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Old 02-01-2010, 12:28 PM   #41
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So in summary then...nobody really knows do they. I certainly am not ignorant, and I am not trolling here either. I simply wanted to get the pluses and minuses. I think most people have been taught some basic tenants about equities and buy and hold etc. and have chosen to stick with that.
Knows what?
Knows which bonds and stocks will do well and which ones will default? No, no one knows that with certainty.
Knows that lowering your risk while maintaining your return is generally a good idea? Well, I would say almost everyone here knows that
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Old 02-01-2010, 12:28 PM   #42
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With a portfolio with equity etc., you only need to save $1,250,000 in order to get income of $50,000.
But have you received that income over the last ten years?

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Right now the interest is LOW LOW LOW... so if you needed $50,000 CASH to live... well, you have to get that cash... the rate for TIPS is 1.5% to 2%. So, you will need $3,333,333 in TIPS at the lower rate and $2,500,000 at the higher rate to get your $50K. Remember, your inflation amount need to go into your principal so your income goes up with inflation.... you can not spend it...
If I have $3 million in TIPS and inflation is 5%, coupon 1.5%, then in the first year TIPS interest is 45K. But my TIPS are now worth $150,000 more due to the inflation factor, so at the end of the year I have $3,150,000. But to keep up with inflation in year 2, I only need an extra $2,250, because I only need to make inflation on my living expenses, yet I'm making it on my entire savings. So in year 2 my TIPS income is $47,250. At the end of year 2 my TIPS are worth $3,307,500.

So after 2 years I need an extra $2,250 to keep up with inflation on my living expenses, but I've made $307,500 on my inflation factor.

I think with a decent sized all TIPS portfolio and inflation, life is good. With no inflation, the returns are poor, but then if there is no inflation I could probably safely draw down my principal and still be fine.

This is just a hypothetical portfolio for now, but it has me intrigued.

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Remember, your inflation amount need to go into your principal so your income goes up with inflation.... you can not spend it...
I think I can. The current TIPS models all assume people never draw down on the principal, but with high inflation, based on my spreadsheets, it is safe to do as long as there is a decent amount of inflation.

I see no reason for never drawing down the principal. The key is just to have enough money so that you won't outlive your savings. Why die with tons of money in the bank just because it is technically one's principal? I think you have to do a 50+ year spreadsheet under different inflation scenarios and coupon rates to see what I mean. Under high inflation the principal balance becomes huge.
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Old 02-01-2010, 12:32 PM   #43
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Regularly, we see people who invest or plan to invest 100% of their money in cash, gold, stocks, bonds or real estate.

Making concentrated bets can pay off (my portfolio's average rate of return has been 9.57% over the last 10 years and maybe half of those gains can be attributed to a single stock) but it can also end in disaster. If it does, you will be the one lining up at the soup kitchen and no one here will shed a tear. As long as you understand the risks and are comfortable with your bet, you should do what you think is best for you.
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Old 02-01-2010, 12:41 PM   #44
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I hope you appreciate how polite our members have been to you in this thread.
Darn it. I had something to say but I didn't want to ruin the "image" of being polite ...

Truthfully, I never offer my "opinion" on how to invest, as pertaining to your life - your specific situation. Since my own way of investing (along with my DW) has been more "traditional" (e.g. well diversified, and generally held long-term) along with a lifestyle that ensures we can continue to live in the manner we wish, regardless of market flux, our "solution" would be quite boring to the OP's way of thinking.

As for me? If I felt I had a plan that meets my (and my DW's) desires on how to live my life (financially speaking), I need not "validate" that plan with others (especially on a public board).

Simply make the plan, execute the plan, and monitor the plan. In your case I would add one more step - that is being responsible for the plan; it's your life...
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Old 02-01-2010, 12:44 PM   #45
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Well then...I guess I should bow to all of the experts and take my leave
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Old 02-01-2010, 12:45 PM   #46
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I simply wanted to get the pluses and minuses.
I think there are 2 risks you are taking:

(1) During bad periods when a lot of high-risk companies fail many of the companies in the fund will not be able to pay dividends and your 7.5% yield may go down significantly; say to 2-3% or maybe even 0.1%? who knows...

(2) Whatever yield you get is not guaranteed to keep up with inflation, whereas other investments might achieve this via a combination of price appreciation + (likely lower) dividends or via some explicit guarantees (e.g. by government / insurance company)

Overall, you are assuming the markets undervalue high-risk bonds because they will give you higher return/risk ratio. You might be right. Do you have any good reasons as to WHY you think this mispricing it taking place? You don't have to have a reason, but sometimes it helps to have one, so you have to wonder less if you are crazy or rest of the world is... (and sometimes it's the rest of the world that's crazy indeed...)
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Old 02-01-2010, 12:54 PM   #47
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Also, don't forget taxes. They will ensure that you will come out behind if your TIPS are in taxable account.
My hypothetical portfolio assumes the TIPS are all in retirement accounts.
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Old 02-01-2010, 12:56 PM   #48
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Well then...I guess I should bow to all of the experts and take my leave
Hopefully to take time to read the recommended books, think about what people here have said and then return to ask further questions if you have any. You have been to two different boards where there are very smart people giving you essentially the same advice. That should be telling you something.

