Tips on answering the question - What Should I Do?

[Rick Ferri]

[If you are reading this for the first time, please note the post dates - admin alex]

That is a question I have been getting quite frequently. Rather than post ad-hoc when this topic comes up, I decided to make my own post that slices together some advice that I have already put on this forum.

What should you do in this current market environment?

First, do not act emotionally. Think things through before making any changes. Second, if you decide to make a radical change, don't do it until next week. Chances are you will change your mind again by then.

Here is how I believe people should handle the current situation based on how I classify investors;

* 1) Early Savers (20s and 30s) - buy equities index funds like crazy with what you can and do not look at your account balance for 10 years.

* 2) Mid-life Accumulators (40s and 50s) - rebalance your portfolio back into equities when it needs to be rebalanced, and you will be very happy you did by the time you retire.

* 3) Near Retirees and retirees (60s and 70s) - live off your cash flows from dividends, interests, Social Security, pensions, annuities, and other. Leave your principal alone.

The only people who should be concerned are those who are currently taking out 7% or more per year from their portfolio to live on. This situation is just as much a budgeting issue as a portfolio management issue. My first response is to spend less. However, if spending cannot be controlled, then there may be a legitimate reason to change an asset allocation because the portfolio was more aggressive than it should have been from the beginning. Looking further at this topic:

When should you change your asset allocation strategy?

Significant changes to your stock and bond asset allocation strategy is a major decision and can be compared to changing careers. There are several good reasons to change your asset allocation strategy along life’s journey. Below are three reasons I believe a person has a legitimate reason to make an asset allocation change:

1) Your target retirement goal is well within reach.
2) You realize that you will not need all your money during your lifetime.
3) You have realized that your tolerance for risk is not as high as you once thought.

Consider a reduction to risk when you are within reach of your financial goals. That is the time to take your foot off the gas pedal and move into the middle lane. For example, assume you wish to retire in 3 years with $2,000,000 in retirement savings. If you already have $1,800,000 in savings, the rate of return you need to achieve your goal does NOT require a high risk asset allocation strategy. It might be time to permanently lower your equity exposure because you no longer need to take as much risk.

Second, a change to your asset allocation strategy may be appropriate if you realize that you will not outlive your money and will likely have excess assets. In that case, you are investing part of your portfolio for yourself and another part for the needs of those who will inherent your wealth. Your overall asset allocation should reflect the needs of both parties jointly. Assume you have $2,000,000 in retirement savings. You may need $1,000,000 of that amount which might be allocated at 30 percent stocks and 70 percent bonds. The second $1,000,000 will be passed on to your heirs. Since heirs tend to be younger, they can be more aggressive. That portion might be allocated at 70 percent stocks and 30 percent bonds. With both allocations put together, an appropriate asset allocation strategy for this example might be a portfolio that is 50 percent stocks and 50 percent bonds.

The third reason to change an allocation is because you have taken on more risk than you can handle. If you are not sleeping at night because you are worried sick about your portfolio, and you are on the verge of making an emotional decision to ‘sell it all”, then you should consider permanently reducing your equity position to see if that helps. Your portfolio has an appropriate level of risk when you are able to think clearly during all market conditions. Once you find this level of risk, stay at that level, even when the market recovers.

I hope this helps!

Rick Ferri

[Roberteyewhy]

Calm, logical and non-emotinal words of wisdom from Rick Ferri!

"It's only a loss if you sell."

Thanks,
Robert

P.S. My mom at 78 finally retired in December '07 and I changed her portfolio to 100% Admiral Treasuries MMF early that month. Paid of ALL her existing debts too.

[Adrian Nenu]

A very timely post Rick. Everyone should read it. Thanks.

Adrian
anenu@tampabay.rr.com

[chaz]

Rick, Good advice.

[rich]

Thank you Rick! It always helps to have this reinforced by one of the forum's "stars".

[dbr]

Rick, I am curious about a couple of your ideas for retirees.

The first is the one about dividend streams. Do you consider failure to reinvest dividends to not be invasion of principal? In different words, do you think the dividend component of total return and the capital component of total return are not fungible. Is it advisable to restrict spending to what is provided by dividends and interest (plus others mentioned) because this will provide an automatic brake on spending rate?

The second is the advice concerning rebalancing. If one fails to rebalance when equities decline that enforces an automatic allocation change toward a less risky portfolio. Do we agree this is appropriate for retirees because the loss of assets has reduced the ability to take risk? Do we expect the result will be a reduction in future expected return which means retirees will have to cope with increased need to take risk by reducing planned budgets rather than by rebalancing back to the originally more agressive allocation. Is there any credibility to the idea that one should expect better future returns after an equity decline and this should compensate for the reduced equity allocation.

