Need Help with Asset Allocation

[Deleted]

Hi All,

I could use some of the smarts here to help us transition over to a retirement portfolio. This is long so I'm post in two parts. The first question is how best to invest $300k in intermediate bond fund(s). We do have an appointment with a USAA financial advisor which I'm sure will be an ok plan but biased towards USAA products (they don't work on commission). I would appreciate the collective wisdom of the board to recommend some other products.

As background, DH's contract ends in 18 months. Then he has 6 months of severance pay. Then we need to live on our investments. Here is a snap shot of where we are and I'll go into further detail.
www.networthiq.com/people/Carefreeap

So we've basically sat on our cash for the last three years primarily because DH's job status was so uncertain. Now it looks like the next 18 months are as secure as they will ever get. We prepared a proposed retirement spending sheet and compared it with what we've actually spent over the last 3 months. Once we back out rent (mortgage only) we find we are in the ballpark of 65k/yr gross, assuming combined fed & state taxes of 20%.

DH will be 54 and I will be 51. Because of the potential of around 50 years in retirement we want to try to live on the earnings of our assets. I believe that if we pay off the mortgage of the house we will be moving to and buy into intermediate bond fund(s) and simply reinvest the earnings as well as our stock dividends and 401ks/457 we should have an asset base of about $1,350,000. Assuming a 3% rate of return of the investments we would have income of around $40,500/yr. In addition we have earned conservatively 24k/yr for 10 years from Oil Royalties. We'll invest the remaining $200k in laddered cds. That's my thinking on how to generate $65k for years 2013-2017.

Thoughts and comments?

[Deleted]

Part 2 How best to reposition our current 457 and 401ks

Because DH's contract ends the year he turns 54 he can't access the 401k without penalty (he misses out by 5 months). We could transfer over to an IRA and do the annuity thing but I think it will be much easier to simply draw down on my 457. It's currently at $90k and $55k is invested in Oppenheimer Global Fd A and $35k is invested in Vanguard Ins't Inx Port. At 17k/yr draw down it approximates a 3% return on our total 401k/457 balance.

In 2018 DH will turn 591/2 and can access his 401k. Balance is approximately $410k with $57.4k in Fid Div Intl, 112.8k in Fid freedom 2020, $71.6k in Fid low pr stk, $77.4k in Pim Total Rt and $91k in Rainier sm/md cap. My remaining 401k is accessible in 2021 with $22.7k in Vang 500 and $27.3k in Vangd Wellington.

Thoughts on how this money should be allocated?

Thanks!

ETA: We do plan on selling some of this real estate we're holding. But the timeframe is uncertain. Best guess is around 5 years for house 1. That will free up money to buy down the next loan and remodel money. Assuming no appreciation, we're talking about netting another $300k so we should be able to keep up with inflation with respect to the purchasing power of the 65k.

[bimetalaupt]

Bon nap,
I know your feelings as I did go thought the same thing. I invested in my MBA with Theses. I did finish it when I was 55. I used to work as a Pharmacist and saved about 50% of my total income using things like your oil and gas systems etc to keep taxes down.. Problem because AMT. I think I will stick to my 50/50 with bonds and CD's being used as a back stop .. Problem is I have not replaced bonds due to the increased and increasing yields reducing the value of the holdings. My GF is an expert on art and I do have a large holdings of Picasso and Chagall she want to get her hands on. As far as taxes go I have been at 38% so long I keep forgetting about anything other they what will this do to my taxes.

One thing.. It looks like you pay a lot of fees on your investments.. The 63/37 Efficient Frontier investment system with stocks ( 34) and Bonds ( 30 year T-Bonds ) has average some 8.75% over the last 50 years real return. Ok bonds are at a interesting turning point so I am out of the bond market for the first time in 30 years. Cash is counted as risk free part with bonds. ( if you ask Axel Weber this could be a joke in Germany)

Best of Luck... How do you like living in Bonn? Our Family cam out of Wassweiler.. That was at the time Luxembourg. Banking is all about service.. do not forget the Royalty. .KASH IS KING!!!

Just a thought,
Bi metal Au Pt

[phil5185]

I like your plan to make your funds grow in perpetuity rather than deplete in 30 or 50 or X years.
I would simplify - put the $1.35M at 40/60 to 50/50 stocks/bonds (with a longterm return goal of 7% to 8%) and leave 3% to offset inflation. So the $1.35M would grow to $4.4M over 40 yrs, and the annual draw would increase from $54k/yr to $176k/yr.

The stock portion could be SP500 index funds, & an int'l fund. And the bonds could be an FBIDX fund and a VFIIX (GNMA) fund. They are both short to intermediate, have been returning 6% to 7%/yr. (Contrary to Suze Orman, I like bond funds with the real-time current value - as opposed to owning individual bonds that will someday mature at face value).

