Do you have a “Sleep at Night” Allocation? Timing the Market…..

Well, the stock market has certainly gone crazy, with the Fed pumping in money and another round of stimulus being offered (with more on the way?). In addition, the operations by day traders has increased dramatically, further fueling a rise in the market (can you say Tesla?). For many folks, the double-digit increase in the market at the end of the year was a welcome bonus. Still…….

I wrote earlier in the month about how I was moving out of bond funds. I provided my reasons, and the numbers behind my decision. At the time, I was thinking that the bonds just couldn’t keep up with the market, and were holding me back.

As part of my new year analysis, I look at some basic finance info to try and get a “feel” for the direction of the market, based on the writings of Ben Stein in his book “Yes you can Time the Market.” Its pretty much the trends on stock price, P/E ratio, and bond yields. I used it to determine how well I would have done if I followed it since I graduated (Roughly 8% – 11% better than straight dollar cost averaging over last 35 years), at the end of 2019 (where it predicted a drop) and in mid-March 2020 (where it predicted you should jump back in). The overall lesson is that, if you have a long-term outlook, you can do a little better than just following the market.

Well, the concept is there are four (4) areas where you can follow the trend and determine if you should be purchasing stocks, or purchasing bonds.

  1. Price of S&P500 vs. 15-year average: Jan 1, 2021 = 3,756.07 vs.15-year average of 2,160.4. Signal says stocks are overpriced, do not buy more
  2. S&P500 P/E ratio vs. 15-year average: Jan 1, 2021 = 37.74 vs. 15-year average of 24.7. Signal says stocks are overpriced, do not buy more
  3. S&P 500 Dividend yield vs. 15-year average: Jan 1, 2021 = 1.55% vs. 15-year average of 2.04%. Signal says stocks are overpriced, do not buy more
  4. Earnings vs. AAA corporate Bonds. Jan 1, 2021 = 2.65% (1 / PE ratio of 37.74) vs. AAA bond yield of 2.28% (very low yield). Signal says bonds are provided lower yield (though not by much) so bonds are overpriced for their yield

So 3 of the 4 signals say stocks are overpriced, and the 4th one is a close as it has been in a decade. All signs seem to speak to current stocks being overpriced.

Note that the concept does not suggest you should sell all your stocks, or sell all your bonds. What it is saying is that in the current environment, the stocks (or bonds) are too high priced, and you should focus your purchases on another asset class. Relook at it later on, and potentially change your purchases with the new data (I look at it once/year).

So why the subject line? Well, its often said that you should have an investment allocation that it aggressive, but still lets you sleep at night. After finding out that the P/E ratio was 37+ yesterday, I had a difficult time sleeping last night. The other times when this ratio topped 35+ was right before the dot.Com bust (2001) and the great recession (2008).

I know I just changed I just changed my allocation to get out of bonds, but I’ve decided to go back with them (20% of my allocation). I think the market is just a little too expensive right now, with all the money being pumped into it. I may end up with lower returns than some other folks – but it will help me sleep better at night.

How are you guys doing with the run up?

Mr. 39 Months

OK, I’m out!

That’s it – I’m moving out of my bond funds!

As many of you know, I changed by allocation at the beginning of the 2020 to reduce my bond portion from 30% to 20% of my portfolio. My reasoning was that the US Fed was keeping rates for borrowing low, so the yield I could expect from fixed assets would be low.

Of course, my timing sucked (as usual) and within 2 months of purchasing more stocks, the market tanked and the bonds became more valuable. Still, I held my course and even rebalanced In July, selling bonds and purchasing underpriced stocks – even though the market wasn’t going anywhere. That is why I have been very happy with the Nov/Dec. recovery

The US Federal Bank continues to keep rates low. The yield on the 10-year treasury is running at 0.947%! Thus, if you loan the fed $100, at the end of the year, you will have made $0.95. In ten years, you will get back $109.89. How can anyone make money in this?

