The Definitive Retirement Number

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With a hat tip to Chuck Jaffe Fidelity has run the numbers and figured that having eight times your final salary in the bank or brokerage account or 401k is the magic number. And to help benchmark along the way, at age 35 people should have one year's salary set aside, at age 45 it should be three times and at age 55 people should be up to five years salary set aside.

The objective here is to replace 85% of the final income which as Jaffe notes is up from the "rule of thumb" of replacing 75% of the final income. There were some details missing and no link to the  research by Fidelity. There was no mention of a withdrawal rate or whether the 85% includes Social Security benefits. If not then the withdrawal rate would have to be astronomically high.

To use round numbers, let's say the final salary is $100,000 so the target savings balance would be $800,000 with an income objective of $85,000. If they are not including social security then obviously the withdrawal rate would be more than 10%. If it includes social security then the total benefit for a couple might be about $3000-$3300 per month in today's dollars so the portfolio would need to come up with $3783-$4083 per month which works out to a withdrawal rate of 5.3%-5.7% which is a big bogey. If the money is in an IRA of some sort then there is the additional problem of taxes on the withdrawals.

There may be more to it though, again no link was provided.

Long time readers will know that I believe in taking no more than 4% out annually. If that means ratcheting down the lifestyle then so be it. People want what they want but if that does not fit with reality then something has to give.

Another cornerstone here has been that focus should be paid to the spending part of the equation. People who live below their means don't need to focus on a percentage of their income they need to focus on their spending needs and whether those needs might go up or down after they retire and then they either have enough or they don't. It is not unreasonable that moderately well to do couple could have a $60,000 lifestyle, $1 million saved, $10,000 in income from sort of monetized hobby, $36,000 in combined social security benefit and so only need $14,000 from the portfolio.

If the above couple had saved $600,000 instead of $1 million they would not be placing a heavy burden on the portfolio at $14,000 and might be able to grow the portfolio meaningfully before possibly needing to increase the withdrawal. This would of course rely in some measure on what the market does; it is not realistic to think a portfolio will go up by 40% in five years if the market is flat. It could happen, it just wouldn't be an assumption that people should make.

I would also not give up on the notion of being able to reduce spending in retirement. No financial plan can account for every possible life circumstance but with a little planning it is feasible to have the mortgage paid off upon retirement (or maybe sooner). I found a stray reference that the average mortgage payment is 20% of income. Who knows if that is accurate but if it is, that along with not saving 10% of income anymore would allow for a 30% reduction in expenses before even needing to consider any lifestyle changes.

While we can appreciate the positive aspect of what Fidelity is trying to do with this sort of research  (the negative is that it is just an AUM grab) it seems that most people don't start to think about retirement until their 40s or 50s and we know that very few people that age have three, four or five times their annual income socked away. Great for those who do but for those who don't; something will have to give. They will have to live a more modest lifestyle than they envision and do something that creates an income for a little longer than they envision.

Related bit of humor; I was talking to one of the other firefighters yesterday, who is of retirement age but chooses to work, about department business. As the conversation wound down he asked what I had done today (meaning Sunday) and I said "hiked, watched football and got some work done, how about you?" Without missing a beat he said "I practiced retirement; I took a nap."

Should Anyone Buy MLPs Yielding 19%?

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Yesterday the WSJ had an article about recent MLP IPOs that offer higher yields from non-traditional partnership assets. I had a similar post a couple of weeks ago but the Journal piece includes mention of a partnership that pays off of sand used for fracking and another one based on gas station revenues.

These alternative MLPs are being portrayed as being riskier than some of the more mundane MLPs and while I don't know for a certainty that they are riskier, the significantly higher yields are a good indication that they are. Working on the assumption these new alternative MLPs are riskier it is a repeat of past market behaviors. The IPOs are being created to meet investor demand for higher yield. The arc of this is that as the theme/mania/whatever you want to call it matures, the quality of the IPOs get progressively worse. I do not know what inning we are in with this, it could be very early days but the pattern is one that recurs.

Hopefully it is clear that MLPs yielding 4-6% will generically have less risk than those yielding 8-9%. Northern Tier (NTI), the gas station MLP, was priced at its IPO to yield 19% and now that it is up a lot the yield at the current price is expected to be 12%. It looks like it has not actually paid out yet and I have no idea what the actual payment will be. The article cites a couple of these that have done well so far and one that has done poorly.

MLPs have been doing very well for a while now along with many yield oriented equities which creates a sense of comfort which creates a willingness to take a little more risk until something bad happens. Again this is a pattern that repeats often but does not have to happen every time. It is worth understanding the behavior and the pattern, though.

