Tag: retirement

Categories
Investing

The Death Of Index Investing And Other Silly Stats

I recently came across yet another post on investing which goes something along the lines of “If you invested 10 years ago in the Dow then you would have earned exactly nothing in that time”.  I hate to pick on any one blogger since I’ve read these articles all across the blogosphere but this one is the latest and he also had the temerity to tie in poor index performance with the death of index investing.  Of course all the stock pickers out there ALWAYS beat the index so poor market are no concern to them…!  I want to emphasise that Jacob at Extreme Early Retirement does a great job with his blog and I don’t want to sound like I don’t like the blog – just that one post!  🙂

What about the dividends?

Usually these posts look at the point value of an index at a previous time, say 10 years ago and compare it to the present index point value.  This is incorrect because they are missing dividends.  Published index returns always included reinvested dividends and any type of analysis on index performance should always include the same.  Admittedly, if you are looking at a 10 year period where the index point value hasn’t changed, the addition of dividends isn’t going to change the argument very much but it should be there.

Selectivity of stats

Why is it that all the articles always pick the worst peak to trough period to illustrate their rather suspect point that maybe equity investing or even index investing is evil?  Have you ever heard of such a person who invests all their money on the same day the markets peak and then doesn’t invest any more?  Doesn’t seem all that likely to me.  Most people invest their money over time because that’s how they earn it, then save it, then invest it.  Picking one particular time period to prove or disprove a theory is like measuring your gas mileage one mile at a time and then using the best or worst mile to prove your point.

Investment performance

And what about active stock pickers – did they all do better than the indexers over that period?  Or did some of them do better, some of them the same, and some of them didn’t do as well?  I’ve asked many bloggers and non-bloggers who claim they can beat the index by picking their own stocks to prove it – measure their performance and let me know if they did better than the market or not.  You know what?  Not one of them has ever shown that they can beat the market – oddly enough, most of them don’t even bother to measure their performance.  How can someone who doesn’t even know how their own investment method measures up criticize someone else’s?

What is average?

One of the criticisms of indexing is that you will only achieve “average” results – again – will I do better by randomly picking stocks or paying someone lots of money to pick them for me?  One thing about indexing is that you will get the index return minus a very small fee – you will never beat the index but more importantly you won’t underperform the index (except for the small fee) either.  Active pickers can certainly outperform the market but they can also underperform as well – sometimes by a huge margin.  I like making money – if I thought it was possible for me to beat the market then you can rest assured that I would give it my best effort.

Dividends, smividends

Ok – one more rant… I like getting dividends just as much as the next investor but I really think there is an over-weighting on the importance of dividends in the blogosphere.  Yes, the idea of living off your dividends is nice but investment performance measures total return which is capital gains plus any reinvested dividends and interest payments.  That’s it.  I don’t care in what form the company pays out in the end – if the total return is higher, then its a better investment.  If that includes dividends, fine – if not, that’s fine too.

Categories
Personal Finance

Safe Withdrawal Rule for Retirement Funds

Yesterday I posted part one of this topic Why Retirees Should Have Equities In Their Portfolio.

One of the biggest concerns for retirees is the fear of running out of money. If you are retired and living off a pension which is indexed for inflation then you don’t have much to worry about since the pension should keep going until you expire. What happens if you have no pension or only a little bit of pension income from a source like a government pension plan? Then you need to live off income from your investments.

How much can I safely withdraw from my retirement funds?

Simple – use the 4% rule. This will give you a great chance of not running out of your money and it’s valid for 25+ year periods. If you are at an advanced life stage where 25 years is a dream then the 4% can be adjusted upwards.

The way the 4% rule works is that you start by taking 4% out of your portfolio in the first year – this includes dividends, interest, withdrawals. The next year you take out the same figure you took out the first year plus inflation. So if you start by taking $40,000 out and then inflation is 3% then the second year you take out $40,000 + 3% ($1200) = $41,200. Every year after that you adjust the previous year’s withdrawal amount by the inflation rate.

Keep in mind that this amount only covers the withdrawals from your investments. Any other income you have, such as pensions, will be in addition to the withdrawals. If you find the 4% rule doesn’t give you enough income then you can either cut back your spending or increase the withdrawal amount (which will increase the chance you will run out of money later on).

The 4% rule is really a guideline rather than a hard and fast rule – If your equities perform better than expected then you can spend a bit more than the 4% rule amount however the opposite is also true, if you encounter a bear market and the value of your portfolio drops then you should be prepared to cut back on the withdrawals.

 

Categories
Investing

Why Retirees Need Equity In Their Portfolios

One of the standard pieces of advice for retirees is that they have to have a very conservative portfolio since they are too old to take any chances with equities. There are “rules” around what percentage of fixed income (ie bonds) a retiree should have. “90 minus your age” is one that I’ve heard a lot.

These rules were probably pretty good guidance at a time when your average retiree finished work at 65 and could reasonably be expected to live for another ten years or so. With a short term investment horizon it didn’t make sense to invest a lot of money in equities because the retiree wouldn’t live long enough to recover from any major losses. Inflation was also not a major concern since the time line was fairly short.

Fast forward to now and there are two major differences in retirees – first of all they are retiring earlier which lengthens the retirement time and they are living longer which of course also increases the retirement time which in turn means that they have a longer investment time horizon so a higher allocation of equities is appropriate. Typically most financial planners will assume an estimate lifetime of around 90, so if an investor retired at aged 60 and lived until age 90 – that’s a 30 year time horizon.

You might be asking – who cares how long the retirement lasts for? Shouldn’t you just be conservative and buy guaranteed fixed income products or annuities and live off the payments? One problem is that while retirees might be living longer once retired, they aren’t working longer, in fact they might even have slightly shorter careers on average so current retirees might not have any more money saved (adjusted for inflation) than someone who retired a generation or two ago and they are less likely to have any kind of company pension plan to help fund the retirement.

The reality is that historically equities have outperformed bonds by a long shot. According to William Bernstein – author of “The Four Pillars of Investing”, two reasons to invest in equities are for the higher expected return and because equities can keep up to rising inflation. If you are retired and your portfolio is entirely fixed income (or annuity) you might run into the problem of a steadily lower standard of living if inflation increases.

Other reasons to invest in equities are that interest is taxed at a higher rate than dividends and capital gains (in Canada and USA) so you will probably be better off if you can only pay dividend and capital gains taxes rather than income tax on interest payments.

What to do?

The answer is two fold. First of all, retirees should have a significant equity holding in their portfolio. Bernstein recommends anywhere between 50% to 75% equities depending on your tolerance for risk. One of the key points that Bernstein emphasizes is that whatever asset allocation you choose, you have to stick with it so pick an allocation that you can handle in rough times. If you choose a higher percentage of equities and then sell when the equities drop and then buy back in when they go up, then you will be further behind compared to if you had just picked a more conservative portfolio and stuck with it. Even if you choose to have an equity allocation of less than 50% then stick with that allocation.

Tomorrow we’re going to discuss the 4% withdrawal rule which will help determine when you can retire.