So, with the S&P 500 paying a 1.6% dividend, and my Income account paying 4.19% dividends for the year, my thought is that I am going to take those bond funds in my 401K/IRAs, and convert them to mutual funds that focus on Dividend growth. For 2020, my bond funds returned about 2.2% growth and 3.0% in dividends – total of 5.2%

For my IRA/401K/Mutual Funds, I’m looking at three funds:

  • Wife’s IRAs (Trowprice): PRDGX (Dividend growth) – 13.93% 1 year / 14.49% 5 year
  • My IRAs (Vanguard): VDADX (Dividend Appreciation Index) – 15.46% 1 year/ 14.92% 5 year
  • My 401K/Deferred: VIMAX (Mid-Cap, my company does not offer a dividend growth fund, and I’m already invested in S&P500, small cap and international here) – 18.24% 1 year/ 13.28% 5 year

The plan here would be to use my rebalancing step, which I normally do in early January, to shift out of bonds and move into these new dividend growth stock funds. I’ll try and do that later this week.

Of course, knowing how well I time things, I’d expect a major market correction/crash shortly after I do this – so you’ve been warned.

So what changes are you guys making at the start of the year?

Read more

Mr. 39 Months

Investment Update Dec 2020 – What a difference a month makes!

Wow. Just Wow.

Not sure whether it’s the announcement of a potential vaccine, or the election being over, the market took all its pent-up energy and exploded. The investments were up across the board, and I’m sure everyone benefited from their investments shooting up. The result for us was an overall 10.7% increase in our accounts, and our annual number being pushed back into the “black” and the annual return rising to 7.53%. Maybe the year isn’t a total loss.

So our allocation is as follows, as of July 2020:

  • 20% Bond Index Fund
  • 20% S&P500 Index Fund
  • 20% International Index Fund
  • 20% Small Cap Index Fund
  • 20% REIT Index Fund

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

  • Bonds were up 1.1%
  • S&P was up 10.9%
  • International was ups 13.0%
  • Small Cap up 16.9%
  • REIT Index up 10.1%

My dividend account new allocation (as of Jan 2020) was:

  • 50% Dividend Stocks
  • 50% REITs

The dividend paying stocks were up an average of 12.5%, and the REITS were up an average of 19.8%. Again, wow. The dividend account has been down all year and hasn’t recovered anywhere near what the 401K/IRA accounts have. Now its come roaring back. Hopefully it will end the year in the black.

I hope December is at least level, so that we can end the year in the black.

Hope everyone is healthy and your market returns for the rest of the year go up!

Read more

Mr. 39 Months

What Assumptions are you making for your Retirement?

Was listening to an earlier podcast from the Retirement Answer Man from May of this year. His four Podcasts during that month dealt with the assumptions people make in planning for their retirement. Obviously these assumptions will greatly affect the amount we save, the timeline of our retirement, and the potential happy future we will have.

Some of the areas covered by

  • Life Assumptions (how long will you live, how long will you continue to work, who will care for you as you get older, etc.)
  • Costs (spending, regular inflation, healthcare inflation, use of averages, etc.)
  • Markets (returns on stocks, bonds, withdrawal strategies, etc.)
  • Rules for making assumptions (recognize these are assumptions, be flexible, beware of extreme assumptions, etc.)

It made me think of the assumptions we are currently using, especially after our meeting with the financial advisor at the end of 2019.

Our base assumptions:

  • Longevity: Me 97 Years old, Mrs. 39 Months 99 years old
  • Work till I am 58, Mrs. 39 Months is 60
  • Take Social Security at 67
  • Social Security annual increases: 2%
  • Inflation: 3.25%
  • Healthcare inflation: 6%
  • Investment returns (60/40 split): 7.2% before inflation
  • Budget and pay our own medical until we hit 65. Medical costs will be roughly what they are now (plus expected medical inflation rate)
  • Budget of $78,000/year for expenses (including medical for first 5-7 years) – adjusted for inflation
  • Move to new home at some point, but it will be roughly same cost as what we sell existing home
  • Place we move to will have roughly same living costs as what we currently have (i.e. no savings)

So what are the assumptions you are using to do your planning?

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Mr. 39 Months

Have you changed your asset allocation?

I tend to re-balance every six months (In July and January). Re-balancing – make it regular and timely. Its helped save me some money (I didn’t suffer as much in Feb/Mar as others, as I took a share of my stock increases for 2019 and purchased bonds with them). So now its July and time to re-balance again.

