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The power of always staying invested
Old 07-21-2013, 11:18 AM   #1
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The power of always staying invested

I was reviewing our progress towards ER and was fascinated by some of the results so I wanted to share some thoughts about why itís imperative to ignore the financial headlines, build an asset allocation plan that works for your situation and stick to that plan.

Disclaimers first: I am 48, my wife is 42; We lived in Canada from 2001 until 2007 and used $435K from the sale of our Canadian house for a down payment on a house in suburban San Francisco; We took a $400K, 15 year mortgage in 2008 and should have it paid off 2018; (We prepay as much as possible). Our plan is to expatriate to Southeast Asia and live off the house proceeds for as many years as possible before using any retirement assets. A small pension that can begin 3 years into the ER should help. So basically we started our retirement plans from scratch in 2007, excluding about $50K left from the house sale (invested in a taxable brokerage account) and about $40K in an IRA Rollover from a previous 401k. We opened up two IRA Roths in 2007 and have maxed out both ever since. (Not everyone will be able to do contribute to a ROTH while participating in an employee sponsored tax-sheltered plan; Hint: The more you contribute to the 401k, the more you lower your taxable income which is what is used as a guideline for the allowance of ROTH contributions.)

Anyway, today I analyzed our total return relative to our total contributions and there are a few points I wanted to stress that will certainly help with ER: I know I sound like an article from Kiplingers but the message bears repeating.

1) Always max out your retirement accounts and ensure you use dollar cost averaging to always invest at different times all year long: My wife started her 403b and 457b in September, 2007, 3 months into the bear market and 18 months ahead of the market bottom and subsequent huge march back up. Our returns are: Contributions: $193,087.29 / Current balance: $251,648.25 Total return: 23.27%. Our asset allocation is at least 40% in diversified fixed income, in ONLY non-passive (managed) mutual funds and a few ETFís. Granted we are very lucky to have Fidelity as the sponsor who offers a wide variety of investment choices; We prefer employment with larger institutions who usually carry the clout to offer better retirement plans.

2) If your company plan has a match, always ensure you get the maximum: Hereís where it gets interesting; My company matches 50 cents on every dollar up to the federal maximum of 6% AND my company contributes 0.5% of annual income into the 401k as a profit sharing bonus every year. I have significantly less investment options but still have quality fund companies like T Rowe Price and TCW (masters of fixed income). I started in January, 2008. Contributions: $70,066.46 / Current balance: $99,376.97 / Total Return: 29.5%. Itís astounding what a difference the company match has made, even with less contributions.

Although my wife makes and contributes double what I do, our combined total return is 25.03% thanks to always staying invested regardless of how bad the markets get or what ridiculous calamity-du- jour occurs. Obviously timing has a lot to do with it because starting 3 retirement plans near the start of a 5 year bull market obviously helps. But that brings me to my third point:

3) If a core investment in your asset allocation hasnít changed fundamentally, donít sell because everyone is heading for the exits: Two examples here: our oldest investment is T Rowe Price Mid Cap Value Fund, which has long since closed to new investors; We own it for 9 years in the IRA Rollover and have purchased 4 blocks of $2500 in í04, 06, í08 and í11, each time using rebalancing options since this account is non-contributory. Iím a huge proponent of US Mid-Cap funds which and always want that asset class as a core component. Looking at the graph on my financial software program, we bought the fund at a NAV of $22.00. It peaked in April í07 with a 65% gain including distributions and then fell as low as a $20.00 NAV, turning 3 years of gains into a -6.0% loss. It then recovered and passed where it was at its peak in Feb, 2011 and is currently sitting at a 90% gain including distributions. Never bail on stocks when most everyone else does because you will most certainly lose the rise back from the bottom. I aim to double the return of an active mutual fund in 8 to 10 years and even with a 47% drop in value during the crisis, staying the course has worked.

We also have some Canadian mutual funds in my wifeís RRSP,the Canadian version of a tax-sheltered plan; Believe me, itís very hard to grow wealth in Canada, mostly due to exorbitant fees and less skilled fund companies; We own a High Income Balanced fund since 2001, consisting mostly of the large banks like CIBC, Royal and TD; This fund is up 123% with no contributions since 2005. If you find an allocation that works, stick with it.