[yclept]

Here's my opinion, for whatever it's worth:
Bonds have only one way to go, and that's down. Right now you're not getting a rate of return that even beats real inflation. As interest rates inevitably rise (and probably sooner than we've all been lead to expect), bonds are going to go down. So you will be caught on the horns of a dilemma -- falling bond price eating away at your assets, together with an interest rate that is constantly falling farther below the rate of inflation.
Unlike air-to-air missiles, there is no fire-and-forget method of investing that will do anything other than transfer your assets into the hands of others.
At the very least, diversify a lot of the "fixed income" portion of your portfolio into stocks that are paying dividends higher than the rate of inflation. You might have a fighting chance to stay even with inflation by doing that, and you won't see it dribble away as it will with bonds. It doesn't sound like you want to take on the risk of high-yield (junk) corporate bonds, but they are the only ones likely to give a decent return in the bond arena over the next few years.
I have no experience with USAA. But I can say with confidence that unless their operating expenses are underwritten by the government, then they are getting those expenses from their clients one way or another. Give me a straight forward discount broker over anyone who claims to have my best interests at heart any day.

[bimetalaupt]

Jan 31, 2011 20:12:18 GMT -5 phil5185 said:

I like your plan to make your funds grow in perpetuity rather than deplete in 30 or 50 or X years.
I would simplify - put the $1.35M at 40/60 to 50/50 stocks/bonds (with a longterm return goal of 7% to 8%) and leave 3% to offset inflation. So the $1.35M would grow to $4.4M over 40 yrs, and the annual draw would increase from $54k/yr to $176k/yr.

The stock portion could be SP500 index funds, & an int'l fund. And the bonds could be an FBIDX fund and a VFIIX (GNMA) fund. They are both short to intermediate, have been returning 6% to 7%/yr. (Contrary to Suze Orman, I like bond funds with the real-time current value - as opposed to owning individual bonds that will someday mature at face value).

Phill , I thought I was clear.. This is net figure of inflation over a long period of time with regard to the Efficient Frontier/ trading system ( now 63/37)..

as above..One thing.. It looks like you pay a lot of fees on your investments.. The 63/37 Efficient Frontier investment system with stocks ( 34) and Bonds ( 30 year T-Bonds ) has average some 8.75% over the last 50 years real return. Ok bonds are at a interesting turning point so I am out of the bond market for the first time in 30 years. Cash is counted as risk free part with bonds. ( if you ask Axel Weber this could be a joke in Germany)

Read more: www.notmsnmoney.proboards.com/index.cgi?board=startinvesting&action=post&thread=2665"e=99707&page=1#ixzz1Cfq4hrDZ
As I am now calling it a trading system.. It takes steel balls for the Bull to sell STOCK when everyone one else is buying .. LIKE 1999 with the .. and yess we are getting above our Value at risk limits for stock...Time to rebalance..

Bi Metal Au Pt

[Deleted]

Hi All,

Thanks for your responses. I'll respond individually but in the meantime I realized I failed to list the individual stock holdings.
$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

So with the exception of Tata, these are basically old man, blue chip dividend paying stocks. DH inherited them from a by-pass Trust about 10 years ago. I believe most of them were bought in the 80s and therefore have some serious tax consequences if we sell them all to invest in an index fund. Since they were purchased to give dividend income to DH's dad I think they are still appropriate for our needs.

I know that long term, inflation is an issue. And I know that interest rates are at a historical low. I guess I'm not convinced that there's going to be a radical change over the next 2 years, hence the desire for intermediate bond fund vs long. I think the US recovery is still pretty slow. If I'm wrong I think the stock and real estate part of our portfolio will benefit.

I think events like Egypt's revolution could have some short-term affects like a spike in oil and gold and a flight to US Treasuries which could drive short term rates even lower. The US has a lot of problems but at least it's politically stable. We have our (mostly) orderly revolutions every 4 to 8 years.

[bimetalaupt]

Feb 1, 2011 3:29:30 GMT -5 @bonnap said:

Hi All,

Thanks for your responses. I'll respond individually but in the meantime I realized I failed to list the individual stock holdings.
$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

So with the exception of Tata, these are basically old man, blue chip dividend paying stocks. DH inherited them from a by-pass Trust about 10 years ago. I believe most of them were bought in the 80s and therefore have some serious tax consequences if we sell them all to invest in an index fund. Since they were purchased to give dividend income to DH's dad I think they are still appropriate for our needs.

I know that long term, inflation is an issue. And I know that interest rates are at a historical low. I guess I'm not convinced that there's going to be a radical change over the next 2 years, hence the desire for intermediate bond fund vs long. I think the US recovery is still pretty slow. If I'm wrong I think the stock and real estate part of our portfolio will benefit.

I think events like Egypt's revolution could have some short-term affects like a spike in oil and gold and a flight to US Treasuries which could drive short term rates even lower. The US has a lot of problems but at least it's politically stable. We have our (mostly) orderly revolutions every 4 to 8 years.
Not bad.. I counted 12 Alpha stocks in the mix with three none - USA names..more on the efficient frontier.. 50/50 re-balancer system... One more thing.. The USA economy is on all 12 cylinders.. One of the best in the world..low inflation and solid growth..too good for a lot of bonds..
Just a thought,
Bi Metal Au Pt

The Efficient Frontier and Portfolio Diversification

The graph on the previous page shows how volatility increases your risk of loss of principal, and how this risk worsens as your time horizon shrinks. So all other things being equal, you would like to minimize volatility in your portfolio.

