Coming Crisis.. What to do?

[Ol_Rancher]

Greetings,

I seek the advice of members here. I am a bit over 58 years old (born '46 , lead boomer).

My portfolio has served me well enough in the past but I feel that Scott Burns' recent column is correct. A real economic crunch is coming in the not to distant future.

As I see it the over 70 million boomers who will be demanding their social security checks in the next couple of decades will force a combination of options from the US government. Decrease benefits by raising age and/or taxing SS payments more; Increasing payroll taxes even more; Printing more money to pay benefits with cheaper dollars.

I will be 59 1/2 in about 14 months and wish to have a more defensive portfolio in place that is appropriate in a rising tax and inflationary enviornment.

Current portfolio:

Qualified (tax deferred) -
Equivest common stock - 55K
Equivest Capital Guardian Research - 44K
Equivest Alliance International - 4K

Taxable -
American Balanced - 26K
American Capital Income builder - 109K
American Europac - 36K
American Wash Mutual Investors - 260K
Enterprise Growth - 79K
Enterprise Small Cap Value 25K

cash - MMA = 200K @ 2.1%

I have a 27K/yr pension (no cola), expect 1000/mo SS at age 62, and have a rental property. At this point the cash flow from these is enough to meet my expenses. (no debt of any kind, frugal living, medical insurance - not cheap)

I fear that in 5 to ten years the looming economic crises and medical needs will force me to use the investments to meet my expenses.

I feel that in within the next two years I should make the changes that will hold up against the tax and inflation pressures.

Some of my investments seem not to be defensive enough. The Equivest and the Enterprise funds do well in a rising stock market which now does not seem to have much upside potential and the cash will erode over time unless invested. So my first changes would be in these three segments of my overall portfolio.

Question: Where to move monies from them?
What investments for rising tax and
inflation over time.

Now, does not seem the time to buy bonds thus the cash position, but in 14 - 18 months that could change.

The market is flat at best and rightly fearful of political risk .. with the olympics, elections, & Iraq, come too many possible negative outcomes, but again in 14 - 18 months perhaps we will have a different picture.

Comments? Suggestions ?

Many thanks to those who respond !

 

[charlie]

Hi Ol_Rancher,

I think you can do better with your cash for starters.
I-bonds are currently paying 1% plus trailing 6 mo
inflation for a total of 3.39% currently. The inflation
component will likely increase in November. IMHO,
you should only keep enough in cash to cover emergencies. I-bonds can be cashed after 1 year up
to 5 years with a 3 mo. interest penalty. After 5 years
there is no penalty. They will grow tax deferred for up
to 30 years.

I don't know what your tax situation would be to
shuffle your taxable stock funds, but you should
convert to a diversified mix of low cost, tax efficient
index funds to the extent practical. I have no idea about the tax efficiency of your current taxable stock funds, but I suspect it is not good.

Your total portfolio, not including your property, is
about $838k with $200 of that allocated to fixed
income. That is about a 76/24 stock/ fixed allocation.
If you invested your qualified account in TIPS, your
mix would be 64/36, which is more appropriate for
your age. As you know, you can move stuff around
in a qualified account with no tax consequences.

It is great that your pension, SS and rental income
will cover your expenses. Let your qualified account
grow until age 70, if possible.

Cheers,

Charlie

 

[wabmester]

If you trust Burns' analysis, perhaps you should also consider investing the way he does. Here's his portfolio (from another thread):

27.5% Vanguard TIPS Fund
27.5% Vanguard Total Stock Market Index Fund
22.0% International stock index funds
7.0% REITs
10.0% large-cap Energy stocks
6.0% Gold Stocks

 

[John Galt]

Hello Ol_Rancher. I am only slightly older than you, with no pension, health insurance problems, a
fraction of your net worth, and no intention of ever
working again. I think you worry too much, but I belong to the "in the long run we are all dead" school
of investing. I was talking to a good friend about this
(investing). He is 68. We are amused when people
encourage us to plan "long term". We both feel that we no longer have a
long term to work with.

John Galt

 

[unclemick]

Ol_Rancher

Taxes, Inflation, less volitile, and perhaps lower expenses.

I'd take my time and look at Vanguard Tax managed balanced, The Target Retirement Series (analyze the asset mix change over time and assess SD). Look at your taxible funds and when they distribute cap gains etc.

? Do you want to hold your own against inflation, take out what you can and leave a nest egg at the end. Or run it to zero. Or something in between.

