Yields

[clifp]

For me it's the simple fact that I have a very low return bogie to hit . . . my WR. If an asset is up 100%, as many were over the past two years, I can lock in many, many years of withdrawals without needing to take any additional risk. It becomes a pretty simple sell decision when your investment objective isn't to maximize returns, but simply to beat a fairly low hurdle rate.

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Interesting philosophy and probably completely consistent with a total return investing.

As income investors this bothers me a bit. So for example if my desired WR is 3.5% but my actual income from my portfolio is only 2.8% due to primarily to horrible cash returns. One way of looking at my spending is that is 20% higher than my income (almost as bad as Uncle Sam).

The other way is saying I'm only dipping into my principal by .7% and even after 30 years it is only 20-25% decline not a big deal.

Of course if 2.125% TIPs coupon covers your withdrawal needs than you must have a lot of assets or nice pensions.

 

[rescueme]

It becomes a pretty simple sell decision when your investment objective isn't to maximize returns, but simply to beat a fairly low hurdle rate.

For me, that's just another advantage of retirement. If you've hit "your number", you don't need to maximize returns, nor take the risk to do so.

It's better to concentrate on retirement cash flow and ensure that your cash bucket contents are sufficient to get you over the gaps in the market (be it equity or bonds) to ensure that cash flow.

 

[Gone4Good]

So I have some gains from fixed... now what?

Part of the point is by focusing on the right target (earning my WR over the long-term) I don't feel presured to chase short-term returns. Sitting on gains, I don't need to find another winner right away. I have plenty of time, a decade in fact. So 'now what' can very easily be to sit and wait in Ally CDs or something similar. It can also mean changing asset classes altogether, like buying another rental property, which is currently on my radar.

These decisions are a lot easier when evaluated against a specific return threshold. My goal isn't to beat some hypothetical buy-hold-and-rebalance portfolio. My goal is to earn my WR over the long-term and minimize my risk of coming up short. Taking risk off the table when risky assets are priced to return less than my WR is a no brainer as far as I'm concerned.

At the very least it is worth asking the question: "If I'm planning on withdrawing 4% real from my portfolio every year, how can it be a good idea to have 50% of that portfolio invested in the Total Bond Market index, when that fund promises real returns of just 0.5% and nominal returns of 2.35%?"

 

[Chuckanut]

WR? Oh, withdrawal rate!

 

[chinaco]

Part of the point is by focusing on the right target (earning my WR over the long-term) I don't feel presured to chase short-term returns. Sitting on gains, I don't need to find another winner right away. I have plenty of time. So 'now what' can very easily be to sit and wait in Ally CDs or something similar. It can also mean changing asset classes altogether, like buying another rental property, which is currently on my radar.

These decisions are a lot easier when evaluated against a specific return threshold. My goal isn't to beat some hypothetical buy-hold-and-rebalance portfolio. My goal is to earn my WR over the long-term and minimize my risk of coming up short. Taking risk off the table when risky assets are priced to return less than my WR is a no brainer as far as I'm concerned.

I agree with you. I am not going to chase yield on fixed.

My comment was partly rhetorical and partly the question I am wrestling with.

Those low penalty 5 year CDs look pretty good at this point.

 

[Gone4Good]

The other way is saying I'm only dipping into my principal by .7% and even after 30 years it is only 20-25% decline not a big deal.

I'm not sure I agree.

Does a 41% gain in value immediately become 'principal' that is now sequestered in a 'do not touch' silo? I'd say that gain is nothing more than a giant advance on future coupons. If I were to hold those bonds till maturity, eventually that gain depreciates away. All I get back is 100 cents on the dollar, not 141. So if you view a $141 premium bond as your 'principal', you can't consume the entire coupon anyway without consuming $41 in 'principal' along the way. Basically you'd be limited to drawing the yield to maturity, which in the case of those 30-yr TIPS was 0.86% real when I sold them. Not good enough, IMO.

My choice is to lock in that $41 and either redeploy it to something that meets my WR target or, failing that, to live on those 'coupon advances' while I wait for opportunities that meet my withdrawal threshold.

 

[Chuckanut]

That seems to be an ongoing problem with bonds - the capital gains dissappear as the bond approaches maturity. I know of no way around this problem, except to sell the bond, lock in the gain, and then, reinvest it. Of course, the gain is usually caused because rates have gone down, so reinvesting means earning less on your original investment. Right?

 

[Gone4Good]

That seems to be an ongoing problem with bonds - the capital gains dissappear as the bond approaches maturity. I know of no way around this problem, except to sell the bond, lock in the gain, and then, reinvest it. Of course, the gain is usually caused because rates have gone down, so reinvesting means earning less on your original investment. Right?

Basically, yes. Although I'm not advocating selling bonds that I view to be poor investment risks and reinvesting those proceeds in the same market.

There are a several threads running through my thoughts:

1) The current environment of negative real yields is not normal, and likely not sustainable.
2) Because of capital appreciation in the bond market, I don't have to play in that market for years. Cash is just fine when incorporated with the returns I've already banked.
3) Locking in long-term fixed rates of return far below my withdrawal rate is counterproductive to my goals.
4) Near zero duration, low break-fee CDs offer cash-like flexibility with far better yields than bonds or cash. They offer a low-risk place to park fixed income gains while waitng for yields to normalize.
5) A fixed asset allocation may lead you astray if it prevents you from considering other investment alternatives that offer above WR returns . . . rental properties, for example.
6) This is a marathon, not a sprint. Next year's returns are not terribly relevant. What is relevant is whether my returns exceed my withdrawal rate over the next several decades. Current long-term bond yields give me very little chance of doing that; so I wait.

