Archives for July 2023

“Waiting for It to Recover” Before Selling

Allan and Bill are each retired.

Allan purchased 100 shares of Vanguard Total Stock Market ETF (VTI) on November 5, 2021 at a price of $242 per share.
Bill purchased 100 shares of VTI on September 30, 2022 at a price of $179 per share.

Now imagine that today is February 24, 2023, and the price of VTI $200 per share.

So each person’s 100-share lot is worth $20,000. (We’re assuming here that they each have dividends set to not be reinvested, so that they can use the cash flow for spending. Point being, each person still has the same 100 shares they purchased originally.)

Now imagine that Allan and Bill each have an unexpected expense arise, for which they need to spend about $20,000 from savings.

To Allan, selling VTI would probably feel bad. He bought it at $242, and now it’s worth $200. It feels like he’s “selling low.” Allan might be reluctant to sell this holding to raise the cash needed for spending.

To Bill, selling VTI would probably feel good. He bought it for $179, and now it’s worth $200. It feels like he’s “selling high.” Bill would probably be happy to sell this holding to raise the cash needed for spending.

But the truth is, even though the current price feels low to Allan and feels high to Bill, it’s the same $200 price per share for each of them. They would each be getting the same amount of money, for the same amount of shares.

And, critically, the fund’s future performance is unaffected by the price at which either person bought it. Allan might be tempted to hold on and wait for the fund to recover, while Bill would be happy to sell. But the fund is no more likely to have good future performance for Allan than for Bill.

If you need to sell a holding (either to raise cash for spending, to rebalance, or for any other reason), what does matter is:

Would selling this holding bring your portfolio more closely in line with your ideal portfolio (e.g., because it simplifies the portfolio, reduces costs, or brings you more closely in line with your target asset allocation), or would selling this holding move you further from your ideal portfolio?
What would be the tax consequences of selling this holding? (If it’s in a retirement account, there are no consequences. If it’s in a taxable account, it’s actually a good thing if you would be selling for a loss, because that loss can be used to offset other capital gains or potentially ordinary income.)

Some people would add a third consideration to the list, which is whether now is a good or bad time to sell the investment in question. Without getting into a discussion of “does that count as market timing?” I’ll just note that if you want to try make such a determination, it should depend on things like current real interest rates and stock valuations (e.g., PE 10), and it would have nothing at all to do with the price at which you personally happened to purchase the investment in question. Whether the current price is higher or lower than the price at which you purchased is only relevant for tax considerations.

July 31, 2023

Investing Blog Roundup: Employers Request Delay for SECURE Act 2.0 Catch-Up Contribution Roth Requirement

One of the changes made by the SECURE Act 2.0 is that, effective 1/1/2024, catch-up contributions to employer-sponsored plans must be Roth (rather than tax-deferred as they are now) for any employee whose wages for the preceding calendar year from the employer sponsoring the plan exceeded $145,000.*

And if the plan cannot satisfy that requirement, the Act says that the plan must not allow any employee to make catch-up contributions at all.

Many employers are reporting that they won’t be ready to administer such a change by the beginning of the year — which would mean they’d have to “turn off” the option for catch-up contributions for everybody. So they’re requesting a delay in the effective date for the change.

401(k) Industry Pleading for Delay in SECURE 2.0 Catch-Up Contribution Requirement from Brian Anderson

Checking out an Investment Adviser: Form ADV Part 2

If you’re shopping for fresh parsley, you won’t find it by searching in the freezer aisle.

And yet people do this all the time when it comes to looking for financial professionals — or when recommending them to others.

For instance, on the Bogleheads forum, you’ll often see:

People asking about a robo-advisor (e.g., Vanguard Personal Advisor Services) when what they’re looking for is financial planning, or
People recommending an advice-only planner (e.g., Mark Zoril or Jon Luskin) to somebody looking for an advisor that will manage their portfolio.

To back up a step, registered investment advisers (RIAs) can be broadly grouped into three categories based on what services they offer:

Those that are “advice-only” (i.e., they provide planning but do not actually manage the client’s portfolio),
Those that provide investment management only, and
Those that provide financial planning as well as investment management.