? Are you comfortable with the number of funds you have - like to mutliple asset class some or a lot - Burns, Bernstein, Coffeehouse or tend toward simple - Burn's old couch potato, Balanced index, Target Retirement.

Don't do this - but consider Vanguard Tax Managed balanced for your taxable funds and Vanguard Target Retirement say 2015 for your qualified and then write down why you like or dislike - benchmarking and then putzing from there helps me. And taxes - what is the cost of moving funds - which tax years.

Wow - this is more of a fall question - not the good ole summertime.

 

[brewer12345]

Rancher, I have to say that I think the doom and gloom redictions are way over stated. There are a number of possible (likely even) solutions to these problems, all of which are predicated on gummint projections, which aint too reliable in the first place. However, if you really want to be paranoid, I'd say that the biggest risks from the scenario you seem to be fretting about are highr taxes and inflation. I' not all that sure what you can do about the taxes art except that the more tax-efficient you can be, the better off you are. Real estate, LTBH, and certan other things (partnerships, etc.) tend to be pretty tax-savvy so spend some time investigating avenues you haven't used before. The inflation worry is pretty easily solved. Invest in real assets (real estate, commodities, etc.) and inflation-based assets (I-bonds, TIPS, etc.).

Just e aware that you give up a lot of potential upside by hedging an unlikely scenario.

 

[Robert Henson]

Hello,

I have been following this board for some time, but don't generally post. And, I don't consider myself a prophet of "doom and gloom." However, this is one case where I tend to agree with Scott Burns and I don't believe Ol_Rancher's concern is misplaced or overstated.

The demographics speak for themselves and even the Social Security trustees admit that we have a big problem. The baby boomers, once they retire, will be a big voting block intent on preserving SS benefits. On the other hand, the workers who fund the "pay as you go" SS system are also a big block of voters. I don't think they will relish having to make substantially increased contributions to support the baby boomers. Something has to give. I suspect there will be some sort to compromise, i.e., taxes will go up and SS benefits will go down. I also suspect Uncle Sam will borrow more money which will in turn lead to a higher rate of inflation (it's always nice to pay off your debts with inflated dollars).

The upshot of all this is that I, too, believe it is prudent to take steps to shield oneself from the anticipated effects. Of course, there lies the proverbial $64,000 question -- how?

As for myself, I am hoping that the fixed return on TIPS swings upward to 2.5 or better and then I am going to pick up a truckload. Perhaps I miss some upside potential in equities, but I sure do have piece of mind and that's something I value greatly in retirement.

Robert

 

[Skylark]

It sounds like the guy who bought a huge house beyond his means and is up to his neck in debt is going to come out smelling like a rose.

And the frugal guy who bought a small house, paid it off, and put his money into equities is going to be the loser.

(sigh)

Inflation based assets: can anyone explain what that means?

How do TIPS and I-bonds respond to inflation?

 

[unclemick]

Ho Humm - back to the future - dust off the 70's and 80's portfolios. At times I had over ten mutual funds plus real estate plus gold and silver coins plus a share in a patented non working gold mine.

The new kids for us are inflation protected securities. The Brit's I worked with weren't that impressed with the English versions which had been around a lot longer - BUT cross border currency fluctuations may have had something to do with it. Foriegn currencies and collectibles - art, stamps, guns, etc also had their day in the sun.

I neither got rich or poor - luckily most funds were index or low expense.

I think Scott is chasing sectors - and for many/not all it smacks of 'the horse is already out of the barn'. His old couch potatos are more to my liking.

 

[unclemick]

I forgot timber - being originally from the Pacific NW - you gotta have some trees - like the rich people when I was a kid - Doctors and Longshoremen - gentlemen tree farming was big where I grew up.

 

[ats5g]

Ol Rancher,

I couldn't locate [couldn't find a symbol for] the Equivest Common Stock. Same goes with the Equivest Mutual Funds. Do you have the symbols? Are these variable annuities (mutual funds wrapped in insurance) in a retirement plan (457, 403(b), etc.)? Are you paying outrageous insurance M&E fees, 12b-1 fees, admin fees? Outrageous being anything over .35%. Just curious.

I'm surprise that no one has mentioned possibly converting the tax-deferred assets to a Roth IRA before your reach SS age. Your income appears low enough (below $100,000 I think) to do so, and you've got taxable assets to pay the taxes on the conversion. If you're expecting higher future tax rates, paying the taxes now at lower tax rates might be preferable. Have you thought about it?

