Maximizing portfolio return with very low risk - Page 2

Bob_Smith · 11-20-2004, 02:52 PM

Yep, there are two reasons I bought TIPS on the secondary market instead of direct. The primary reason is because I get an inflation adjusted income stream of ~3.2% of my initial capital, instead of the ~2.5% I would have received buying direct. Of course I get commensurately less at maturity, but I need the higher income stream, and prefer not to be exposed to the market risk and brokerage fees I'd have if I were forced to sell a little each year. The second reason is that I can buy and forget about it for ~28 years. At the time one could only lock in for 10 years through Treasury Direct. If neither of those issues were important for me, I'd use Treasury Direct.

brewer12345 · 11-20-2004, 05:08 PM

Quote:

As a potential RE at 48 with wife and 3rd grader son, here is a way that I am thinking of structuring my portfolio to maximize income and minimize risk. Equity in the house is $0.6M, debt is less than $0.2M. Portfolio size is $1.1M, 85% in taxable, 15% in tax-deferred. The objective is to extract $40K of passive income with some amount of risk.

1. 100K 5 yr CD at 5%
2. 100K 4 yr CD at 4%
3. 350K Moneymarket at 3%
4. 60K I-Bonds @3.67%
5. 125K Dividend paying stocks, 5-6 @ 8%
6. 125K Preferred Shares and REIT * @7%
7. 100K Vanguard HY Corporate & ST Bond @4%
8. 100K Vanguard Wellington@4%

Comments?

I think you are making this far too hard. If you look at the safe withdrawal studies on the REHP, you can reasonably assume 4% on your portfolio if it is invested in a model S&P500/T-bill port. Since you are sitting on $1.1 million, that equates to $44k last time I checked. If you spend under a hundred bucks on some portfolio optimization software and get something with better risk-adjusted returns than the model, you are likely to be even safer than the SW study suggests. I'd gues that adding some small caps, commodities, foreign equity and foreign bond to the mix would greatly boost risk adjusted return.

brewer12345 · 11-20-2004, 05:11 PM

Quote:

While we wait for Cut-Throat to get his bond
investing degree *

...............
I had a real good experience yesterday with a new broker. *Had cash that needed to be put to work
(no lazy money). *My old trusted guy *(very stodgy
conservative firm) had nothing to suggest that had appeal. *I called another local guy and in 15 minutes he got the message. *When I went in, he had a big
printout of stuff that pretty much matched what I wanted, all bonds, various yields, pars (premiums and
discounted) call dates etc. *Nice to have a bunch of stuff to chose from. *And, he didn't try to sell me stocks.
Anyway, ended up with a 20 year bond at par, rated
just above the cutoff for investment grade. *Pays 7%
and can't be called for 5 years. *I like it!

John Galt

JG, given your appetite for credit risky assets with high duration (interest rate risk) as well as your eagerness not to pay taxes, I have to wonder why you haven't jumped into some publicly traded limited partnerships. After all, CHC and MMA pay out roughly 7% in tax free income and increase their distributions over time. Lots of other MLPs pay out handsomely, are usually tax deferred, and also increse their payouts over time. Any reason this isn't attractive?

Dante · 11-22-2004, 11:58 AM

Quote:

While we wait for Cut-Throat to get his bond
investing degree

...............
I had a real good experience yesterday with a new broker. Had cash that needed to be put to work
(no lazy money). My old trusted guy (very stodgy
conservative firm) had nothing to suggest that had appeal. I called another local guy and in 15 minutes he got the message. When I went in, he had a big
printout of stuff that pretty much matched what I wanted, all bonds, various yields, pars (premiums and
discounted) call dates etc. Nice to have a bunch of stuff to chose from. And, he didn't try to sell me stocks.
Anyway, ended up with a 20 year bond at par, rated
just above the cutoff for investment grade. Pays 7%
and can't be called for 5 years. I like it!

John Galt

John,

Is this a good bond?

Description:GMAC
Coupon: 7.000%
Maturity: 11/15/2024
Rating: Baa1/BBB- Moody's/Standard& Poor's
Price: 100
Yield: 7.000% To Maturity
Callable 11/15/2009

I am thinking of getting it?