Of course the problem is that there is another effect that works in the opposite direction: if you limit yourself to low-risk securities, you'll be limiting yourself to investments that tend to have low rates of return. So what you really want to do is include some higher growth, higher risk securities in your portfolio, but combine them in a smart way, so that some of their fluctuations cancel each other out. (In statistical terms, you're looking for a combined standard deviation that's low, relative to the standard deviations of the individual securities.) The result should give you a high average rate of return, with less of the harmful fluctuations.

The science of risk-efficient portfolios is associated with a couple of guys (a couple of Nobel laureates, actually) named Harry Markowitz and Bill Sharpe.

Suppose you have data for a collection of securities (like the S & P 500 stocks, for example), and you graph the return rates and standard deviations for these securities, and for all portfolios you can get by allocating among them. Markowitz showed that you get a region bounded by an upward-sloping curve, which he called the efficient frontier.

The Efficient Frontier is the upper boundary of the region of all possible investments based on a given class of securities

It's clear that for any given value of standard deviation, you would like to choose a portfolio that gives you the greatest possible rate of return; so you always want a portfolio that lies up along the efficient frontier, rather than lower down, in the interior of the region. This is the first important property of the efficient frontier: it's where the best portfolios are.

The second important property of the efficient frontier is that it's curved, not straight. This is actually significant -- in fact, it's the key to how diversification lets you improve your reward-to-risk ratio. Combining securities lowers risk To see why, imagine a 50/50 allocation between just two securities. Assuming that the year-to-year performance of these two securities is not perfectly in sync -- that is, assuming that the great years and the lousy years for Security 1 don't correspond perfectly to the great years and lousy years for Security 2, but that their cycles are at least a little off -- then the standard deviation of the 50/50 allocation will be less than the average of the standard deviations of the two securities separately. Graphically, this stretches the possible allocations to the left of the straight line joining the two securities.

In statistical terms, this effect is due to lack of covariance. The smaller the covariance between the two securities -- the more out of sync they are -- the smaller the standard deviation of a portfolio that combines them. The ultimate would be to find two securities with negative covariance (very out of sync: the best years of one happen during the worst years of the other, and vice versa). TWO POINT ON THE CHART.. MORE RISK= MORE RETURN BUT THEY DO NOT HAVE TO BE DRIVEN BY THE SAME ITEM.. THEY CAN BE MUTUALLY EXCLUSIVE...

Attachments:

[bimetalaupt]

Jan 31, 2011 22:26:03 GMT -5 bimetalaupt said:

Jan 31, 2011 20:12:18 GMT -5 phil5185 said:

I like your plan to make your funds grow in perpetuity rather than deplete in 30 or 50 or X years.
I would simplify - put the $1.35M at 40/60 to 50/50 stocks/bonds (with a longterm return goal of 7% to 8%) and leave 3% to offset inflation. So the $1.35M would grow to $4.4M over 40 yrs, and the annual draw would increase from $54k/yr to $176k/yr.

The stock portion could be SP500 index funds, & an int'l fund. And the bonds could be an FBIDX fund and a VFIIX (GNMA) fund. They are both short to intermediate, have been returning 6% to 7%/yr. (Contrary to Suze Orman, I like bond funds with the real-time current value - as opposed to owning individual bonds that will someday mature at face value).

Phill , I thought I was clear.. This is net figure of inflation over a long period of time with regard to the Efficient Frontier/ trading system ( now 63/37)..

as above..One thing.. It looks like you pay a lot of fees on your investments.. The 63/37 Efficient Frontier investment system with stocks ( 34) and Bonds ( 30 year T-Bonds ) has average some 8.75% over the last 50 years real return. Ok bonds are at a interesting turning point so I am out of the bond market for the first time in 30 years. Cash is counted as risk free part with bonds. ( if you ask Axel Weber this could be a joke in Germany)

Read more: www.notmsnmoney.proboards.com/index.cgi?board=startinvesting&action=post&thread=2665"e=99707&page=1#ixzz1Cfq4hrDZ
As I am now calling it a trading system.. It takes steel balls for the Bull to sell STOCK when everyone one else is buying .. LIKE 1999 with the .. and yess we are getting above our Value at risk limits for stock...Time to rebalance..

Bi Metal Au Pt

I POSTED THE CHARTS BACKWARDS
The Sharpe Ratio

The previous page showed that the efficient frontier is where the most risk-efficient portfolios are, for a given collection of securities. The Sharpe Ratio goes further: it actually helps you find the best possible proportion of these securities to use, in a portfolio that can also contain cash.

The definition of the Sharpe Ratio is:

S(x) = ( rx - Rf ) / StdDev(x)

where

x is some investment
rx is the average annual rate of return of x
Rf is the best available rate of return of a "risk-free" security (i.e. cash)
StdDev(x) is the standard deviation of rx

The Sharpe Ratio is a direct measure of reward-to-risk. To see how it helps you in creating a portfolio, consider the diagram of the efficient frontier again, this time with cash drawn in.