4) Sometimes the bond market is wrong: During the recent global bond market sell off, I made no changes to my fixed income allocation which includes US agencies, GNMAís, intermediate term corporates, emerging markets, and global sovereign funds. I also didnít lower duration despite the fear that bond markets are destined to be crushed due to an immediate start to QE tapering; although most of my bond funds are down for the year, the amazing equity returns have more than made up for the losses which keeps my portfolio with a nice return but significantly less risk than one with more equities. I will eventually lower duration on my core fixed income but rates are not going anywhere until 2015 or later. I did sell my long holding of TIPS when the yields crossed back over into positive territory and took a whopping 12% gain; Imagine that: investors accepting a negative yield based on an unwarranted fear of inevitable runaway inflation due to QE that never happened.

Obviously everyoneís situation is unique and we have some added advantages like no kids (they are expensive). But we live below our means, prepay almost $17,000 a year in addition to maxing out 5 tax-sheltered accounts every year. I believe the key to ER is a strategy of capital preservation and growth; I add value in country specific ETFís like Malaysia (EWM)which fared better than every emerging market ETF during the recent selloff but also returns less over a 10 year period than others with more risk. I hope this advice serves as a boost to anyone thatís on the fence about whether they can afford ER.
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Old 07-21-2013, 01:31 PM   #2
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. . . I also didnít lower duration despite the fear that bond markets are destined to be crushed due to an immediate start to QE tapering; although most of my bond funds are down for the year, the amazing equity returns have more than made up for the losses which keeps my portfolio with a nice return but significantly less risk than one with more equities. I will eventually lower duration on my core fixed income but rates are not going anywhere until 2015 or later.
Hmm. Well, when rates rise, it would seem that the higher rates will negatively impact both bonds (esp longer-term) and equities. So, in that case a LT bond investor who owns equities will have highly correlated assets, and that won't do much to reduce overall fluctuations in portfolio value. And if everyone knows Ben won't be raising rates until 2015, I wonder if everyone will just sell on Jan 2 2015 and those who sell in the afternoon will take a beating. Maybe some folks would prefer to sell on the last day of 2014 to be sure. Or maybe the last month--it seems crazy to wait until the last minute given the paltry yields on these things and risk the big crash in price. So maybe that means sell in early 2014. Maybe it means the owner should sell now.
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Old 07-21-2013, 02:00 PM   #3
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Hmm. Well, when rates rise, it would seem that the higher rates will negatively impact both bonds (esp longer-term) and equities. So, in that case a LT bond investor who owns equities will have highly correlated assets, and that won't do much to reduce overall fluctuations in portfolio value. And if everyone knows Ben won't be raising rates until 2015, I wonder if everyone will just sell on Jan 2 2015 and those who sell in the afternoon will take a beating. Maybe some folks would prefer to sell on the last day of 2014 to be sure. Or maybe the last month--it seems crazy to wait until the last minute given the paltry yields on these things and risk the big crash in price. So maybe that means sell in early 2014. Maybe it means the owner should sell now.
The way I look at this is that all of the "what ifs", expectation for future interest rates, etc, etc, are already priced into the markets. I believe the markets are smarter than I am, so my best option is to stay the course.
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Old 07-21-2013, 02:10 PM   #4
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Itís astounding what a difference the company match has made, even with less contributions.
Yes, that's pretty obvious.
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Old 07-21-2013, 02:13 PM   #5
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Hmm. Well, when rates rise, it would seem that the higher rates will negatively impact both bonds (esp longer-term) and equities. So, in that case a LT bond investor who owns equities will have highly correlated assets, and that won't do much to reduce overall fluctuations in portfolio value. And if everyone knows Ben won't be raising rates until 2015, I wonder if everyone will just sell on Jan 2 2015 and those who sell in the afternoon will take a beating. Maybe some folks would prefer to sell on the last day of 2014 to be sure. Or maybe the last month--it seems crazy to wait until the last minute given the paltry yields on these things and risk the big crash in price. So maybe that means sell in early 2014. Maybe it means the owner should sell now.
I'm selling my bond funds very soon and not waiting until the last minute of 2014.
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Old 07-21-2013, 03:18 PM   #6
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The way I look at this is that all of the "what ifs", expectation for future interest rates, etc, etc, are already priced into the markets. I believe the markets are smarter than I am, so my best option is to stay the course.
I'll even take that one step further. The bond market has priced in the start of QE tapering and possibly even the first rise in rates. They started doing this a few months back before the huge sell off in global bonds. I don't deny that duration will need to come down in any properly balanced portfolio in the future. I don't see how selling all your fixes income investments would help anyone with ER. Where would you put the proceeds? When rates rise it will be very slow and gradual; bit enough to dump bonds and go back to CD's or money markets. I will stick to my guns when I say that every diversified portfolio needs fixed income of some sort unless you enjoy watching 47% of your retirement disappear after the next calamity which will happen again in most of our lifetimes.
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Old 07-21-2013, 03:29 PM   #7
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I'm selling my bond funds very soon and not waiting until the last minute of 2014.
I'm curious what you plan on doing with all the proceeds from your bond funds in 2014? Do you intend to be fully invested in equities? Not all fixed income gets clobbered when rates rise. GNMA'a have negative convexity to help ease the losses ; you can buy funds that are in local currency and protect against a falling USD and you can own funds that hold triple A sovereign debt in countries whose central bank has not engaged in zero rate interest policies for 5 years. And finally, one of the beat options in a rising interest rate environment is a floating rate short duration fund where most issues reset to LIBOR quarterly. Even bank loans are less subject to interest rate risk. Abandoning fixes income outright seems like a poor option to me. Bonds have been on a long bull thanks to world monetary policies that are forces to change post crisis. One needs to adjust for the next 20 or 30 years and not listen to the media warning about how much money you will lose if you keep any fixed income
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Old 07-21-2013, 05:39 PM   #8
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The way I look at this is that all of the "what ifs", expectation for future interest rates, etc, etc, are already priced into the markets. I believe the markets are smarter than I am, so my best option is to stay the course.
I'm generally on this same wavelength. But on the subject of interest rates, I think non-market forces are at work (i.e. government policy) and I'm not confident in the market's ability to correctly price this. I could be wrong, but given the present rate environment, I just don't think the risk/reward ratio of holding long term debt is very favorable.
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Old 07-21-2013, 11:18 PM   #9
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I'm curious what you plan on doing with all the proceeds from your bond funds in 2014? Do you intend to be fully invested in equities? Not all fixed income gets clobbered when rates rise. GNMA'a have negative convexity to help ease the losses ; you can buy funds that are in local currency and protect against a falling USD and you can own funds that hold triple A sovereign debt in countries whose central bank has not engaged in zero rate interest policies for 5 years. And finally, one of the beat options in a rising interest rate environment is a floating rate short duration fund where most issues reset to LIBOR quarterly. Even bank loans are less subject to interest rate risk. Abandoning fixes income outright seems like a poor option to me. Bonds have been on a long bull thanks to world monetary policies that are forces to change post crisis. One needs to adjust for the next 20 or 30 years and not listen to the media warning about how much money you will lose if you keep any fixed income
1. I am in the process of liquidating the bond funds only and taking profits (IRA accounts). I have not thought through what I will reinvest that money into.

