Need Help with Asset Allocation

[mtntigger]

So, did the USAA financial planner help? Did it work well over the phone or would it have been more worthwhile if you could have seen them face-to-face?

[Deleted]

Slow,

We're getting our "Plan" in 2 weeks. I sent her a ton of info and she's running it through the magic data masher. DH is out of the country (ok he's in Malaysia this week and AZ next week) returning to Germany next Friday. He has the opportunity to meet with her face to face when he's in AZ but I don't think he will. We've gone through this process before when we were BofA Wealth Management clients. I'm pretty sure it will be similar. I think we'll get a recommended asset allocation based on our existing holdings and the answers to a risk tolerance form we filed out. I'm sure the recommendations will featuring USAA products. We'll thank her for her recommendations and research the products. I'll be taking a hard look at fund costs and 10 year performance over their competitors.

If you have never gone through this process before and can say "no" to a salesperson I recommend it. If nothing else it's forced DH and I to ask ourselves questions about our future that we never seem to have time for.

[Deleted]

I'm back with my report.

The planner wanted to do another scenario which lowered our standard deviation so we were delayed a week.

Therefore last Thursday we got a report recommending that we move most of our cash into a combination of regular and muni bond funds. Also to my surprise was a recommendation to move a lot of our large cap stocks about $200k or 13% into bonds as well. We won't be doing that right away; possibly through our taxed deferred accounts. And tax deferred munis won't do us any good because of our tax situation here in Germany. Germany taxes all interest and dividend income outside our tax deferred retirement accounts. We're fine with moving the cash into bond mutual funds. We've known we've needed to do this for a while so while I hate dumping in $300k at once, this is a long term investment and hopefully the fluctuations in price will even out over time. Therefore the revised recommendation is 30% Short Term Bond Fund, 60% Intermediate Bond Fund and 10% High Yield Bond Fund. This will change our $1.5M allocation to:
35.5% Large Cap
5.5% Sml Cap
15.6% Int'l
28.2% Bonds
15.2% cash

We will then draw down the cash so we can pay off the mortgage on the house we want to move to (approx 232k). And we will dollar cost average 2k/mth over the next year + until DH separates from service.

I'll update Net Worth IQ with the global picture when we're done with moving money around.

Thanks everyone for your comments.

[Deleted]

Updated Networth IQ entry.

Latest is that DH will probably be retiring at the end of the year instead of 7/31/12. Sounds like the company division is going to go through the drill of making everyone apply for their jobs as a way of eliminating ex Pat packages. Not really worth it for us to stay given the taxes and COLA. Hopefully DH can collect his bonus for 2011.

I'm disappointed and a little pissed. Company is making money and could afford to let the 50 or so ex-Pats finish their contracts. This will mean two moves for us as our Bay Area house is rented through 7/31/12.

[phil5185]

Therefore the revised recommendation is 30% Short Term Bond Fund, 60% Intermediate Bond Fund and 10% High Yield Bond Fund. This will change our $1.5M allocation to:
35.5% Large Cap

For what it's worth - Bill Gross was on CNBC at 5:30A (AZ Time) this morning, I caught part of it. As mentioned in an earlier post, PIMCO lightened up on bonds a few months ago. Today he said that his favorite places to invest in bonds was our North American neighbors, Canada & Mexico, and Germany. Their balance sheets are, and have been, far more stable than the US. (He probably threw in that N. Amer comment to appear pc and a non-traitor?)

[Deleted]

Hi Phil,

Actually it was interesting doing the rebalancing the 401k/457 rebalancing exercise and trying to find a "Global" mutual fund that had lower "North American" stock exposure. Most of them do because they classify companies like Coca cola and PG as "global". I classify them as "large cap" in our portfolio.

I'll re-read the Bill Gross info but my understanding wasn't that he was getting out of bonds. I think he's just warning everyone that the returns aren't going to be anything like they were. I'm o.k. with that. We only need $40k/yr from the (now $1.4M) more liquid side of our portfolio. That's less than 3% per year. We have plenty of exposure to equities so the bond part is still on the lower end when you look at our total NW.

ETA: I should clarify "corporate" bonds vs Treasuries.

