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Take some volatility risk off table?
Old 12-03-2013, 10:44 AM   #1
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Take some volatility risk off table?

Wife and I are 56 years old. We retired this year. I worry about inflation risk. My wife is more concerned with volatility risk.

We both agree about our rule of thumb: a conservative investor = age in fixed income; moderate = age-10; aggressive = age -20.

I'm extremely worried about the fact that our fixed income allocation has a negative real return = -0.9%. IMHO, this must be compensated with an aggressive allocation of 65% stocks.

My wife is more worried about a sequence of bad stock market returns forcing us to lower our annual withdrawals in the future. She wants 45% in stocks.

Should we go to 55% stocks?

A little background on us. We are not US citizens or residents. No future pension. We own our very luxurious home free and clear. It makes up 25-30% of our total net worth. We bought it in 2000. It has gone up 300% in nominal US$. We are in the top 1% here according to net worth. In the USA we'd be in the top 5%.

Our country, Costa Rica, used to be very inexpensive. It is now VERY expensive. More expensive than most parts of the USA.

We have 4 children living with us ages 27, 24, 19, and 17. This is common with many young people here. Average wages here are LOW. About 1/6th of average USA wages. The two oldest work. The two youngest are still in school.
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AA = 60/35/5. Expected CAGR = 5.7%. GSD (5y) = 7.8%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.5%. Net Port Yield = 1.7%. Term = 36 yr. FI Duration = 4.9 yr. Portfolio survival probability = 86%.
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Old 12-03-2013, 11:41 AM   #2
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You sound like you have given much thought to the subject, and I suspect you will come to the appropriate compromise between you and your spouse.

Without knowing more about your situation it's hard to give you specific advice. It would be helpful to know what percentage of your savings you plan to withdraw every year. If you are hoping to withdraw 4% or greater, you will need a reasonable amount of exposure to equities. If you need to withdraw 2% or less, you can get by with a very modest exposure.
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Old 12-03-2013, 12:03 PM   #3
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Hey, galeno. DW and I are 40 and I will pull the plug next year. I am trying hard to keep my equity allocation up to 65% for the long term, since I think lower allocations are asking for trouble given the inflation risk and the poor outlook for fixed income. However, I am keenly aware that as a newly minted bum I am exposed to sequence of returns risk in a major way. I struggle with the idea of buying puts or VIX calls since I think that both are likely to be money thrown away over the long term, but I have not entirely rejected the idea. A hedge may be an option for you to mitigate volatility risk concerns.

On the fixed income side, I share your concerns and I have been trying to mitigate them as best I can. I don't own much in the way of traditional US index bond funds. Instead, I have parcelled out my FI allocation to cash, merger arnitrage funds (ARBFX and MERFX), foreign bond funds (GIM is my current choice here), I bonds (not available to non-USians I believe), and US bank and credit union CDs. I also have been trying to dumpster dive in heavily discounted bond closed end funds, but without much success lately. I assume you cannot buy US bank or credit union CDs?

Would you consider relocating to somewhere other than Costa Rica to escape the expense? Colorado has now legalized weed.
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Old 12-03-2013, 12:23 PM   #4
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How's the rental real estate market down there? I suspect you could get a very good return buying and renting out upscale apartments to recent US retirees like me and my wife. Since the wage scale is so low in CR, you could farm out maintenance and management chores, making it more of a passive investment.

My cousin and her husband (former Peace Corps volunteers) have done very well catering to the tourist trade in Antigua, Guatemala, over the years. Seems like the rise in the COLA in Costa Rica may have something to do with the influx of foreign money. Ride the rising tide, perhaps.
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Old 12-03-2013, 01:21 PM   #5
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@Ready. Our port info = my signature.

@Brewer12345. Be careful with those bond funds. They can be as volatile as stocks.

Our current 35% FI allocation = 20% cash (2%MMF + 18% CD ladder in USA FDIC insured banks) + 15% offshore bond funds (PTTAX and PAIIX).

USA FDIC insured bank accounts and offshore funds are the only exceptions to the 30% USA NRA taxes we have to pay on all interest and dividend income.

