Investment Update Sep 2019 – The benefits of Asset Allocation

One of the key aspects of working towards Financial Independence is the asset allocation of our investments as we move towards FI, and after we have reached it. For many of the investment advisors we have talked with, their area of expertise is on the “accumulation” phase of investments, i.e. gaining the most and growing your investments.  This results in a larger weight towards stocks and reduced use of bonds and other fixed investments. The key with this is that if you have time, then ‘swing for the fences” and get the highest return.

But what happens as you close in on FI, or once you hit it? In some cases, folks continue to work, and so they don’t mind remaining heavily invested in stocks – as they can withstand a market correction like 2008/2009 – they just keep working and accumulating, and eventually it comes back.

However, as you get to the point in your FI journey where you are looking at the full “FIRE” reality (retire early) you start having to look at protecting what you have, and dialing back some of the stock investments. I don’t believe you should dial it back completely (after all, you could have 4+ decades to go before you pass away). This is where “asset allocation” becomes a part of your life.

For asset allocation, you determine the level of risk you are comfortable with at this time (it changes obviously as you move towards full retirement) and then determine the percentage of your investments you want in stocks, bonds, savings, and other assets. The objective is to maximize returns, while at the same time keeping your risk of major losses in line with what you are comfortable with.

As many of you know, the allocation for my retirement accounts (IRAs, 401K, etc) is pretty much index funds, spread out between the  S&P 500, small-cap, international, REITs and bonds.

Retirement Accounts: Remember, my allocation for these is:

  • 30% Bond Index Fund
  • 17.5% S&P500 Index Fund
  • 17.5% International Index Fund
  • 17.5% Small Cap Index Fund
  • 17.5% REIT Index Fund

My 401K doesn’t have REIT option, so its just 25% for each.

The folks more heavily invested in stocks have done better than me for 2019 (other than international stocks), though they did worse in 2018.

For the month of August, stocks were down (-1.6% for S&P500, 2% for international, and 4% for small cap) yet my REITS and bonds were up (+1.6% and +2.8%), so the end result for my accounts was only a -0.3%.

My dividend account allocation is:

  • 25% Dividend Stocks
  • 25% REITs
  • 50% Bond Index Funds

So as you can guess, it actually was up 1.3%

Overall, I’m just down -0.3% for August, and still trending at +13.3% for the year. My asset allocation may not be as “speedy” as some, but it allows me to sleep as night as I close in on FI. Only 10 Months left to go!

I hope you had a good August, and your journey continues to go well!

Mr. 39 Months

The Rent vs. Buy Decision for Housing

There has been a lot of talk lately about renting housing vs. buying lately, especially in light of the article from folks in Dallas who said they lost about $60K by buying vs. renting and re-investing the difference. Some key points in reference to that article:

  • Their time to own was very short (about 43 months). The general rule is only buy if you are planning to be there for 5+ years
  • They are assuming that they would have invested the extra money, but you can’t always assume that. Many folks find other ways to spend the money they save on renting instead of buying rather than investing it.
  • They are “backward looking” in regards to the amount they could have made. When they purchased in late 2015, nobody could predict the markets would shoot up like they did. In fact, many people were expecting a recession in 2017. If they had bought before the 2000 market crash, then they’d be patting themselves on the back.

An important update to most rent vs. buy is the 2018 tax reform act, which got rid of a lot of tax write-offs for home ownership (property taxes, mortgage interest. Etc.) for a generic $12K single/$24K for married couple. The result is that it gives that same benefit whether you buy or rent – so it makes renting more cost effective than before.

To do a real analysis on whether you should rent or buy, you are going to have to dig into the numbers and make some assumptions. Based on how those assumptions bear out, Its possible your numbers might come out differently, but they shouldn’t be too far off – provided no major market crashes or fueled jumps up in value.

This example comes from Focus on Personal Finance, by Kapoor, Dlabay, Hughes & Hart. I’ve shown the pre- and post-2018 tax reform.

  • Apartment has rent of $1,250/month
  • Home costs $200,000
Rental Cost Before Tax reform 2018   After Tax reform 2018
  Annual Rent payments $15,000   $15,000
  Renter’s Insurance $210   $210
  Interest Lost on security deposti (amount of security deost times after-tax savings account interest rate) $36   $36
Total Annual Cost of Renting $15,246   $15,246
Buying Cost
  Annual mortgage payments $15,168   $15,168
  Property taxes (annual) $4,800   $4,800
  Homeowner’s insurance (annual) $600   $600
  Estimated maintenance & repairs (1%) $2,000   $2,000
  After-tax interest lost on down payment & closing costs $750   $750
  Growth in equity ($1,120)   ($1,120)
  Tax savings for mortage interest (annual mortgate interest times tax rate) ($3,048)   $0
  Tax savings for property taxes (annual property tax times tax rate) ($1,344)   $0
  Estimated annual appreciation (1.5%) ($3,000)   ($3,000)
Total annual cost of buying $14,806   $19,198

As I stated, the tax reform act certainy makes it look like renting is better. Another thing to throw in here are the purchasing costs. Typically, you are going to spend 5%-8% of the home costs ($10-$16Kk if above home) for fees, points, commission, etc. to purchase. To evaluate this, you would spread these costs over the lifetime of the home (i.e. the longer you stay in, the less it will be per year).

