Maximizing portfolio return with very low risk

[John Galt]

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]

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]

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.

 

[John Galt]

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]

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]

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]

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]

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]

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]

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.

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]

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]

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]

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]

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.

 

[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.

Every quoted block of text needs to be surrounded by a pair of quote commands. You start off with a [ quote ] and end with a [ /quote ] - remove the spaces between the quote or /quote and the brackets. So, if you press the quote button and it drops everything the other person said into a quote block then just go in and add an end quote - [ /quote ] - before you type your reply. Then for the next block start it off with a begin quote - [ quote ]. Just make sure that every block begins with a quote command and ends with an end quote command. If you mess it up then just hit the modify button and go back in and edit it to fix the problem.

 

[Hyperborea]

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.

You do need to think about inflation though.  With it all in fixed income you are going to be slowly but surely falling behind inflation.  That $40K / year is going to be like $20K / year in only 20 years with a probably low 3.5% inflation rate (with the same spendthrift administration in power US debt levels will continue to climb and inflation could really ratchet up beyond that).

So maybe you can't handle the recommended amounts in equities.  How much could you handle?  Perhaps you could consider a fixed income buffer (maybe 20% or so) and put the rest into a nice balanced fund that has a reasonable yield and some growth?  A number here are very fond of Vanguard's Wellington and Wellesley funds for this.

 

[Dante]

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

ESR Bob,

My mortgage is about $195K and the house was appraised at $850K about 2 years ago.

I am definitely thinking of supplemental income - either contract work part-time or home/small business.

Do you know of any discussion boards where people are talking about the sources of the supplemental income - examples, experiences, etc.?

I agree with you on running the numbers on a debt free basis because if (when) our income drops to the level when taxes become very low, there won't be a need to keep the mortgage. I prefer to be totally debt-free anyway - just a personal preference

Dante

 

[azanon]

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..

LOL - i think if he sells a 600K dollar house and is paid for selling it, i'm guessing he wont have to finance the 150K dollar one.  Dont you think?  

 

[azanon]

It depends where that house is.

Ultimately i guess this is correct. Where i live (little rock, AR), a 600K dollar house is the top 1/4 of 1% (or better) of houses. You simply dont own a house that nice, and live in a neighborhood that nice on 40K/year, paid for or not, unless you're insane and trying to see just how fast your money can run out.

 

[farmerEd]

LOL - i think if he sells a 600K dollar house and is paid for selling it, i'm guessing he wont have to finance the 150K dollar one.  Dont you think?  

You missed my point, or maybe I wasn't clear...if a guy making $40K per year, can afford to have a $150K house and make the tax and mortgage payments on it, why would I guy making $40K from his investments have a hard time living in a  paid for house that could sell for much more?

Depends on the house, the location and a whole bunch of factors. What the house is worth has very little do with how much it costs to live there...except for property taxes and that depends largely on the state you are in.

Edit: and even though I could sell my house for $800K or more (maybe much more) very few people would call the house "nice", unless they were being polite. The land on the other hand...with room for a minimum of 11 more houses, and perhaps as many as 50 or more (w/4 acre lots) if a subdivision plan was approved, is where the value is.

 

[sgeeeee]

Depends on the house, the location and a whole bunch of factors. What the house is worth has very little do with how much it costs to live there...except for property taxes and that depends largely on the state you are in.

I agree with farmer when he says it depends . . . but property tax, utilities and maintenance all scale roughly with house size/house value. So it can make a big difference. As farmer said, it depends.

 

[azanon]

You missed my point, or maybe I wasn't clear...if a guy making $40K per year, can afford to have a $150K house and make the tax and mortgage payments on it, why would I guy making $40K from his investments have a hard time living in a  paid for house that could sell for much more?

Simple.  

1.  If he sells his 600K house and buys a 150K one, his portfolio just went up by 450K for one.  That's an extra 5K/year at 10% (if he listens to my stock allocation portfolio) for living.   I refuse to entertain a senseless fixed portfolio like my grandpaw had if your timeframe is 30-40 years.  That is unless you were worth several mil, then why take any chance.  But he isnt.

2.  If you think the upkeep on a 600K dolllar home is anywhere near a 150K one, you're dreaming, unless you're talking about an outlier situation like someone referenced here.  Where i live, you're looking at thosands, maybe 10s of thousands more to own a 600K dollar home and all of the added expenses such a home would entail.  

I recommend "the Millionairre Next Door" to get some idea of the lifestyle of someone that lives in a 600K dollar home.  If your home cost that much, you aint frugal in my book unless you're worth 5mil or more.  Sorry if that sounds strict.


Back to you Dante,

You have to realize if you dont come here a lot of these folks are fanatics, and frankly, i find some of them to give recklass advise.  Retiring at 48 on a portfolio of less than 1 Mil, YET insisting on living in a 600K dollar house is a serious matter than I fear you will regret.  