@Mr._Graybeard. Real estate is ridiculously expensive in Costa Rica. IMHO it's far smarter to rent vs owning. E.g. we could maybe rent our home for 2-3% gross rental revenue. It's not worth it.

My wife, like all Costa Ricans, LOVES real estate. Her 107 year old grandmother made a fortune on it. She already gave a lot of it to our 4 kids and their 4 first cousins in a trust fund that cannot be touched until she dies. I HATE real estate. To me, it's not an investment. It's a job.

I think my kids should sell it when she dies and put the money to better use. 99.9% of Costa Ricans are terrified of the stock market. My immediate family understands my investment philosophy. The rest of the family thinks it's crazy.
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AA = 60/35/5. Expected CAGR = 5.7%. GSD (5y) = 7.8%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.5%. Net Port Yield = 1.7%. Term = 36 yr. FI Duration = 4.9 yr. Portfolio survival probability = 86%.
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Old 12-03-2013, 01:27 PM   #6
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@Brewer12345. Be careful with those bond funds. They can be as volatile as stocks.

Our current 35% FI allocation = 20% cash (2%MMF + 18% CD ladder in USA FDIC insured banks) + 15% offshore bond funds (PTTAX and PAIIX).

USA FDIC insured bank accounts and offshore funds are the only exceptions to the 30% USA NRA taxes we have to pay on all interest and dividend income.
Foreigh bonds tend to have low correlations with US equities and fixed income, which is the reason I like them as a portfolio component. I think highly of the people who manage GIM, so I am happy to buy at a discount to NAV.

I am about 30% in fixed income. Including the foreign bond fund, only half is market sensitive (i.e. mark to market like a bond fund), the rest is in instruments like a CD that accrue interest and can be withdrawn at book value (possibly with a small penalty). Given the chance totake some profits at what I would consider an attractive price, I would further reduce my bond fund exposure.
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Old 12-03-2013, 03:19 PM   #7
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@Brewer12345. As long as you understand and accept the risk of those bond funds you'll be ok.

I used the USA onshore version of GIM in the mid 1990s. The problem was the 30% US-NRA tax. E.g. ER = 0.72%. Distribution rate = 5.17%. TR = 1.55%. So TER = 2.27%. Outrageous!

Templeton has an offshore "total return fund": TER = 1.40%. PIMCO's version costs 0.85%. That's the cheapest bond fund available to us so that's what we use. We also use a PIMCO "world bond fund" that costs 0.99%.

If we were LEGAL USA residents or citizens, our bond allocation would be 50% BND + 50% BNDX. Offshore PTTAX + PAIIX is our version of BND + BNDX. Oh well.
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AA = 60/35/5. Expected CAGR = 5.7%. GSD (5y) = 7.8%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.5%. Net Port Yield = 1.7%. Term = 36 yr. FI Duration = 4.9 yr. Portfolio survival probability = 86%.
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Foreigh Bond Fund Placement
Old 12-03-2013, 07:38 PM   #8
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Foreigh Bond Fund Placement

Quote:
Originally Posted by brewer12345 View Post
Foreigh bonds tend to have low correlations with US equities and fixed income, which is the reason I like them as a portfolio component. I think highly of the people who manage GIM, so I am happy to buy at a discount to NAV....
Brewer,

For US based investors, where do you keep foreign bond funds? Taxable, tax sheltered/deferred, some split?

Apologies for derailing from original discussion; but, this did not seem worthy of its own thread.
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Old 12-03-2013, 07:56 PM   #9
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Brewer,

For US based investors, where do you keep foreign bond funds? Taxable, tax sheltered/deferred, some split?

Apologies for derailing from original discussion; but, this did not seem worthy of its own thread.
These are not tax efficient investments, so tax deferred is best. I have some in a taxable account, but it is a small position there.
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Old 12-03-2013, 08:14 PM   #10
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...My wife is more worried about a sequence of bad stock market returns forcing us to lower our annual withdrawals in the future. She wants 45% in stocks.

