Investing

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Before discussing this subject, I want to make it clear that we are not offering financial guidance, advice, recommendations or making any representations. Each of us is individually responsible for managing their own financial affairs and accountable for their actions and decisions. As it is often stated, seek professional advice.

OK, so what about investing? Let me say that this topic is so vast, so much has been written, there are so many variables (such as risk tolerance, types of investments, markets, age, goals and current financial status to mention just a few) that it is impossible to do it justice. Plus, that’s not the goal of Retirement Journeys. We just want to share some of our experience with you with the goal of informing, engaging and inspiring. So when it comes to investing, we’re going to share a high level view of our approach. Is it the “best” approach? Probably not. But it works for us and we can sleep at night regardless of what the markets are doing or what kind of crazy stuff is happening in the geo-political arena.

Our Approach

From the beginning, we agreed that we each would manage our own investments for several reasons. First, we both were already managing our own finances when we met. So it was natural to continue doing so. Second, we both liked finance and enjoyed managing our respective investments. Third, we have different investment styles. And fourth, there is an 8 year age difference between us so CeCe is comfortable taking on more risk than I am. Together we achieve a blended balance that we feel achieves our objectives. Lastly, it is important to point out that we talk about what moves we make and what we are thinking about. Our respective investments are totally transparent to each other.

Top Investment Priority

Creating an emergency or rainy day fund.  Our goal is to have at least one year’s worth of expenses available in liquid investments (such as money market funds) to cover us in the event of unforeseen expenditures.

Asset Allocation

We never put too many eggs in one basket such as investing solely in one company’s stock. Way too risky! Diversification, at any time in life, is crucial. Diversification is a means of managing the risk inherent in various markets – US stocks, international stocks, all types of bonds, currencies, real estate and commodities (there are many more).

Diversification is achieved by holding a mixture of investments across markets and is often stated in percentage terms such as 50% in US stocks, 10% in international stocks and 30% in US Treasury bonds and 10% in corporate bonds. Typically the asset allocation of one’s investment portfolio is weighted more heavily in riskier assets when one is younger and gradually moves towards less risky investments as one gets older.

The Fear Factor

People are more conditioned to respond to fear than to success. This facet of our nature leads to panic which leads to bad decisions which only stokes the fires of fear. It is really difficult not to give in to the sense that the financial world as we know it is: a) collapsing; or b) so volatile, so unpredictable that I just can’t take it anymore. Get me out!

We have experienced several huge market disruptions in our lives. The first was on Black Monday, October 19, 1987 – the biggest one day percentage loss in the history of the DOW. I remember several co-workers in various stages of agitation and shock. The collapse happened so fast, and stock trading was much more difficult back then, that I didn’t do anything. I can’t recall being fearful. Perhaps because I didn’t equate what happened in the stock market with whether I had a job or not (e.g. I would still have income to pay my bills). Also, my level of wealth was modest so it didn’t hurt as much and I knew that I had a lot of time to recover losses. In fact, the Dow was actually up for the year in 1987 even though it took 2 years to reach its August high water mark. Still, the markets did recover. This was a lesson that has been reinforced in subsequent market collapses including the dot com crash, the market decimation in 2008 which was part of the Great Recession, and the flash crash on May 6, 2010. After experiencing these events we’ve formulated an opinion about the eventual recovery of markets. Our opinion is that the combined forces of governments, central banks (such as the Fed and ECB), financial institutions, lending agencies, traders and corporations have such a vested interest in the continued viability of these markets, that they will not let them fail. Based on what I’ve seen in terms of stimulus packages from various countries to central bank actions (Quantitative Easing and near-zero interest rates), there is a tremendous and overriding vested interest to ensure that markets will not fail. In other words, we have faith that the markets will live on and this belief helps us ride out market extremes.

There is another strategy we employ to help us deal with the fear factor. It is called the Bucket Strategy. We didn’t come across it until shortly after we retired. We were at a seminar on Estate Planning that was offered by our financial institution. The presenter was a senior adviser who we like and respect. In his seminars he often would offer up additional insights. So in this seminar we somehow got on the topic of the Bucket Strategy. The Bucket Strategy is a way to construct, allocate and to logically view your investments relative to return, risk and time. According to the presenter (we haven’t verified what he told us but we have no reason to doubt what he said), when you look at cash, bond funds, hybrid funds and equities, each have a period of time during which those investments (as a class) did not lose money. That doesn’t mean that they made a lot of money or beat the market (aka the S&P 500) but that they did not lose money. The time frames over which no losses were incurred are for bond funds 5 years, hybrid funds (aka balanced funds) 7 years and for equities 10 years. However, for equities (S&P 500) there is one 10 year contiguous period (also known as the Lost Decade) where there was a loss (1999 – 2008; -1.47%).