The Sharpe Ratio of X is the slope of the line joining cash with X

There are three important things to notice in this diagram:

1. If you take some investment like "x" and combine it with cash, the resulting portfolio will lie somewhere along the straight line joining cash with x. (This time it's a straight line, not a curve; cash is riskless, so there's no "damping out" effect between cash and x.)

2. Since you want the rate of return to be as great as possible, you want to select the x that gives you the line with the greatest possible slope (like we have done in the diagram).

3. The slope of this line is equal to the Sharpe Ratio of x.

Putting this all together gives you the method for finding the best possible portfolio from this collection of securities: First, find the investment with the highest possible Sharpe Ratio (this part requires a computer); Next, take whatever linear combination of this investment and cash will give you your desired value for standard deviation. The result will be the portfolio with the greatest possible rate of return.

Next: really use the Sharpe Ratio to build a risk-efficient portfolio.

Attachments:

[bimetalaupt]

Jan 31, 2011 22:26:03 GMT -5 bimetalaupt said:

Jan 31, 2011 20:12:18 GMT -5 phil5185 said:

I like your plan to make your funds grow in perpetuity rather than deplete in 30 or 50 or X years.
I would simplify - put the $1.35M at 40/60 to 50/50 stocks/bonds (with a longterm return goal of 7% to 8%) and leave 3% to offset inflation. So the $1.35M would grow to $4.4M over 40 yrs, and the annual draw would increase from $54k/yr to $176k/yr.

The stock portion could be SP500 index funds, & an int'l fund. And the bonds could be an FBIDX fund and a VFIIX (GNMA) fund. They are both short to intermediate, have been returning 6% to 7%/yr. (Contrary to Suze Orman, I like bond funds with the real-time current value - as opposed to owning individual bonds that will someday mature at face value).

Phill , I thought I was clear.. This is net figure of inflation over a long period of time with regard to the Efficient Frontier/ trading system ( now 63/37)..

as above..One thing.. It looks like you pay a lot of fees on your investments.. The 63/37 Efficient Frontier investment system with stocks ( 34) and Bonds ( 30 year T-Bonds ) has average some 8.75% over the last 50 years real return. Ok bonds are at a interesting turning point so I am out of the bond market for the first time in 30 years. Cash is counted as risk free part with bonds. ( if you ask Axel Weber this could be a joke in Germany)

Read more: www.notmsnmoney.proboards.com/index.cgi?board=startinvesting&action=post&thread=2665"e=99707&page=1#ixzz1Cfq4hrDZ
As I am now calling it a trading system.. It takes steel balls for the Bull to sell STOCK when everyone one else is buying .. LIKE 1999 with the .. and yess we are getting above our Value at risk limits for stock...Time to rebalance..

Bi Metal Au Pt

Build a Portfolio: Asset Allocation with the Sharpe Ratio

This interactive demo shows how the Sharpe Ratio is used to build a portfolio that provides a maximum rate of return for a given level of risk tolerance.

Your Risk Tolerance Available Asset Classes
Conservative 3 %
Moderate 5 %
Aggressive 10 %
Other: %

r StdDev Covariance
1. % %
2. % %
3. Cash % 0 %






(Note that risk tolerance is defined as your maximum acceptable value for standard deviation.)

Here are three things you should verify. For (1) and (2), start with a portfolio that includes stocks, bonds and cash.

1. If you lower your risk tolerance level, the allocation ratio of stocks-to-bonds will remain constant, and the amount of cash will increase. (Graphically, you're on the straight line joining cash to the Efficient Frontier, and moving to the left.)

The line with the highest Sharpe Ratio contains all optimal portfolios.

2. If you decrease the covariance between stocks and bonds, you can allocate more money to stocks and bonds and less to cash, thus raising your rate of return. (This is taking advantage of the curved shape of the Efficient Frontier, stretching it further to the left and tilting the line up. By the way, this demo only lets you decrease covariance to zero, although negative covariance is possible, at least in theory. The size of the covariance will be on a scale roughly equal to the product of the two standard deviations; so for example, if the two investments have standard deviations of 15% and 7%, a large value for the covariance would be .15 x .07 = 0.0105.)

3. If you increase your risk tolerance to a high enough level, you'll get a zero-cash portfolio. This means you're up on the Efficient Frontier, but to the right of the point where it intersects the straight line. (In theory you could get up to the line even here if you are willing to hold a "negative" amount of cash, that is, to invest on margin.)

Attachments:

[Deleted]

Bimetalaupt,

Thanks for your input but I'm having a hard time understanding your posts. I understand the concept of having investments in different sectors to optimize return and to lower risk. I've read the Intelligent Asset Allocator, hence the reason for Asset Allocation question in the first place. Between the straight out stock share ownership and real estate we're definitely poised for growth in equity. Perhaps I wasn't clear? The reason for investing in intermediate bond type products is to give some balance to our portfolio and realistically generate some income ($11,000/yr) in the near (3 years) to mid (8 years) assuming a pretty low rate of return given current rates. When I look at the 10 year average for Vanguard's Intermediate Bond index I see 6.40% but I know that's not what I'm going to get today.

Thanks for reminding me to review our fees. We do have limits on what we can invest in given DH's 401k is active and keeping money in the 457 (rather than rolling it over into a IRA).