Is it any wonder why fewer people are buying homes, and more people are renting in this society?

Mr. 39 Months

Social Security Fixes in the United States

A lot of ink has been spilled over the last 10 years on the state of the United States’ social security program. For those outside the US, this is the base retirement investment program, which takes 6.2% of someone’s salary, and another 6.2% of the salary from the employer, and uses this tax to pay for current retirees. Most folks think they are paying into an “account” for themselves, but it is actually sort of a giant Ponzi scheme, where current tax money is used to pay off outstanding bills. For folks in the FI community, Social Security is a part of the program, but probably not a major part.

Like so many Ponzi schemes, it is predicated on getting more and more people/taxpayers to pay into it in order to keep it rolling. Unfortunately, the folks in the US have not been having 3+ kids to help defer this, and the bill for the “Baby Boomers” is coming due. The taxes taken in are now not enough to pay current beneficiaries, and so the system is spending up the excess it has built up over the past decades. Depending on which accounting system you use, the year it goes “belly up” is around 2032. Unless something is done, benefits will be cut to 75%, which could be very serious for the ones who most depend on social security.

This happened previously, and the two sides of the political aisle got together in the 1980s and came up with a series of items (extend retirement age, tax benefits, etc.) to fix it, at least for the next several decades. Well, we are fast approaching the time when we need to do something similar, but both sides of the US political aisle seem to not want to even discuss it. Probably because it has been called the “third rail” (i.e. the electrical rail for trains) for politics – to touch it means death.

Which is sad, because the closer we get to the magical date, the more severe the changes that will need to be made in order to keep it solvent.  I recently read a report from the Society of Actuaries (an accounting field that specializes in longevity, insurance, etc.) on potential fixes, and what percentage they could go to in fixing the problem.

  1. Raise the retirement age to 70. Life expectancy is longer, but it could be hard on people with physically demanding jobs or who are disabled. +68% of fix
  2. Reduce the cost-of-living-allowance (COLA) by a certain percentage. A congressional commission felt the consumer price index (CPI) was overstated by 1.1%, meaning the COLA was too high. However, these would be cumulative, so as retirees get older, they fall further behind in purchasing power. +37% fix
  3. Reduce benefits by 5% for future retirees: Puts everyone in the same boat, but would hit low income the hardest. +26%
  4. Increase the number of years used to calculate average wage from 35 to 40 years. This would encourage people to work longer, but would hurt folks who work less than 40 years, especially mothers. +24%
  5. Affluence test: Reduce benefits for those whose total retirement income exceeds $50k/year. This preserves the benefits for most, but discourages savings and encourages people to hide assets. It also changes Social Security from a universal, “all in this together” program, to one of need. Would hurt support for program. +75%
  6. Raise payroll taxes from 12.4% to 13.4%. Would not hurt because real wages are going up, but we may also have to increase Medicare payroll tax (it is in even worse shape) so total taxation would be burdensome. +53%
  7. Increase wages to social security tax: Currently capped at , this would make Social Security a worse deal for higher incomes, further eroding universal support
  8. Invest 40% of Social Security Trust Fund in private investments. Could boost returns with less risk to individuals, but this would be 5% of private market. Stock voting and selection could be politicized. +48%

While there does not seem to be one single answer, the best way to do this is with a series of 3-5 of these, and this will get us over the 2032 “hump.” All we have to do is have the political will to do it.

That is the problem.

Sorry to be a bit of a bummer, but we all need to be planning on our financial future, and for those in the US, this is an important part of it.

Mr. 39 months

Timing the Market – Update for Aug 2019

Back two years ago, I reviewed Ben Stein’s & Phil DeMuth’s book “Yes You can time the Market” in which they discussed ways  to time the market over the long term, using various signals signs to determine the long term (15 year trend) of the market. They definitely did not believe in short-term timing, but they did present a good case for how to look at the current state and make long-term determinations.

I followed up with several other posts in which I looked at short-term timing, and at what Stein/DeMuth’s strategy would have resulted if I had followed it since graduating college in 1986 (answer, I would have been 5% – 10% richer over a 30 year period, including the crash).

I thought I’d provide a slight update to folks in case they were interested.

If you remember, Stein/DeMuth had four key measurements to determine the long-term direction of the market:

  1. Price vs 15-year average
  2. Price-to-earnings ratio vs. 15-year average
  3. Dividend yield vs. 15-year average
  4. Bond yeld vs Dividend yield

For Jan 1, 2018, the numbers showed:

  • Price (adjusted for inflation) of $2,883 vs 15 year avg of $1,789 – don’t buy stock
  • P/E ratio: 24.97 vs 15-year average of 23.2 – don’t buy stock
  • Dividend Yield: 1.83% vs. 15-year average of 1.99% – don’t buy stock
  • Earnings Yield (inverse of P/E) vs. AAA bond yield: 4.0% vs 3.5% – buy stock

So three out of the four metrics said don’t buy. The S&P 500 for 2018 was down -6.2% (source CNBC). A lot of folks paid money for stocks that were overpriced at the beginning of 2018.

