It’s Impossible To Plan A Retirement Without Looking At Valuations

 Guest Post  15 Responses »
Jul 302010
 

Another guest post by everyone’s crazy PF guy Rob Bennett. For the record, I really like this post. It’s short and to the point. It does a good job of giving all of us a decent primer to what the heck he’s talking about.

My question to Rob is this: If a retiree has say 80% of her portfolio in bonds, how does that affect the way things are calculated? Do bond valuations get factored into Rob’s formula?

Anyway, without further adieu, let me give the floor to Rob.

Matt and Sam both retire with $1 million portfolios. Mike plans to take out $40,000 to cover each year’s living expenses. Sam plans to take out $80,000. Which retirement is safer?

Your first thought is probably that Matt has the safer retirement. He’s withdrawing only 4 percent of portfolio value each year while Sam is withdrawing 8 percent.

Not so fast. To know which retirement is safer, you need to look at what valuation level applied at the start of each of the two retirements.

If Matt retired in 2000, when stocks were priced at three times fair value, the true value of his portfolio was only $350,000. His true withdrawal percentage is three times 4 percent, or 12 percent, That’s a dangerous withdrawal percentage.

If Sam retired in 1982, when stocks were priced at one-half fair value, the true value of his portfolio was $2 million. His true withdrawal percentage is one-half of 8 percent, or 4 percent. That’s a safe withdrawal percentage.

It turns out that Sam’s retirement is a whole big bunch safer than Matt’s. But you wouldn’t know it by using the retirement calculators available on the internet today.

None of today’s retirement calculators (except for the retirement calculator that I developed — The Retirement Risk Evaluator) contain an adjustment for the valuation level that applies on the day the retirement begins. Dallas Morning News Columnist Scott Burns explained why in a June 2005 column — “It is information most people don’t want to hear.” Most of us want to hear fairy tales about stock investing during a bull market and most “experts” are happy to go along.

It’s our desire to hear fairy tales and the willingness of the “experts” to go along that causes failed retirements. Valuations matter. We need to start taking valuations into consideration when telling people whether their retirement plans are safe or not.

Rob Bennett created the Investor’s Scenario Surfer, a portfolio allocation calculator. His bio is here.

 Posted by Nelson Smith at 12:15 am

Should You Bother With Individual Bonds?

 Bonds  3 Responses »
Jul 292010
 

I like debt. Wait, let me rephrase that.

I like investing in debt. Prices are more stable, so are returns. It gives you exposure to an entirely different asset class, a class that performs pretty much inversely to stocks.

Debt comes in many forms. You could buy mortgage debt, government debt, corporate debt or the much riskier corporate debt, junk bonds. You can also buy convertible debentures, municipal bonds, real return bonds and lend money to regular people through social lending websites. The world of debt is absolutely massive, and that doesn’t even count preferred shares.

With all these options, how does the average person include debt in their portfolio?

My favorite method is to buy individual preferred shares. While they’re somewhat illiquid, they can easily be traded by the retail investor. Typically they hover between the $20 and $25 range, meaning an investor can buy a block at a much more reasonable price than buying a block of bonds.

If someone has $20,000 to put towards debt, they could easily buy 8 different preferred shares in 8 different sectors. Is that diversified enough? If one company gets hammered and goes to zero, 12.5% of the portfolio gets wiped out. I’m confident that the preferred shares I’m invested in are from only high quality companies, but an investor is taking on some risk by only holding a handful of prefs.

What’s an investor to do? Luckily, the market has come up with a great solution. Bond ETFs.

I absolutely love bond ETFs. You can buy everything in the risk spectrum from short term government debt to high risk junk bonds and everything in between. They offer instant diversification and if you’re willing to buy into some of the riskier issues you can earn double digit yields.

Personally I hold some shares in a closed end fund called the Dreyfuss High Yield Strategies Fund. This is an interesting play, as they use leverage to help amplify returns. The fund currently pays out a hair less than 10% and I’m sitting on a comfortable gain over the $3.00 purchase price, a nice return once you include the income distribution. This fund is definitely on the higher end of the risk spectrum in the world of debt.

I’m not smart enough to try to trade debt. Yes, interest rates will be going up soon, probably having a negative effect on bond prices. If you’re smarter than me then perhaps you can figure out how to use that information to make money. I’ll just buy a good fund of debt at a yield I’m happy with and hold it long term.