So how did we implement the bucket strategy? First, using our budget, we extrapolated annual expenses into time periods of 2 years, 5 years, 7 years and 10 years. We then classified each of our investments into one of the buckets based on the type of investment. Next we compared the amount invested in each bucket to the projected costs assigned to each bucket.

Here’s a simplified example with some hypothetical data.

Annual budget amount = $50,000

Inflation factor = 3%

Cost assignment for buckets

Bucket 1 – Years 1 -2: $50,000 + ($50,000 X 1.03) = $101,500

Bucket 2 – Years 3 – 5: ($50,000 X 1.03) + ($50,000 X 1.03) + ($50,000 X 1.03) = $154,500

Bucket 3 – Years 7 – 10: ($50,000 X 1.03) + ($50,000 X 1.03) + ($50,000 X 1.03) = $154,500

Bucket 4 – Years 10+: costs not applicable because by default, any remaining investments (i.e. after allocating to other buckets) fall into this bucket

Investment Allocations*

Money Market Funds: $105,000

Treasury, corporate and municipal bond funds: $150,000

Balanced and/or asset allocation funds: $170,000

Equities: $50,000

* Based on investment type.

Analysis Based on Bucket Strategy Example

  • There is an excess of liquid assets (cash and money market) in Bucket 1 ($105,000 – $101,500) of $3,500
    • It is perfectly OK to leave the $8,500 in this bucket because we view the Bucket Strategy as a high level guideline, just another tool to help manage investments.  Or you can increase your position in one of your bond funds to help make up for Bucket 2’s shortfall of $3,500.
  • The same logic applies to the surplus in Bucket 3 of $15,500 ($170,000 – $154,500). Just leave your investments as is. Or, buy more equities for Bucket 4.

For us the Bucket Strategy offers up another way or filter by which to analyze our investments. As such, we look at it as a high level guideline rather than a formula. That said, we do use it to help us with asset allocation re-balancing.

Perhaps the best thing about the bucket strategy is that it reduces the anxiety we feel when the markets are in turmoil. If stocks are in the tank, we tell ourselves that the disruption and the consequences will be resolved in a future time frame that doesn’t apply to the present!

Annuities vs. Bond Ladders

Income generation is an important goal for retirees. Many people elect to purchase an annuity. However, we have decided that we prefer to use a technique called bond laddering.

You can read about it by clicking here.

Tax Considerations

Here are some beliefs and practices that we follow.

  • Taxes will go up over time
  • Defer payment of taxes if you project being in a lower tax bracket at the time of withdrawl
  • If you have tax exempt investments such as government or municipal bonds, keep them in a taxable investment account
  • Set up a 401K and/or an IRA
    • Gains are not taxable until withdrawn
    • Unfortunately, investing in a Roth IRA didn’t work for us
      • A Roth IRA works sort of the opposite from a 401K. You invest taxed income and withdrawls, including gains, are not taxed.
    • With a 401K you don’t pay taxes on what you put in but get taxed when you start withdrawing. The idea is that when you start to withdraw money, it will be taxed at a lower rate. However, this is not always the case. Some people wait until they must, by law at age 70 1/2, make what are called Required Minimum Distributions. Sometimes the amount of the RMD actually pushes them into a higher tax bracket which affects all their income!
  • I actually began taking 401K distributions early because it is tax advantageous for us to do so. To learn more about our distribution strategy, click here.
  • Take advantage of other tax deferred accounts such as Flexible Spending Accounts and Health Savings Accounts.
  • Roth – Unfortunately we never had the opportunity to contribute to a Roth IRA and a conversion just wasn’t feasible. Roth IRAs are very attractive in retirement since distributions are tax free. I wrote an article comparing a Roth IRA with a 401K which included taxation.
    • There are no minimum required distributions like there are for 401k’s.
    • Roth distributions do not count towards income that determines Social Security taxes.
    • Hedge against future tax rate increases.