What share class are the American funds? Hopefully class A shares. The other classes of shares (B and C) can have exceedingly high 12b-1 fees - around 1.00%. Also, since these funds are in a taxable account, you could look for more tax friendly ways to hold the different asset classes. For example, AEPGX is more or less a closet MSCI EAFE (int'l index) fund. You could go over to Morningstar and compare the after tax returns of AEPGX and Vanguard's Tax Managed Int'l, VTMGX.

You can also do the same thing with Enterprise Small Cap Value, ENSPX, and Vanguard's Tax Managed Small Cap, VTMSX. Note, however that the maximum tax rates are used for dividends and short term cap gains distributions, so if you're in a low tax bracket, the tax drag wouldn't be as bad. Though, ENSPX appears to be an absolutely horrible small cap value fund, especially after taxes [also note the 0.45% 12b-1 fees you could be paying on the Enterprise funds - horrible].

Also note that the Enterprise Growth Fund appears to be a closet S&P 500 Index fund, looking at its past returns. Why pay the higher expense ratio, including the 12b-1 fees, when you can just buy a S&P 500 index fund from Vanguard for 0.18%?

When considering dropping or selling mutual funds in a taxable account, you should consider the tax consequences. How much short term or long term capital gains will you be generating? Etc. Also, would selling them generate any surrender charges if these are say B class shares?

Just be aware that you give up a lot of potential upside by hedging an unlikely scenario.

If we're talking about Long term upside potential I'd like to disagree. Check out this chart from Roger Gibson. If stocks were priced to have much higher returns that say, REITs, TIPS, etc., then I could agree. However, I think stocks have about the same expected returns, from now, as Long term TIPS, therefore, not much long term upside potential lost. Not only that, but Ol Rancher's income appears to be very susceptible to inflation. So, he should actually want to include a lot of assets that can do well (better than stocks) during higher inflationary times - TIPS, commodities, REITs. Will diversifying more reduce the short term (1-2 year) upside potential? Yes, but if the name of the game is to reduce portfolio volatility while hedging inflation risks, I'd seriously consider other asset classes than just stocks.

Now, does not seem the time to buy bonds thus the cash position, but in 14 - 18 months that could change.

This assumes of course that interest rates will rise. People have been predicting that for how long now, 3-4 years?. This article, from Morningstar, explains the relationship b/w the market's expectations of rising interest rates, the FED, etc. The market's expectations have already been priced into bonds' prices and yields, so it would take an unexpected rise in interest rates (which the FED has absolutely no control over) to send bonds tumbling. You also don't have to buy bond funds. You can buy Treasury notes, hold them to maturity, and just ignore the price fluctuations. You can buy FDIC insured CD's (out to 5 years). You can buy EE bonds (whose interest will rise when 5 Yr Treasury interest rates rise, without losing any value).

- Alec

 

[cute fuzzy bunny]

I'm not sold on the inflation adjustable securities just yet.

Dont get me wrong, throwing another 2-3% inflation adjustment onto 1-2.5% returns isnt bad for a fixed income instrument.

But I dont think inflation is 2-3%. Sure as hell isnt around here. In fact, my "back of the paper napkin" look at cost like housing, cars, food, utilities, etc tells me that around here we're paying 8-10% more per year.

Besides housing jumping 40% in the last 4 years, a replacement for my four year old truck costing 35% more than mine did new, gas being up 25% in 2 years, many foods (milk, meat, eggs, cheese) all being up 25% in the same time period, theres invisible inflation.

Beer now comes in 10.2oz and 10.8oz bottles quite often instead of 12. I just saw a major yogurt brand advertising "new lower price!"...it was indeed about 10% lower, but the container is 30% smaller. The fish and chips place I go to used to have free refills on drinks...now the sign says "50c". Extra sauce at the bbq joint used to be free, now its 50c per little plastic cup. The breakfast buffet at one restaurant used to include orange juice and coffee, now those are extra and together cost almost as much as the meal.

I guess the point is...if you invest in ibonds and tips and rationalize that the dividends will pay the bills while inflation is kept in check by CPI/PPI adjustment for 20 or more years...you might want to think again...

 

[ats5g]

TH,

Excellent point. The CPI may not, and probably will not, reflect your personal inflation. Unfortunately, neither will most other financial assets.

- Alec

 

[charlie]

Ol_Rancher once mentioned that he lives in the Texas
hill country west of Austin. That is a long way from
the Left Coast. Down here in the heart-land, inflation
is measured by how many axe handles wide is the a$$ of the new waitress at the local DQ. Ol_Rancher says
he lives frugal. Now I don't know if he is a native, but
you don't know frugal unless you were raised on a dry
land farm in Texas. My bet is that his personal inflation
rate is closer to the CPI than most of us.