Should we go to 55% stocks?
Keeping in mind that most SWR studies have been done using the S&P 500 & the US Bond market index....

SWR studies show that there isn't much difference in success rates from 40% to 70% in equity allocations for any given withdrawal rate. If you choose 65% and equities do well, you'll think you're a genius. If they don't, DW will think she's the genius.

If it were up to me, I'd just split the difference and try to stop worrying about it. On the bond side, my longest bond funds of "intermediate" duration. (I don't have the knowledge (or interest to learn) to participate in sophisticated strategies/allocations like Brewers)

Personally, I plan to use my mental energies to maintain the AA through the good times & bad.
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Old 12-03-2013, 11:37 PM   #11
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It all boils down to eat well vs sleep well i.e. greed vs fear. It's true that SWR success rates are very similar for 40-70% stock allocations. My greed glands look at the terminal values.
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AA = 60/35/5. Expected CAGR = 5.7%. GSD (5y) = 7.8%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.5%. Net Port Yield = 1.7%. Term = 36 yr. FI Duration = 4.9 yr. Portfolio survival probability = 86%.
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Old 12-04-2013, 10:45 AM   #12
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It all boils down to eat well vs sleep well i.e. greed vs fear. It's true that SWR success rates are very similar for 40-70% stock allocations. My greed glands look at the terminal values.
Are you planning to take it with you?
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Old 12-04-2013, 01:05 PM   #13
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Be careful with those bond funds. They can be as volatile as stocks.
Short term maybe, but how would they be as volatile as stocks long term?

Inferior returns yes, negative real returns while interest rates rise yes, but the value and return on bond funds is way more predictable (for a given duration and interest rate delta) than stock funds.
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Old 12-04-2013, 01:12 PM   #14
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Bonds are significantly less volatile than stocks. Standard deviation for domestic equity is probably in the range of 18-20 and for a US bond portfolio probably mid single digits.
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Old 12-04-2013, 02:54 PM   #15
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We have four kids. What's left will go to them. Wife and her sis will soon sign the trust that passes two properties to our four kids and their four first cousins.nMy oldest thinks this will amount to $250K per kid. I'm thinking more like half that.

Regarding the GSD of bonds. Are we talking short to intermediate term investment grade bonds or junk bonds leveraged and "derivatized" to the max?

Junk bonds are like stocks. Michael Milken taught me that.
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AA = 60/35/5. Expected CAGR = 5.7%. GSD (5y) = 7.8%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.5%. Net Port Yield = 1.7%. Term = 36 yr. FI Duration = 4.9 yr. Portfolio survival probability = 86%.
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Old 12-04-2013, 02:59 PM   #16
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Junk bonds are like stocks. Michael Milken taught me that.
Junk bonds are also one of the easiest markets I know of to time. This has a lot to do with how these bonds are issued, bought, financed and managed. At the moment, I would not own any junk except the shortest, highest quality coupon-clipping stuff. Take a look where we are vs. historical spreads: BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread (BAMLH0A0HYM2) - FRED - St. Louis Fed
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Old 12-04-2013, 05:38 PM   #17
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One way to take away volatility is thru an annuity- many don't like them but they have a place in many plans. Certainly not for all assets, but to create a floor of income it can't be beat.
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Old 12-04-2013, 07:15 PM   #18
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I build retirement plans that work, even when the markets tank, from high yield guaranteed income sources.
Nice sig.

"Guaranteed" eh? In a thread discussing stock investments and asset allocation... Bernie, izzat you?

Is that a variable indexed annuity in your pocket, or are you just happy to see me?
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Old 12-04-2013, 07:54 PM   #19
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Nice sig.

"Guaranteed" eh? In a thread discussing stock investments and asset allocation... Bernie, izzat you?

Is that a variable indexed annuity in your pocket, or are you just happy to see me?
I think that is the mating call of the annuity salesman.
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Old 12-04-2013, 08:14 PM   #20
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I think that is the mating call of the annuity salesman.
I think I've seen those in this neighborhood before. I understand that after attempting to mate, they silently pass away within a few hours. Ah, the Circle of Life...
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