Now, my standard allocation is:

  • 30% Index Bond funds
  • 17.5% S&P 500 Index
  • 17.5% Small cap Index
  • 17.5% International stocks index
  • 17.5% REITs index

I have found in the first six months of 2020 that my bonds were up to around 33% of my investments, while my REITS were down around 15%, and the stocks were lower as well. Usually, I’d just rebalance everything to the numbers above, and be “on my way.”

However, the Chinese Covid virus and the market volatility had me thinking. The “Fed” (US Federal Reserve Board) in an attempt to keep the market afloat, has dramatically dropped interest rates, and begun buying debt again. The result is that, as before, savers got punished and folks looking to increase their debt could find easy money. It thus made bonds less attractive, as any new debt issued is going to be at lower interest rates for the foreseeable future.

What is someone to do as they close in on retirement? Typically you pull money away from the volatile market and embrace safer investment alternatives – but you can’t do that with rates this low. I’ve tried experimenting with an income account for years, and I just can’t make it work with dividends. So I am stuck, like so many others, in shifting my allocation to more stocks.

In early July, I returned to the allocation that we had for most of the last 20 years:

  • 20% Index bond funds
  • 20% S&P 500 Index
  • 20% Small Cap Index
  • 20% International stocks index
  • 20% REITS index

Based on my previous horrible timing, I’m assuming we’ll have a stock collapse in the next 3 months, so be ready.

Have you made any changes to your investment allocations recently, based on current events?

Read more

Mr. 39 Months

I don’t need to tell you that taxes suck

Finally was able to get everything together for the taxes in 2019. We use a CPA because of some complications, though its fast closing in on the time when I plan on taking back over doing our own taxes (I did them up till about 2011).

Well, we got the info back, I reviewed them, and the end result was….. we owed about $2,400 to the Fed (and $500 to our state). Plus penalties. Ouch.

I thought we’d prepaid enough to make sure this wasn’t an issue, but apparently not. We’ll have to take some money out of savings to pay for it. This way, we won’t be selling stocks during the current down market. That is why you have spare funds in place.

I can kick myself a bit, but in the end, the next step should be to evaluate your current tax withholdings for 2020 and make sure they are taking enough out. Low and behold, after running the numbers – we were about $2,800 low in withholding, based on what I see coming for the year.

Back to the federal/state W-4 form, where we determine withholdings, make a few adjustments which will reduce our available income a little over $200/month, and we should be set for taxes at the end of 2020. Better to take action at the beginning of the year than to try and find money at the end of the year.

I tend to try and get our taxes to $0, or have us owe a little money. I know some people like to get a nice refund, but I’d rather not give the government and interest free loan. I can use the money better.

Hopefully, your tax situation is better than mine!

Mr. 39 Months

Financial Advisor meeting #5 – Final Sad Trombone & comment on Financial Samurai

I’ve included several posts about our recent meetings with a financial advisor

Well, our advisor had some major family health issues with a loved one (cancer), so needless to say, it took a while to get our final report. We got it yesterday, in the form of a large, 3-ring binder, full of lots of data, analysis and recommendations. There was analysis of cash flow, net worth and draw down for several scenarios:

  1. Base scenario of both of us continuing to work for 4 more years, till I hit 60 and Mrs. 39 Months hits 62
  2. Scenario where we pull out more than the minimum from our 401K from 60-70 in order to reduce our RMDs
  3. Scenario where we I leave my current job, and get a much lower paying job that I love that earns $40K a year, and work at it till I hit 67
  4. Scenario where we have a major health issue requiring long-term health care when I hit 80
  5. Scenario where we retire the July (my FI date)

The analysis was very comprehensive. It was also very disheartening. In the first three scenarios, they all ended up pretty close to the same, we end up running out of money when we are 94/96 (i.e. three years before my target “death” date of 97/99). The major health and my July 2020 scenarios pretty much had us running out of money in the mid-80s. Since Mrs. 39 Months family has lots of her Aunts living into their 90s and 100s, that doesn’t seem like a good bet for us.