Cheers,

Charlie

 

[cute fuzzy bunny]

Yeah, I have limited expectations from most other assets as well.

Just wanted to suggest further thinking that ibonds and tips will neutralize inflation and you can just count the returns as 'real'.

I'm thinking thats not going to work out very well for you.

 

[Whakamole]

TH,

Excellent point. The CPI may not, and probably will not, reflect your personal inflation. Unfortunately, neither will most other financial assets.
- Alec

What I do instead is buy from companies that profit from inflation. Miners and others in the commodity business, health care, stuff like that. It can take the pinch out of seeing the price of something go up if you know you are making some money on it

 

[Ol_Rancher]

Lots of good advice given... It seems one impoartant move to make would be to get out of the Equivest annuity without penalty .. I think I have held it long enough, roll it over into a roth (am now in 15% tax bracket) and buy TIPS and I bonds.

Then, reduce the cash position into the same.

Will keep the American Funds (all class A)

Finally I plan to take the money from the Enterprise funds .. and buy some Vanguard total stock Index

John ... the changes needed for SS and Medicare may happen sooner than you think .. the government will have to act in the not too distant future.

UncleMick .. all my moves may have to take place over 2 or 3 tax years .. some this fall, some in January, perhaps the last in the year after. Will give your recommends some thought. Timber ? Some billionaires like natural gas. Commodity investment not for me, though these sound like winners over the period of time I have in mind.

Brewer - will leave American Funds alone for market exposure. Will add to them if I am wrong about crisis, the breakpoint at 500K makes this well run fund family feasible for future market investment.

Skylark - read some threads here on TIPs and IBonds .. investments those who fear long term rising inflation, as like us must consider.

ats5g - you certainly identified the worst of my portfolio .. Enterprise and the Equivest .. Got into the Equivest when I taught school and 403b s were new. I believe I have passed or will soon pass the time of surrender charges. Will verify ASAP.

Chuck-Lyn & TH - Got out of Austin ... sold home in overpriced upscale neighborhood, had a 1050 sq ft. home and a 12' X 24' cabin and pole barn built on ridgetop acreage. Now mortgage free, utilities are now 1/4 what they were, property taxes less than 1/3 of what they were. Instead of cashing shares of a portfolio investment of about $1000 - $1500 each month, I have a cash flow surplus of $400 - $600 if I do not need to make a major purchase.

To be honest, another reason for my wanting to be defensive is the political risk. Maybe I am becomming paranoid as I age, but now the market must factor in terrorism risk which angers me but has such negative potential.

 

[John Galt]

I agree that changes to SS may happen "sooner than I think". As you know I have no faith in our "leaders"
in either party. However, I am so close now (to SS)
I don't worry about it. As dumb as they are, said leaders know drastic SS cuts would be political
suicide.

I once owned an EQIVEST variable annuity, bought without much investigation. My ex. got it in the divorce
so I dumped 2 problems at once.

I have a Class A American Fund now (bonds). I am
satisfied. I owned another American Fund previously.
Satisfied with that also.

I am in the -0-% tax bracket. Better than sex

John Galt

 

[Skylark]

I don't think I would bet it all based on the demographic of aging boomers taking the economy down with them. There are a lot of countries not too far from the US with a huge population of young people.

Migration could change everything. The government already seems to have a don't ask, don't tell policy towards hispanic illegal immigrants, although other ethnic groups don't get always that treatment. Imagine if the whole world had the opportunity to live and work in the US that Mexican nationals currently have.

Low wage immigrants reduce the cost of a lot of goods and services to the average US citizen. There are some US citizens making a lot of money off of hiring low wage illegals, and some businesses would go bust at home and move offshore if they couldn't hire low wage employees in the US. Even AARP has recommended increasing immigration, if I remember correctly. So expect a huge wave of immigration in the next 20 years, either legal or not.

For example, I bet that anyone willing to work in health care will be given a visa in the near future.

As often is the case, the markets respond and find an equilibrium in unexpected ways.

 

[John Galt]

Hello Skylark. Excellent post!

John Galt

 

[charlie]

Ol_Rancher,

Sounds like you are on the right track. I recommend
you use TIPS in your qualified account and I-bonds
in after tax. No point in sheltering I-bonds which are
already tax deferred.

Cheers,

Charlie