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Jay Johannesen
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Jay Johannesen is a principal and investment strategist at Portfolio Research, LLC. Jay holds an MBA from the Haas School of Business at the University of California at Berkeley and a CPA certification in Washington state. Portfolio Research is the leader in building risk controlled portfolios... More
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  • Will You Survive Retirement? Planning for Retirement Drawdown and Avoiding Financial Ruin

    How likely it is that your desired level retirement spending could result in a depletion of savings and financial ruin during retirement?

    What is the number one financial fear for investors approaching retirement? It is not health care or inflation or nursing home costs. The number one fear is running out of money. And with good reason. With defined pension plans disappearing, individuals living longer, and investment markets becoming more volatile, it is increasingly up to each individual to manage a complex investment plan and an extended period drawing down savings during retirement. It is impossible to predict how long you will live and how well markets will perform, but it is extremely helpful to understand how much you might need to save and spend under different scenarios.

     Free online tools make it simple and easy to experiment with different plans. For example using the free Portfolio Research Retirement Planner you can see how long your savings is predicted to last based on different savings levels, drawdown levels, retirement dates, and risk-adjusted investment return projections.

     Let’s say your current situation is as follows:
    -$50,000 in invest-able savings
    -50 years old
    -plan to contribute $10K to retirement portfolio until retirement
    -plan to retire at age 62

    We will assume you invest in a medium-risk return portfolio until retirement and a low-risk portfolio after retirement, and 2% inflation. How much can you withdraw from your nest egg without running out of money? In this case, trying to live on a modest $25,000 per year from your savings appears precarious, with a 50% expected probability your portfolio will be depleted by around the age of 72.

     However if your plan is to work until 67 your savings have a 50% likelihood to last until the age of 82. Then if you also increase the risk level of your portfolio prior to retirement (essentially investing in more stocks and other higher risk, higher return assets) your nest egg has 50% probability to last until you are 84; and if markets perform well the portfolio will not run out until after the age of 100. But if markets perform poorly it will be depleted by around the time you are 75.

     The scenarios above of course are quite simple and merely designed to give you a sense of the significant impact adjusting variables can have on your lifestyle for years to come. The order of withdrawal amounts and the timing of market fluctuations can have a dramatic impact on these scenarios. Experimenting with different scenarios can help you with saving and spending goals and selecting the level of investment risk you are willing to take.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Oct 11 10:09 PM | Link | Comment!
  • Bond Diversification - How It Can Help Control Your Portfolio Risk

    Generating high yields with limited risk seems to only get more and more difficult for long-term investors. Traditionally US Treasury Bonds have served as the core of a conservative portfolio. Potential inflation, rising interest rates, and political turmoil make the current environment treacherous for what used to seem like safe haven investments.

    Assembling a blend of fixed income assets that includes TIPS and international bonds - along with US Treasury Bonds - can make a portfolio more efficient – increasing yield while at the same time reducing risk. Below we discuss why and how to diversify your bond portfolio to achieve risk-controlled performance in a potentially difficult environment.

    Diversity Benefit of US Bonds, TIPS, and International Bonds
    The global nature of the international financial crisis in 2008 heightened the sense that individual markets are following a single, globalized business cycle. But regional macroeconomic fundamentals frequently dominate yield changes.The chart below shows returns over the past seven years of US Bonds (the Barclays US Aggregate Bond Index), International Bonds (the S&P/Citigroup Intl. Treasury Bond Index) and TIPS (the Barclays Capital US TIPS Index):

    US Bonds, TIPs, Intl Bonds Returns

    As you can see above, Barclay’s US aggregate bonds, unhedged global bonds and TIPs have performed quite differently in recent years. The TIPS return is a function of US inflation expectations and real US interest rates, whereas unhedged global bond returns are driven by foreign interest rates and exchange rate fluctuations (if the US. currency falls in relation to the currency paid on the foreign bond, the bond investor will gain as the foreign currency will convert into a greater amount of US dollars). Looking ahead, if the entire world experiences uniform inflation, TIPs would be the better choice for defensive investors, but in the case that US inflation is higher than the global average, global bonds will likely perform better. So a combination of both asset classes are good to hold in your portfolio, with the precise mix determined by the your risk-aversion level.

    How to invest in international bonds?
    There are numerous historical examples of sovereign nations defaulting on their sovereign debt or severely devaluing it. Conservative investors are best to consider broadly diversified international bond funds. iShares S&P/Citi International Treasury Bond (NASDAQ:IGOV) and SPDR Barclays Capital International Treasury Bond (NYSEARCA:BWX) are examples of ETFs that target the performance of fixed-rate, local currency, sovereign debt regions in regions outside the US. These are indexed funds weighted by global, investment grade, sovereign debt balances.