It would seem clear that retirees should not be liquidating equities at this time, but the wisdom as to whether or not retirees should add to equity investments either by dividend reinvestment and/or rebalancing seems less obvious.

Perhaps your could expand on this latter point.

[sewall]

Below are three reasons I believe a person has a legitimate reason to make an asset allocation change:

1) Your target retirement goal is well within reach.
2) You realize that you will not need all your money during your lifetime.
3) You have realized that your tolerance for risk is not as high as you once thought.

Rick,

First of all, this is just about the best post for these times I've seen. Concise, wise, practical, simple-to-implement, easy-to-understand...an A+ in many ways. However, I have one small issue/question. Did you really mean to write "asset allocation" above or did you really mean "asset allocation plan"? That is, I plan to change my AA gradually as I age. I suppose one could argue that I'm really following number 3 above: that my risk tolerance changes as I age. But the difference is that this isn't a sudden realization (as your 3 implies), but is my plan. So, it may be clearer to add a fourth reason to your list:

4) You have changed investor class: from "early saver" to "mid-life accumulator" or from "mid-life accumulator" to "near retiree or retiree". Such transitions warrant gradual adjustment of one's AA toward more conservative holdings.

(Your wording will be better. This is just a suggestion.)

[mwgr5]

Excellent advice. It is critical to not act emotionally during market downturns.

[Rick Ferri]

Do you consider failure to reinvest dividends to not be invasion of principal? Is it advisable to restrict spending to what is provided by dividends and interest (plus others mentioned) because this will provide an automatic brake on spending rate?

Both stock prices and stock dividends go up over time, so I do not consider taking dividends an invasion of principal even on an after inflation basis. Fixed income is another story. Taking interest from fixed income investments is an invasion of principal on an after inflation basis. However, the real gains from equity prices have tended to offset the inflation reduction on the fixed income side. That is one reason to have equities in a retirement portfolio.

The strategy of not outspending income in bear markets is a defensive measure during difficult times. And that does help pinpoint a 'spending target' for lack of a better term. Chicken prices may fall for a long-time, but if you only eat eggs, what does it matter? It is okay to loosen up on that target when the markets recover.

The second is the advice concerning rebalancing. If one fails to rebalance when equities decline that enforces an automatic allocation change toward a less risky portfolio. Do we agree this is appropriate for retirees because the loss of assets has reduced the ability to take risk?

No, I do not agree that retirees should let their asset allocation drift. Retirees should continue to rebalance. Stocks are yielding over 3%, which is higher than intermediate-term Treasury bonds and not much lower than investment grade bonds. So there is not much income reduction from rebalancing.

The loss of equity value has nothing to do with a retirees ability to take risk if they had the right allocation to start with. The risk of losing 40% or 50% in equity has always been there. We are just realizing the known risk at the moment. So, why has anything changed? Perhaps I do not understand the question.

Do we expect the result will be a reduction in future expected return which means retirees will have to cope with increased need to take risk by reducing planned budgets rather than by rebalancing back to the originally more aggressive allocation. Is there any credibility to the idea that one should expect better future returns after an equity decline and this should compensate for the reduced equity allocation.

Yes. Expected risk premiums are clearly much higher now. In fact, the expected returns are higher than they have been since 1974. IMO, I believe investors will enjoy 10% compounded returns from equities and high yield bonds for several years in the future, with large gains occurring on the front end.

It would seem clear that retirees should not be liquidating equities at this time, but the wisdom as to whether or not retirees should add to equity investments either by dividend reinvestment and/or rebalancing seems less obvious.

Depending on each retiree, the strategy could be different. Here are some scenarios:

Retiree #1: Scenario: has a modest amount in retirement savings and has developed a budget that allows them to spend their income including dividends and interest without touching principal. Action: Nothing has changed. Rebalance the portfolio as normal to a target allocation.

Retiree #2: Scenario: is taking little or nothing from their investment portfolio and will likely never take much. Action: The portfolio is going to heirs. If the heirs are young, and self-sufficient, and the portfolio is invested to be very conservative, i.e. a low allocation to equity, then it might be a good time to increase that allocation to equity for the benefit of the heirs.

Retiree #3: Scenario: taking all income plus a fair amount of principal from a portfolio each year. Action: reduce monthly spending if feasible. Delay large purchases. Stop gifting. Travel less. Whatever it takes to reduce outflows. When all spending cuts are made, if the portfolio is still not producing nearly enough income, then drastic measures may be needed. Consider a reverse mortgage on the house. Consider a reduction in equities and a move to corporate bonds, including high yield bonds (VWEHX). That will boost income.

Rick Ferri

[diehards]

Rick
Many thanks for your thread concerning the current market environment.