 

[clifp]

I'm not sure I agree.

Does a 41% gain in value immediately become 'principal' that is now sequestered in a 'do not touch' silo? I'd say that gain is nothing more than a giant advance on future coupons. If I were to hold those bonds till maturity, eventually that gain depreciates away. All I get back is 100 cents on the dollar, not 141. So if you view a $141 premium bond as your 'principal', you can't consume the entire coupon anyway without consuming $41 in 'principal' along the way. Basically you'd be limited to drawing the yield to maturity, which in the case of those 30-yr TIPS was 0.86% real when I sold them. Not good enough, IMO.

My choice is to lock in that $41 and either redeploy it to something that meets my WR target or, failing that, to live on those 'coupon advances' while I wait for opportunities that meet my withdrawal threshold.

Ah the light bulb goes on. You are simply taking the profits now instead of collecting the coupons in the future. It also sounds like <1% is below even your WR.

Of course this begs the question of where do you put the money now, since the bond market isn't favorable, and cash pays absolutely nothing. I guess CD's despite the pathetic rates unless you are willing to up your AA.

I guess somebody needs to write a book. How to retire in a deflationary environment even if you fear inflation is just around the corner.

 

[Chuckanut]

3) Locking in long-term fixed rates of return far below my withdrawal rate is counterproductive to my goals.

6) This is a marathon, not a sprint. Next year's returns are not terribly relevant. What is relevant is whether my returns exceed my withdrawal rate over the next several decades. Current long-term bond yields give me very little chance of doing that; so I wait.

Bingo! The same thoughts keep bouncing around in my mind.

 

[Gone4Good]

Of course this begs the question of where do you put the money now, since the bond market isn't favorable, and cash pays absolutely nothing. I guess CD's despite the pathetic rates unless you are willing to up your AA.

I earn 1% on cash and can still get 2.25% in CDs. Nothing great, but risk to my principal is zero with these. The 30-yr TIPS I sold promise 0.86% real and carry considerable risk to my principal. In fact, held to maturity, I'm guaranteed a 29% depreciation in price.

Let's say I'm targeting 2% real (just for laughs) on my original $1,000 investment, and let's assume that inflation comes in at current market expectations. For simplicity we'll assume that I'll be able to reinvest at 2.25% nominal forever. Lots of assumptions, I know, but my downside risk to each of these assumptions is pretty small. If rates rise, I can break my CD at minimal cost. If my reinvestment rate is lower, inflation is probably lower too, which makes my primary goal of not outliving my money easier to achieve.

With these assumptions in palce, I can sell the $1,410 TIPS I own, plunk that money in CDs, and basically draw 2% real for 21 years before my principal drops below the inflation adjusted value of my original investment ($1,000). Said another way, I can hit my target rate, with minimal risk, for 21 years while I wait for interest rates to rise again. (If rates fall to zero after my CD matures, I still have another 6 years - 11 in total - before I start consuming my original investment. If inflation spikes, interest rates will too, and I'll be out of my CDs.)

Considering my view that negative real rates are not something that can be sustained in the long-term, I'm pretty confident that I'll have far better reinvestment opportunitites at some point over the next decade or two. That's my 'gamble' anyway.

Edit to Add: The above, of course, assumes only one investment alternative: CDs. Currently I'm earning >4% real on a professionally manged rental property. There are larger, and different, risks to investing here. But the spread is large, it's a currently unloved asset class, and is one possible alternative that more than meets my return objectives.

 

[Lsbcal]

Here is a 3 minute audio interview with Jack Bogle. He discusses the stock/bond ideas some of us have talked about here: Bogle: Stocks Poised to Outperform

Seems to prefer stocks.

 

[calmloki]

We continue to make loans on property. Banks are all sticky and risk averse about making loans, which makes for a bunch of people with the desire for cash, the tangible assets - land, buildings - to put on the line as security, and the willingness to pay 10%+. When you get an investor who makes his best deal on a short sale or at an auction, borrows 80% of the auction price from us, keeping 20% skin in the game, and pays 10%+ on our short term loan it is an attractive investment.

Stocks and bonds and rentals are not the only way to get a little money coming in. There is the risk that you end up with a piece of property at a bargain price instead of your money back - on the other hand, GM. Enron. What did the stockholders end up with when those big boys went kerblooey? Not selling, just saying...

 

[Chuckanut]

Just listened to the interview with John Bogle. More sense in 3 minutes of Bogle's comments than hours of reading the financial press. Like many of us, I owe a successful retirement to Mr. Bogle and his low-cost ideas.

 

[Chuckanut]

Calmloki, this sounds like you have a good deal going. Of course, an 80% loan on a property that has lost 30+% of its value (like many in my area have) is not something anybody wants to be stuck with. Still, if one picks the properties correctly.....

I lost very little on GM and Enron because I don't buy individual stocks. Index funds protect me from individual stock risk.

 

[Chuckanut]

There are several interviews with Bogle at this site: Bogle: Stocks Poised to Outperform

They are well worth listening to, assuming one is not looking for a quick fix, instant answer, and thinks the market is easy to figure out.