    TIPS Yield
    TIPS may not appear appealing at first glance, now –the yield on the Vanguard Inflation Protected Securities (MUTF:VIPSX) is at 2.44%, but as noted in by Larry Swedroe in hisTIPS Update for March 2011, current Treasury Yields are only slightly higher than TIPS yields, so with exposure to TIPS you’re getting inflation insurance while “paying” very little insurance premium.


    Bond Duration
    Finally, one basic necessity to control risk in your Bond Portfolio is to manage the duration of your bonds. Investors who have pushed out further on the yield curve by investing in longer-term bonds will see a greater decline in the principal value of their investments if interest rates continue to rise. In our September 28 Portfolio Research Analysis we discussed how duration is a useful measure of the sensitivity of a bond's market price to interest rates.


    Achieving Higher Returns with less risk
    Many risk-averse investors are abandoning fixed income assets altogether - since December 2011, US investors have yanked over $18 billion from their fixed-income portfolios. Even after this shift, a high percentage of household fixed income allocation remains in long-term treasury bonds. But now, as much as ever, we argue that: (1) bonds are always part of a diversified portfolio, (2) international bonds and TIPS should be part of that bond allocation, (3) the potential risk of inflation makes diversification particularly important now, (4) diversification across different types of bonds can produce a portfolio with lower volatility.


    Apr 18 3:25 AM | Link | Comment!
  • Core / Satellite Investing - A simple approach for maintaining a cost-efficient retirement portfolio

    Core /Satellite Investing refers to a model for structuring an individual's investment portfolio between:

    (1) an efficient, diversified, longer-term portfolio (the core), and 

    (2) opportunistic, usually shorter-term investments (satellites).

    The core satellite framework balances the individual's need for a risk-controlled, disciplined, investment with the individual's desire to exploit perceived market opportunities and outperform the markets. 

    The core portfolio should be composed of broad asset classes - equities, bonds, cash, commodities, TIPS and REITs - ideally in the form of low-cost index funds or ETFs.  The percentage allocated to the different assets is driven by the investor’s risk-return criteria, while emphasizing a diversified approach. As the core portfolio is invested in passive investment vehicles it seeks market-like returns within asset classes. This may not sound like a particularly ambitious or impressive goal, but matching the returns of the market as a whole is difficult due to the pitfalls of "behavioral finance". Human nature works against investors causing them to trade at the wrong time - usually buying at market peaks and selling at market bottoms. By segregating and maintaining a core portfolio of assets that are rebalanced based on pre-determined, objective factors like fixed weights or a consistent dynamic strategy, investors can more easily adhere to a disciplined, long-term retirement plan. A final important consideration in the core portfolio is costs. With the plethora of low cost ETFs and index funds that can be used to cheaply build efficient asset allocations, it’s not worth paying others to seek alpha in the core portfolio.

    The satellite investments, unlike the core portfolio, seek "alpha" or market out-performance. A satellite investment can be any investment that satisfies an individual's whim - Apple stock, silver mining ETFs, contemporary art, bank certificate of deposits, whatever. For most investors the core portfolio provides their primary retirement savings while the satellites provide the means to speculate, pursue financial dreams or address immediate cash concerns. Satellites should be subordinate to the core and pursued only after the core portfolio is adequately funded.

    In the diagram below, the core portfolio is depicted as the central element with satellite objectives orbiting around it:

    Core Satellite Diagram

    How much of an individual investor's wealth should be invested in their core portfolio versus satellite investments?
    The allocation between core and satellite portfolios can vary based on the investor's age, risk tolerance, their overall wealth relative to their financial needs and their desire to actively manage and trade investments. In the simplified case of an investor with $500,000 in investable assets and a retirement timeframe of 25 years, an advisor might recommend 65-80% of funds be allocated to the core portfolio with at least some of the satellite funds apportioned to cash equivalents.

    What should be the composition of the core portfolio?
    Financial professionals will offer various preferences for core asset classes. An example of small cap, mid-cap, large cap equities, emerging market funds, global and domestic bonds, REITs, commodities and TIPS can provide a diversified mix that can be used to mitigate the risks of inflation, deflation, equity bear markets, credit defaults and general market volatility that investors will face in broad market cycles.

    Apr 04 6:24 AM | Link | Comment!
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