay a 12B-1 fee.

If she had considered my long term interests rather than her short term gain, it might have been different story. Today, I might have been quite happy to pay her the traditional 1% per year to manage my money. Today, the amount of my money under her supervision would be a whole lot more than a few thousand dollars. A lot has changed over the course of the last 15 years. Instead, after a few years she left the business.

I wonder why?

During the depths of our family emergency, I ended up interacting with a total of 14 banks. The very best bank employee I met during this difficult period of my life was a young woman working as a low level banker in the local office of a well know bank. She was one of those people who had a private fish bowl office but she was not the branch manager.

Although she was young, she already knew the three secrets of customer service.

Never say, “I don’t know,” unless you add, “But I will find out and get back to you by close of business on Thursday.”

Never say, “It’s not my job,” unless you add, “But I will find out who does this and I will get back to you by close of business on Thursday.”

Never say, “But we’ve always done it this way,” unless you add, “But I can work around this problem by changing X.”

She was an enormous help. I had her pegged as someone who was going places. After a few months, the company sent her off to get her brokerage licenses. Then she was promoted to a “private banker,” a position where she was assigned to work with around 200 high net worth individuals with complex financial issues. I have recently learned that she has received another promotion, the second in about two years. She is going to manage pension money in the brokerage side of the house.

When I met her, I was a random stranger with a lot of unusual time consuming problems, but she treated me like I was her most important client. I expect I was not the only customer who received this kind of treatment. It is obvious that I wasn’t the only one evaluating her performance, important people in high places were also watching her. Who knows? Perhaps we will see her photograph on the cover of a business magazine someday.

You just never know who you are dealing with or who they might become. Play it safe. Choose to live by the Golden Rule and let the chips fall where they may. Carl Icahn began his career as a financial manager by offering his clients a higher level of service for less money than was customary at that time. In addition, over time he also proved to be a more competent financial advisor than his competition. He found a way to become a greater blessing to his clients. The rest, as they say, is history.

Wednesday, May 11, 2016

Cash Flow and Capital Allocation

I recently heard a Youtube lecture delivered by William Thorndike, author The Outsiders, a study of CEOs who beat the S&P and their segment competitors over decades. He found that they weren’t genius inventors, superb marketers or salesmen, or the charismatic leaders that appear on the covers of business magazines. They were frugal, humble men, who focused on cash flow and capital allocation beyond all other measures of business success. I was intrigued enough to order a copy of the book, using a $15 discount coupon. After all, I do have to watch my cash flow.

Should this be all that surprising? Running a company or a family do have similarities. It is necessary for both to live on a budget, allowing for the creation of free cash flow after all the basic expenses are covered. Now that you have some free cash to allocate, where should it go? Shall we build the most luxurious and extravagant corporate headquarters building in New York City or increase the dividend to the shareholders and buy a small business that might greatly increase our future profitability? Think Google buying Youtube. Should I drive this old car for a few more years so I can pay down my mortgage, or should I lease a new Lexus?

These men were not ideologues. They were pragmatists. If something ceased to work, they would change directions and try something else. The author tells the story of the manager of a sexy go-go conglomerate of the ninety sixties. When the early seventies proved that diversification was often actually worsification, this manager fired his business acquisitions department en masse. He then set about optimizing his existing businesses for efficiency and profitability. Instead of issuing new shares of stock to underwrite corporate purchases, he instituted a buy back program that ultimately pulled 90% of company shares off the market. The investors who stayed with this manager through two business cycles saw a fantastic return on their investment, even as similarly structured corporations faced bankruptcy or became mere footnotes in corporate history books, cautionary tales for future managers intent on building their own corporate empires. When I couldn’t find a job with a liberal arts degree, I went back to school and earned a degree in mechanical engineering.

Another interesting discovery made by the author is that the younger employees mentored by these boring old men also frequently became successful corporate executives in other businesses. Like NFL owners, the boards of corporations should look at the “coaching tree” that produced that potential coaching hire. If you want to run a 3-4 Defense, look for someone trained by Bill Belichick. If you want to run the West Coast Offense, hire a student of Bill Walsh. This isn’t so different to families. Often the apple doesn’t fall far from the tree. If a child is taught the value and meaning of money, there is a good chance she will carry those lessons into her adult life.

As is so often the case, important things are simple, but simple things can be hard. Managing cash flow over the course of a lifetime gives one capital that can then be allocated. How individuals choose to allocate this capital, whether for consumption, as a down payment for future indebtedness, or for investment, as a down payment for future wealth will make a huge difference in the outcome of their financial lives.

Time and compound interest can work for you, or against you.

Sunday, May 8, 2016

Not Yet

"In a fixed mindset students believe their basic abilities, their intelligence, their talents, are just fixed traits. They have a certain amount and that's that, and then their goal becomes to look smart all the time and never look dumb. In a growth mindset students understand that their talents and abilities can be developed through effort, good teaching and persistence. They don't necessarily think everyone's the same or anyone can be Einstein, but they believe everyone can get smarter if they work at it."—Carol Dweck

Most of you know the story. Michael Jordan, arguably the greatest basketball player in history was cut from his high school basketball team. Instead of quitting, he played on the junior varsity squad for a year developing his skills and his legendary work ethic. Instead of saying, “I failed,” when the world asked him about basketball, he instinctively gave Carol Dweck’s answer, “Not yet.” The following year he made the basketball team. The year after that, he was named to McDonalds All American Team. The year after that, he had a basketball scholarship at the University of North Carolina, playing for Dean Smith, the most famous college basketball coach of that time.

When actually working to help real live people learn how to overcome their personal finance problems (as opposed to writing these blog articles) I have discovered the biggest problem they face is an “I can’t” mindset. They view other people who have reached success as luckier and more talented. They can’t seem to get past a shame based relationship with money. Carol Dweck observes that children who have been shamed react in one of two ways. Either they hide or they lash out. Sound familiar?

I can’t make a monthly budget.
I can’t live on a budget.
I can’t get out of debt.
I can’t find a better job.
I can’t build an emergency fund.
I can’t pay cash for a car.
I can’t save for retirement.

Believe me. At one time or another I have heard them all. I am not going to tell you that it will be easy or that if you follow a path that will lead you to a successful relationship with the money equation that you will end up a billionaire:

Money In = Money Stored + Money Out

I will tell you that no matter who you are or what your situation you can do something—today that will make your life better. The NBA is not loaded with overweight 65 year old white men with arthritic knees (such as this humble author) but if I wanted to improve my basketball game, I could make decisions that would improve my physical conditioning and begin to practice foul shots. I could get better. Basketball isn’t important to me, but my health is becoming a more important issue as I age. I am working and I am getting better, except in the area of diet.

Food In = Fat Stored + Calories Out (Exercise)

I can’t improve my diet.

It is too expensive, time consuming, and inconvenient to eat nutritious food. Besides that, food that is good for you tastes like medicine. As you can see, we all have a way to go in some area of our lives.

What you think you can’t do isn’t going to help you or anybody else. Instead, find something you can do. Instead of saying, “I’ve failed,” choose to say, “Not yet.”

Then, maybe someday in someway you will be able to look back on your life and say.

“I've failed over and over and over again in my life and that is why I succeed. I can accept failure, everyone fails at something. But I can't accept not trying.” Michael Jordan