I'm currently researching how to go about Tax Loss Harvesting (TLH) my many funds showing unrealized capital losses.

VG has their frequent-trading policy and will not let you transfer to a MMF for 30-days and then back into the same fund.

Any ideas how to TLH and comply with the IRS wash sale rule?

Is there a list of VG funds showing which are "substantial identical"?

Should I THL all at once or take several weeks?

Thanks for any ideas, A diehard.

[dbr]

Rick, thank you. Your clarifications are most helpful. Note this amateur would agree with your basic outline and the clarifications.

It may perhaps be a distraction to niggle on one small point however. That point is that I do not agree that dividends (and interest) should be singled out as not fungible with total return in general. In my view there is no question that failing to reinvest dividends and interest is invasion of principle to exactly the same degree and same manner as removing money from assets by "selling shares." It can't be any other way.

What could be a distinction, however, is what we already mentioned, namely that liquidating no more than what is provided by dividends and by REAL interest automatically restricts withdrawals to the success or failure of assets to produce dividends and interest. This is a natural restriction on overliquidating. Of course, an investor who chases yield to very dangerous high yielding but risky investments would again be making a big mistake not amelioriated by the fact that the "income" was dividends and interest.

It is also helpful to observe that the critical issue whether "dividend" or "liquidation" is the RATE of consumption of investment resources, as you point out above. I imagine retirees following a "4% rule" and retirees spending the yield at a yield of 4% are in practice doing pretty nearly the same thing.

Thanks again.

[Rick Ferri]

Rick
I'm currently researching how to go about Tax Loss Harvesting (TLH) my many funds showing unrealized capital losses. VG has their frequent-trading policy and will not let you transfer to a MMF for 30-days and then back into the same fund. Any ideas how to TLH and comply with the IRS wash sale rule?

Being close on asset classes is good enough when TLH. You are only in the other fund for a few weeks, and most equity markets are highly correlated at the moment.

For example, I recently sold Vanguard Total Stock Market and bought the S&P 500. I will stay in the S&P 500 for 31 days and swap back. You could sell Europe and Pacific and buy Developed Markets, then move back into your original position next month.

[Paladin]

Rick
I'm currently researching how to go about Tax Loss Harvesting (TLH) my many funds showing unrealized capital losses. VG has their frequent-trading policy and will not let you transfer to a MMF for 30-days and then back into the same fund. Any ideas how to TLH and comply with the IRS wash sale rule?

Being close on asset classes is good enough when TLH. You are only in the other fund for a few weeks, and most equity markets are highly correlated at the moment.

For example, I recently sold Vanguard Total Stock Market and bought the S&P 500. I will stay in the S&P 500 for 31 days and swap back. You could sell Europe and Pacific and by Developed Markets, then move back into your original position.

Rick,

Would you swap back if you had a cap gain in the S&P 500 after 30 days?

Thank you.

[Derek Tinnin]

3) Near Retirees and retirees (60s and 70s) - live off your cash flows from dividends, interests, Social Security, pensions, annuities, and other. Leave your principal alone.

IMO, leaving your principal alone encourages not enough principal.

Retirees often structure their investments to maximize current income and minimize exposure to potential loss. They feel their biggest risk is in covering current cash flow needs and they just can't afford to lose principal caused by market fluctuations. It is understandable, then, that they find a portfolio comprised of fixed income investments (bonds, bank cds or even annuities) attractive. The apparent safety and steady cash flow delivered by these holdings lets them clearly see where their next "paycheck" is coming from.

The retiree's biggest liability, however, is not in providing income for current consumption. It is his or her future consumption - which is highly sensitive to inflation. Fixed income investments provide a known source of cash flow, but they are a terrible way to cover the risk of inflation - especially when using longer-term/higher-yielding bonds. Assuming an inflation rate of 4%, a 60 year old retiree today with a cash flow requirement of $50,000 per year will need $100,000 per year by age 78 and $150,000 per year by age 87 just to maintain their purchasing power. The unintended consequence of pursuing near-term safety and steady cash flow is a devastating long-term loss caused by inflation.

The conclusion is that financial security is driven by total wealth, not current income. It is imperative for retirees to structure their portfolios to include multiple asset classes to stay ahead of inflation. But what about income for the here and now?

Money is money. Whether it comes from an interest payment, a dividend or from capital growth doesn't really matter. There's no reason to prefer one source of money above the other. In the context of a broadly diversified portfolio, producing cash flow is not a problem. When cash is needed, simply redeem assets from wherever it makes sense (the overweighted asset class). This approach has the added benefit of managing the impact of taxes and other costs more effectively.