(To be clear, this is only one way to group such professionals. They can also be grouped based on how they charge: hourly, flat fee, percentage of assets, etc. Or they can be grouped based on expertise; to draw a medical analogy, some financial professionals are specialists with deep expertise in a sub-field of financial planning, whereas other professionals are more akin to general practitioners.)

Before considering a specific advisor (or recommending a specific advisor to somebody else), it’s important to know what services are being sought. Are we looking for just investment management? Are we looking for just financial planning? Or are we looking for both? Any of those three options is perfectly valid, but you must know the answer, otherwise our parsley shopper is going to end up in the freezer aisle looking at a bunch of tasty treats but very few herbs.

Once you do know what you’re looking for, how do you know which category a given advisory practice falls into? You read the firm’s Form ADV Part 2 (a.k.a. “Part 2 Brochure”).

What’s Form ADV Part 2?

Form ADV is a form that investment advisers have to file with the SEC. Part 2 of the form contains most of the important information that you’d want to know about an investment adviser. For example, you can see:

How the adviser charges for their services (hourly, fee-for-service, percentage of assets under management, etc.),
How much the adviser charges for their services (e.g., if it’s hourly, what is the hourly rate?),
What services the adviser offers (e.g., if you’re paying 1% per year, are you getting comprehensive financial planning? Or is it just portfolio management, and you would have to pay extra for other financial planning services?), and
The adviser’s investment philosophy (i.e., how they pick investments and how they allocate between those investments).

What’s nice about this form is that it’s a way to get the relevant information quickly, without having to filter through a bunch of sales talk (as you would often have to do if you visited the adviser’s website), and without having to give the adviser your contact information.

For instance, if you’re wondering whether PlanVision provides investment management, their Form ADV Part 2 has this very clear statement: “PLANVISION’s services are limited to providing investment advice only and not asset management services to Clients.”

And if you’re wondering whether Vanguard Personal Advisor Services provides comprehensive financial planning, you can find this statement in their Form ADV Part 2: “The Services are not intended to provide comprehensive tax advice or financial planning with respect to every aspect of your financial situation.” Elsewhere it states more bluntly, “We don’t provide tax advice.” (Vanguard PAS is basically portfolio management, plus a basic level of advice relating mostly to the portfolio.)

How to Find an RIA’s Form ADV Part 2

Downloading an RIA’s Form ADV Part 2 is easy:

Go to the SEC’s Investment Adviser Search website.
Look up the adviser by firm name.
Click “more details” then “Part 2 Brochures.”
If necessary, click the link for the most recent brochure filed.

Looking up a registered investment adviser’s Form ADV Part 2 should certainly not be the only research you do on an adviser. But it’s an excellent first step to quickly check for things that would eliminate the adviser from consideration (e.g., they don’t offer the service you’re seeking, they have an important conflict of interests, their fees are too high, they have a minimum asset level that you don’t meet, or they have an investment philosophy that’s markedly different from your own).

July 17, 2023

Investing Blog Roundup: Four Pillars of Investing, New Edition

I’ve read a lot of books about investing and personal finance over the years, and to date my single favorite is William Bernstein’s The Four Pillars of Investing.

There’s a new edition, just released this week. It’s rare that I give an unqualified recommendation for a book. Usually it’s a recommendation to read the book if you’re in some very specific group.

Four Pillars is a book that I think everybody would benefit from reading. It will help you do a better job of managing your own portfolio. Or, if you prefer to outsource that job, it will help you make a more informed decision in that regard as well as help you to understand better what your portfolio manager is doing on your behalf (or, should be doing).

You can find the new edition here:

The Four Pillars of Investing: Lessons for Building a Winning Portfolio (2023 Edition)

What’s Your Funded Ratio?

The following is an adapted excerpt from my book Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less.

In a recent episode of the Bogleheads on Investing podcast, I mentioned the idea of calculating a funded ratio — and how that can be more useful than “4% rule” -style guidelines, especially when a household’s level of non-portfolio income will be changing materially at various points through retirement.

