New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 21,000 email subscribers:

Articles are published Monday and Friday. You can unsubscribe at any time.

Overweighting REITs: Why Don’t More Experts Recommend It?

A reader writes in, asking:

“My husband & I are on a pension & SS. We have been retired for 17 years but inflation has been fairly low. However we can see our medical bills & insurance going up just about every year. I learned about REITS from reading on the internet. You mention them in your book but almost as an afterthought. With interest rates so low & getting lower why wouldn’t you want more of your money in REITS if the majority of your income is guaranteed?

Why do REITS seem to be a secret? Money columnist in the paper never mention them.”

Because REITs are stocks, they are already included (at their market weight) in a “total stock market” sort of index fund. So the primary question with REITs — as with any subcategory of stocks (e.g., value stocks, small-cap stocks, or any other industry-specific category of stocks) — is whether overweighting them in a portfolio improves the portfolio’s performance.

That’s a trickier question than it might appear at first, because performance can be measured in a number of different ways and because results vary considerably depending on what period we look at. But in most cases, the answer seems to be “no, it doesn’t particularly improve the portfolio to overweight REITs.”

For instance, here’s a paper from Vanguard that looked at whether adding a tilt to REITs (or commodities) would improve their target-date funds (or target-date funds in general). Here’s what they found:

“The results suggest that when adding commodities or a REIT overweight relative to the Vanguard glide path, the improvements are minimal at best. Of the outcomes generated by the addition of REITs, for example, those in the 5th percentile see a 0.20 increase in the wealth multiple, while those in the 95th percentile see a 2.77 decrease in it.” [Mike’s note: by “wealth multiple” here, they are referring to wealth at age 65, as a multiple of the hypothetical person’s ending salary.]

Or later in the paper:

“Our analysis suggests that even if alternatives can be used at a low cost and with limited administrative complexity (and participant confusion), these strategies are likely to deliver modest benefits at best. Our conclusions are consistent with earlier Vanguard research, which finds that any improvement in participant outcomes produced by changes in sub-asset class allocation is likely to be small compared with what can be achieved through other strategies such as reducing investment costs, increasing savings amounts, adjusting retirement age, and managing the desired replacement ratio.”

Or, here’s a relevant paper from Jared Kizer of Buckingham Strategic Wealth and Sean Grover of Georgetown University. The paper looks at a broad set of questions about REITs, but here is what the authors had to say on the topic of adding a specific allocation to REITs in a stock/bond portfolio:

“Utilizing tests of mean-variance spanning, we also examine the diversification properties of REITs on a statistically inferred basis. These tests suggest that REITs do not reliably improve the mean-variance frontier when added to a benchmark portfolio of traditional stocks and bonds.”

(If you’re interested, you can also find a somewhat easier-to-digest summary of that research in an article from Larry Swedroe here.)

The point isn’t that overweighting REITs makes a portfolio worse. But it doesn’t seem to make it clearly-better either.

An important aspect of this conversation is that, while REITs provide a higher level of income than most other stocks, income from investments is not, in itself, a useful goal. Rather, it’s total return that matters, because capital appreciation can be used to fund living expenses just as well as income can. For instance, in a given year, if a given mutual fund provides an 8% total return, it does not matter whether the return is 8% from income and 0% from capital appreciation, 8% capital appreciation and no income, or any other combination in between.

An important exception is that if we’re talking about a taxable account (as opposed to retirement accounts such as IRAs or 401(k) accounts), income is actually detrimental relative to capital appreciation, because it results in an immediate tax cost rather than a deferred tax cost. And as a result, it can even make sense to underweight REITs in taxable accounts.

Investing Blog Roundup: Financial Therapy

I hope you all enjoyed your Thanksgiving holiday yesterday.

For decades the field of behavioral economics has been pointing out that we are not simply spreadsheets with arms and legs. The decisions we make are frequently at odds with what a perfectly rational analysis would recommend.

A newer field, however, is the field of financial therapy. Financial therapy essentially takes as a starting point the fact that emotional factors play a huge role in our financial decisions. And it then asks, “given that, how can we help people to make better financial decisions (i.e., financial decisions that will better serve their overall well-being)?” In other words, the financial therapist uses a blend of financial competencies and therapeutic competencies to actually help people enact behavioral change.