[Deleted]

Hi Phil,

You do simplify it! Are you really an Engineer?
Seriously I appreciate your comments. I will check out your recommendations. I do think we've got some duplication already and want to use this opportunity to streamline.
Thanks!

[phil5185]

3. If you increase your risk tolerance to a high enough level, you'll get a zero-cash portfolio. This means you're up on the Efficient Frontier, but to the right of the point where it intersects the straight line. (In theory you could get up to the line even here if you are willing to hold a "negative" amount of cash, that is, to invest on margin.)

But keep in mind that the time period is key. Sharpe's Ratio is a good trading tool for 3, 5, 10 yr time periods. But for long term (>25 yrs) programs, the standard deviation rolls off substantially, and the +/- function converges. And since std dev is the denominator of the Ratio, the Ratio goes 'high', ie favorable risk.
Eg, the std dev of the SP500 is 21.67 for a 3-yr period, and 17.49 for a 5-yr period. And way lower for a 30-yr period.

Yes, you can use 'negative' cash to dial in a higher risk and optimize and to avoid uncompensated risk. I've used margin, but the rates are high and I was always one-step from a margin call. I do better by using other sources of margin capital - ie, I put loans on our houses, that way I have 30-yr fixed rate low cost capital to invest - and I'm not limited by the 2:1 leverage of the 'margin' rule.

[Deleted]

Yclept,

Thanks for your comments. I'm not thrilled about a 3% rate of return either but it seems like a realistic income at this point in time. The intermediate "bonds" that we want to buy now would be actually in the 10% range of our total portfolio. Once you factor in the turnover in an intermediate bond fund (70% in Vanguard's interm) we're only buying a really small portion of our total portfolio in any particular year. So another way to look at it is that we expect to be at about a 80% equity (stocks + real estate) and 20% bond fund, bond component (e.g. Pimco, Wellington, Fed Freedom) and cash in two years. I still think it's a pretty aggressive portfolio for a retiree but not a young retiree.

With respect to USAA; think of them as a super credit union for the Military and their families. We're not military but both sides of DH's family hail from military backgrounds, hence our eligibility. Obviously nothing is for free but their costs are reasonable. But as I said in the beginning of my post I want to investigate other options. For example, I'm comparing their Intermediate Bond fund with Vanguard's. Expense ratio for USAA's Interm bond is .65% Vanguard's is .22%. USAA's 10 year total return is 6.00%, Vanguard's is 6.40%. I think this is a situation where the difference in the yield is primarily due to the fund's fees.

[phil5185]

You do simplify it! Are you really an Engineer?

LOL - yeah! And sometimes simplicity of design is a beautiful thing.
In the old days of carburetors on cars, the germans smoothed out performance with little gee-whiz mechanisms, many little lever arms, vacuum compensators, progressive linkage, automatic choke, yada. It looked like the workings of a cuckoo clock. Had to go to the dealer to be 'tuned' and readjusted every 15,000 miles.
Meanwhile the japanese analyzed the issue, made a couple venturi changes in the permanent casting, and accomplished the same thing. And it didn't need 'tuning'.

For the last 15 or so yrs, I have avoided individual stocks, IMO the invention of index funds and ETFs makes the risk unnecessary. Eg, an index fund carries the risk of a nation's economic pulse (and returns about 11% long term). A sector carries the nation's risk plus the added risk of the sector's variability/obsolescence (and also returns ~ 11%). An individual stock carries the first two risks plus the added risk of a corporate failure (and also returns ~11% long term). IMO, since you are drawing from the same population of stocks (500) in all three cases (and get 11%), and the ETFs and ind stocks carry higher risk, that is uncompensated risk. I want high risk/high returns but I want it to be compensated risk.
In your 14 stocks, you have effectively built your own mutual fund - the group is diversified so the risk is spread. But even so, a P&G bk would cost $78k - unlikely, but so was the GM bk. And GE, probably OK, but it is run by Jeff Immelt (to state it delicately - he's an idiot).

[yclept]

The only point I was trying to make is that we've seen a couple of years of really rough sledding where bonds performed well because the Fed was lowering rates and doing everything else they could to keep the economy afloat. I think the next surprise, and I call it a "surprise" only because all the talking heads, commercial and governmental, are saying it's not going to happen soon, is going to be the Fed having to reverse its easy-money policies to beat back rising inflation. Many commodities are rising again, and much of the rise is concentrated in goods that consumers can't avoid (food and energy). Neither food nor energy are counted in the BLS "core" CPI, which is the number most often quoted.
The Fed is going to have a difficult balancing act (as always) -- keep inflation in check, but don't torpedo the economy. But interest rates are essentially zero, there is only one way they can go. Usually the Fed is late in responding to inflation, but whether they decide to act early or late, the market sees what's going on and reacts accordingly (that should probably read "over-reacts accordingly").
Investors have retreated to bonds seeking safe-haven from the financial crisis and the effect it had on equities. This crisis was not typical because the other usual "safe-haven", real estate, was proving at least as bad an alternate as stocks. Bonds are clearly both over-valued and over-bought -- some of the latest treasury instruments sold at prices that guaranteed a small negative return, and you can't get more over-bought than that!
To me this all adds up to an environment where interest rates are going to start rising and bond prices are going to fall. Balanced portfolio be damned! I don't want any assets in a class that is merely awaiting the fall of the sparrow. I think we can even be fairly certain that the time-frame is "sooner, rather than later".
Bonds right now feel to me like getting on a plane and hearing the captain say "This planes engines are in the shop for repair, but don't worry, we've strapped a half-a-dozen JATOs on the back that'll get us a few hundred feet off the ground, and we've got plenty of fuel, though right now it's just running out on the ground." Methinks I'll take the train!