So why the difference? What has the advisor’s numbers coming in so much under my original planning? I’ve identified some callouts:

  • Original vs. Adjusted Budget: My original budget had us spending $72K/year, but after going deep into conversation with Mrs. 39 Months, this was revised up to $78K/year. Only $6K, but it does add up
  • Social Security & cost-of-living adjustments: I used the reports that came from social security to estimate our payments, but the reports assume you continue to work till you hit your retirement age (67 for us). Stopping at 60/62 reduces it, and stopping in July 2020 would reduce it even more. In addition, the advisor assumed a Social Security increase of 2% a year (below his inflation rate, see below), so the money will slowly be losing it purchasing power. I just assumed a straight line that would match inflation. Seeing the current state of social security in the US, I can’t say I disagree with the advisor
  • Inflation: My original planning just took inflation out of the picture. I used historical investment returns post-inflation (i.e. the returns I used had historical inflation already taken out). The advisor used a 3.25% inflation rate and a 6% for medical. I can’t really argue with the assumptions –  they do appear somewhat logical to me.
  • Return of investments: This is where I have real issues with the advisor. Based on our asset allocation (about 60% stocks, 40% bonds/savings) he came back with an estimated return over 40 years of 5.3% (i.e. only 2% above inflation). Since the average stock return from 1926 – 2018 is almost 10%, I found that too low. I’ve asked him to do another scenario with a 7.2% return (more in line with a 60/40 split)
  • Lifestyle spending: I have asked him to drop some of our lifestyle spending (travel, dining out, etc.) by 35% starting at age 75. I just don’t think we’ll be traveling or partying as much in our 80s and 90s.

We’ll see how this works out with the changes, but overall, I have to say I’m a little disappointed in the results, though not in the process. I believe the advisor is being very conservative in a lot of his assumptions – which appears to be the opposite of the FI community. Let’s face it, we are all very optimistic go-getters!

This sort of falls in line with news that the FI community found out about recently from the Financial Samurai blog last week. He wrote that he was planning to go back to work after 7+ years of early retirement. In his post, he listed his reasons (I invite you to read the posting) and I’m sure many of the readers could see his points (though his budget is way out of line with mine, since he lives in San Francisco). If you read closely, I think a lot of his reasons are non-financial. He just misses being around folks, the comradery, etc. It goes back to all the warnings that run through a lot of our community postings – you need to retire “to” something, rather than “from” something.

So, since I enjoy many of the aspects of my work, I am not too “bummed” about the potential of having to work longer in order to achieve “Fat FIRE.” We will see where the journey goes.

.

Mr. 39 Months

Excellent Post at the Retirement Manifesto on your beginning of the year financial moves

Pretty much parallels what I do each year in the first day or two. Excellent checklist!

Retirement Manifesto: A step-by-step guide-to-your-annual-financial-update

Steps:

  • Update Net Worth Statement
  • Update investments/capture current asset allocation
  • Determine portfolio rebalancing actions
  • If retired, update your bucket strategy (how much in cash bucket, how much in 5-8 year bucket, how much in long-term bucket)
  • Update your spending from the previous year
  • Determine your spending goals/limits for the new year
https://www.theretirementmanifesto.com/a-step-by-step-guide-to-your-annual-financial-update/

WOW! Just WOW! Investment update for Jan 2020

I think I speak for everyone when I say – Wow.

The year 2019 will go down as one of the best years for most people in terms of their investments. The S&P 500 (everyone’s standard for judging US stock performance) went from $2,607.39 to $3,235.14 (Jan 1 to Jan 1) – a 24.0% increase. Tack on the 1.77% dividend yield and you were seriously kicking butt, as long as you just left it in the market in an Index Fund! Hopefully the readers here didn’t panic in Dec 2018 and sell their stocks.

I’ve been an index investor for most of my investing life. Whenever I have dabbled in individual stock pickings, I mostly got my head handed to me. So here I stay. My allocations tend to be broader than just your typical “dump it all into the S&P 500”

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 company 401K/Deferred account doesn’t have a REIT option, so I’m 25% for the other 4 categories.

I set up my father’s inherited IRA to see how it would perform if it was concentrated on creating income (i.e. dividends). My allocation for that was:

Dividend Income Account: Allocation:

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

Finally, my “fun money” post-tax account is primarily setup for value investing, with a mix of USAA and Vanguard index accounts.