[Value Buy]

$29,700 Abbott labs
$18,500 At&t
$27,100 Coca Cola
$16,900 General Electric
$17,100 Microsoft
$12,800 Pfizer
$78,700 Procter & Gamble
$ 9,100 Sysco
$19,000 US Bancorp
$31,200 Wells Fargo
$35,400 3M
$35,100 Royal Dutch Shell
$67,500 Schlumberger
$11.900 Tata Motors

For what it is worth, I did not like either bank listed. JPM is my preference.
I dumped Microsoft from my portfolio last year. It is just living on past heroics. Would prefer a Google, maybe.
GE, another Dow dog, but has no where to go but up from here, so maybe a keeper.
Royal Dutch, is good, but I would also add either Exxon or Chevron, and look at Marathon also.
ATT looks interesting now, I would stay there.
No electric or gas utilities? There are several paying in the 4 to 5% range, where you can get some probable price rise with the stock at the same time.

I just do not see the big interest in bonds right now-too much economic turmoil around the world, to have that much tied up in it at this time. My bond funds are negative value right now, but I keep for the monthly dividends which are currently reinvested.
As always, never, never, PROMPTLY act on any information or suggestions, from anyone on a message board for what YOU WILL ACTUALLY DO, but I have to say some of the posters here are a heck of a lot smarter than any financial planner you will ultimately work with, myself, not included, in those posters.
I am three and a half years from retirement (hopefully) so this does hit close to home.
Good thread!

[Deleted]

Value Buy,

Thanks for your comments. I know my posts tend to be long so you probably missed my post explaining that DH inherited these stocks 10 years ago. They were in a by-pass Trust so unlike most inheritances today we did not get a step up in value. Since most of them were purchased back in the late 70s early 80s when DFIL inherited them we would have substantial tax consequences including an even bigger hit with AMT. I like Phil's advice to reduce our exposure in P&G. If I can talk DH into selling I would prefer to buy into Vanguard's S&P 500 index fund in order to maintain our asset allocation. I agree with Phil that over the long run (we're talking potentially 50 years in retirement) that we're much better off in low cost mutual index funds rather than individual stocks.

"I just do not see the big interest in bonds right now...but I keep for the monthly dividends"
Exactly. We were sitting on $680k in cash earning nothing with retirement months away. Another choice which would have had minimal tax consequences would have been to pay off another mortgage to generate $1500/mth income which is about a 6% rate of return. But that would then increase the % of our NW invested in real estate to nearly 60%. I'm already uncomfortable that we have 20% of our NW in one house in the SF Bay Area and 5 miles from the San Andreas fault! . We're only a mile from the beach but at least we're on high ground, LOL!

[yclept]

"We're only a mile from the beach but at least we're on high ground, LOL!"

The San Andreas is a strike-slip fault. Strike-slip faults do not have vertical displacements, and thus do not generate tsunamis.
Cascadia fault is a subduction-zone fault and has and will again generate tsunamis -- beware Seattle, Vancouver, and environs!

[Deleted]

Yclept-didn't you see the damage in Santa Cruz by the Japan earthquake? Could the Cascadia fault cause a tsunami further south?

I found it was a little ironic that I was inquiring about earthquake insurance just days before the Japan quake. I'm a 49 year old native Californian and had never made a serious investigation into earthquake insurance. I wanted to see if it made sense before we paid off the house.

Nope, it still doesn't. My biggest fear is part of the back yard falling away (we're on a hill). No insurance will cover land slippage.

[IPAfan]

I think your adviser has it all wrong when advising you to sell some of the individual stocks (which seems like a pretty solid portfolio to me) to invest in bonds at the top of the market.

I echo the sentiment of several others that you should avoid bonds at this point. On the short durations you make no return, and on the long durations you're taking serious interest rate risk, and risking a negative real return.

Based on your stated goal to live on income, and keep the principal I actually think you need to beef up your individual security portfolio. Instead of looking at "standard deviation" as a way of looking at portfolio risk, start looking at the fundamental risk of each position. Often a company with solid financials will have a high beta (high standard deviation) while a lower quality company may be less volatile in many market conditions.

A bond heavy portfolio is based on backward looking analysis. The fundamentals of bond investments are terrible right now with the money supply increasing dramatically while nominal interest rates are at record lows.