[Deleted]

"sometimes simplicity of design is a beautiful thing"

I love it. Sometimes I hear my father's voice with respect to cars "the more things to operate, the more things to break". And "Audi-engineering marvel, mechanical failure". I'm such a mean wife I wouldn't let DH buy an Audi (or even take it as a company car). I loved my family's 1973 "Fox" but it was in the shop all the time...

I appreciate your comment about our existing stock portfolio. I hadn't really thought of it as our own index fund but it makes sense. Good reminder about about the overweight P&G stock. I agree a bk doesn't seem likely (it's apparently is doing really well overseas) but a couple of serious product recalls can really hurt a company. DH did finally part with some Microsoft stock a couple of years ago. It probably makes sense to take the P&G down to the $35k level. Sclumberger is also getting up there at $67,5k. Boy it's hard to part with stock when it's doing well!

[Deleted]

Yclept,
I hear you. But it's been my experience that these recessions move relatively slowly and I can never really time the market. But one good call I made was not investing in TIPS a year or two back. I kept saying "what inflation"? And these things can go negative? I'd rather sit in cash.

BTW I just heard from the woman who handles our mail in the US. Got our oil royalty checks in the mail today. $3,100 this month. (I budgeted for $2,000 mth who-hoo!) The checks are for December sales. With the dust up in Egypt I think January's check is going to be really nice. Maybe I found our inflation fighter or the off-set to the SF Bay Area fuel prices we'll be paying when we return to the US!

[yclept]

I filled up the car a few days ago. Best I recall, it was $3.37/gal for regular. But I would think that will seem cheap to you after paying for gas in Europe.

[Deleted]

Ha ha. Company car + company gas card. We get taxed on it but still a much better deal.

ETA: I should add that in spite of having these perqus, we actually don't drive much. DH walks to work nearly every day and if I put more than 15 miles a week on the car I'd be surprised.

However a BIG surprise to me was finding out how expensive gas is in Turkey (going next month). $10/gal! Who would have thought? My map says it's pretty close to oil producing areas...

Actually my comment refers to my memory from a couple of years ago. I was driving from our house in AZ to CA. I stopped in Bakersfield thinking, hey they have oil fields here it should be cheaper! $4.25 a gallon. Mind you there were a few months where we were getting $5k a month oil royalties but paying $80 to fill my 4 Runner hurt!

[bimetalaupt]

Feb 1, 2011 12:25:04 GMT -5 @bonnap said:

Bimetalaupt,

Thanks for your input but I'm having a hard time understanding your posts. I understand the concept of having investments in different sectors to optimize return and to lower risk. I've read the Intelligent Asset Allocator, hence the reason for Asset Allocation question in the first place. Between the straight out stock share ownership and real estate we're definitely poised for growth in equity. Perhaps I wasn't clear? The reason for investing in intermediate bond type products is to give some balance to our portfolio and realistically generate some income ($11,000/yr) in the near (3 years) to mid (8 years) assuming a pretty low rate of return given current rates. When I look at the 10 year average for Vanguard's Intermediate Bond index I see 6.40% but I know that's not what I'm going to get today.

Bon Nap,
I see that.. The extra income is selling one at the top and buying the other at the bottom...
Sorry, I do not hold a lot of funds in my system.. I hold T-Bonds and Stock. I did start with one ETF but have never made aq second investment.. Say you Bonds have a sd of 15% and Stocks of 22%.
look at the numbers for March 2009..
Sell (sold) bonds at 2.6% ( 30 year T-Bonds and bought ETF QQQQ at $29.74
Today the same T-Bonds yield is up to 4.58% ( yield up price is down..made money)
Now QQQQ is at $56.18...Made money.. That means you total income from bonds are greater then expressed by interest.. It becomes a trading Pair.. That is the only way you can keep your ratio.. As stated on my post i AM RUNNING LATE ON MY REBALANCE.. NOW AT 63% STOCK/ETF AND 37% BONDS AND CASH.. WATCHING INFLATION ESP IN THE ECU. I THOUGHT THIS WAS CLEAR IN THE EF ARTICLE..LET ME KNOW IF THIS IS NOT ENOUGH INFO.. IT TAKES STEEL BALLS TO SELL WHEN EVERYONE ELSE IS BUYING.. THE SYSTEM HAS A LONG HISTORY OF BETTER RETURNS THEN STOCK/BOND MARKET WITH LESS RISK ( LOWER SHARPS INDEX)...++

THE GOAL IS MAX RETURN WITH THE LEAST RISK.. Just a thought, Bi Metal Au Pt
Thanks for reminding me to review our fees. We do have limits on what we can invest in given DH's 401k is active and keeping money in the 457 (rather than rolling it over into a IRA).