So how do we structure a portfolio to cover both current income needs and long-term inflation protection? Financial theory teaches us that for two portfolios with equivalent average returns, the portfolio with lower volatility will produce greater terminal wealth. Greater terminal wealth means more assets to produce cash flow. The goal then is to maximize return for a given level of volatility. Maximizing return relative to volatility is done first by eliminating unnecessary or uncompensated risks (in other words, pursue maximum diversification - diversifiable risk is uncompensated risk) and secondarily by eliminating inefficient risk exposure.

In a stock/bond portfolio, inefficient risk is usually found on the bond side of the portfolio. Bonds other than short-term, high quality bonds usually do not produce enough additional return to justify the additional risk they add to a portfolio. When it comes to taking risk, take it with stocks where you have higher expected returns per unit of risk. Use lower-risk/lower-yielding short-term bonds to manage the volatility of the stocks. Don't worry about the reduced levels of bond income. Again, money is money and the source of cash flow is the portfolio itself - not just certain parts of the portfolio.

Because retirees rely on their investments more, they should stay focused on strong tradeoffs between risk and return and avoid the extremes of portfolio structure. Stocks are risky in the short run (negatively affecting cash flow) and bonds are risky in the long run (negatively affecting cash flow). Combining short-term risk with long-term risk ultimately maximizes sustainable retirement income.

[bob90245]

For those who may be interested, I have an article that explores the question of Harvesting Withdrawals in Retirement on my website.

[Sidney]

Stocks are yielding over 3%

While I don't disagree with your point regarding re-balancing, none of the funds I am investing in yield anywhere near 3%. Even SCV is showing 2.77%.

[Rick Ferri]

Derick,

The flaw in the classic 'financial planning model' of retirement spending is that spending is linear over a person's retirement. That is a misconception. There is a distinct spending curve that trends upwards slightly when a person is in their 60s, and then trends downward over time.

Government statistics clearly show that an 85 year old will spend less in inflation adjusted dollars than they did when they were 75, and considerably less than when they were 65. People reduce driving, reduce trips, don't go out as much, sell the second car, and a assortment of other changes the reduce outflows.

Rick Ferri

[Derek Tinnin]

Is there any credibility to the idea that one should expect better future returns after an equity decline and this should compensate for the reduced equity allocation.

It would seem clear that retirees should not be liquidating equities at this time, but the wisdom as to whether or not retirees should add to equity investments either by dividend reinvestment and/or rebalancing seems less obvious.

IMO, this argues for less frequent rebalancing or at least to not just focus on price movements. You have to also factor in expected return. Prices go down, expected returns go up. Rebalancing based on prices alone has the potential of adding more risk than necessary or intended.

For retirees with cash flow needs, they will be automatically rebalancing with those cash flows by selling bonds which presumably would be overweighted in this type of market.

Yes, rebalance now and then, but look at the total picture.

[retiredjg]

The only people who should be concerned are those who are currently taking out 7% or more per year from their portfolio to live on.

Rick, can you comment on why you believe 7% is the right number here? Why not 4% or 10%? Thanks, jg

[InvestingMom]

Rick,
Thanks for your post.
I agree with most of it and so I am glad that you posted it.
That being said, I cannot entirely agree with your third point. I would modify it to say something like, continue to use your plan for generating cash whether it be from living off of dividends, interest, etc or from selling funds/stock. In my opinion one should not be living off of dividends and interest (See Derek Tinnin's post which he explains much better than I ever could) but I would not necessarily advise a retiree to change this right now or because of the crisis... and so I would say stick to whatever you are doing right now (which presumably is a plan they understand)...and stay the course.

[Speedy]

Rick:

Thanks for the post. Sensible and timely.

Regards,
Bill

[Derek Tinnin]

Derick,

The flaw in the 'classic financial planning model' of retirement spending is that spending is linear over a person's retirement. That is misconception. There is a distinct spending curve that trends upwards slightly when a person is in their 60s, and then trends downward over time.

Government statistics clearly show that an 85 year old will spend less in inflation adjusted dollars than they did when they were 75, and considerably less than when they were 65.

Rick Ferri

Good point. I still feel though that the unintended consequences of relying "too" heaviliy on the income component can be significant. I think we get to the same point anyway by gradually reducing equities over time.

[Taylor Larimore]

Hi Rick:

This article by John Montgomery reflects your experienced wisdom with more facts and figures:

http://www.bridgewayfund.com/assets/pdf/Surviving%20a%20Bear%20Market%202008.10.17.pdf

Thank you and best wishes.
Taylor

[Derek Tinnin]

Hi Rick:

This article by John Montgomery reflects your experienced wisdom with more facts and figures:

http://www.bridgewayfund.com/assets/pdf/Surviving%20a%20Bear%20Market%202008.10.17.pdf

Thank you and best wishes.
Taylor

Except for the small (and somewhat reluctant) reference to commodities...