I received several email questions from people asking for more information about that topic.

One limitation of “safe withdrawal rate” rules of thumb is that they assume that the amount you have to spend from the portfolio does not change from one year to the next (other than due to inflation). In real life, however, most households find that the amount they must spend from the portfolio does change significantly at various points in time, as their level of income from non-portfolio sources changes.

EXAMPLE: Raman (age 55) and Nisha (age 57) are married and both are still working. Raman plans to retire at age 60 (5 years from now), and Nisha plans to retire at age 65 (8 years from now). They each plan to file for Social Security at age 70.

When Raman retires, they’ll initially have to spend about 3% from their portfolio each year to cover their expenses. When Nisha retires, they project that their spending rate will go up to about 7% of the portfolio balance each year. When Nisha’s Social Security kicks in, their spending rate will fall back to about 5%, and when Raman’s kicks in it will fall to around 2%.

Based on guidance like the 4% rule, it’s hard to tell if Raman and Nisha’s plan is safe (because they’ll be spending less than 4% most years) or unsafe (because they’ll be spending considerably more than 4% for some years early in retirement).

Guidelines like the 4% rule simply can’t account for such situations very well. And for some households there could be even more stages to account for, if either person has a pension or is planning on a “phased” retirement in which they scale back work gradually.

Calculating your “funded ratio” is one way to get a sense of your retirement preparedness, when you anticipate that your amount of non-portfolio income will change from one year to the next.

What’s a Funded Ratio?

Your funded ratio is the sum of your current portfolio value and all of your future non-portfolio income, divided by the sum of all of your future expenses.

Or more precisely, it’s the sum of your current portfolio value and the present value of all of your future non-portfolio income, divided by the present value of all of your future expenses. The point of this “present value” wording is simply to account for the fact that dollars in the future are less valuable than dollars today. For instance, if you received $1,000 of income today, you could use that sum to pay for more than $1,000 of expenses 20 years from now, because you could invest the money between now and then. (See this article for a more thorough explanation of the present value concept.)

Said yet another way, your funded ratio is the ratio of your income and assets to future liabilities, if we assume that the assets will grow at a conservative interest rate.

Funded ratios are often expressed as a percentage. If your funded ratio is at least 100%, that indicates that your portfolio and future income should be enough to cover your future expenses. A funded ratio of less than 100% indicates that something in the plan should be changed (e.g., working longer, thereby increasing the sum of your future income, or cutting expenses).

A Simple Funded Ratio Example

Below you can find a spreadsheet that gives a simple example of a funded ratio calculation:
https://obliviousinvestor.com/FundedRatio.xlsx

Note that in the example spreadsheet, I have lumped income all into one column and expenses all into one column. You may prefer instead to separate them out by source (e.g., a column for work income, a column for Social Security, etc.).

Funded Ratio Caveats

There are a few caveats to keep in mind when calculating your funded ratio.

Firstly, it’s critical to use a conservative discount rate. The discount rate can be thought of as the rate of return that the portfolio will earn. And there is no uncertainty reflected. In other words, we’re assuming that the portfolio will earn this rate of return every year, without fail. So if you choose an aggressive discount rate (such as the return you’d expect from a portfolio with a considerable stock allocation), you’re setting yourself up for failure if your portfolio happens to earn a lesser return. Hence, the expected return from very safe assets should be used.

Second, in addition to being sensitive to the discount rate input, a funded ratio calculation is sensitive to the planning horizon input. That is, it’s up to you to make an assumption about how long you’ll need your savings to last. Picking a shorter planning horizon can make your funded ratio look much better — and can again set yourself up for failure, if you live beyond that point.

Finally, I don’t think that a funded ratio calculation should be the only type of retirement-preparedness analysis that you do. Additional tests with Monte Carlo simulations (or potentially historical simulations) can be informative as well.

Retiring Soon? Pick Up a Copy of My Book:

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

See it on Amazon.

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."

Read other reviews on Amazon

July 3, 2023