I went back and pulled total return over the last 11 years...

Bonds were about 8.6%
Stocks were 11.25%.. Sold a lot at the top and did not replace as I used the funds for Oil and gas that returned about 18%..

Attachments:

[bimetalaupt]

Bon Nap,
From MT.. ON Equity Risk Premium.. Or RF rate + ERP = Total Return .. Historical: it has 5% + 6%= 11%.. Rebalancing as added a bit as did a huge bull market in Bonds .. Yield went from 16% in 1980 to 2.69% in 2008.. about the same time Stock Market had the 6.48% Risk Premium,,

Just a thought,
Bi Metal Au Pt

As you know FTI and I have had this game on defending our system balance... He won as I am shifting to the Equity side due to the increased ERP calculations by Robert Barro vs Dr. A. Damodaran , PhD 5.2% ERP.... Yiou can see where I got my 4.36% from.. OK it is out of date...4.36% +3.843 = 8.203% total return for 10 year risk free of 3.843% as of 12/31/2009

Bi Metal Au Pt..
For the record from Dr. Damodaran site on NYU Stern School of business....

Implied Equity Risk Premium (US)

I will be posting my updates on the implied equity risk premium (ERP) on the S&P 500 on a monthly basis at the end of each month. (To see my explanation of the implied equity risk premium, please download my paper on the ERP)

Implied Premium on 1/1/11 =5.20%
Implied Premium in previous month = 5.08%


Implied ERP (US) on 12/31/09= 4.36%
Implied ERP on 12/31/08 = 6.43%
Implied premiums by month for recent months

Download spreadsheet to compute implied premium

Read more: notmsnmoney.proboards.com/index.cgi?action=userrecentposts&user=bimetalaupt#ixzz1ClC3Mt5K

[Deleted]

Hello Bimetal,

Sorry my other post got lost.

I do want to thank you for your posts. I think I understand what you're saying now. By using the Efficient Frontier system I should be able to harvest a much greater return than the 3% rate of return I'm trying to obtain with my mix of stocks, bonds, mutual funds and cash. I'll spend a little time looking into what you are talking about. But I'm curious; how often are you trading or rebalancing? It sounds like one would really need to pay attention; perhaps weekly or monthly vs the typical annual asset allocation that many financial advisors recommend. Do you know that within our qualified plans that we are limited in our ability to trade? I'll have to double check but I think it's something like 3x per quarter.

As to the index funds; I do seem to recall from one of your older posts, perhaps on the MSN YM that you are an advocate of do it yourself index funds vs paying a fund to do the same thing. I seem to remember thinking at the time that would take a lot of time and money but as Phil noted, we've already effectively done that with our existing stock holdings. Buy some bonds and add in our cash and yeah, we've got a super conservative non qualified investment portfolio.

I guess I need to make a confession. I don't find researching stocks and rebalancing a lot of fun. We haven't done it in a while (as in years) so the research is interesting right now but honestly, I'd rather be hiking or working on the houses than researching stocks once we return to the States and live in nice weather again. So the indexed mutual funds as Phil suggests may be the way to go for me. DH may feel differently. He's happy being in front of a computer all day.

[Deleted]

Hi Wxyz,

Glad you made it over. I hadn't seen you post over here yet.

I wouldn't say my goal is 3% per se, more like that's my budget, e.g. it seems realistic based on what's going on today. The two bond funds I had been looking at Vanguard Interm Bond (last year's yield at 7.15) and USAA's Interm Bond at 11.47%. But there's a good chance that over the next 8 years that the yield could go down if interest rates rise. But then again, interest rates may not change much especially if investors go back into US treasuries over worries overseas. My thinking is that with a slow rise in interest rates the interim bond fund is going to be buying new bonds as the old ones mature. So if rates do rise then the fund will be buying those higher rate bonds so the yield should still stay in their 6%-6.50% 10 year historical range. Does that make sense?

So I circle back to the original question about asset allocation. Typically you want SOMETHING other than cash to give some balance to a heavy equity oriented portfolio. Right now that $650k cash might have earned us a whopping $300 in interest last year. Better than losing it but really sad!

[Deleted]

"why rush into bonds right now"

That's the thing. I see nothing wrong with having about 8% of our NW in non qualified bond funds. But moving $300k into bond funds at once sounds pretty drastic, doesn't it?

I didn't post the details but at the end of 2009 BofA gave us 30 days notice to sell all of our mutual funds and move our stocks elsewhere because they didn't have a license that would allow them to sell securities overseas. Otherwise they were going to sell everything and send us a check to our P.O. Box. I've already ranted and raved about the poor customer service so let's move on. The timing was really bad and we hurriedly sold the mutual funds (mostly bonds but total value of 186k) and opened up an account with USAA and moved the stocks. Then shortly afterward DH got word that he might be out of a job at the end of last year. That finally got rectified in mid Nov so here we are at the beginning of the year saying we can't just let the money sit and collect .01% interest, it's stupid. So my thought process is let's invest in products that we need for the next 8 years until we have access to the 401k earnings. 3% ain't great but it's achievable.