[Rick Ferri]

Thanks for catching typos.... ...I fixed them.

[Heath]

Rick, with all due respect, I must disagree with what you are saying. I understand that your advice is straight from the Diehard playbook, but this time it is different. If one were to consult with the 10 most respected authorities on the economy (you pick) all would say that this crisis is at least the second worst since ’29. All would say that the economy will not recover for a long time. Most would say that at best the market will not increase but more likely the market will decline until recovery.

So my question is what is the hurry? Of course the market might rebound tomorrow, but the broad consensus is that it will not. Why not instead go with the probabilities and wait-and-see?

[nisiprius]

Fan mail. This is a great post. I hope it achieves a wide circulation. I liked the part you posted earlier, "when should you change your asset allocation," and I like the first part, "What should you do in this current market environment?" I fall into category three.

live off your cash flows from dividends, interests, Social Security, pensions, annuities, and other. Leave your principal alone.

Darn it, I was afraid someone would say that. What fun is that? That's what my wife is saying. I wanted you to give me permission to spend 4% this year and COLAed from then on. Maybe 5%. Killjoy. I know you're right, but I don't have to like it.

Seriously, I really appreciate the fact that you've tackled the question head on, with specific answers that get you somewhere into the range of what's sensible.

[Rick Ferri]

Rick, with all due respect, I must disagree with what you are saying. I understand that your advice is straight from the Diehard playbook, but this time it is different

"This time its different." Those famous 4 words that get so many people in so much trouble. Bubbles go both ways, and this time people have a once in a lifetime opportunity to buy great companies at riduclously low prices. So I agree with you. This time IS different.

Didn't know there was a Diehard's playbook. I have been doing this for 20 years and have developed my own beliefs. My belief is that a person would do much better sticking to one consistent strategy rather than trying to weave in and out of the markets based on their own fear and greed.

So my question is what is the hurry? Of course the market might rebound tomorrow, but the broad consensus is that it will not. Why not instead go with the probabilities and wait-and-see?

There is no hurry. I am rebalancing to take advantage of normal market pricing that will occur maybe next year, maybe the year after, maybe not for 5 or 6 years. No rush. This bear market allows Mid-Life Accumulators like me to set ourselves up nicely in retirement 10 or 15 years down the road.

BTW, what "probabilities" are you referring too. Who's "probabilities"? The mass media? They are only telling us what they think we want to hear. The media is a reflection of society's fears and greeds as a whole.

[NYCPete]

...but this time it is different.

Different from what? Heath, with all due respect, I just laugh out loud when I read that phrase. It's always different, isn't it? The truth is, no one knows, and we can only control what we can control.

Yet again, some investment wisdom can be found in words from long ago...

To the extent that a fool knows his foolishness,
He may be deemed wise
A fool who considers himself wise
Is indeed a fool.

Best,
Peter

[renditt]

Rick
Great post, as always. Exactly what we need.

In my 30s myself, but my nest egg is fairly substantial, so I have been busy rebalancing to my target AA - but not going all equity yet. If the market drops another 20%, I will. Just too tempting too pass.

I get the impression that many people don't realize that the market is now much less risky that it was one year ago. If you buy stocks at these levels, you are practically guaranteed a nice return over 10-20 years.

[Heath]

Rick

There is no hurry. I am rebalancing to take advantage of normal market pricing that will occur maybe next year, maybe the year after, maybe not for 5 or 6 years. No rush. This bear market allows Mid-Life Accumulators like me to set ourselves up nicely in retirement 10 or 15 years down the road.

Maybe we don’t disagree that much. How would you deal with this? Joe has just sold his business at age 55 and received enough cash to retire provided he can earn about 4-5% real. Should he invest some in equities today? How much? My advice would be for Joe to invest in TIPS and/or ST Treasuries and wait-and-see before investing in equities (which he should eventually plan to do). Would you suggest that he invest in the entire equity piece today?

[lucky7]

Stocks are yielding over 3%, which is higher than intermediate-term Treasury bonds and not much lower than investment grade bonds. So there is not much income reduction from rebalancing.

Rick Ferri

Rick, thanks for posting, need a little reassurance every now and then. How confident are you that earnings yield of equities, or dividend yield won't collapse?


Bob

[Derek Tinnin]

...but this time it is different.

Different from what? Heath, with all due respect, I just laugh out loud when I read that phrase. It's always different, isn't it? The truth is, no one knows, and we can only control what we can control.

Yet again, some investment wisdom can be found in words from long ago...

To the extent that a fool knows his foolishness,
He may be deemed wise
A fool who considers himself wise
Is indeed a fool.