This begs another question: at what point should you sell your debt? I have a nice sized capital gain on my Dreyfus fund. Is it time to sell and lock in profits?

Knowing when to sell is always a tough decision. I think that if you look at your bond fund and you wouldn’t buy it because the yield is too low then maybe it’s time to sell.

 Posted by Nelson Smith at 9:12 am

Should You Buy The New Chevy Volt?

 Big Picture Stuff  No Responses »
Jul 282010
 

Even before General Motors entered chapter 11 bankruptcy protection, they announced plans for the first fully electric car, the Chevy Volt. While GM had experimented with a fully electric car before and basically failed,  (anyone remember the EV1?) their new car is widely expected to be a huge hit. There are many reasons for this, a couple of the obvious being that the public is much more environmentally conscious and because the technology is much better.

Granted, the Volt would still have a gasoline engine, but that engine wouldn’t activate until the car had exhausted the batteries. For the first 40 miles of the journey the car will be fully powered by the lithium ion batteries. Once the batteries are dead the gasoline engine kicks in and powers a generator, expanding the maximum daily range of the car to more than 300 miles (483 km). This marks a huge improvement compared to the EV1 because the car isn’t limited to the range of the battery.

GM announced yesterday that the price tag for the Volt will be $41,000. The car would be eligible for a $7500 federal tax in the U.S., as well as additional tax credits in several states. There will also be a lease option of $350 per month for 36 months with $2500 due at signing. This allows someone to drive the Volt at an affordable price tag.

The car will only be introduced in 7 states at first. GM plans to offer the car almost everywhere else within a year. So if you’re chomping at the bit to buy one you may have to wait a little while. If you get the chance to buy one right away, what should you do?

There’s always a risk of buying the first issue of a brand new model of car. Even though the company does vigorous for years before it releases the car to the public, there’s always a chance of something going wrong. If you add in the new, unproven battery technology, you can very easily envision all sorts of recalls.

The mileage the car will get is debatable. The EPA has yet to issue an official fuel mileage for the Volt. General Motors has come up with 85 miles per gallon, which combines highway and city driving and battery and gas driving. Sure, that’s pretty darn good gas mileage, assuming you believe the company’s numbers. The actual numbers could end up much different, either positively or negatively.

A new Chevy Cruze will get about 45 miles per gallon. If the Volt ends up being double that, the person who drives 10,000 miles per year will save 111 gallons of fuel. If a gallon of gas costs $3.75 the savings add up to over $416 dollars per year. If you’re someone who drives a lot of miles then the Volt will have an impact on your gas costs.

GM also claims that the Volt saves 4.4 metric tons of CO2 emissions compared to a regular car. If you care about the environment at all, that also has to be a consideration.

At the end of the day, I can buy a brand new Ford Focus for around $20,000 that would average around 40 MPG. To make the Volt a better deal on the gas savings alone would take a long time and an awful lot of miles. If you really care about the environment then perhaps the Volt is a smart purchase. You’re making a statement with the car, just like people do with their Prius’. If you’re buying it to save on gas though, the price tag just isn’t worth it.

 Posted by Nelson Smith at 1:15 am

Bottled Water

 Marketing  2 Responses »
Jul 272010
 

Check out this great graphic from the Huffington Post on bottled water:

Bottled Water
Via: Term Life Insurance

I have a bit of a confession to make. I drink bottled water all the time. It’s just so darn convenient. I’m drinking a bottle of water as I type this post.

Whenever I’m thirsty, or I have to take some water with me to go play sports, it’s just so easy to grab a bottle or two out of the fridge. I don’t have to worry about filling up a water bottle or washing that water bottle. (Aside: how often would one wash their water bottle? Daily? Weekly? I don’t know.)

Marketers have also done a great job convincing us that bottled water is somewhat healthier. This is, of course, hogwash. As the graphic states, many brands of bottled water are simply tap water. An inexpensive filter can turn bad tasting tap water into water that is as comparatively tasteless as bottled. These filters only cost about $10 and can be used for months. Buying a filter is easily the frugal choice.

When faced with a frugal choice, many people take the path that’s more convenient. The convenience of bottled water is its main drawing point. Thanks to retailers like Walmart and Costco, the cost to buy a case of bottled water has plummeted in recent years. Because of this, the price of convenience has become affordable for just about every consumer, myself included.