Of course the smart thing would have been to re-evaluate our asset allocation and dollar cost average some amount into a few different funds. But hind sight is always 20-20...

[bimetalaupt]

Feb 3, 2011 10:35:28 GMT -5 @bonnap said:

Hello Bimetal,

Sorry my other post got lost.

I do want to thank you for your posts. I think I understand what you're saying now. By using the Efficient Frontier system I should be able to harvest a much greater return than the 3% rate of return I'm trying to obtain with my mix of stocks, bonds, mutual funds and cash. I'll spend a little time looking into what you are talking about. But I'm curious; how often are you trading or rebalancing? It sounds like one would really need to pay attention; perhaps weekly or monthly vs the typical annual asset allocation that many financial advisors recommend. Do you know that within our qualified plans that we are limited in our ability to trade? I'll have to double check but I think it's something like 3x per quarter.

As to the index funds; I do seem to recall from one of your older posts, perhaps on the MSN YM that you are an advocate of do it yourself index funds vs paying a fund to do the same thing. I seem to remember thinking at the time that would take a lot of time and money but as Phil noted, we've already effectively done that with our existing stock holdings. Buy some bonds and add in our cash and yeah, we've got a super conservative non qualified investment portfolio.

I guess I need to make a confession. I don't find researching stocks and rebalancing a lot of fun. We haven't done it in a while (as in years) so the research is interesting right now but honestly, I'd rather be hiking or working on the houses than researching stocks once we return to the States and live in nice weather again. So the indexed mutual funds as Phil suggests may be the way to go for me. DH may feel differently. He's happy being in front of a computer all day.

++

Bon Nap,
Yes I know.. When I first got started it was a lot of fun. After time it is a job so I look at "Asset management" as a job. Like some of my friend would say..My head is in my cloud.. Well , it is all driven with a huge Math Model called MMXI.. or Money machine XI..

Two things, You could start a new account with one of those great Luxembourg Banks like Royalty. If you noticed the numbers I posted and the numbers wxyz posted are exactly net fee difference. Take His 7% and add the net fee of about 2% you get 9%.. So if you held stocks( like the ones you talked about your a not paying the 2%). and should bet getting better returns.

I bet you are not getting the fee worth of service. So Welcome to the big boys club. Have fun and I like to go hunting more then crunching numbers..
Trade of net but more often then not antonymous. I just sell one when it is totality out of line with value. At this point I am not as disciplined on trading at point as I was 10 years ago.

I wish you the very best of luck, I have tried to answer your question the best way I know how.. Great question !!thank-you,Bruce

[Deleted]

Hi Bruce,

I've got DH exploring the Sharpe index. Researching that should make him happy for a while.

As to the 2% fee you are talking about; we're not paying fees other than on the mutual funds. Our 401ks/457 (qualified funds) won't let us hold individual stock other than my old employer, Southern Pacific, which was bought by Union Pacific. And the highest fee we're paying is for DH's 401k investment in Rainier Sml/Mid cap of 1.21%. I would complain except last year's total return was 24.9% .

Mid point typical is PIMCO Total Return Fund at .46% expense ratio(Bond fund at 8% total return last year) but all the way down to my Vanguard Inst Port (S&P Index fund at .18 ratio and 14.91% total return last year).

But it is fun to compare. If I look at the total return of our individually owned stocks I get a 14.78% rate of return for 2010. They are so close I'd call it a tie.

But I guess I need to repeat what I was trying to do with my model which is for us to try to live on the INCOME of the investments vs the total return (income + capital appreciation), hence the 3% number.

[yclept]

Bill Gross on bonds:
finance.yahoo.com/news/Big-Returns-on-Bonds-Have-tsmf-2288685471.html;_ylt=AsFh4ic4PrtcdfYf03OTlJO7YWsA;_ylu=X3oDMTE2aTE3bzF0BHBvcwMxMQRzZWMDdG9wU3RvcmllcwRzbGsDYmlncmV0dXJuc29u?x=0&sec=topStories&pos=8&asset=&ccode=

[phil5185]

(S&P Index fund at .18 ratio and 14.91% total return last year).

our individually owned stocks I get a 14.78% rate of return for 2010

Interesting how that comes out isn't it? That's what I was referring to earlier with compensated & uncompensated risk.

what I was trying to do with my model which is for us to try to live on the INCOME of the investments vs the total return (income + capital appreciation), hence the 3% number.

I purposely avoid separating yield & appreciation, I just look at return (it's simpler, LOL). If I want to use 4%, I sell something every few months and add it the checking account.

[Deleted]

Hi Phil,

Yes, both DH and I can make things a lot more complicated than necessary, LOL!

And between the Random Walk on Wall Street and my own limited experience I am definitely a believer in Index funds. I really like the idea of having an index fund that's cheap to add to as well as sell if we need to supplement our income.

We set aside some time Sunday to talk about some of the issues brought up here. This has definitely been a good exercise for the two us. We'll have the phone conversation with the USAA planner Thursday evening (Bonn time) and I'll report back.

Thanks everyone!