The best strategy in theory might not be the best strategy for you. How can this be?
Harvard’s Endowment has been making headlines recently due to its $2 billion investment loss in the fiscal year 2016. And the Crimson (the student newspaper) is up in arms about this “unacceptable” loss.
From their article The Urgency of the Present come the following gems:
Harvard Management Company announced a $2 billion loss for the fiscal year 2016.
Let’s not mince words: this is unacceptable.
Now, a $2 billion losses certainly catches attention and grabs some headlines, but it’s only a major loss in dollar terms. Because of the endowment’s size (a good thing for Harvard) it’s not a major loss in percentage terms as the paper admits:
“…help to bridge this small (in percentage terms) loss.”
The editorial continues with some advice of sorts:
“We also recognize that we are not investment advisors. College students have no business telling seasoned analysts and managers where to invest the endowment. Instead, we wish to urge the administration to prioritize endowment performance before Harvard falls further behind peer institutions.”
From my vantage point this is a case study on how NOT to evaluate your investment performance. Let’s take a look at what we can learn from this example.
During the First World War, Britain had the greatest Navy ever assembled in world history. And yet, through most of the war, it used its Naval superiority to play defense, not offense.
Dan Carlin in his excellent podcast Hardcore History describes the situation as follows:
“The opportunity was there for the numerically superior British fleet to apply their numbers and kick German tail, but the problem was Naval outcomes were quite variable. One lucky punch could turn the tables and in this case, remove the British numeral advantage.”
He continues, quoting Winston Churchill directly:
“The great disparity of the results at stake in a battle between the British and Germany navies can never be excluded from our thoughts.”
This “great disparity of the results” and the quite variable outcomes could produce a major victory, but it could also produce an unacceptable outcome. Again to quote Churchill:
“The chance of that happening [a British loss] may not be great, but if that happens, it could cost us the whole war.”
The strategy was to stay alive and play the long game—Not to make some grand, heroic strike.
You should apply a similar strategy with investing as well.
After starting the year down around 10%, markets have rallied since early February (including the June Brexit blip) and through the third quarter global equities are up 6.6% for the year. But, the question on everyone’s mind is: will this continue? With an election looming five weeks away, many are expecting market volatility to pick up. And everyone is wondering what impact the election of a new president will have on their portfolio.
“To attain knowledge, add things everyday. To attain wisdom, remove things every day.”
― Lao Tzu
One of the wonders of the modern world is our access to information. The answer to (or at least someone’s opinion on) every question under the sun is right at our fingertips, just a google search away.
But this limitless information and the apparently continuous increase in the pace of modern life presents a challenge for investors. Additional data at an ever faster pace create more decisions and tempt one to increase their activity. But with investing, the quality of decisions matters more than the pace.
Recently on the blog we’ve looked at a few key decisions anyone retiring from Intel must make once they stop working. We saw how to generate a paycheck via a rebalancing process and learned how ‘withdrawal order’—a seemingly simple change—can have major ramifications on your ending wealth and the amount of taxes you end up paying. Another key decision those leaving Intel must make is what to do with their pension benefit.
We’ve outlined before how the Intel minimum pension plan works. But, here we want to break down the decision that comes at retirement: should you take the monthly pension income benefit or a lump sum withdrawal from the plan?
Like so many decisions with wealth management, this is an individual decision that must be made in light of one’s goals, objectives, other assets and income sources, and risk tolerance. There is no global rule. Option A or B isn’t always optimal. The monthly income isn’t the best choice in all cases and neither is the lump sum. There are advantages and disadvantages to either option. The key is making this decision in light of your personal situation.
The remainder of this post will highlight the key decision criteria to weigh when making the pension decision with the goal of optimizing the result for your specific situation.
How much can I spend in retirement? For many, that’s the million-dollar question – literally.
The first step taken of any retirement planning should be developing a baseline financial plan, and understanding the appropriate withdrawal rate is paramount to this process. During the early stages of plan development for our clients, we often get questions about the 4% withdrawal rule and how it applies to their situation. The popular financial “rule of thumb” was the result of research done in 1994 by a financial planner and MIT grad, Bill Bengen, and produced what is now known as the 4% Withdrawal Rule.
Trying to do right by his clients, Mr. Bengen sought out to produce something that wasn’t yet available – a framework for providing guidance that was rooted in research and data. Here’s what he came up with – a “rule of thumb” that posits that retirees who withdraw 4% of their initial portfolio at retirement, and then adjust that amount for inflation, can sustain that spending amount for 30 years and not outlive their money. The research assumed the retirees’ portfolio consisted of an equal mix of stocks and bonds (S&P 500 & Intermediate Government Bonds) and was rebalanced annually. From there, he tested every rolling 30-year period dating back to 1926 to determine the maximum withdrawal rate that would survive all periods. For that time period, the worst-case scenario in U.S. history produced a 4.15% withdrawal rate. Thus, the 4% rule was born.
Words of caution - Oversimplification
When it comes time to make the decision on retirement, and answering the ultimate question of, “Do I have enough?”, using the 4% Rule to help answer that question is a decent starting point. However, for a variety of reasons, we caution against blindly accepting this rule and applying to your situation.
Ask anyone off the street to name a great investor and chances are you'll hear Warren Buffett---often held up as the paragon of investing success. But what if I told you he spent more time underperforming the market than he did beating it?
According to Eric Crittenden at Longboard Asset Management this is exactly the case. Based on their research, over the last thirty years, Buffett's Berkshire Hathaway has underperformed the market a little more than half the time.
And it’s not just Buffett’s performance either that frequently lags. Crittenden found this same phenomenon among other successful investors.
Last time we looked at how to generate a paycheck from your investment accounts. Getting money out of your portfolio is important, but just as important is knowing from which account to pull the funds as most retirees are going to have some mix of taxable, tax-deferred (IRA, 401(k), etc.), and tax-free (Roth IRA) accounts at retirement.
For many retiring from Intel, or simply leaving to pursue other opportunities, one of their primary questions is: how do I get a paycheck now that it’s not coming from Intel? I still need to pay bills, buy groceries, etc., so, how do I fund my bank account?
For most, it means a transition from accumulating assets (contributing to the 401k, deferring income from bonuses, etc.) to supporting your spending from the portfolio you've built. Getting a paycheck from your investments can be done in two ways: 1) By spending investment income (interest and dividends) as you earn it—called an Income Approach or, 2) Through a rebalancing process on your broadly diversified portfolio—known as a Total Return Approach.
The Income Approach is simple to setup and execute but has significant drawbacks. Let’s find out what they are and learn the key to generating a paycheck from your investments via a Total Return approach.