So what did Jan 2019 look like?

  • Price (adjusted for inflation) of $2,654 vs 15 year avg of $1,862 – don’t buy stock
  • P/E ratio: 19.6 vs 15-year average of 23.0 – Buy Stock
  • Dividend Yield: 2.14% vs. 15-year average of 2.03% – Buy Stock
  • Earnings Yield (inverse of P/E) vs. AAA bond yield: 5.1% vs 3.98% – Buy Stock

So three out of the four metrics say “buy stocks” – and the market is up 15.23% year-to-date

Does this prove that Ben Stein and Phil DeMuth’s market timing strategy is still valid. It appears to be still going well.

Anybody out there with an interesting market timing strategy?

Mr. 39 months

Frugal win – doing your own minor home repairs

Well Mrs. 39 Months is out for week (she is doing a craft-related project with friends up in Vermont with my brother and his wife). So I’m a bachelor for the week. My grocery shopping consisted of a cart full of meat (steak, pork, chicken) and ice cream. I did purchase some fruit and broccoli as well, so I’m not a complete nut. The pets have been a little traumatized – they are used to me being gone for the week on business, but not my wife. Still, things are going OK.

When we remodeled the house ten years ago, we added a half-story to our rancher to make it sort of a “cape cod” kind of house. Our bedroom is now on the second floor, and we have a separate heating and cooling unit for it. Unfortunately, our AC guy, for some reason, thought water flowed uphill, so in the summer when we cranked up the AC (about 5 months after construction was done) it started leaking over our ceiling (the AC unit is in the attic). Ruined some drywall.

The construction guys came back in, fixed the AC issue, and put in drywall, but only put on the mud coat. Never came back (we were already occupying the bedroom, and it was difficult scheduling all of it). So for the last ten years, we have been living with a plain sheet of drywall over the bed, with its mud coat alone – and un-sanded. The problem has been that we were never in a situation where we could clear out the bedroom and do the work – Mrs. 39 Months didn’t like the idea of setting up temporarily somewhere else in the house.

Well, now that she is gone, I’ve decided to do the work, which consists of:

  • Clearing out the existing space (Mon)
  • Putting down tarps and protecting other surfaces (Mon)
  • Sanding/scraping the old drywall compound (Mon)
  • Priming the surfaces (Tue)
  • Putting on 2 coats of paint (Wed)

Its not work that I (or most other people) enjoy. Still, I had the chance, and rather than spend money to have someone else do the work, I chose to tackle it myself. I’ve already got a lot of the tools (rollers, scrapers, brushes, etc.). About $70 for some of the materials (paint, spackle, primer) and I was ready to go. Moved everything out (I have been sleeping on the ground in our family room) got it setup and off we go.

Doing a ceiling is a little rough on the arms, but not too bad. As of last night, I was done, and checking in this morning it appeared the ceiling was fairly close to the existing color. I knew I couldn’t get it perfect, but I’m pretty happy with where we are. Hopefully Mrs. 39 Months will like it we she gets back Friday night.

Mr. 39 Months

Spreadsheet Software to do financial calculations

Many of us in the FI community are numbers “nerds” who revel is using spreadsheets, software and programs to review and manipulate data. We love to plan on future value of our investments, timing for FI date, and the amount of savings we have to make in order to hit our goals. Its fun and informative for us.

There is also a host of financial programs and software available (look at the side bar for a few of the calculators). Still, sometimes its nice to know how to do some calculations for yourself, using simple formulas put into your spreadsheet software (like MS Excel). I thought I’d share of few of these with you, in case you would like to use them yourself.

  1. Calculating Future Value: What would the future value of money be if you deposited a certain amount (say $1000) for  a specific period (say, 5 years) at a certain interest rate (say 10%). To do this, you would type in the following formula into your spreadsheet software:
    • =FV(rate, period, amount per period, amount you start with)
    • =FV(.10,5,-1000,0)
    • =$15,937.42
  2. Calculating Present Value: What amount must you invest today, in order to have a certain amount (say $50,000) within a certain time frame (10 years from now) at a certain interest rate (say, 8%). To do this, you type the following formula into your spreadsheet software:
    • =PV(rate, periods, payment, future value amount type)
    • =PV(.08,10,0,-50000)
    • =$23,159.67

Microsoft Excel has a host of these type of calculations (55 different ones). To find them, just open up a blank workbook, type in “FV” in the search function and look for “financial” under the search. By clicking on one of the 55 different ones, you are bound to find one which will meet your needs.

By using these, as opposed to just using some pre-set software, I feel you will have a better understanding of the core concepts behind the calculations, and be better able to map your path to Financial Independence.

Good luck on your journey!

Mr. 39 Months