Other Recommended Reading

Thanks for reading!

Monte Carlo Analysis: Understanding What You’re Dealing With

A reader writes in, asking:

“What are the pros and cons of using the Monte Carlo tool for retirement planning?”

I wouldn’t focus so much on the pros and cons of Monte Carlo simulations, because there’s so much variation among how the Monte Carlo simulation concept is applied. Instead, I would focus on knowing what is going into (and coming out of) a specific Monte Carlo tool — or a study based on such.

For instance, what assumptions are being made about returns? Is the analysis using historical mean return as the mean return for each asset class? Or is it making a downward adjustment to account for today’s relatively low interest rates and high valuations? And what type of distribution is being assumed about returns? (For instance, many Monte Carlo tools assume a normal distribution for stock returns, which significantly understates their risk.) And what assumption is being made about reversion to the mean? That is, are the simulations assuming that several bad years in a row increases the likelihood that the next year is a good year? A set of simulations that does include such an assumption will have fewer very bad scenarios than a set of simulations that does not include such an assumption.

And what assumptions are being made about mortality? Are you (and your spouse, if married) assumed to live precisely to your life expectancy but no longer? Or is age at death one of the variables that the simulation is allowing to fluctuate? Or is mortality completely ignored, and the analysis is simply looking at a fixed length of time, such as 30 years?

And what assumptions are being made about spending? Most analyses don’t account for the possibility of spending shocks (i.e., an unanticipated and unavoidable large amount of spending in a given year). That’s fine, but it is important to recognize then that the analysis is leaving out one significant type of risk that exists in real life.

Overall point being, if you don’t know what assumptions are being made by the tool (or if you’re reading a study/article based on a set of simulations the writer performed and you don’t know what assumptions were made), it’s hard to get a lot of value out of the conclusions.

And what metrics are coming out of the simulations? For instance, if the simulations are regarding retirement strategies (i.e., a combination of spending decisions and asset allocation decisions — and possibly Social Security/tax decisions), does the tool give us something other than simply “likelihood of running out of money”? For instance, a few other metrics that are useful to know are:

  • In scenarios in which the portfolio is depleted, when is it depleted (e.g., does the average/median depletion occur 15 years into retirement or 25 years into retirement)?
  • In scenarios in which the portfolio is not depleted, what is the average/median bequest?
  • If the strategy allows spending to fluctuate based on market performance, how much does it end up fluctuating?

(See this excellent paper paper from Wade Pfau, Joe Tomlinson, and Steve Vernon for a more thorough discussion of useful metrics for evaluating retirement plans.)

In short, one Monte Carlo analysis can vary significantly from another. So I wouldn’t worry so much about the pros and cons of Monte Carlo analysis in general, but rather make sure you understand what you’re dealing with when you use a given Monte Carlo tool or read about a Monte Carlo-based study. What types of risk are being excluded from the analysis? And what information is being left out of the output?

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Investing Blog Roundup: Less Time Working, More Deep Work

This week I enjoyed two articles discussing workplace experiments about how different changes to the workday (or workweek) affect productivity.

At least for me, whether it’s writing, research, or coding, I cannot come remotely close to cranking out 8 consecutive hours of productivity with only a brief break for lunch (at least not on a regular basis). I tend toward starting work early, getting in a few hours of really good work, then taking a long break doing something completely different — riding my bike, climbing at the gym, or walking around the neighborhood or our local Botanical Garden. Then I have another few good hours in me, and that’s it.

Other Recommended Reading

Thanks for reading!

2020 Tax Brackets, Standard Deduction, and Other Changes

Last week the IRS published the annual inflation updates for 2020. As was the case for 2019, it’s really just regular inflation adjustments, as opposed to the major legislative changes we had two years ago (i.e., effective for 2018).

If you have questions about a particular amount that I do not mention here, you can likely find it in the official IRS announcements: Rev. Proc. 2019-44 (which contains most inflation adjustment figures) and Notice 2019-59 (for figures relating to retirement accounts).