2. I have several individual bonds bought at Schwab in 2008 - 09 that are YTM around 4% that mature in 2015 (IRA account). These will not be touched, obviously.

3. My other fixed income consists of several 10's of thousands of 2.4% CD's at Ally (taxable) and cash at same bank. Cash is enough for 3 years living expenses. I am near the FDIC insured limit at Ally.

4. I will stay being long total stock market ETF's in Schwab and Vanguard going forward with current IRA fund, not including the cash from the sale of the bond funds. I know this is risky, but I am not going to watch the NAV of the bond funds take a big hit when rates rise.

5. I am pretty well diversified with two houses paid for and no debt. I got that way being cautious and conservative over the years, especially after a huge hit I took 20 years ago in a very expensive California divorce.

There is no perfect portfolio and we all have different situations. At my age (over 60+), we will be good for the long run. I can't predict the market, interest rate moves, or the economy, so I just try to stay diversified. I will have more time to "watch the store" this October when I leave the workforce permanently.
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Old 07-22-2013, 07:03 AM   #10
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The way I look at this is that all of the "what ifs", expectation for future interest rates, etc, etc, are already priced into the markets. I believe the markets are smarter than I am, so my best option is to stay the course.
+1 I feel sometimes that the only places left where there is any "truth" is the markets and sports statistics.
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