Value Account: Allocation

  • 12% PAWZ ETF (it invests in pet related companies, a vanity play on my part)
  • 44% USAA Market Index (my brokerage is USAA)
  • 44% in Vanguard Value Index fund

So how did they perform for the year?  Here are all my portfolio items (not weighted)

Name Symbol Capital Gain % Dividend % Total Return
TRowe Price S&P 500 PREIX 28.5% 1.8% 30.2%
Extended Equity Market Index PEXMX 22.0% 1.0% 23.0%
International Equity Index PIEQX 17.7% 2.6% 20.3%
Real Estate TRREX 3.7% 2.5% 6.2%
US Bond Enhanced Index PBDIX 5.2% 2.9% 8.1%
Vanguard Bond Index Fund VBTLX 5.7% 5.24% 11.0%
Vanguard 500 Index Fund VFIAX 28.8% 1.85% 30.7%
Vanguard REIT Index Fund VGSLX 24.5% 3.31% 27.8%
Vanguard Small-Cap Index Fund VSMAX 25.5% 1.38% 26.9%
Vanguard Int’l Index Fund VGTSX 17.7% 2.98% 20.7%
Vanguad Welesley Income Fund VWINX 11.8% 0.95% 12.8%
Eagle Small Cap growth   18.7% 0.00% 18.7%
Vanguard 500 Index Fund   28.8% 1.74% 30.6%
Vanguard Total International Index   17.7% 2.08% 19.8%
Vanguard total bond Mkt   5.7% 2.52% 8.3%
Eagle Small Cap growth   18.7% 0.00% 18.7%
Vanguard 500 Index Fund   28.8% 1.74% 30.6%
Vanguard Total International Index   17.7% 2.08% 19.8%
Lord Abbot Total Return   6.2% 2.71% 8.9%
Chevron Corp CVX 10.8% 3.9% 14.7%
Cisco CSCO 10.7% 2.9% 13.6%
Healthcare Realty Trust HR 17.3% 3.6% 20.9%
Ishares Preferred PFF 9.8% 4.9% 14.7%
Realty Income Corp O 16.8% 3.7% 20.5%
Service Properties TR SVC 1.9% 8.8% 10.7%
UMH Properties Inc UMH 32.9% 4.6% 37.4%
Verizon VZ 9.2% 3.9% 13.2%
Vanguard Total Bond Index VBTLX 5.7% 2.5% 8.3%
Vanguard Int-term Bond index VBILX 7.2% 2.5% 9.7%
USAA Extended Market Index USMIX 24.0% 1.3% 25.2%
Vanguard Value Index VVIAX 22.5% 2.6% 25.1%

As you can see, no real negative items in the bunch. While the bonds and REITs didn’t light the world on fire, the other stocks really jumped off. The bonds and REITs  will help balance the portfolio out when the stocks have a correction (and we all know a correction is long overdue here).

Overall, I was up 20.1% for the year, which definitely exceeded my expectations. Even with all the bonds and REITs, the overall performance was excellent.

Mr. 39 Months

Roth Conversion for 2019

For some who have been following, you will remember that I did a Roth conversion of $100K at the end of 2018, and it screwed me up a bit. It basically pushed me into a tax bracket where I could not do our annual contribution of $7K each to our Roth IRA. So I managed to switch $100K to Roth, but lost out on the ability to put the normal $14K into it. Sad face, and a kick on me for not knowing what I was doing, here.

Fast forward to the end of 2019,, and I’m studiously looking at the income levels of Mrs. 39 Months and myself, and it looks like we’ll be about $45K under the limit for contributing to our Roth 401K for 2019. So today, I took the opportunity to shift $40K in my Vanguard IRA to my Vanguard Roth IRA. Note that this is a taxable event. Going from an IRA that I contributed in pre-tax and moving it to Roth, where it is supposedly post-tax and non-taxable in the future means having to pay the government their taxes.

Luckily I have other money set aside to pay the taxes on this item. If I didn’t, then I’d have to take out more from the IRA to pay the taxes, and potentially pay a penalty on that money being withdrawn before I hit 59-1/2. It’s a real accounting nightmare, so better to pay the taxes from another account (like a savings account) rather than going through the hassle.

So now we currently have more in our Roth IRAs than in our normal IRAs. The 401Ks we have continue to grow, but both of these are Roth 401Ks, so in essence we should continue to enhance our future tax-free investments.

Its kinda sad that retirement is such a complicated numbers game, but for those of us in the FIRE community, its part of the fun – finding new ways to squirrel away more money and better prepare for the good life.

Mr. 39 Months