Dante

ESRBob · 11-22-2004, 01:14 PM

Dante,
Yield to Maturity is essentially meaningless on a callable bond: you need to calculate the yield to call as that bond will probably be called in 3 years in 2007. So you are buying a 3-year bond, not a 20 year bond.

Re: your original post -- I think you need a lot more equity in your portfolio to counter inflation and give yourself return. Your fixed income is designed to dampen volatility, not pay real yields that will make your hoped-for 4% SWR come true. To see this, just look at the yields: anything less than 7% (4% SWR +3% assumed inflation) is pretty much guaranteed to under-perform your 4% SWR -- that is fine if it represents up to 40% or so of your portfolio, is laddered and/in shorter duration bonds that you hope to retire and buy something longer when/if bond yields return. But you can't have an average 3-4% nominal yield on an 85% fixed income portfolio and still expect to have your 4% SWR! Nice work if you can get it, but you can't. Same goes for TIPS paying 2% real -- you are planning to take out 4% real (meaning you want to keep the value of your portfolio intact and growing by at least the inflation rate over decades of ER), so how can this work if you have major chunks of the portfolio locked in at 2% real?

Again, if the portfolio is properly diversified, you can do this with a portion (40% or less of total portfolio) in FI, underperforming your SWR and waiting for higher yields, while dampening volatility and giving you safety of principal. But it is a part of a bigger plan, not the whole plan.

If you haven't already, pick up Bernstein's 4 Pillars and study it till you are comfortable. Post any questions from the book you'd like the group to answer.

ESRBob

11-22-2004, 03:07 PM

Hey Dante.............post those questions from
"Four Pillars" after you wake up

BTW, re. your
question about the GMAC bond, That is the EXACT
bond that I just bought, and I shopped hard.

John Galt

wabmester · 11-22-2004, 03:20 PM

If it were me, I would be praying that GM called that bond after 5 years. I've never gone out as far as 20 years on a corporate. But I suppose worst-case would be that Toyota takes over the obligation after they consume GM in 10 years or so....

markplus4 · 11-22-2004, 05:47 PM

Quote:

If it were me, I would be praying that GM called that bond after 5 years. * I've never gone out as far as 20 years on a corporate. * But I suppose worst-case would be that Toyota takes over the obligation after they consume GM in 10 years or so....

I tend to agree. There's a huge lien on GM's future cash flows from their pension obligations & other retirement commitments.

11-22-2004, 08:03 PM

I've thought about these GM obligations a lot. For me, I don't care if they call it or not. A steady 7% is okay by me until I depart this life. Don't intend to touch
the investment. If they do call it after 5 years, then I have made 7% instead of 4.5% on a 5 year CD, in
effect. Also, GM is bigger than a lot of COUNTRIES, so my
confidence in them meeting their obligations is pretty
high.

John Galt

azanon · 11-23-2004, 03:52 AM

As a potential RE at 48 with wife and 3rd grader son, here is a way that I am thinking of structuring my portfolio to maximize income and minimize risk. Equity in the house is $0.6M, debt is less than $0.2M. Portfolio size is $1.1M, 85% in taxable, 15% in tax-deferred. The objective is to extract $40K of passive income with some amount of risk.

1. 100K 5 yr CD at 5%
2. 100K 4 yr CD at 4%
3. 350K Moneymarket at 3%
4. 60K I-Bonds @3.67%
5. 125K Dividend paying stocks, 5-6 @ 8%
6. 125K Preferred Shares and REIT * @7%
7. 100K Vanguard HY Corporate & ST Bond @4%
8. 100K Vanguard Wellington@4%

Comments?

a. *Your house is way too big/expensive for your assets, unless you make 250K/year and you plan on working several more years. * Sell it for one worth 250K (or less if you live in the south).

b. *If the debt is anything but your house mortgage or a low interest student loan, pay it off immediately or as soon as possible with the taxable portion. *You should never have to borrow for anything else again, also.

c. *That's a very low risk portolio that's only maximizing your chance of barely keeping up with inflation. *Anyone retiring that young cant afford to not have a sizable portion in equities unless you have a pile of cash, which you dont. Please consider 110-your age in equities, dividend paying stocks if you must. I recommend growth right now though.

d. *You have several years of work left to safely retire.

