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 Post subject: Investing for Retirement
PostPosted: August 11 17, 7:53 am 
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I've decided to make a dedicated thread to this topic. We've already had significant discussions regarding retirement investing in the "Our financial system is crumbling this week." thread which is worth checking out. Most of the investing discussions start here.

As an FYI - this is my personal investment strategy:

Michael wrote:

When investing for retirement just do the following:

1) Follow a low cost three fund portfolio.
2) Decide the % you want of each fund. A good place to start looking is the vanguard target date retirement funds. For example, if you project your retirement to be 2040ish Vanguard has the following asset allocation:

87% Stocks
13% Bonds

60% domestic equities
40% international equities

Personally I do a little less international, but that's a reasonable %.

3) Make sure you're tax efficient
4) Auto re-balance once a year
5) Don't time the market or sell in a panic. Just make regular contributions.


There are other small optimizations people can make, but doing above will put you in a great position.


Last edited by Michael on August 24 17, 2:53 pm, edited 2 times in total.

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PostPosted: August 11 17, 8:00 am 
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I'm starting to see more and more of this chatter:

The Atlantic: Are Index Funds evil?


Quote:
Index funds have grown exponentially since John Bogle founded Vanguard in the mid-1970s. The top three families of index funds each manage trillions of dollars, collectively holding 15 to 20 percent of all the stock of major U.S. corporations. Best of all for their investors, index funds have consistently beaten the performance of stock-pickers and actively managed funds, whose higher fees may support the Manhattan lifestyle of many bankers, but turn out not to deliver much to customers.


Quote:
It’s a feel-good story—a populist victory, as finance goes. Except there’s a problem, or might be. Over the past year or two, a growing chorus of experts has begun to argue that index funds and shareholder diversification are strangling the economy, and need to be stopped. That’s the maximalist claim, anyway, and it is a strain of thinking that is spreading with surprising speed.


Quote:
Azar, schmalz, and tecu’s paper went viral among academics, launching a whole new field of inquiry and many heated debates. An array of new research blames common ownership for various ills, including high bank fees and stratospheric CEO pay. At the annual meeting of the American Law and Economics Association, in May, common ownership was the subject of multiple presentations and nonstop chatter. Various remedies have already been proposed, some of which are punitive. One journal article argues that large index funds are violating antitrust law; another recommends a limit on index funds owning stock in more than one company in an industry. No one expects these ideas to lead to political action under the current presidential administration, but they are gaining traction among Democratic lawmakers.]



Although I think there is a logical conclusion where index funds distort the markets, most mainstream economists don't think we're close to a significant problem. I also find the concerns in the article to be unconvincing.

It's also worth noting, there are a lot of powerful people who don't like index funds because they cut in to their bottom line.


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PostPosted: August 24 17, 2:36 pm 
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For those who wonder, if I have X amount of dollars when I retire, what can I safely withdraw each year? A guy named Bill Bengen looked in to this and he determined a 4% withdrawal rate (later modified to 4.5%) adjusted for inflation is very safe over a 30 year period. He recently did a pretty good AMA, where he explains the concept:

Quote:
Thanks for your question. Before I answer it specifically, why don't we dispense with some preliminaries, so we are all on the same page?
The "4% rule" is actually the "4.5% rule"- I modified it some years ago on the basis of new research. The 4.5% is the percentage you could "safely" withdraw from a tax-advantaged portfolio (like an IRA, Roth IRA, or 401(k)) the first year of retirement, with the expectation you would live for 30 years in retirement. After the first year, you "throw away" the 4.5% rule and just increase the dollar amount of your withdrawals each year by the prior year's inflation rate. Example: $100,000 in an IRA at retirement. First year withdrawal $4,500. Inflation first year is 10%, so second-year withdrawal would be $4,950. Now, on to your specific question. I find that the state of the "economy" had little bearing on safe withdrawal rates. Two things count: if you encounter a major bear market early in retirement, and/or if you experience high inflation during retirement. Both factors drive the safe withdrawal rate down. My research is based on data about investments and inflation going back to 1926. I test the withdrawal rates for retirement dates beginning on the first day of each quarter, beginning with January 1, 1926. The average safe withdrawal rate for all those 200+ retirees is, believe it or not, 7%! However, if you experience a major bear market early in retirement, as in 1937 or 2000, that drops to 5.25%. Add in heavy inflation, as occurred in the 1970's, and it takes you down to 4.5%. So far, I have not seen any indication that the 4.5% rule will be violated. Both the 2000 and 2007 retirees, who experienced big bear markets early in retirement, appear to be doing OK with 4.5%. However, if we were to encounter a decade or more of high inflation, that might change things. In my opinion, inflation is the retiree's worst enemy. As your "time horizon" increases beyond 30 years, as you might expect, the safe withdrawal rate decreases. For example for 35 years, I calculated 4.3%; for 40 years, 4.2%; and for 45 years, 4.1%. I have a chart listing all these in a book I wrote in 2006, but I know Reddit frowns on self-promotion, so that is the last I will have to say about that. If you plan to live forever, 4% should do it.