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Old 02-01-2010, 12:58 PM   #49
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Well then...I guess I should bow to all of the experts and take my leave
A. Why did that sound so much like "Fine, I am going to take my ball and go home!!"

B. You were the one asking for opinions. Don't be upset because you got what you asked for.

You are more than welcome to stick around. Just because the majority don't agree with your method doesn't mean you have to leave.
In any event, what ever allows you to sleep at night is probably the right method for you. A local casino may get you there quicker though
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Old 02-01-2010, 12:58 PM   #50
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FloatingDoc,

I'm going to repeat what some others have said. Hopefully this will help.

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So in summary then...nobody really knows do they.
Nobody really knows what the weather will be, so why should "they" know which ultimate single investment would meet your requirements? But! What many who have studied the American financial markets over the last 80 years know is that for the average investor, a mix of stocks and bonds provide consistent returns over time.

You are asking about a decumulation plan that will generate a set amount of cash annually. Certainly, there are those who have invested in a single investment, and if you have enough up front, a TIPS investment or an annuity can generally provide one with the cash needs you identify.

I said generally, or as economists would say: "all other things being equal." That is, there are risks to consider, as others have mentioned, ASSUMING you will be actively managing your nest egg. You expressed a desire to stop reading and analyzing the best method.

If you are looking for a "set it and forget it," you need to be in a combination of stocks and bonds, or, you need to be paying an adviser to do it for you. But nothing is guaranteed -- except guaranteed investment contracts -- as long as the insurance company remains solvent.

So, it's quite a problem you've presented. As some else said, if you have $3Million available, then TIPS could be used, as long as in your retirement, you don't hit a patch where there is negative interest. So it's a risk. Modern portfolio theory which advocates for asset allocation, says that a combination of assets smooths the risk and the return for the investor.

That's what most on this board believe. Certainly you proved it with your recovery from the 2008 markets. The hard part as you've discovered is deciding what that combination should be.

One poster here advocates for a majority of investment in Wellesley Fund, with another significant portion in a Target Retirement fund, and then some stocks to play around in. He focuses on achieving an SEC yield equal to 3.5-4%, which covers his cash withdrawal.

It works for him -- you have to decide what works for you.

So you see, there are risks to everything.

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Old 02-01-2010, 01:45 PM   #51
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Answer: "I'm not sure, but you do exhibit a number of interesting symptoms".
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Old 02-01-2010, 02:01 PM   #52
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Can someone tell me why it is 100% certain that the dividend will decline with time. ... I will be the first to admit I don't have "the answer" but this seemed as plausible as many others out there
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It isn't.
People are looking at odds.
Who is more at risk of loosing everything, the investor with one stock (or bond) or the investor with 100?
What you are doing very well may work out great for you. But you also have a much better chance of getting hit harder than you would if you were diversified.
In short, you are not investing, you are gambling.
It's not 100% certain that the dividend will decline with time.

But the longer you persist with an undiversified portfolio, the higher the probability that the dividend will decline with time.

It is 100% certain that you're not protected against that probability.

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So in summary then...nobody really knows do they. I certainly am not ignorant, and I am not trolling here either. I simply wanted to get the pluses and minuses. I think most people have been taught some basic tenants about equities and buy and hold etc. and have chosen to stick with that.
We don't know the future, but we know what's worked in the past. Not your blink-of-the-eye fads of the last 20 years, but the last century or so. Past may not be prologue but some defensive techniques have worked well in all market conditions. One of those defensive techniques has been diversification. Another defensive technique has been annuitizing a portion of your income. A third defensive technique has been educating yourself, and a fourth has been staying open to constructive criticism.

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Well then...I guess I should bow to all of the experts and take my leave
Good luck with that... feel free to come on back after you've done some reading.
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Old 02-01-2010, 03:01 PM   #53
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snip...

I see no reason for never drawing down the principal. The key is just to have enough money so that you won't outlive your savings. Why die with tons of money in the bank just because it is technically one's principal? I think you have to do a 50+ year spreadsheet under different inflation scenarios and coupon rates to see what I mean. Under high inflation the principal balance becomes huge.
True... you can draw down from principal... and you can calculate out how much that would be each year with and end date based on a bunch of options... but then you are into an inflation adjusted annuity.. but with TIPS you have an end date.. with an annuity you can not outlive it...

Also, remember your inflation probably will be different than the one used for TIPS.. it might not be enough to worry about, but I doubt it will be the same..

