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Conservative distribution phase portfolio

 
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peteyperson
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PostPosted: Sat Mar 19, 2005 5:37 pm    Post subject: Conservative distribution phase portfolio Reply with quote

"Conservative" may be a misnomer, but the portfolio is intended to survive a decade like the 1970s and keep on tickin'.

Sample portfolio:~

Global Common Stocks - 35%

Global Real Estate - 20%

Timber - 10%

Oil & Gas | Metals & Minerals - 5%

Absolute Return - 10%

10-Year TIPS - 20%
========================
Total - 100%


A conservative strategy would be to aim for income over capital gains. This might include indexing the large cap universe globally via VTI, EFA, EEM, going low-cost on global REITs, direct stocks for Timber, Merger Fund for Absolute Return and direct purchase TIPS. Where available, one could instead opt for large-cap value indexing and today this would deliver 0.25% higher yield even after the slightly higher fees. Long-run returns may well be better too.

The portfolio yield excluding TIPS would be circa 2.2%. Annual capital sales needed circa 1.8%. The idea behind directly-held TIPS would be for a 10-year ladder where 2% of the 20% allocation falls due each year. In a 70s environment, one could live off this capital and not touch other assets. The value is inflation linked, as is the yield. Other yield revenue may not keep up with inflation as happened in the early part of the 70s, but you'll still make it through the decade with all your higher returning assets still in place. Including the initial TIPS yield, portfolio yield is circa 2.6%. This provides a bit of padding if things get out of hand, reducing gradually as you sell TIPS off thru a 70s environ.

The degree to which one aims for growth in the common stocks allocation depends on the level of yield desired for the portfolio as a whole, the level of capital sales required annually, and the (sometimes) conflicting desire for greater returns thinking this will boost withdrawal rates. The truth is that higher returns don't always translate into higher withdrawal rates if your portfolio is poorly structured. One may well get better diversification with a split of large and small cap, as one might get from value exposure instead of blend. Exposure to small cap would reduce the yield on the portfolio and increase the need for capital sales however.

Diversification and real growth should be sufficient on these assets to provide the capital gains to survive. The payout levels are not so high that this puts a strangehold on future growth. Debt levels are not so high that this puts the investments in danger. Leverage is not so high that you might get wiped out. The asset allocation is intended to be simple to own and manage. Total assets fall between twelve and fourteen.

I'd welcome thoughts, observations & ideas.

Petey


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unclemick
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PostPosted: Sun Mar 20, 2005 3:04 pm    Post subject: Reply with quote

Alrighty

Lets nit pick a little. This be a high maintence portfoflio. Expense control might become an issue - if you fall into the trap of excessive rebalancing.

However - here's what I like. In a period of stress one can sidestep market bonkers moves via the TIPs ladder and allow primary trends to restablish themselves - provided one doesn't get overly obsessive about strict rebalancing to asset %. The global aspect obviates my American provincial problem.

I suspect a benchmark bogey (mental or actual calculation) would be internal - you have to determine your own success criteria.

Such a portfolio assumes a high skill and experience level to pull off. And a good nose for value.

One more thing - capital sales can occur keeping to portfolio tuned up as well as taking money out to live on - sometimes the difference is moot.


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unclemick
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PostPosted: Sun Mar 20, 2005 3:24 pm    Post subject: Reply with quote

Petey

Here is a weird thought - remembering the old stock volitility curves - at 4 or more stocks you enter the heel of the curve.

So with your estimate of 12 - 14 assets.

If one got 'in' at acceptible prices (?? at the start of a primary trend??) - why rebalance in your lifetime. Just nip out a little capital as required for expenses.


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peteyperson
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PostPosted: Sun Mar 20, 2005 5:58 pm    Post subject: Reply with quote

unclemick wrote:
Alrighty

Lets nit pick a little. This be a high maintence portfoflio. Expense control might become an issue - if you fall into the trap of excessive rebalancing.