If you read enough you will find suggested allocations to MLPs as high as 20-25% of a portfolio. I think that kind of weighting is very aggressive. Every so often odd things happen in narrow segments. In October 2006 you may recall that the Canadian government announced changes in the way the Canadian royalty trusts would be taxed which caused a meltdown in the group. The hindsight brigade might say that they would just hold on in the face of an outlying event but based on the price action people were clearly selling in a panicked fashion into the news.

Anyone wanting to build a portfolio that yields 4-6% can probably do so without having to put 20-25% in one segment/product. I want to be clear that a portfolio that yields 6% is not going to be well diversified in my opinion. If your reading 4-6% and thinking "more like 8-10%" then I hope you realize the risk you are taking and if you don't think you're taking a lot of risk then I hope you don't learn the hard way.

MLPs have a place in a diversified portfolio and also yield-centric portfolios. Allocations smaller than 20-25%, like maybe 5-10% each could go to MLPs and REITs, there are obviously sectors known for yield that could be modestly overweighted without putting 25% into one of these sectors, there are a coupe of high yielding low volatility country funds out there along with some high yielders in sectors that may not be thought of for their yield. Most people are probably aware that dividends in the tech sector have been going up a lot in the last few years. There are also plenty of foreign stocks with hefty yields.

So anyone wanting a lot of yield can find it without putting 25% into one niche. One risk factor that does not come up enough in related articles is the extent to which going all out for yield exposes the portfolio to interest rate risk. Rates are very low and the Fed is committed to do all they can to keep them low but if rates go up then a portfolio with a very high yield is vulnerable to a big drop. Some might say that as long as the dividends keep flowing and growing they will be fine and maybe that is so but this line of thinking reminds me of the quote related to boxing about everyone having  plan until they get hit in the mouth.

Risk Can Kiss My Grits

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If you remember the TV show Alice from the late 70s you probably remember the character Flo whose tag line was kiss my grits. I couldn't find a picture of Flo that was funny enough so I went with the sign that was supposed to be for the restaurant.





Earlier this week I had a post about recent MLP IPOs and whether they might be a sign of a maturing mania. Seeking Alpha re-ran that post and it drew a lot of comments with a surprising tone to several of them. To read through the comments there would appear to be very little regard for risk.


In my post I talked about being able to get plenty of yield (for anyone wanting to concentrate their portfolio in that way) without putting 20-25% in MLPs, I mentioned allocating to various yield products to build a yield. Several of the comments however revealed investors with far more than the 20-25% in MLPs that I think is way too much. Here was the most interesting snippet from all the comments;

I'm over 50% in MLPs and have been for quite awhile. And within the MLP universe you can be fairly diverse.   

 
I was really surprised to read that, really surprised, and I would add there were other comments that were kind of in the same ball park. The comment excerpted above acknowledged the need to keep close tabs but we have all seen the sentiment from the excerpted quote before. To me it was the same as being diversified by owning a search engine, a web hosting company, an etailer and a B2B company.

There was also this comment;

My fairly large portfolio is 35% in REITs, 23% in BDCs, 21% in MLPs and pays me 10% annual dividends. I don't really give a "feather or a fig" about the risk involved!

Holy cow.  

In the last 42 months the market is up more than 100% and while there have been a couple of small declines along the way, the move since the March 2009 low has been huge and based on the comments it has inspired a willingness on some portion of the investing public to eschew risk (I realize how unscientific a comment thread left on one blog post is).

I do believe the comments on blog posts can capture a sentiment that exists. Four years ago after a large decline there were many emotional and irrational comments left on my posts and I view the above as just as emotional and irrational after the market has doubled.

In December 2008 I wrote a 2009 outlook piece called Expecting a Massive Rally which drew 100 comments. Most of them were along the lines of "Dream on! There will obviously be tradable bounces in any market, but this one has no chance of a solid long term rally" and "Well the $CPC and ISEE are both at levels of market tops, so sorry Rog, the market is about to CRACK" and finally "These guys have been calling bottoms all throughout 2009. They have been wrong all along. But we're supposed to buy it this time?"

The intention here is not to call a top as Bernanke has actually commented about the stock market making people feel better but the excitement in the first two excerpted quotes is a behavior that we've seen before and often it has hurt people. It is the same type of psychology that causes people to buy high, sell low and end up grossly overweight the wrong thing at the wrong time. There may never be a consequence for being more than 50% in MLPs, right here right now that is unknowable, but there are certain behaviors that if recognized and avoided allow for a much better chance for long term portfolio success. 

The Big Picture for the week of September 30, 2012

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We are headed back to Arizona early on Saturday. A few pictures from our Friday in New York. The first picture is from the Knight Capital trading room which is actually in Jersey City, NJ.