You still did not address the fact that you would have to save more to get the starting income you want.. that could be more than a decade of savings (maybe two)... not someone who wants to RE...
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Old 02-01-2010, 03:43 PM   #54
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Pssst - oh nevermind. I just wanted folks to know I read some of the posts on this thread.

heh heh heh - 1974 50/50 ala Ben Graham's Defensive Investor, 1980 60/40 da policy or traditional pension porfolio, 2006 Target Retirement 2015. Retired at 49 1993 and yes I did own a small % of high yield corporate for a while to boost cash income while nursing my IRA past age 59 1/2.

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Old 02-01-2010, 04:27 PM   #55
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Yes, this is a crazy plan. Here's why.

1) Part of the current yield on a high yield bond goes to compensate for their very high default rate. You can probably expect to lose a couple of percentage points per year averaged over the course of a business cycle in a HY bond fund to defaults. If you're spending the cash flow, you're essentially consuming the portion of your principal lost to defaults. You can see this pretty clearly in a long-term price chart of VWEHX. The fund started at an NAV of $10 in 1979 and is now down to $5.48 (a loss of nearly 2% per year compounded). So in 30 years the principal balance has shrunk by 45%. You can expect something similar over the next 30 years. And assuming a constant yield over the next 30 years, your cash flow will decline along with your principal.
I don't think you can equate NAV price with default rates on the held bonds.
Just like you can't equate the price of gold with the amount gold available.
More likely it has to do with the interest rates at the time being in the
stratosphere (prime rate was around 20%).
TJ
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Old 02-01-2010, 04:31 PM   #56
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The chart shows the Nav OVER THE LAST 20 YEARS to vary between 6 and 8 dollars a share.
The 1989 date probably exaggerates the performance of this asset class. Junk bonds blew up in the late 80s, which is not reflected in that 20 year span (remember Michael Milken and Drexel?). By 1989 (IIRC) they were considered pretty toxic so they would have been near all time lows.
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Old 02-01-2010, 04:47 PM   #57
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Can someone tell me why it is 100% certain that the dividend will decline with time. Silverton 39 motor yacht.
I did.

The reason is that the stated yield of a bond fund assumes that all of the bonds mature according to schedule at par. This is not true of a high yield fund. Bonds default and receive less than par recovery in bankruptcy. This gradually erodes your original principal.

But if the proof of the pudding is in the eating, then you are in for some very slim gruel. Here's what your income stream would have looked like had you invested $1MM in the Vanguard HY fund in 1981 and never sold a share . . . .
Attached Images
File Type: jpg HY.JPG (146.9 KB, 29 views)
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Old 02-01-2010, 04:57 PM   #58
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I don't think you can equate NAV price with default rates on the held bonds.
Just like you can't equate the price of gold with the amount gold available.
More likely it has to do with the interest rates at the time being in the
stratosphere (prime rate was around 20%).
TJ
Yes there is going to be noise year to year but the overall trend for 30 years running is down. And it trends down for a very good reason. Assume you have a portfolio of 10 bonds each with $1,000 face value and an NAV of $10. If one of those bonds defaults and recovers 50 cents on the dollar your NAV goes down to $9.50. That process is going to happen repeatedly. Remember that most HY bonds are issued at par. Someone is buying those par bonds. And a meaningful fraction of those bonds will never pay par back, which means guaranteed principal loss for the market. That loss is presumably compensated for through coupon payments but if you spend all of your coupons, you'll slowly deplete your principal.

This is the price chart for VG HY bond fund. And as you point out, yields were declining during this entire time (which should cause bond prices to go up)
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File Type: gif sg2010020136848.gif (40.7 KB, 16 views)
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Old 02-01-2010, 05:07 PM   #59
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I did.

The reason is that the stated yield of a bond fund assumes that all of the bonds mature according to schedule at par. This is not true of a high yield fund. Bonds default and receive less than par recovery in bankruptcy. This gradually erodes your original principal.

But if the proof of the pudding is in the eating, then you are in for some very slim gruel. Here's what your income stream would have looked like had you invested $1MM in the Vanguard HY fund in 1981 and never sold a share . . . .
You may have just ruined this guy's chance for getting a Darwin Award. Well, for now.

Ha
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Old 02-01-2010, 05:14 PM   #60
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Yes there is going to be noise year to year but the overall trend for 30 years running is down. And it trends down for a very good reason. Assume you have a portfolio of 10 bonds each with $1,000 face value and an NAV of $10. If one of those bonds defaults and recovers 50 cents on the dollar your NAV goes down to $9.50. That process is going to happen repeatedly. Remember that most HY bonds are issued at par. Someone is buying those par bonds. And a meaningful fraction of those bonds will never pay par back, which means guaranteed principal loss for the market. That loss is presumably compensated for through coupon payments but if you spend all of your coupons, you'll slowly deplete your principal.

This is the price chart for VG HY bond fund. And as you point out, yields were declining during this entire time (which should cause bond prices to go up)
Great response and great spreadsheet YrsToGo !
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