Dante · 11-23-2004, 08:16 AM

Quote:

As a potential RE at 48 with wife and 3rd grader son, here is a way that I am thinking of structuring my portfolio to maximize income and minimize risk. Equity in the house is $0.6M, debt is less than $0.2M. Portfolio size is $1.1M, 85% in taxable, 15% in tax-deferred. The objective is to extract $40K of passive income with some amount of risk.

1. 100K 5 yr CD at 5%
2. 100K 4 yr CD at 4%
3. 350K Moneymarket at 3%
4. 60K I-Bonds @3.67%
5. 125K Dividend paying stocks, 5-6 @ 8%
6. 125K Preferred Shares and REIT @7%
7. 100K Vanguard HY Corporate & ST Bond @4%
8. 100K Vanguard Wellington@4%

Comments?

a. Your house is way too big/expensive for your assets, unless you make 250K/year and you plan on working several more years. Sell it for one worth 250K (or less if you live in the south).

Answer: I do make $250K /year , love the house and the neighborhood and would not trade it. It was appraised at $850K 2 years ago. Entry-level new construction here goes for $1.6M so the land value is enormous and appreciation is excellent.

b. If the debt is anything but your house mortgage or a low interest student loan, pay it off immediately or as soon as possible with the taxable portion. You should never have to borrow for anything else again, also.

Answer: The only debt is the home mortgage, 15 years at 5.375% with 13 years to go - gives me a much needed tax break. My federal taxes in the prior years even with deductions (allowable only and not so creative ones) have been in the $75K range.

c. That's a very low risk portolio that's only maximizing your chance of barely keeping up with inflation. Anyone retiring that young cant afford to not have a sizable portion in equities unless you have a pile of cash, which you dont. Please consider 110-your age in equities, dividend paying stocks if you must. I recommend growth right now though.

Answer: That would be 62% of my portfolio - way more than I feel comfortable with. I know that at a theoretical level, inflation considerations are significant but if I look at my own situation, my savings have been growing steadily in spite of the low risk cash equivalent type portfolio - I understand though that that maybe due to compensation increases and frugal lifestyle - I am not able to strip out these effects to really understand the impact of inflation on my own accumulation history.

d. You have several years of work left to safely retire.

Answer: My idea of "retire early" is to get unshackled from the daily 7 to 7 commitment and to do something on my own for supplemental income but mostly to enjoy the time with my 3d grader son.

8)

Dante · 11-23-2004, 08:18 AM

Azanon,

My comments to your earlier remarks are inside the quote box in the post above. I don't know how to separate them out. Sorry.

Dante

ESRBob · 11-23-2004, 10:34 AM

Quote:

Description:GMAC
Coupon: 7.000%
Maturity: 11/15/2024
Rating: Baa1/BBB- *Moody's/Standard& Poor's
Price: 100
Yield: 7.000% To Maturity
Callable 11/15/2009

Dante and John,
My mistake -- the yield to Maturity would be the same as the yield to call on this bond, since it is a new issue. *I was assuming it was a 'used bond' sold at a premium which would make the YTM and YTC different.

7% is tempting, especially given that the rating makes this better than 'good junk'. *The question to ask yourself: would you rather have a diversified portfolio of good junk like the Vanguard High Yield Corporate? *(YTD and 10-year returns both over 7%, yield currently about 5.75%) or possibly another corporate bond fund with ratings and yields around the level of this GMAC bond, , or this single bond?

I remember my Mom was asking me about worldcom bonds a few years back, because it was such a 'good, well-known' company and it yielded so well. *GMAC were the other bonds on Vanguard's Bond Desk database that were showing up around the same yields at that time. *

Not implying that GMAC could be another WorldCom, just that non-diversified credit risk is what you are being payed to take when you own individual less-than-AAA bond issues like this, and sometimes debtors default.

ESRBob

azanon · 11-23-2004, 10:36 AM

I guess i just dont see how one can live in a neighborhood with an 600,000 dollar home, and live off of 40,000/year. * I know i couldnt pull that off. *Not just the maintenance on a house of that size, but the associated utilities, the rich joness around you to keep up with, etc etc.

I apologized if someone addressed this already. I didnt have time to read the whole thread. I just answered you directly with my personal opinion.