The second picture is a parking lot on Spring Street next to the New York Fire Museum. Interestingly both the Boston and NY fire museums can't hold a candle to the one in Phoenx--go figure.
Friday was Random Roger day at the MLB Fan Cave! We stumbled across it by accident and although it was closed while we were there, the guy working inside held the door open for me and let me take a picture.
We stumbled across this view by accident as we were walking around.

Investment Lessons from John Templeton

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Barry Ritholtz posted Sir John Templeton's 16 Rules For Investment Success as follows;

1. Invest for maximum total real return
2. Invest — Don’t trade or speculate
3. Remain flexible and open minded about types of investment
4. Buy Low
5. When buying stocks, search for bargains among quality stocks.
6. Buy value, not market trends or the economic outlook
7. Diversify. In stocks and bonds, as in much else, there is safety in numbers
8. Do your homework or hire wise experts to help you
9. Aggressively monitor your investments
10. Don’t Panic
11. Learn from your mistakes
12. Begin with a Prayer
13. Outperforming the market is a difficult task
14. An investor who has all the answers doesn’t even understand all the questions
15. There’s no free lunch
16. Do not be fearful or negative too often

Barry also include Templeton's writeup on each of the 16 Rules that would be worth clicking through to and reading. A few of them are of particular interest that I wanted to expand upon.

Starting with number nine and monitoring your investments; not all news that comes is story-ending or thesis-altering even if the stock has a big reaction. For anyone using individual stocks or narrow based ETFs, if a lot of time can be spent on the holdings then there is a better chance of knowing when news does create a sell catalyst and when it doesn't. No one can be perfect of course but this does fall under the heading of managing the portfolio.

Not panicking has been a recurring theme in blog posts over the years. Unfortunately too many investors succumb to emotion and do the wrong thing at precisely the wrong time driven by some sort of emotion (usually fear or greed). This is very difficult to first come to and some people never come to realize this aspect of investing. I've told the anecdote of one former client who would call me in an absolute panic during market corrections of varying sizes and often my end of the conversation included reminding him that he had been through more of these than I had but he never came to understand this point.

Every investor has made mistakes and will make mistakes in the future. In addition to learning from mistakes I would add not letting the consequence of any mistakes have a ruinous impact on the portfolio. If a mistake is unavoidable and there is no way to know which future purchase will end up being a mistake then this makes the argument for smaller position sizes.

Number 14 is probably my favorite one. Included in Templeton's writeup on this one is the need to continue learning. The chance to keep learning is one of the reasons why the job is so fun. The world continues to evolve as do many aspects of investing. The need to learn creates work that needs to be done but for people who enjoy this, the task becomes easier. Chances are anyone spending time on a site like this does want to learn but we know that most people do not have this interest and so long term investment success could be tougher to come by.

I would sum up that a financial plan, whether it includes equity market participation or not, is a life long endeavor. I believe the Templeton list orients to the long term investor. Set and forget has not been applicable for a while and is unlikely to come back anytime soon. If that is correct then the work requirement embedded in Templeton's thoughts stand up today even though he wrote the list many years ago.

The picture is from our hotel room in Boston and is unlike any picture of Fenway I've ever seen.

Grisly Drug War Fact of the Day

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"The American news media continues to report the body count in Mexico’s “War on Drugs” at more than 50,000 dead. But Molly Molloy, a researcher at New Mexico State University, tallies more than 100,000 Mexicans killed to wage a war financed and mandated by American authorities and led by Mexican president Felipe Calderón."

From the article "Mexicans Pay in Blood for America's War on Drugs."  

Note: That would be a casualty count that approaches the U.S. body count during WWI (116,500 deaths) and more than the combined American casualties during the Korean War (36,500 deaths) and the Vietnam War (58,000 deaths).

Quotation of the Day: A Duty Is a TAX on Imports

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From Don Boudreaux's open letter to Mitt Romney:

Your wish to “label China a currency manipulator” means that you seek a pretext to impose (as your website says) “countervailing duties” on imports from China – which is to say, you seek a pretext for raising taxes on Americans who buy goods and services from China. Yet in other episodes of your campaign you promise (as you did here* last month) “I will not raise taxes on the American people. I will not raise taxes on middle-income Americans.” 

If you keep your promise to impose countervailing duties on imports from China you will thereby break your promise to not raise taxes on the American people. (Americans who buy imports from China are, after all, American people.) But if you keep your promise to not raise taxes on the American people, you must – as I hope you will – break your promise to punitively tax those many Americans who buy imports from China.  

MP: It's a simple, but often neglected point that a tariff or duty on imports is just another word for a sales-type tax on imported goods, and those tariffs/taxes/duties are not imposed on China or other U.S. trade partners, they are imposed on, and paid for by, Americans (consumers and businesses) who purchase foreign-produced goods.