I think you can create a portfolio of individual stocks with a current yield of 3.5-4.5% (around the same as a bond portfolio) which should provide you above average income growth. I already like your current positions in ABT, KO, T. I'd strongly consider buying some tobacco stocks (preferably MO and PM.) These companies are the best of both worlds as they provide a high current yield, insane ROE (which allows the companies to increase earnings while still paying out a high % of income as dividends), solid dividend growth, and an excellent long term record. You can create a dividend portfolio of companies that have raised their distribution every year for a period of time and trade at good valuations. You can sprinkle in some MLPs to increase your current yield, however the valuations are pretty high right now and I'd wait for a pullback.

If I were you I would create a list of individual securities that you could buy and hold onto for the long term (so we're thinking blue chips), which pay an above avg. yield, and have historically increased the yield faster than the S&P. I'm thinking of companies like MCD, MO, PM, JNJ, ABT, PG, CB, KMB, KO, PEP. When the valuation seems attractive then open a position or add to an existing position. Sell cash secured PUTS while you wait for a good entry point. Honestly I think all the stocks I listed above are excellent companies, and would probably do as well or better than the S&P while providing a higher dividend yield and no fees to hold.

I'd also look at companies like: MGEE, PNY, SYY, CTWS, WGL, ABT, MSEX, CTBI, UBSI, KMB, LEG, UVV, BKH, CINF, ED, BWL-A, HCP, VVC, ORI, WRE, PBI, MO, T, CTL, and IREIT. (These are the highest yielding dividend champions which have raised their distributions every year for over 30 years each.) I haven't done any research on most of these companies, but if you buy the group of them you'd get an avg. starting yield of about 4.5%. Some of these companies are bound to miss their dividend raising streaks, but on the whole you're very likely to have an income that grow annually. This starting yield is going to provide you substantially more income than the S&P and probably provide you more dividend growth as well.

There's another huge advantage of a diversified stock portfolio over an index investment that most people overlook. If you have a diversified portfolio you will have winners and losers. You can offset taxable gains by selling losers. The winners in a dividend growth portfolio are likely to be the stocks that continue to increase their distributions. Thus you can sell losers and winners with a net neutral tax impact (whereas in an index investment you're either going to have a tax loss or a tax gain.) This allows you to reallocate the portfolio towards stocks with higher yields or better prospects of dividend growth.

Lastly, I honestly think you'd be better off to have a set of stocks like I outlined instead of a bond investment. The standard deviation will be higher, but the income stream will likely be about the same to begin with and should continue to grow with time (where the bond funds will depreciate in value as interest rates rise, good companies like PM/MO/KO/PEP will better keep up with inflation.) Your bond funds will get killed when interest rates rise. If you buy a bond and hold to maturity then you can calculate your total return and buy if that return is acceptable (at these rates I don't think the return is acceptable.) However, with bond funds you will NOT be holding bonds to maturity. Instead the fund will sell the bonds when they no longer meet the fund's duration target. When interest rates rise these bond funds WILL lock in losses on bonds instead of holding to maturity.

Hope this (alternate) view is helpful to you.

[Deleted]

Beerfan,

Thanks for your comments.

You probably skimmed over the prior post. We meet with the advisor with 2 goals in mind. 1) Prepare for retirement and the big drop in income. We were sitting on $680k of cash or about 20% of our NW.Therefore we were asset rich but income poor. Not the place to be with about a year to go to retirement. Hence goal 2): Get our asset allocation right for spending 50 years in retirement. If you look at our December 2010 NW post you will see that we were approximately 45% in real estate, 25% stock/index funds, 20% cash and less than 5% bonds.

So in mid-March we invested $300k of the cash in 3 different bond funds (30% short term, 60% intermediate and 10% High Yield) and we paid off our $231k mortgage on our SF Bay Area house that we will be moving to July 2012. We still have around $130k in cash. (We just came back from an expensive trip to Turkey that involved buying carpets ). We want to set aside some cash so we can do some much needed remodeling/capital improvement to the house we've moving to. We've owned it for 16 years and it will have been rented out to the same folks for 9 years since we relocated to AZ in 2003.