For ME, not being sure if i had enough would cause me to be less happy than not getting to see my son as much but knowing I could care for him and my wife without question. I do think an option though is to downsize your standard of living to match 40K/year.
Certainly there are some that live off of that or maybe less. But they dont have 600,000 dollar homes.

Hyperborea · 11-23-2004, 10:56 AM

Quote:

I guess i just dont see how one can live in a neighborhood with an 600,000 dollar home, and live off of 40,000/year. * I know i couldnt pull that off. *Not just the maintenance on a house of that size, but the associated utilities, the rich joness around you to keep up with, etc etc.

It depends where that house is. *Here in Silicon Valley that $600K will buy a nice townhouse that has maybe $600-$900 / year in utilities depending on how high you set the heat and how low you set the air conditioning. *There isn't any pressure from any "Joneses" that you don't create yourself (or that you let a member of your family create for you).

If my home here was paid off then I could easily live on $40K / year.

Quote:

Certainly there are some that live off of that or maybe less. *But they dont have 600,000 dollar homes.

I would suggest that Th is in such a situation. *I don't think his house is quite $600K but then his spending rate is less than $40K so his ratios are similar.

ESRBob · 11-23-2004, 11:00 AM

Dante,
Are you counting your mortgage payment in the 40k annual expenditures you want to make? My way of calculating costs, SWR etc would be that you'd need to cover that along with all other living expenses out of the 4% SWR (unless of course you have part-time income, like I do, to help bridge the gap).

While your mortgage tax break is valuable now during your peak (highest marginal tax bracket) earning years, that will change in ER.

Specifically, you may find you pay little or no federal income tax.

That makes things like home mortgage deduction and municipal bonds a good idea of the past.

We've had other posts on this topic some months back, but it really works. The key is to deduct your home's property taxes and have home office/part-time business deductions. Then you structure your assets so they are yielding less taxable fixed income and more dividends and capital gains (sorry, back to equity holdings again!). Then you sell appreciated assets only as needed and pay the (much lower) capital gains. In fact, if you are in the 10% or 15% income tax bracket (a reasonable goal for ERs), then your capital gains and dividends get taxed at just 5%, (thanky W).

Anyway, just a headsup that the home mortgage thing might not be so attractive, post-ER. If you then look at your assets as if you'd paid off the mortgage in full, (not sure how big yours is), you may start thinking of hanging onto that dreaded job a few more years.

Others may disagree, but I did the math on my situation some years back and came to the conclusion that I should look at the whole picture on a debt-free basis to get a true handle on my situation and financial readiness to ER.

ESRBob

farmerEd · 11-23-2004, 11:04 AM

Quote:

I guess i just dont see how one can live in a neighborhood with an 600,000 dollar home, and live off of 40,000/year. *

I do it just fine in a house that would probably sell for 800-900K. Biggest single expense however is property taxes, and that sucks, but if you live in an expensive house, and its paid off, and even with $8200 year in property taxes, its better than living in a $150K house house, with a $1000 mortgage payment plus property taxes..

Dante · 11-23-2004, 11:35 AM

Quote:

It depends where that house is. Here in Silicon Valley that $600K will buy a nice townhouse that has maybe $600-$900 / year in utilities depending on how high you set the heat and how low you set the air conditioning. There isn't any pressure from any "Joneses" that you don't create yourself (or that you let a member of your family create for you).

If my home here was paid off then I could easily live on $40K / year.

I would suggest that Th is in such a situation. I don't think his house is quite $600K but then his spending rate is less than $40K so his ratios are similar.

Hyperborea,

When you reply to a post (like you did here) how do you break up the quote and respond to specific parts of the quote? I tried to do it with my response to Azanon's post but could not do it.

Dante

Dante · 11-23-2004, 11:48 AM

Quote:

I do it just fine in a house that would probably sell for 800-900K. Biggest single expense however is property taxes, and that sucks, but if you live in an expensive house, and its paid off, and even with $8200 year in property taxes, its better than living in a $150K house house, with a $1000 mortgage payment plus property taxes..

Our house is in that range - it was appraised for refinancing purposes at $850K two years ago. Property tax is pushing $10,000. My mortgage on the house is less than $200K.

Just to be clear ........ my goal is to maximize the portfolio return with very low risk .......not so much to rely on the $40K as my sole source of subsistence.