However - here's what I like. In a period of stress one can sidestep market bonkers moves via the TIPs ladder and allow primary trends to restablish themselves - provided one doesn't get overly obsessive about strict rebalancing to asset %. The global aspect obviates my American provincial problem.

I suspect a benchmark bogey (mental or actual calculation) would be internal - you have to determine your own success criteria.

Such a portfolio assumes a high skill and experience level to pull off. And a good nose for value.

One more thing - capital sales can occur keeping to portfolio tuned up as well as taking money out to live on - sometimes the difference is moot.

=-=
Here is a weird thought - remembering the old stock volitility curves - at 4 or more stocks you enter the heel of the curve.

So with your estimate of 12 - 14 assets.

If one got 'in' at acceptible prices (?? at the start of a primary trend??) - why rebalance in your lifetime. Just nip out a little capital as required for expenses.

Hi Uncle,

Some good points there.

The portfolio is intended to be reasonably simple. I don't however subscribe to the notion that one can go for outright simplicity and still get the same results. But what I am striving for is as fewer funds and as fewer asset classes as can get the job done. I don't desire a nightmare of paperwork trackdown on 20+ assets during FIRE or while accumulating. I enjoy the discussions and thinking about things but that part is drudgery.

I agree with the stock volatility curve issue. I will continue to attempt to refine it some more.

I agree on the benchmark issue. It is far less on the maximum performance one could have gotten and much more being able to live off your assets & obtain your withdrawal rate over time. You need real returns to do that so one still needs to place capital in different types of risk to achieve this.

The rebalancing I'm still mulling over. To some extent it makes sense but the analysis always fails to take account of the cost of additional sales both for the transaction and the hit due to early capital gains taxation. Net of these costs how much do you truly benefit from selling high and buying low? As yet I am unsure. Ultimately I'll probably construct some kind of test to see at what threshold of overvalued vs undervalued it makes financial sense to do so. It might be 120 vs 80 with 100 as fair value. In terms of judging value and this being tricky, it is and it is not. Ben has shown the way in simply weighting 5% or 10% for different assets, and simply rebalancing when they fall too far out of whack from that. He is not usually making a determination of value so much as just putting things back where they were. He is aided by lower costs as a percentage of his nest egg and no tax implications.

One does not need to complicate rebalancing with an assessment of value on each asset class, one can do it as automatically as one can save automatically by paying yourself first! I do think however that one can pickup what are fair value estimates as you learn more - I certainly have. This also suggests keeping the number of asset classes and individual holdings within each asset class as low as makes your plan work because this increases the learning speed. Today I have data on historical avg. dividend and real capital growth on the UK & US total markets. This is useful in judging future expected returns and how low payout rates are, or how much overvalued things are. It is another way to look at it besides P/E or P/B. I have data that I can collate now on the UK small cap index from 1955 onwards which has dividend yields over time. This can provide me with an additional metric to consider there. This asset class is starting to peak a little in valuations and I have already begun pairing back future expected returns there. Valuation assessments come naturally from that process I think.

In terms of getting a great price and holding, there are pros and cons. If taxes are an issue then this makes good sense. If rebalancing is less viable for someone then there is a toss-up on the benefits if say an asset if 30% overvalued today but you will lose 20% of the capital if you sell. We have tiered tax rates on capital gains so a large sale would trigger the higher rates. This is one argument for keeping individual fund allocations small so that one can be a little nimble, make additional sales in a year when some valuations have peaked but you've already taken out that year's withdrawals. Even a 10% position in one asset would make this difficult, especially if you setup a 2% dividend, 2% capital sales setup. Even if your portfolio had fallen 50%, you would still only be selling 4% a year. Would still take a decent shift to clear the 10% in that year and that would be pushing the tax thresholds. So I think one may be stuck in assets that have risen too high like the S&P 500 Index. There I think the essential point is to properly assess the fair value of the asset and at least reduce the future expected return appropriately. This at least reduces your portfolio withdrawal rate to take account of it but you are still left with high capital risk due to peak values upon retirement. One has weighed that against the cost of far earlier capital gains taxes and holding is basically saying you're no better off holding to selling. Becomes a toss-up as to which move is right. Of course if the asset class fell and overshot fair value as often happens in a steep decline then you would have done better to sell expecting a fair value correction and reallocate elsewhere till values fall or hold cash or I-Bonds in the interim. Here you're arbitraging the lower future return vs the probably still lower I-Bonds return and hoping to come out ahead buying a cheaper S&P 500 later. This is essentially what Warren Buffett is doing today. He can do this because he does well enough to compensate, but whether I actually would is open to question. I do know that I would probably prefer the lower tax basis going forward and not holding a PE 25 S&P 500 though. I would sleep more comfortably I think. I also believe the current situation is quite rare and there is likely most of the time to be other assets one can move into and not necessarily lose returns by the transaction - only reduce tax basis and obtain the same future expected return but with less risk to capital (buying at fair value instead of holding overvalued perhaps). This was the case in 1998-9 when one could have bought US REITs or Int'l REIT as 20-30% discount selling an overpriced S&P 500, or Oil & Gas which declined to $10. If you have a reasonable grasp of the main asset classes one can more easily spot mispricings.