So the investment has been made. The nice thing is that we only needed to achieve less than a 3% yield on the $1.3M more liquid portfolio of our portfolio to meet our income needs. Of course our stocks and stock mutual funds have done a lot better than that. And our oil royalties are really doing well so we are building up our cash cushion again. I want the bonds to generate some steady income. If rates rise significantly (and I think it will be a slow process given the still weak state of the economy) the bond fund will be reinvesting in new bonds at higher interest rates. (It is my understanding that the fund buys and holds short term bonds until maturity and reinvests the proceeds upon maturity-but I'll double check).

In an ideal world we should have made the big shift into bonds back in 2008, 5 years from retirement and dollar cost averaged from there. In fact, I still have a print out from the first time I posted a question on YM about what to do with $200k. Consensus:reorganize your asset allocation including 401ks and 457 and you should be investing this extra money in bond funds given that you are planning an early retirement. Shortly after we received that advice our life went into crisis mode with sick parents (my mother died) settling a very difficult estate, multiple threats of lay-off both during and after the financial crisis and picking up and relocating to Germany. I wrote out the long version of our last three years and swear if I didn't have YM I would have been seeing a psychiatrist! We didn't panic or sell anything; but we just kept husbanding our cash. We've been saving a lot of money but when I saw our interest 1099s from the $600k+ cash we're sitting on I said we have to do something different.

We're not stupid people and this is why I agree with Phil's take on index mutual funds and even those target funds. So many people here on this board think they are totally rational with investments but after nearly 50 years on this planet, I say it's the very rare individual who truly is. Whoever said life happens while you are making other plans was right! Plus ego gets in the way, greed can come into play and we all can predict things like Deep Horizon, the Arab Spring and earthquakes, right? And let's not forget the market is always rational, LOL

I'm telling you this life stuff can sure keep you humble!

[IPAfan]

bonnap,

I admit to skimming the thread, but I don't think that changes my opinion any.

I obviously don't think you're stupid people. You and your husband have certainly done an above average job at accumulating wealth for your age. However, I entirely disagree with the idea of index mutual funds especially given your stated goals.

First, I don't think anyone is totally rational with investments.

However, it's MORE rational to buy a basket of companies with better valuation, fundamentals, and dividends than to buy the S&P500 (or other index.)

The idea that investors can't outperform the S&P is ridiculous (the laws of nature require that if some individuals under-perform the market then others outperform.) However, if your goal is to create an income stream the day to day fluctuations of the market shouldn't matter at all. A dividend growth portfolio that trades at better valuations and higher dividend yields than the S&P will provide a growing stream of income (that's probably double what you can make on the S&P right now.) Most of the stocks won't need to be sold, but those which do will fall in two categories: 1) companies that have stopped increasing their dividends; and 2) companies that have become extremely overvalued. You can likely offset the taxable profits from category 2, by selling stocks in category 1.

There are many ways that have been PROVEN through extensive back testing to beat the market over time. Some of these have more than doubled the LONG TERM performance of the stock market. Dividend growth stocks have managed to outperform by a couple percentage points a year (dividend stocks in general outperform the S&P, dividend growth stocks outperform un-managed dividend portfolios.) However, there are a few characteristics of a dividend growth portfolio that make more sense for a retirement income portfolio than some of the other alpha generating strategies:

1) You can create a diversified portfolio with a yield double that of the S&P, and grow this income stream faster than avg.
2) Dividend-growth portfolios are largely comprised of mature companies with wide economic moats, and huge returns on invested capital. These stocks tend to be low beta which means less downside in a falling market.
3) Also, historically dividend paying stocks have outperformed all other valuation measures (PE, FCF, BV, etc.) in falling markets.

A good investment strategy does not have anything to do with predicting things like Deep Horizon, Arab Spring, etc. It has to do with selecting a portfolio of companies that provides adequate safety and opportunity for meaningful return. Investing in a group of 20-30 dividend growth stocks provides plenty of diversification especially if you look at investing in mature companies with diversified operations.

RE: BONDS

My comments about interest rate risk apply to intermediate; long term funds; and junk funds. With that said, you face another risk with short duration bond funds which is lost purchasing power. Honestly I think you'd be better off substituting the bond allocation to dividend growth stocks as well. You will obviously see more fluctuation in market value, but will reap MUCH more income over the long term. If you can start out at 4% yield then you're already getting 2-2.5% more than you make on a short duration bond fund, but then dividend growth will double your income stream every 10-12 years (with a conservative 6-7% dividend growth rate.) Did I mention that you keep more of your dividend income because its taxed at lower levels?