As I said in my response to Azanon (unfortunately, my answers are embedded in the reply quote to his post), my concept of early retirement is to be free from the need to continue working at a job from 7 AM to 7 PM. I would like to have sufficient cash flow/passive income from the portfolio so that I can be "almost retired" i.e. be self-employed at my own pace. Clearly, we would ratchet down our expenses as much as we can to minimize the need for supplemental income.

My job is that of a business unit general manager with P&L responsibility for a division of a Fortune 500 company and it does not leave me much opportunity for work life balance.

11-20-2004, 02:52 PM	#21
Bob_Smith Full time employment: Posting here. Join Date: Sep 2003 Posts: 902	Re: Maximizing portfolio return with very low risk Yep, there are two reasons I bought TIPS on the secondary market instead of direct. The primary reason is because I get an inflation adjusted income stream of ~3.2% of my initial capital, instead of the ~2.5% I would have received buying direct. Of course I get commensurately less at maturity, but I need the higher income stream, and prefer not to be exposed to the market risk and brokerage fees I'd have if I were forced to sell a little each year. The second reason is that I can buy and forget about it for ~28 years. At the time one could only lock in for 10 years through Treasury Direct. If neither of those issues were important for me, I'd use Treasury Direct.

11-22-2004, 01:14 PM	#25
ESRBob Thinks s/he gets paid by the post Join Date: Mar 2004 Posts: 1,278	Re: Maximizing portfolio return with very low risk Dante, Yield to Maturity is essentially meaningless on a callable bond: you need to calculate the yield to call as that bond will probably be called in 3 years in 2007. So you are buying a 3-year bond, not a 20 year bond. Re: your original post -- I think you need a lot more equity in your portfolio to counter inflation and give yourself return. Your fixed income is designed to dampen volatility, not pay real yields that will make your hoped-for 4% SWR come true. To see this, just look at the yields: anything less than 7% (4% SWR +3% assumed inflation) is pretty much guaranteed to under-perform your 4% SWR -- that is fine if it represents up to 40% or so of your portfolio, is laddered and/in shorter duration bonds that you hope to retire and buy something longer when/if bond yields return. But you can't have an average 3-4% nominal yield on an 85% fixed income portfolio and still expect to have your 4% SWR! Nice work if you can get it, but you can't. Same goes for TIPS paying 2% real -- you are planning to take out 4% real (meaning you want to keep the value of your portfolio intact and growing by at least the inflation rate over decades of ER), so how can this work if you have major chunks of the portfolio locked in at 2% real? Again, if the portfolio is properly diversified, you can do this with a portion (40% or less of total portfolio) in FI, underperforming your SWR and waiting for higher yields, while dampening volatility and giving you safety of principal. But it is a part of a bigger plan, not the whole plan. If you haven't already, pick up Bernstein's 4 Pillars and study it till you are comfortable. Post any questions from the book you'd like the group to answer. ESRBob __________________ ER for 8 years; living off 4.3% of savings (and a few book royalties ;-)

11-22-2004, 03:07 PM	#26
John Galt Guest Posts: n/a	Re: Maximizing portfolio return with very low risk Hey Dante.............post those questions from "Four Pillars" after you wake up BTW, re. your question about the GMAC bond, That is the EXACT bond that I just bought, and I shopped hard. John Galt

11-22-2004, 03:20 PM	#27
wabmester Thinks s/he gets paid by the post Join Date: Dec 2003 Posts: 4,461	Re: Maximizing portfolio return with very low risk If it were me, I would be praying that GM called that bond after 5 years. I've never gone out as far as 20 years on a corporate. But I suppose worst-case would be that Toyota takes over the obligation after they consume GM in 10 years or so....