Best,
Peter

Here's a couple more:

"It's better to know what you know than to know what you don't know." - Unknown

"Those who have knowledge, don't predict. Those who predict, don't have knowledge. " - Lao Tzu, 6th Century BC Chinese Poet

[BlueEars]

So my question is what is the hurry? Of course the market might rebound tomorrow, but the broad consensus is that it will not. Why not instead go with the probabilities and wait-and-see?

There is no hurry. I am rebalancing to take advantage of normal market pricing that will occur maybe next year, maybe the year after, maybe not for 5 or 6 years. No rush. This bear market allows Mid-Life Accumulators like me to set ourselves up nicely in retirement 10 or 15 years down the road.

Rick, thanks for starting this post. Definitely some words of wisdom from you and other posters (Taylor, Derek, et. al.).

As a retiree who now finds that his withdrawal rate has reached a somewhat uncomfortable level I think there is no reason to hurry with the rebalancing. If withdrawing from the FI portion one will naturally rebalance towards equities at pace for a year = withdrawal_rate/2. Also let's put some general numbers on this possible loss of rebalance bonus: say my AA is 45/55 and I had targetted 55/45, then if the market goes up 20% over the next year I will loose the opportunity to gain another 2% overall on my portfolio. That kind of rebalance bonus is nice but something that will not harm me long term unless I choose to stay at a consistently low equity allocation. The "natural rebalance" will get me back to my AA in maybe 4 years if I spend at a 5% rate (assuming that equities remain stagnant which I doubt).

[Rick Ferri]

Stocks are yielding over 3%, which is higher than intermediate-term Treasury bonds and not much lower than investment grade bonds. So there is not much income reduction from rebalancing.

Rick Ferri

Rick, thanks for posting, need a little reassurance every now and then. How confident are you that earnings yield of equities, or dividend yield won't collapse?

Bob

In a couple of market downturns over the past 50 years dividend payments declined. For example,

1991-1992: S&P 500 dividends declined from $12.79 to $12.64 (1.2%)
1999-2001: S&P 500 dividends declined from $16.71 to $15.74 (5.7%)

Interestingly, dividends increased in 1973-74, and in 1987.

So far in 2008 through today, S&P reports currently 208 dividend increases, 5 new companies paying dividends, 27 companies cutting, and 14 suspending.

See HEREfor changes in S&P 500 dividend data.

HERE for historic data.

Rick Ferri

[Leif Eriksen]

Rick,

What do you think should be done with capital gains? Some funds will probably be making large capital gains distributions this year. Do you consider capital gains part of principal that should be reinvested, or since the # of shares remains the same, capital gains may be spent like dividends?

[Heath]

Rick

BTW, what "probabilities" are you referring too. Who's "probabilities"? The mass media? They are only telling us what they think we want to hear. The media is a reflection of society's fears and greeds as a whole.

I suppose the media is responsible for articles such as this from today, http://news.yahoo.com/s/nm/20081024/bs_ ... nancial6_4 The probabilities that I’m referring to are those I described before,

If one were to consult with the 10 most respected authorities on the economy (you pick) all would say that this crisis is at least the second worst since ’29. All would say that the economy will not recover for a long time. Most would say that at best the market will not increase but more likely the market will decline until recovery.

Can you name one chief economist for any country or any bank, etc. that does not agree with what I said. You agree that the magnitude does make it different this time. So I repeat my question, why the rush? Why not sit tight for awhile with any new equity investments, including rebalancing?

[Rick Ferri]

Rick,

What do you think should be done with capital gains? Some funds will probably be making large capital gains distributions this year. Do you consider capital gains part of principal that should be reinvested, or since the # of shares remains the same, capital gains may be spent like dividends?

Could be! I remember some posts on the old M* site from 2000 to 2002 when investors reported that their funds distributed large capital gains even though the fund lost money.

I have not really though about that because I do not expect any capital gains distributed from the ETFs and index funds held our portfolios. That said, everyone should be doing some tax-loss harvesting. You can always use those losses to offset gains in the future, and up to $3,000 per year of ordinary income. This is a great TLH year!

Can you name one chief economist for any country or any bank, etc. that does not agree with what I said. You agree that the magnitude does make it different this time. So I repeat my question, why the rush? Why not sit tight for awhile with any new equity investments, including rebalancing?

Warren Buffett is not an economist, but he is buying. He may not be buying at the bottom, but no one knows where or when that will be (could have been last week! Stocks have not tested the Oct. 10 lows yet.)

Rick Ferri

[Leif Eriksen]

Rick,

What do you think should be done with capital gains? Some funds will probably be making large capital gains distributions this year. Do you consider capital gains part of principal that should be reinvested, or since the # of shares remains the same, capital gains may be spent like dividends?