Bottled water isn’t about health benefits, it’s about laziness. If you make a product easier to consume and people want it, you’ll sell more. While I’d like to see more of the bottles recycled, the bottled water craze isn’t going away anytime soon.

 Posted by Nelson Smith at 3:23 pm

Blogger Jamboree #1: If You Could Only Invest In One Company, Which Would It Be?

 Blogger Jamboree  8 Responses »
Jul 272010
 

Being the super smart and sexy blogger that I am, I came up with an idea that I thought was pretty cool. I call it The Blogger Jamboree. The concept is pretty simple. I email 10 different bloggers and ask them a question on money, or investing, or whatever. I take their relatively short answers and combine them together for a post.

I do plan on making this a monthly feature around here, switching up the bloggers that I ask. While I’m sure you all read many blogs, I think that getting differing opinions on one topic can make for some interesting reading.

Thanks to every single one of the bloggers that took time out to respond to my unsolicited email. I got 6 out of 10 responses, which I’m pretty happy with. I realize that bloggers are busy, so I hold no grudges to those that didn’t respond.

This month’s question was: If you could only invest in one company, which would it be? My comments are in italics after each response. In order of when I received the responses:

Andrew Hallam (www.andrewhallam.com)

For me, it would be Berkshire Hathaway.  It’s the closest stock I know to an index fund.  Owning everything from International Dairy Queen to GEICO to Benjamin Moore Paints, it’s an index fund on steroids, in my book.  I see it as an American mutual fund, minus the expense ratio.  I love that Buffett pays himself only $100K a year, and that the culture is going to remain intact when he’s gone.

Agreed. You gotta love Buffett. It’ll be interesting to see how the company performs when Buffett dies, but I think it’ll be fine.

Mike Piper (The Oblivious Investor)

My own. I’m big on extreme diversification via index funds and/or ETFs. If I were completely unable to diversify, the only way I’d be comfortable investing is in a company over which I have complete control.

This is a pretty common answer and one I should have seen coming. Even though guys like Mike write a lot about investments, deep down they’re entrepreneurs who crave control. I can’t say I really blame them.

Len Penzo (lenpenzo.com)

If I could only invest in one company I would make sure I invest in the most important company of all – my household.  After all, my regular readers know my mantra is that all households should be run just like a business!   As CEO of my household, would you expect any other recommendation?  :-)

Make sure you always pay yourself first, setting aside an affordable percentage of your paycheck for your savings and retirement accounts before you do pay for anything else – be it bills, the groceries, or a night on the town.   Remember, most companies that fail to reinvest their profits rarely grow and ultimately go the way of the dodo.   Your household is really no different.

Good advice from Len. Sometimes I get away from the basics and it’s a good reminder to get your own financial house in order before investing.

Michael James (Michael James On Money)

I’m a big believer in indexing and so I would never own just one stock.  If you permit ETFs for your “stock”, I’d probably make it VTI.  If that’s not allowed, then I would find a good company that is quite widely diversified, such as Berkshire Hathaway (BRK).  Among Canadian stocks, I’d pick Bank of Montreal (BMO) mainly for reasons of stability.

I don’t consider these stock tips.  I think it would be crazy to pile all of one’s money into any one stock.

I like the choice of a Canadian bank and for full disclosure I own shares of BMO. Another pick for Berkshire.

Mike (The Financial Blogger)

If I had to invest in only one company, it would be mine! Investing in my online company has been showing the best yield by far compared to any of my other investments! Each dollar you invest in yourself is a dollar that will generate a tons of profit if used wisely. As compared to one of my favorite stock on the market (RIM), I can’t control what the market thinks of RIM but I can control how much money my company is generating for me ;-)

Another vote for investing in themselves. I think we have a winner… Finally, last but certainly not least:

Saj Karsan (Barel Karsan)

Here is my stock:

New Frontier Media (NOOF) generates margins that suggest it has a competitive advantage over its competition. At the same time, it trades at a very low valuation, with a P/S ratio of just .26 when you subtract out the company’s large cash balance. The recession has depressed earnings temporarily for the discretionary products the company sells, which is allowing investors the opportunity to buy the stock cheap. More of my opinion on this stock is available here.

One of my favorite things about Saj is that he finds these gem companies that no one has ever heard of. New Frontier is just one example.

Thanks to each blogger for taking time and participating. Look for one of these types of posts every month.

 Posted by Nelson Smith at 2:43 pm
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