Single 2020 Tax Brackets

Taxable Income
Tax Bracket:
$0-$9,875 10%
$9,875-$40,125 12%
$40,125-$85,525 22%
$85,525-$163,300 24%
$163,300-$207,350 32%
$207,350-$518,400 35%
$518,400+ 37%

 

Married Filing Jointly 2020 Tax Brackets

Taxable Income
Tax Bracket:
$0-$19,750 10%
$19,750-$80,250 12%
$80,250-$171,050 22%
$171,050-$326,600 24%
$326,600-$414,700 32%
$414,700-$622,050 35%
$622,050+ 37%

 

Head of Household 2020 Tax Brackets

Taxable Income
Tax Bracket:
$0-$14,100 10%
$14,100-$53,700 12%
$53,700-$85,500 22%
$85,500-$163,300 24%
$163,300-$207,350 32%
$207,350-$518,400 35%
$518,400+ 37%

 

Married Filing Separately 2020 Tax Brackets

Taxable Income
Marginal Tax Rate:
$0-$9,875 10%
$9,875-$40,125 12%
$40,125-$85,525 22%
$85,525-$163,300 24%
$163,300-$207,350 32%
$207,350-$311,025 35%
$311,025+ 37%

 

Standard Deduction Amounts

The 2020 standard deduction amounts are as follows:

  • Single or married filing separately: $12,400
  • Married filing jointly: $24,800
  • Head of household: $18,650

The additional standard deduction for people who have reached age 65 (or who are blind) is $1,300 for each married taxpayer or $1,650 for unmarried taxpayers.

IRA Contribution Limits

The contribution limit for Roth IRA and traditional IRA accounts is unchanged at $6,000.

The catch-up contribution limit for people age 50 or over does not get inflation adjustments and therefore is still $1,000.

401(k), 403(b), 457(b) Contribution Limits

The salary deferral limit for 401(k) and other similar plans has increased to $19,500.

The catch-up contribution limit for 401(k) and other similar plans for people age 50 and over has increased to $6,500.

The maximum possible contribution for defined contribution plans (e.g., for a self-employed person with a sufficiently high income contributing to a solo 401(k)) is increased to $57,000.

Child Tax Credit

The child tax credit ($2,000 per child) and the related phaseout threshold ($200,000 of modified adjusted gross income, $400,000 if married filing jointly) do not get inflation adjustments. The portion of the credit that can be refundable (up to $1,400 per child) does receive inflation adjustments, but it is still $1,400 for 2020.

Capital Gains and Qualified Dividends

For 2020, long-term capital gains and qualified dividends face the following tax rates:

  • 0% tax rate if they fall below $80,000 of taxable income if married filing jointly, $53,600 if head of household, or $40,000 if filing as single or married filing separately.
  • 15% tax rate if they fall above the 0% threshold but below $496,600 if married filing jointly, $469,050 if head of household, $441,450 if single, or $248,300 if married filing separately.
  • 20% tax rate if they fall above the 15% threshold.

Alternative Minimum Tax (AMT)

The AMT exemption amount is increased to:

  • $72,900 for single people and people filing as head of household,
  • $113,400 for married people filing jointly, and
  • $56,700 for married people filing separately.

Estate Tax

The estate tax exclusion is increased to $11,580,000 per decedent.

Pass-Through Business Income

With respect to the 20% deduction for qualified pass-through income, for 2020, the threshold amount at which the “specified service trade or business” phaseout and the wage (or wage+property) limitations begin to kick in will be $326,600 for married taxpayers filing jointly and $163,300 for single taxpayers, people filing as head of household, or married people filing separately.

For More Information, See My Related Book:

Book3Cover

Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

Investing Blog Roundup: The Best Predictor of Stock-Fund Performance

Morningstar’s John Rekenthaler recently wrapped up a three-part series about a piece of research that found a metric for selecting mutual funds that has considerably better predictive value than simply picking funds with low expense ratios. I would encourage you to read the series in its entirety though. The first two articles are interesting, but the real lessons come in the final article.

Other Recommended Reading

Thanks for reading!

Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a financial or investment advisor, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2019 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy

My new Social Security calculator: Open Social Security