I don't assume a high level of knowledge on valuations. I hope that some contrarian moves based on valuations will provide modestly increased returns during both accumulation and distribution phases.

Petey


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JWR1945
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Location: Crestview, Florida

PostPosted: Mon Mar 21, 2005 12:58 am    Post subject: Reply with quote

peteyperson wrote:
"Conservative" may be a misnomer, but the portfolio is intended to survive a decade like the 1970s and keep on tickin'.

Sample portfolio:~

Global Common Stocks - 35%

Global Real Estate - 20%

Timber - 10%

Oil & Gas | Metals & Minerals - 5%

Absolute Return - 10%

10-Year TIPS - 20%
========================
Total - 100%

This is an outstanding alternative that is likely to do better than a portfolio consisting entirely of 2% TIPS. As we have learned, this is a surmounting a tough barrier, given today's stock prices.

I interpret this as being a stable allocation for 10 or 15 years or, if need be, even longer.

This does not satisfy what I have in mind in terms of coming up with an equivalent of 2% TIPS. I would like a 2% TIPS equivalent to have the general properties of TIPS that our models use. In this case, the 35% global stock holding keeps it from being a 2% TIPS equivalent. I would like the stock allocation that is added to a 2% TIPS equivalent to be variable.

My remark would have been different if you had identified stocks with a special characteristic such as dividends exceeding a particular threshold.

OTOH, this is something for real retirees to look at carefully.

I would personally stay away from Oil and Gas holdings because of the politicians.

I need some clarification about the meaning of absolute return. I would be very reluctant to invest in a hedge fund of any type because of limited disclosure (reporting requirements). If absolute returns are not from hedge funds, what do you have in mind?

Thanks.

John R.


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peteyperson
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PostPosted: Mon Mar 21, 2005 10:25 am    Post subject: Reply with quote

JWR1945 wrote:
peteyperson wrote:
"Conservative" may be a misnomer, but the portfolio is intended to survive a decade like the 1970s and keep on tickin'.

Sample portfolio:~

Global Common Stocks - 35%

Global Real Estate - 20%

Timber - 10%

Oil & Gas | Metals & Minerals - 5%

Absolute Return - 10%

10-Year TIPS - 20%
========================
Total - 100%

This is an outstanding alternative that is likely to do better than a portfolio consisting entirely of 2% TIPS. As we have learned, this is a surmounting a tough barrier, given today's stock prices.

I interpret this as being a stable allocation for 10 or 15 years or, if need be, even longer.

This does not satisfy what I have in mind in terms of coming up with an equivalent of 2% TIPS. I would like a 2% TIPS equivalent to have the general properties of TIPS that our models use. In this case, the 35% global stock holding keeps it from being a 2% TIPS equivalent. I would like the stock allocation that is added to a 2% TIPS equivalent to be variable.

My remark would have been different if you had identified stocks with a special characteristic such as dividends exceeding a particular threshold.

OTOH, this is something for real retirees to look at carefully.