You cant have your cake and eat it too.  Make up your mind.  You hate working like really bad?  Fine.  Sell the house, bring that portfolio up to 1.3 Mil by doing so and MAYBE you'll get by till you die in a paid for, less expensive, house.  Even then, with you insisting on that modest portoflio, you'll be taking a lot of risk if you live into your 80s.

If I were you, and assuming i hated you job, i'd grin and bear it about 3-4 more years, bank a good portion of that killer salary you have, THEN still downgrade the house, and live off of a safer 60-70K/year.  Let be honest here, if you live in a house that nice, how in God's name do you think you'll be content with 40K/year?  Wake up man, you're dreaming.

I like to play it safe AND comfortable.  But that's just me.

(edit) I apologize if that wasnt what you wanted to hear. With my current knowledge of finances (i'm only 33), that's my evaluation of it. I'm being as honest as i can. We're anonymous here, so no harm no foul. If i thought you had it made, i'd say so as well.

 

[Dante]

Simple.

1. If he sells his 600K house and buys a 150K one, his portfolio just went up by 450K for one. That's an extra 5K/year at 10% (if he listens to my stock allocation portfolio) for living. I refuse to entertain a senseless fixed portfolio like my grandpaw had if your timeframe is 30-40 years. That is unless you were worth several mil, then why take any chance. But he isnt.

2. If you think the upkeep on a 600K dolllar home is anywhere near a 150K one, you're dreaming, unless you're talking about an outlier situation like someone referenced here. Where i live, you're looking at thosands, maybe 10s of thousands more to own a 600K dollar home and all of the added expenses such a home would entail.

I recommend "the Millionairre Next Door" to get some idea of the lifestyle of someone that lives in a 600K dollar home. If your home cost that much, you aint frugal in my book unless you're worth 5mil or more. Sorry if that sounds strict.


Back to you Dante,

You have to realize if you dont come here a lot of these folks are fanatics, and frankly, i find some of them to give recklass advise. Retiring at 48 on a portfolio of less than 1 Mil, YET insisting on living in a 600K dollar house is a serious matter than I fear you will regret.

You cant have your cake and eat it too. Make up your mind. You hate working like really bad? Fine. Sell the house, bring that portfolio up to 1.3 Mil by doing so and MAYBE you'll get by till you die in a paid for, less expensive, house. Even then, with you insisting on that modest portoflio, you'll be taking a lot of risk if you live into your 80s.

If I were you, and assuming i hated you job, i'd grin and bear it about 3-4 more years, bank a good portion of that killer salary you have, THEN still downgrade the house, and live off of a safer 60-70K/year. Let be honest here, if you live in a house that nice, how in God's name do you think you'll be content with 40K/year? Wake up man, you're dreaming.

I like to play it safe AND comfortable. But that's just me.

(edit) I apologize if that wasnt what you wanted to hear. With my current knowledge of finances (i'm only 33), that's my evaluation of it. I'm being as honest as i can. We're anonymous here, so no harm no foul. If i thought you had it made, i'd say so as well.

Azanon,

Perfectly fine. I appreciate the candid comments and am not disappointed at all. Its the contra point of view that makes the forums useful and worthwhile.

I know we began to focus on the Retire Early part of my post, which was fine. My main puprose for the post was to get comments on the portfolio as an income producer and I had set a target of 4%. Even if I continued working I would like to put that money to work that way i.e fixed income with limited risk. I also know now that you think that that is more of a "grandpaw" like approach and probably at 33 would favor a much more aggressive investment style. I am interested in knowing what your portfolio would look like if you wanted to generate 4% return today. Thanks again for your feedback.

Dante

 

[farmerEd]

>>If you think the upkeep on a 600K dolllar home is anywhere near a 150K one, you're dreaming,

Your just plain wrong on this one....not sure why you insist on using your neighbord as a generalization for every property in the country....it is simply not true everywhere.

You *might* be able to generalize that a bigger house costs more in upkeep than a smaller one, but even then there are way to many factors to even make the statement worthwhile.

BTW: Living in a cheap house doesn't make you a frugal person....it justs means you live in a cheap house. You can live a long time in the same house and all of a sudden its worth a lot...did you all of a sudden become non-frugal person? Thats kind of counter-intuitive.

 

[retire@40]

I recommend "the Millionairre Next Door" to get some idea of the lifestyle of someone that lives in a 600K dollar home.  If your home cost that much, you aint frugal in my book unless you're worth 5mil or more.

Retiring at 48 on a portfolio of less than 1 Mil, YET insisting on living in a 600K dollar house is a serious matter than I fear you will regret.

Just a comment on not being frugal if you live in a $600K home: Almost every "average" home in my area of the Northeast is selling for $500K to $800K.

Less than 10 years ago, these same homes were selling for half the price, so it's possible to have paid off a mortgage in those 10 years. The yearly expenses for one of these $600K homes is about $4K for real estate taxes, $1K for insurance, and a budget of $3K to $5K a year for all other expenses. So with $9K a year of home expenses, you can still afford to live on $40K of disposable income per year.