Could be! I remember some posts on the old M* site from 2000 to 2002 when investors reported that their funds distributed large capital gains even though the fund lost money.

I have not really though about that because I do not expect any capital gains distributed from the ETFs and index funds held our portfolios. That said, everyone should be doing some tax-loss harvesting. You can always use those losses to offset gains in the future, and up to $3,000 per year of ordinary income. This is a great TLH year!

...
Rick Ferri

Well, back on 8/15/2008 (seems like a decade now), DFA was estimating about a 15% CG distribution on their EM fund. Can you imagine, with a large decrease in NAV and all the selling go on, what that CG distribution will be now? That is why I sold my EM from my taxable account when it reached my purchase price.

But, back to my question, if I may, I presume you think of a CG distribution as return of capital that probably should be reinvested (although I presume not automatically since other funds may need it more to bring them closer to their AA).

[sambuca08]

* 1) Early Savers (20s and 30s) - buy equities index funds like crazy with what you can and do not look at your account balance for 10 years.

I respectfully disagree. I'm in this group (35), and I'm keeping 10% cash on the sidelines (long story, was higher, then I bought into the close today after seeing the apocalyptic headlines this morning and seeing a reasonable close). Anyway, 'buying equities like crazy' has lost 10% a week twice this month (and 5% another week)! There has to be a 'happy medium' where I keep some cash on the side just in case this crash picks up speed. Not looking at my portfolio for 10 years would be impossible, I use the internet every day. Is there any way to reconcile with the addage, 'if you thought it was a buy when it was x, it's surely a bargain at x-10%'? Anyway, I know my USD will have relatively consistent value this time next year, but I don't know if the S&P will be up or down significantly, but judging from Oct. the range could be painfully wide on the downside. So as a hedge, I'd rather have extra dollars to invest then, and shrug if I've 'missed my golden opportunity'. From the tech meltdown, I remember the losses much more than the missed opportunities. I think if I were a financial planner, I'd be recommending a position in cash if, for no other reason, to add ballast to a volatile equity holding. People aren't criticising having cash right now, and if there is a huge rally then noone will remember that it wasn't deployed, they'll just be relieved that it was in reserve and the rest of the portfolio is doing well. Sure, ballast became an anchor, but at that point people don't seem to notice.

[nisiprius]

I get the impression that many people don't realize that the market is now much less risky that it was one year ago. If you buy stocks at these levels, you are practically guaranteed a nice return over 10-20 years.

I disagree. Nobody knows. Nobody knows. That's the simple fact that people have trouble coming to grips with.

Nobody ever knows of course, but what's "different this time" (i.e. the same as it was during previous panics, periods of economic catastrophe, and etc.) is that right now, really really nobody knows.

If buying now would "practically guarantee" a nice return over 10 years, then why won't someone sell me a ten year bond with a 10% coupon? It would be so easy. All they would need to do is take my $10,000, invest it in stocks, hold for ten years, reap the nice "practically guaranteed" return, hand me my $26,000, and pocket the difference.

As far as I know, such "equity-based bonds" do not exist, because the financial community knows darn well that when it comes to stocks, nothing is ever "practically guaranteed."

[jebmke]

1991-1992: S&P 500 dividends declined from $12.79 to $12.64 (1.2%)
1999-2001: S&P 500 dividends declined from $16.71 to $15.74 (5.7%)

There was a recent article on Bloomberg that predicted that dividends on the S&P 500 would decline 10%. Given that (a) many of the problems this time around are banks vs. tech companies (low dividend payers) and (b) the credit crisis is really restricting corporate access to money, I wouldn't be surprised if the decline is closer to 10% vs. the 5.7% we had in 1999-2001

[dbr]

Rick,

What do you think should be done with capital gains? Some funds will probably be making large capital gains distributions this year. Do you consider capital gains part of principal that should be reinvested, or since the # of shares remains the same, capital gains may be spent like dividends?

Leif, why do you think that dividends "may be spent." I think personally that it is more rational to view all removals of money from investment assets as of equal consequence to portfolio survival regardless of the mechanics by which such removals are distributed. That is why I offered the somewhat ironic comment that "failure to reinvest interest and dividends constitutes liquidation of capital (equivalently invasion of principal in the context of this discussion)."

I do agree that there is a property of self limiting behavior when one restricts one's removals of money from investments to that which is provided by interest and dividends. If you feel you are relying on that mechanism to control your rate of liquidation, then you should not spend capital distributions. If you control your rate of liquidation by simply computing your rate of withdrawal of assets, and withdrawing and spending capital distributions does not put you outside your comfort zone, then by all means spend the distributions.