Again, you've obviously done well to accumulate a fair amount of assets. But my opinion is that you don't have enough assets to keep a huge bond allocation (at THESE VALUATIONS) for a 50 year portfolio. Every financial decision you make is going to affect how you live in retirement and what size portfolio you pass on to your heirs. Buying index funds and bond funds is every bit as much a financial decision which may be rational or irrational. I understand the mentality of trying to earn an avg. return and being above avg. at saving and asset accumulation. But you're DONE with that stage in your life, and now you need to make financial decisions that help you live on your ~$3milion for 50 years. It's NOT going to happen on 1-2% bond yields (and the associated capital losses and lost buying power.)

[IPAfan]

Again bonnap, this is all just my opinion. I know you're following conventional wisdom and that will probably cut it for you. I certainly have no problem with indexing (especially because widespread indexing makes it easier to make good investment returns for those of us who don't.)

If you do decide to stick in bonds I have one idea that might give you more upside to rising interest rates. You could invest a small % of your cash/bond allocation into junk bonds and preferred stock and leave the rest in cash. Shouldn't take too many junk bonds and preferreds to bring your avg. yield to the same level, and then your cash interest rate would float (up) with interest rates. If you keep your allocation to junk bonds 10-15% of the bond portfolio then you'd only be looking at 4-7% value at risk on your bond investment.

The big negative to this approach is that you don't get the same market "hedge" that you get with longer duration government bonds. However, a hedge is only useful if you plan to sell your investments at any given time. If you simply want to create an income stream without doing a lot of trading then I think you'd be better off with the cash/junk bond combination (rising interest rates will make you earn more on the cash and give you the opportunity to make a bond investment at reasonable interest rates.)

[Deleted]

Beer Fan,

Thanks for your additional comments.

I understand some people prefer to manage their own individual stocks than to own mutual funds. But as you can see from post #31 the "carefully picked dividend stocks" equalled the performance of the SP 500. Dividends last year for those stocks was about 2.9%. Personally I think it's going to be a lot cheaper and easier to sell mutual fund shares than constantly messing around figuring out what stock shares to sell each month if we're not able to acheive 3% dividend income.

10% of the "new" bond fund allocation is in "High Yield" aka junk bonds. I seemed to recall it returned in the 7% range last year. About 30k of my 457 is in Vanguard's Total Bond Index which has some "high yield" bonds and about 70k of DH's 401k is invested in PIMCO's Total Return which is also invested in "High Yield" bonds.

"keep a huge bond allocation" Perhaps I'm missing something but I don't see $535k as being a huge bond allocation for a $3.5M NW. While it is about 38% our more liquid side, some folks would say we should be closer to 50% of our total NW.

"I understand the mentality of trying to earn an avg. return and being above avg. at saving and asset accumulation. But you're DONE with that stage in your life" Well not quite. Between savings, royality income, dividend income, rents and interest we should be able to save another $100k over the next 12 months. This assumes we have no stock or real estate appreciation. Anything over 3% return on retirement income on the 1.4M should also grow our retirement portfolio. Of course over 50 years I expect we could see another 2008 where we may lose value or have earnings in the 2% range.

I don't know if you caught the part of the strategy where we will be selling two of our properties at the 5 & 10 year mark. That should net us another $1M (in today's dollars) which will give us another $750k to $850k to invest in the market once we pay off our "retirement house" loan.

This is going to be an interesting ride.

PS I just posted our new 401k/457 allocations as a footnote to NW. Unfortunately it doesn't allow you to break out how your "retirement" is invested.

[IPAfan]

bonnap,

Sounds like you've got everything under control, and I like that you're planning to sell some of the real estate. I was just providing some comments about what I thought would be good for a retirement portfolio with liquid assets.

I would want my entire investment portfolio to yield over 4% and have the yield growing by 10% per year. I can understand different points of view.

[Deleted]

Beer fan,

Thanks and I do appreciate yours and everyone's help. Over the years I've learned so much here and I hope I've been helpful to others.

Even if I don't agree with an opinion, I do think about it and even with this one thread I've learned a lot.

Thanks!