That % doesn't include social security. Also, this is based on retiring with a 50/50 bond to equity ratio. Obviously no one knows what the future will bring, but I like this concept to help with planning.


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PostPosted: September 14 17, 7:02 pm 
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9 1/2 years ago Warren Buffet made a famous 1 million dollar bet with a hedge fund manager that pitted 10 years of returns of hedge funds against a simple S&P 500 index fund. You can listen to a fairly entertaining NPR podcast about the bet here.

Well, Buffet is winning bigly:

Quote:
After nine years, the index fund has registered a compounded annual increase of 7.1%. And the average for the five funds (whose names have never been made public) is 2.2%. In total gains, the index fund is up 85.4%. The average gain of the five funds is 22%


The hedge fund guy, Ted Seides, just wrote an article conceding with completely unconvincing rationalizations.


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PostPosted: October 4 17, 2:03 pm 
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First off, I realize no one cares about this thread and it's basically a personal blog. Given no one reads any of this, my plan in the near future is to start posting erotic fan fiction about the moderators. Their selfless dedication to making GRB a cool place to hang out heightens my desire to defile them.

Anyway, I digress. Today I want to post some random thoughts about international equities. This post is for anyone who is skittish about investing international or would like to understand the benefits of international equities investing better.


The Case for International Equities

It's totally understandable that someone might be skeptical about investing internationally. In the last 40 years US index funds have performed much better than international. Here's a chart that illustrates that fact:

Image


Domestic has routed international. However, there's several reasons why I think international equities diversification is still a very attractive option to any portfolio:


1) Japan has been a huge drag on international performance. In the late 80's Japan's stock market valuation was higher than the US. So if you purchased an international index in the late 80's and 90's you were mostly buying Japanese stock. Today Japanese stocks represent about 17% of an international index. In essence you don't have to worry as much about one country tanking the index anymore. More on Japan later.

2) In the past 5-10 years international index fees have gone down significantly. For example, Vanguard's total international has a 0.11% expense ratio which is very reasonable.

3) Portfolio diversification. Let's get back to Japan. Here's the horror story of Japan's stock market in one graph:


Image


Japan still hasn't recovered from its high in the 80's. Now you may look at this graph and think to yourself this is why I don't want to invest international. However, I take the opposite view. There's no rule that says this type of performance can't be the US in the future. I'm not saying it's likely, but it is possible. That's why diversification is powerful/important for any portfolio. International equities gives you significant diversification if the US market tanks like Japan.

Now, some will argue "big US companies do a lot of business overseas so I'm basically diversified in international". However, a Vanguard white paper shows that the correlation isn't as high as most people imagine (figure 2). Additionally, you'll be missing out on industry weighting:

Quote:
Lastly, a portfolio made up solely of U.S. firms, which are more concentrated in biotechnology, computer equipment, information technology and IT services, and software, would be underweighted in “old world” industries such as electrical equipment, durable household goods, and automobiles. In other words, an all-U.S. portfolio would lose not just investment opportunities but also the diversification benefits of a portfolio that’s more evenly distributed across industries.



4) Another concern with international is currency fluctuation risks. However, the same Vanguard white paper demonstrates long term currency fluctuations do not materially impact equities prices and actually help with diversification (page 12).

5) I hesitate to post this last point because it's slightly a market timing thing, but here we go...

Valuations for US equities are historically high right now. It's worth noting, valuations are only a good predictive factor of market returns in the long term (10+ years) and have little correlation with returns in the short term (< 3 years). However, if you are planning to keep your money invested for a long time it doesn't hurt to be aware of valuations. For instance, take this graph:

Image

Higher CAPE means higher valuations. CAPE for the S&P 500 is currently ~31. In non-US developed markets it is roughly 20. CAPE isn't a perfect measure, but if historical patterns hold, it is more probable that we will see higher returns in the next 10-15 years from non-US markets.


