August 12, 2008 Letters to the Editor

Updated: October 5, 2008.

Just checking

I received this letter from Jim.

Just recently retired from mainly Electronics Tech type work -so low pay compared to Eng'r type ...... came across some of your posts on Morningstar forums.

Wondering if you are still around and active .... haven't even checked out your website yet but your Mstar ideas/posts appeal to me …

Main question - are you here?

Thanks

HERE IS MY RESPONSE

Thank you. Yes, I am still up and running. I add several articles to this site each week. Check the Notes and the Letters to read the latest.

I have always been impressed with the technicians that I have worked with. They have always been top notch.

I post most often at the Morningstar Income & Dividend Investing discussion board.

Another website that you may appreciate is Rob Bennett’s Passion Saving dot com. He has recently made four “RobCasts,” lasting 30 minutes each. They provide excellent introductory material. In addition, check out his “A Rich Life” blog. I am sure that you will like it.

Rob Bennett's Web Site
Rob Bennett's Blog

I will add that Jim is a radio amateur in good standing. 73 (best regards).

Flaws with Numbers

I received this letter from William.

I used to write accounting and financial management software for banks. With asset accounting everything used average monthly balances and rates.

When doing long date range analytics and estimating various scenarios, it would seem existing stock data base information with monthly open/close price data the analysis would be flawed.

Anyway nice site.

HERE IS MY RESPONSE

You bring up an interesting point. Thank you.

My data source is Professor Robert Shiller’s online database. These are the same numbers that are used with all S&P500 Safe Withdrawal Rate calculations. I do not know the details behind his numbers.

Professor Shiller’s Web Site

I do know that there can be flaws in the analysis of Small Capitalization stocks. David Dreman went into great detail in “Contrarian Investment Strategies: The Next Generation.” But he discussed the least liquid of all stocks. Bid and ask spreads were wide and order fulfillment was a problem. Even a small order could move the price.

My guess is that the S&P500 is so liquid and that its bid and ask prices are so close as not to be an issue. By restricting myself to a single source, I assure consistency.

Stocks are different from loans and other bank instruments. Stock returns are not guaranteed by any contractual mechanism. Prices are extremely volatile. The outer confidence limits of S&P500 prices are plus and minus 40% to 50% per year (nominal). Dividends are not guaranteed either.

Stock returns and safe withdrawal rate calculations do not have the same precision as accounting.

Reconciling the Year 30 SWR with DVY and PFF

I received this letter from Michael.

Hi John - been following your site for over a year - lots of good thought provoking info so thanks!

2 general questions:

1) My profile - late 30s, thinking about an early retirement with admittedly more modest lifestyle within the next 5 years...does my profile suggest a different approach to retirement then your data /SWR analysis suggests? e.g., what does a 45-50 year retirement (hopefully!) suggest I do differently than say a 15 or 30 year? Anywhere you suggest I look/read?

2) Your SWR (and Scenario Surfer) seems to propose 2 assets: stocks and TIPS - compelling evidence to buy when valuations are low, etc...yet I see some equally compelling analysis on DVY and PFF (coupled with TIPS)...how do I reconcile these two? e.g., is there a Surfer/SWR that contemplates stocks, TIPS, DVY and PFF? Presumably a model that allows for more assets would suggest a higher SWR?

Thanks a lot and thanks again for the information...

HERE IS MY RESPONSE

Thank you for the kind words. Thank you for an excellent letter.

You have picked a great time to retire.

Within a decade or so, stock dividend yields will be very high. There have been times when you could get 8% to 10% dividends from quality companies. Expect to see them again. Your safe withdrawal rate will be 8% (plus inflation), not 4%. Your income stream will last indefinitely, not merely 30 years. Your greatest known risk will be a temporary drop in buying power up to 25% due to inflation.

I would eliminate a traditional annuity (Single Premium Immediate Annuity SPIA) because of your young age. It would produce too low of an income stream. Low cost SPIAs often make sense for traditional retirees. Consider buying one in your old age as your faculties decline.

I have identified a variety of good strategies. Refer to “Five Great Choices” from the Guidelines section.

Five Great Choices

We can eliminate a TIPS-only approach because of the very long time frame. A TIPS ladder at a (real) interest rate of 2% only allows you to withdraw 3% (plus inflation) for 55 years or 3.66% for 40 years. You can do much better living on dividends alone.

I would eliminate a straight income approach as well. It requires considerable effort. But it can also be rewarding.

This leaves the Dividend Blend, the Delayed Purchase and Valuation Informed Indexing. I suggest a natural combination of all three.

The DVY and PFF combination is a dividend blend. Both are ETFs (Exchange Traded Funds). They are very similar to traditional index funds. They are new. But I believe that they will work out well.

If you go into a dividend blend immediately and stock prices continue to decline, as is likely, your account balance will fall.

Keep both considerations in mind. As a retiree, you will need a continuing income stream that keeps up with inflation. As an investor, you still want to protect your portfolio balance. You might need immediate cash, for example, to cover a major expense.

Take advantage of what you have learned from using the Scenario Surfer (and Valuation Informed Indexing). Protect your capital for the time being. Ease into a dividend blend as prices drop. You will be able to buy a larger income stream for your money. But, unlike traditional Valuation Informed Indexing, do not sell shares for income. Replace shares from time to time to upgrade your portfolio, but not routinely.

Because of your long time horizon, you may see exceedingly high stock prices again. If valuations get far out of line again, feel free to cut back your stock holdings to protect your account balance. Otherwise, you should be satisfied as long as your income stream grows steadily.

Always keep in mind that you need to buy an income stream that will last indefinitely and grow fast enough to keep up with inflation. Dividend strategies, including the dividend blend, allow you to do that although dividend increases can be erratic.

A delayed purchase or a Valuation Informed Indexing approach protects the dollar balance of your portfolio. Delaying a purchase allows you to pick up more dividend dollars than buying immediately.

Do not be concerned about my portfolio inconsistencies. I present what I can from the data that are available. There are extensive S&P500 data. Other data are limited. That is why the Scenario Surfer and the SWR calculators have limited choices. They provide great insights. They provide reliable information. Alternatives are likely to do better, but they carry uncertainty.

As for dividend strategies, the hardest part is estimating how well dividend portfolios will hold up. That is why I have had to seek a variety of sources to characterize income streams. I depended upon Morningstar’s Josh Peters for the numbers in “Taken at Face Value.” I use the S&P500 dividends as a lower dividend growth baseline. I refer to DVY and PFF as well. Although there is great uncertainty, there are great opportunities.

You will do very well to visit Rob Bennett’s PassionSaving.com web site and his “A Rich Life” blog. He has put together an outstanding 56 minute audio: RobCast #12: Market Timing -- What Works and What Doesn't.

Rob Bennett’s RobCast page 2

Rob Bennett’s goals are very much like your own. He retired early to pursue a free lance writing career. He has a lot of fabulous ideas. They work.

I recommend that you keep most of your money safe for now. Even Certificates of Deposit and Money Market Funds make a lot of sense. You might allocate 1% or 2% of your holdings for a DVY/PFF dividend blend for learning purposes.

Letters to the Editor in 2008

Letters to the Editor in 2007

Letters to the Editor in 2006

Letters to the Editor in 2005