[jebmke]

I do agree that there is a property of self limiting behavior when one restricts one's removals of money from investments to that which is provided by interest and dividends. If you feel you are relying on that mechanism to control your rate of liquidation, then you should not spend capital distributions. If you control your rate of liquidation by simply computing your rate of withdrawal of assets, and withdrawing and spending capital distributions does not put you outside your comfort zone, then by all means spend the distributions.

I agree. Mental accounting.

[nisiprius]

3) Near Retirees and retirees (60s and 70s) - live off your cash flows from dividends, interests, Social Security, pensions, annuities, and other. Leave your principal alone.

Mischievous question: has anyone told the operators of the Vanguard Managed Payout Funds about this?

(The Managed Payout funds are designed to dip into principal in times like these in order to keep the payouts smooth. The payouts are adjusted once a year each January. The values of these funds are now down about 30% from inception. I may be totally off base on the math, but think the payouts are based on the average fund value over the last year, so I think next January the payouts might drop enough to be quite disappointing to fund owners, yet not enough to stop erosion of the principal).

[Leif Eriksen]

Leif, why do you think that dividends "may be spent." I think personally that it is more rational to view all removals of money from investment assets as of equal consequence to portfolio survival regardless of the mechanics by which such removals are distributed. That is why I offered the somewhat ironic comment that "failure to reinvest interest and dividends constitutes liquidation of capital (equivalently invasion of principal in the context of this discussion)."

I understand your argument. Perhaps it is a bit artificial, but I think of it as follows. Principal is your initial investment. Dividends, in a broad sense, represent a conservative return on growth of that principal. I think is it sufficiently conservative of me, when I reach retirement, to think in terms of spending a portion of the growth of principal.

[RooseveltG]

Rick:

A great post and many thanks for a reassuring voice out there!

Can you comment on what happened to dividends during the great depression?

Thanks.

RooseveltG.

[dbr]

Leif, why do you think that dividends "may be spent." I think personally that it is more rational to view all removals of money from investment assets as of equal consequence to portfolio survival regardless of the mechanics by which such removals are distributed. That is why I offered the somewhat ironic comment that "failure to reinvest interest and dividends constitutes liquidation of capital (equivalently invasion of principal in the context of this discussion)."

I understand your argument. Perhaps it is a bit artificial, but I think of it as follows. Principal is your initial investment. Dividends, in a broad sense, represent a conservative return on growth of that principal. I think is it sufficiently conservative of me, when I reach retirement, to think in terms of spending a portion of the growth of principal.

Reasonable, of course. What could result in practice is an overly conservative spending plan or an overly risky spending plan. The total stock market is yielding only 2.77% now. VGSIX is yielding 4.97% and KMR is yielding 8.60%. VIPSX is currently yielding 5.92%. At Age 65 an immediate annuity can payout about 8% lifetime guaranteed. So, of these which is too risky and which is too conservative and which is the better plan for funding retirement?

[unclemick]

Rick, with all due respect, I must disagree with what you are saying. I understand that your advice is straight from the Diehard playbook, but this time it is different. If one were to consult with the 10 most respected authorities on the economy (you pick) all would say that this crisis is at least the second worst since ’29. All would say that the economy will not recover for a long time. Most would say that at best the market will not increase but more likely the market will decline until recovery.

So my question is what is the hurry? Of course the market might rebound tomorrow, but the broad consensus is that it will not. Why not instead go with the probabilities and wait-and-see?

1929 - Wellington, Walter L Morgan? How about this time it is kinda similar. Isn't this Walter the guy who hired Mr B? Perhaps some Diehards can flesh out the details.

Looks like we may be carrying on tradition with the added improvement of using index funds for even better efficiency.

Not that I'm prejudiced or anything.

heh heh heh - Target Retirement here - 15th yr of early retirement. 3% SEC yield - still good to go.

[renditt]

Nobody ever knows of course, but what's "different this time" (i.e. the same as it was during previous panics, periods of economic catastrophe, and etc.) is that right now, really really nobody knows.

Ok, you got me, I don't know the future

Let's just talk about probabilities.

In the past when the p/e ratio of the market was below 12 as it is now (for the p/e ratio of a year I use the average of the current year's earnings plus the prior 2 years and the following 2 years, so I estimated 08, 09 and 10 earnings), there is a 65% chance that the annualized 10 year return before dividends is over 8%, a 75% chance that it is 3.5% or better and only a 16% chance that the annualized return is less than 2%. Again, this is excluding dividends so you might want to add 3% to this.

There have been 2 10-year periods where the return exluding dividends was negative when the p/e ratio was below 12 (periods starting in Jan 1923 and 25). So agreed, it is possible that stock market returns will be low when investing now. Possible, but unlikely.