How to Add International Equities to a Portfolio

As I've posted in the past I'm a big fan of the simple 3 fund portfolio. It's how I invest. That said, even if you don't utilize a 3 fund portfolio adding international equities exposure is conceptually easy to do. My recommendation is to add 20-40% international equities to your overall equities exposure with a low cost index fund. According to Vanguard, 20% international equities gives you over 80% of full diversification benefits. 30% is 99% of full diversification benefits. 40% is almost full market weighting.

Here's how international equities weighting works in practice (I arbitrarily added 20% bonds, however your allocation might/should be different):

20% (Over 80% of full diversification benefits)

80% Equities
20% Bonds

80% Domestic Equities
20% international Equities

That means for every 100 dollars you invest it should have the following allocation:

Equities - $80 (domestic vs international allocation formula below)

.....80% Domestic Equities - $60 = 80 * .8
.....20% international Equities - $16 = 80 * .2

Bonds - $20


30% (Over 99% of full diversification benefits)

80% Equities
20% Bonds

70% Domestic Equities
30% international Equities

That means for every 100 dollars you invest it should have the following allocation:

Equities - $80 (domestic vs international allocation formula below)

.....70% Domestic Equities - $56 = 80 * .7
.....30% international Equities - $24 = 80 * .3

Bonds - $20


40% (almost full market weighting)

80% Equities
20% Bonds

60% Domestic Equities
40% international Equities

That means for every 100 dollars you invest it should have the following allocation:

Equities - $80 (domestic vs international allocation formula below)

.....60% Domestic Equities - $48 = 80 * .6
.....40% international Equities - $32 = 80 * .4

Bonds - $20


Summary

Investing in international equities is something you should consider. Anywhere from 20%-40% ratio to your overall equities portfolio can provide significant benefits.

Let me know if you have any questions.


***Michael is not a licensed financial adviser and provides investment advice for entertainment purposes only. Not available in all 50 states. Void where prohibited.***


Last edited by Michael on October 4 17, 5:06 pm, edited 2 times in total.

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PostPosted: October 4 17, 2:25 pm 
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It's a lot easier to blow your money on [expletive] that will kill you and not have to worry about this.


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PostPosted: October 4 17, 2:51 pm 
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Erotic fan fiction is good. It ensures people don't lose their imagination.

That being said, I currently don't have any portion of my retirement account invested in international equity. As you said, diversification is key. My particular plan's expense ratios have historically been higher for international equity funds than domestic funds, and their performance hasn't been high enough to offset the higher expense ratios. I typically rebalance and/or change funds a couple times a year, so perhaps I'll shuffle some lower performing domestic funds around with international ones.


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PostPosted: October 4 17, 3:01 pm 
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I'm pleased unscientifically selecting 25% falls in this range.

You should do a post on whether weighting up small caps makes sense.

Edit: Though given the PE data you report in this post, it makes me think it's actually an underweight. Where does one go for international CAPE data?


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PostPosted: October 4 17, 3:10 pm 
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Swirls wrote:
That being said, I currently don't have any portion of my retirement account invested in international equity. As you said, diversification is key. My particular plan's expense ratios have historically been higher for international equity funds than domestic funds, and their performance hasn't been high enough to offset the higher expense ratios. I typically rebalance and/or change funds a couple times a year, so perhaps I'll shuffle some lower performing domestic funds around with international ones.


I hear you on the fees thing. Although, if you have access to good index funds the fee differences aren't really that big. For example, the Vanguard Total Stock Market Index Fund has a fee ratio of 0.04% and the international has 0.11%. A nearly 3x difference sounds like a lot. In reality with these low cost index funds the difference isn't huge because fees are already very low. If you invest 100K in each fund the cost difference between them is about 70 dollars a year.


Last edited by Michael on October 4 17, 3:37 pm, edited 1 time in total.

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PostPosted: October 4 17, 3:31 pm 
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Arthur Dent wrote:
You should do a post on whether weighting up small caps makes sense.


For US equities? I don't think so. Although I prefer total stock market indexes (includes small cap), the performance differences between US total stock market and the S&P 500 index funds are almost immaterial.

I would keep it simple and not get too cute by adding several funds for weighting.

Arthur Dent wrote:
Edit: Though given the PE data you report in this post, it makes me think it's actually an underweight. Where does one go for international CAPE data?


Here's the white paper that created that CAPE pic. See page 11. There's lots of data to dive in to. They also have this site that's interactive. I haven't played around with it too much.

It's worth noting, technically CAPE should be higher than other times because companies don't pay dividends like they used to. Regardless, US valuations are very high compared to the rest of the world.


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