11-22-2004, 08:03 PM	#29
John Galt Guest Posts: n/a	Re: Maximizing portfolio return with very low risk I've thought about these GM obligations a lot. For me, I don't care if they call it or not. A steady 7% is okay by me until I depart this life. Don't intend to touch the investment. If they do call it after 5 years, then I have made 7% instead of 4.5% on a 5 year CD, in effect. Also, GM is bigger than a lot of COUNTRIES, so my confidence in them meeting their obligations is pretty high. John Galt

11-23-2004, 03:52 AM	#30
azanon Thinks s/he gets paid by the post Join Date: Jul 2004 Posts: 1,505	Re: Maximizing portfolio return with very low risk As a potential RE at 48 with wife and 3rd grader son, here is a way that I am thinking of structuring my portfolio to maximize income and minimize risk. Equity in the house is $0.6M, debt is less than $0.2M. Portfolio size is $1.1M, 85% in taxable, 15% in tax-deferred. The objective is to extract $40K of passive income with some amount of risk. 1. 100K 5 yr CD at 5% 2. 100K 4 yr CD at 4% 3. 350K Moneymarket at 3% 4. 60K I-Bonds @3.67% 5. 125K Dividend paying stocks, 5-6 @ 8% 6. 125K Preferred Shares and REIT * @7% 7. 100K Vanguard HY Corporate & ST Bond @4% 8. 100K Vanguard Wellington@4% Comments? a. Your house is way too big/expensive for your assets, unless you make 250K/year and you plan on working several more years. Sell it for one worth 250K (or less if you live in the south). b. If the debt is anything but your house mortgage or a low interest student loan, pay it off immediately or as soon as possible with the taxable portion. You should never have to borrow for anything else again, also. c. That's a very low risk portolio that's only maximizing your chance of barely keeping up with inflation. Anyone retiring that young cant afford to not have a sizable portion in equities unless you have a pile of cash, which you dont. Please consider 110-your age in equities, dividend paying stocks if you must. I recommend growth right now though. d. *You have several years of work left to safely retire.

11-23-2004, 08:18 AM	#32
Dante Dryer sheet aficionado Join Date: Aug 2004 Posts: 36	Re: Maximizing portfolio return with very low risk Azanon, My comments to your earlier remarks are inside the quote box in the post above. I don't know how to separate them out. Sorry. Dante

11-23-2004, 10:36 AM	#34
azanon Thinks s/he gets paid by the post Join Date: Jul 2004 Posts: 1,505	Re: Maximizing portfolio return with very low risk I guess i just dont see how one can live in a neighborhood with an 600,000 dollar home, and live off of 40,000/year. * I know i couldnt pull that off. *Not just the maintenance on a house of that size, but the associated utilities, the rich joness around you to keep up with, etc etc. I apologized if someone addressed this already. I didnt have time to read the whole thread. I just answered you directly with my personal opinion. For ME, not being sure if i had enough would cause me to be less happy than not getting to see my son as much but knowing I could care for him and my wife without question. I do think an option though is to downsize your standard of living to match 40K/year. Certainly there are some that live off of that or maybe less. But they dont have 600,000 dollar homes.

11-23-2004, 11:00 AM	#36
ESRBob Thinks s/he gets paid by the post Join Date: Mar 2004 Posts: 1,278	Re: Maximizing portfolio return with very low risk Dante, Are you counting your mortgage payment in the 40k annual expenditures you want to make? My way of calculating costs, SWR etc would be that you'd need to cover that along with all other living expenses out of the 4% SWR (unless of course you have part-time income, like I do, to help bridge the gap). While your mortgage tax break is valuable now during your peak (highest marginal tax bracket) earning years, that will change in ER. Specifically, you may find you pay little or no federal income tax. That makes things like home mortgage deduction and municipal bonds a good idea of the past. We've had other posts on this topic some months back, but it really works. The key is to deduct your home's property taxes and have home office/part-time business deductions. Then you structure your assets so they are yielding less taxable fixed income and more dividends and capital gains (sorry, back to equity holdings again!). Then you sell appreciated assets only as needed and pay the (much lower) capital gains. In fact, if you are in the 10% or 15% income tax bracket (a reasonable goal for ERs), then your capital gains and dividends get taxed at just 5%, (thanky W). Anyway, just a headsup that the home mortgage thing might not be so attractive, post-ER. If you then look at your assets as if you'd paid off the mortgage in full, (not sure how big yours is), you may start thinking of hanging onto that dreaded job a few more years. Others may disagree, but I did the math on my situation some years back and came to the conclusion that I should look at the whole picture on a debt-free basis to get a true handle on my situation and financial readiness to ER. ESRBob __________________ ER for 8 years; living off 4.3% of savings (and a few book royalties ;-)