I would personally stay away from Oil and Gas holdings because of the politicians.

I need some clarification about the meaning of absolute return. I would be very reluctant to invest in a hedge fund of any type because of limited disclosure (reporting requirements). If absolute returns are not from hedge funds, what do you have in mind?

Thanks.

John R.

Hi John,

Your strategy and this one are totally different. The whole direction you come from there is just a paradigm shift from this. This portfolio is intended to be balanced, provide 2% income and restrict capital sales to 2% of initial capital value (which could double to 4% if the portfolio was halved). The second layer of strategic planning is for 10-year TIPS to come due each year with 2% of original inflation-adjusted value arriving into your brokerage account. This then allows for the first decade livable expenses regardless of market returns. The most risky decade when becoming FIREd is often said to be the first one. This attempts to shield the portfolio as much as possible but without putting too much of a drag on overall returns to do it. Hopefully in that sense it demonstrates an understanding of market history, volatility and shape of returns over time.

The common stocks can be small cap, large cap or specifically higher income stocks. I leave all options open. One indeed has the option to overweight large instead of small cap, and in so doing increase the yield on the portfolio but lessen the long-run portfolio return. On the flip side, the additional yield would further reduce the annual capital sales required possibly to 1.5% a year (or 3% in a year where assets have halved). This adds to portfolio preservation still further and so many increase safe withdrawal rates. At present this is a different strategy to consider however because small cap is cheaper than large cap in most places and yields on large cap are at historic lows. Thus, at these price levels it is difficult to call for overweighting large-cap. Should one be fortunate to experience better yields near FIRE, one can rebalance or reallocate.

Absolute return is a number of things. The Merger Fund MERFX and the Arbitrage Fund ARBFX are two US mutual fund examples of event-driven investing. The Merger fund has delivered 8% net return over the past decade with 6% SD. A good substitute for someone willing to reduce their a-typical 40% bond allocation. Correlations to equities and bonds are pretty much zero as returns depend on corporate merger transactions not not market movements. In a large market fall merger arb. does fall with the market (if somewhat subdued) but rebounds the following quarter as previously announced mergers go thru and companies are bought at pre-agreed prices. So over six month periods merger arb. is unaffected by market movements. Recent fund returns have been poor because of fewer merger deals (though this has increased significantly in the smaller caps that Arbitrage Fund buys into - Merger goes for the large cap mergers) and the increased number of busted mergers last year. This aside, returns have been very consistent in the Merger Fund. There are also new mutual funds that have long/short strategies and plan to reduce market exposure & deliver low return returns. These are pretty new and one will have to see how they do. I have not looked into these as yet.

The net real returns I expect from from absolute return are circa 3%. Better than net real returns from bonds but without the interest rate risk and correlation to equities when rates/inflation move up. Returns here are intended to be lower than equities, but smoother. No yield, so more efficient on taxes. The idea being a small part of your portfolio gives you a steadier 3% real instead of a more volatile 7% once might not get if markets don't cooperate. So it helps smooth out results without losing too much set against the overall 4% target withdrawal rate.

I do have access to a funds of funds here in the UK and that is also a good alternative for me.

Petey


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JWR1945
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PostPosted: Mon Mar 21, 2005 1:43 pm    Post subject: Reply with quote

peteyperson wrote:
Your strategy and this one are totally different. The whole direction you come from there is just a paradigm shift from this.

Actually, your ideas are a lot more valuable than you realize. Not only have you addressed building a conservative retirement portfolio, you have put forth several good ideas that will help solve additional issues.

Thanks.

Have fun.

John R.


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unclemick
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PostPosted: Mon Mar 21, 2005 1:48 pm    Post subject: Reply with quote

I agree.

Do not hesitate to keep posting your thoughts.


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peteyperson
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PostPosted: Mon Mar 21, 2005 2:48 pm    Post subject: Reply with quote

Quote:
I agree.

Do not hesitate to keep posting your thoughts.

Thanks guys.

I think my latest post in the TIPS thread is the best yet.

Petey


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