Introducing our Ultra Equity Portfolio

We are launching a new portfolio model for 2018, Ultra Equity, a 100% stock allocation. Previously, our most aggressive allocation was 85% stocks and 15% bonds. This type of approach clearly is not for everyone, but if you want the highest possible long-term return and can ignore short-term volatility, Ultra Equity might make sense for you.

Bond yields remain very low today, and bond investors face rising risks, including interest rate risk, that rising interest rates depress bond prices, and purchasing power risk, that inflation eats up all your yield. While defaults have been quite low in recent years, as interest rates rise, it will be increasingly difficult for distressed companies, municipalities, and countries to meet their obligations. The level of debt globally has swelled enormously with the cheap access to capital since 2009, and yet the bond market is acting if all this debt hasn’t changed risks at all.

While the Federal Reserve raised the Fed Funds rate again this week, income investors have been disappointed that there are not more attractive opportunities in bonds today. Unfortunately, the rising rates have not benefited all types of fixed income vehicles equally. On the short end, yes, yields are up. We can now access short-term investment grade bonds with yields of around 1.5% to 2%.

However, the yields on longer bonds have barely moved. The 10-Year Treasury is at 2.35% and the 30-Year remains shockingly low at 2.71%. As a result, we have a “flattening” of the yield curve where short-term rates have increased, but long-term rates are virtually unchanged.

I expect this trend to continue in 2018: rising short-term rates and a flattening yield curve, which means there will continue to be a dearth of opportunities for yield-seeking investors. As a point of reference, the historical rate of return for intermediate bonds was 7.25%, but today, you can’t find anything at even half of that rate. We are always thinking about how we can position portfolio allocations to aim for the best possible return with the least amount of risk and the maximum amount of diversification. But at this point, bonds offer little potential for high returns. Instead, we have to think of bonds as risk mitigators, that the primary purpose of our bonds is to offset the risk we have with our equity holdings.

I’ve been reluctant to roll out a 100% equity allocation with the stock market at an all-time high in the US, because it risks falling into the behavioral trap of becoming too enamored with stocks during a bull market, and ignoring stocks’ volatility and potential for losses. For investors with a horizon of more than 10 or 20 years, there is little possibility that a bond allocation will increase your rate of return. If you are comfortable with ignoring volatility, I think some younger investors may want to invest 100% in equities.

Consider this: the expected return on intermediate bonds is only 3.5% over the next 10 or so years. If you have a 60/40 portfolio and earn 3.5% on your bonds, you will need to make at least 11% on your stocks to reach an overall return of 8%. Many investors are coming to the conclusion that to achieve their goals, the optimal allocation to bonds may be zero.

If you are making regular contributions to an equity allocation, you also have the opportunity to dollar cost average, and buy more shares at a lower price, if the market does drop at some point. And while dollar cost averaging does not guarantee you will not experience losses, it is nevertheless an effective way to accumulate equity assets and possibly benefit from any volatility that does occur.

Our Ultra Equity portfolio will differ from our other portfolio models in that we are not looking to reduce risk or to achieve the best “risk-adjusted” returns. Instead, we will invest tactically in areas where we believe there is the greatest potential for strong long-term rates of return. We will always be diversified, investing in ETFs and mutual funds with hundreds or thousands of different securities, but will have no requirement to hold any specific category of investments.

We cannot know how a portfolio like this will fare over the near term, and there will undoubtedly be times when the stock market is down, sometimes even down significantly. If your attitude is that those drops represent opportunity, rather than adversity, then you should ask us more about Ultra Equity to see if it might be right for you.

The Safest Way to Beat Inflation


With interest rates so low today, investors wonder where they can keep their money safe both in terms of their principal and purchasing power. We recently discussed Fixed Annuities as one substitute for CDs or bonds, with the conclusion that Annuities are best for investors over 59 1/2 who don’t need liquidity for at least five years. For others, one often overlooked option is Inflation-linked Savings bonds, officially known as Series I Bonds.

What To Do With Your CD Money


If you’ve had CDs mature over the past several years, you’ve faced the unfortunate reality of having to choose between reinvesting into a new CD that pays a miniscule rate, or moving your money into riskier assets and giving up your guaranteed rate of return and safety. Although you can earn a higher coupon with corporate bonds than CDs, those investments are volatile and definitely not guaranteed. I understand the desire for many investors to keep a portion of their money invested very conservatively in ultra-safe choices. So, I checked this week for current CD rates on a 5-year Jumbo CD and here is what is offered by the largest banks in our area:

Bank of America 0.15%
JPMorgan Chase 0.25%
Wells Fargo 0.35%
Citibank 0.50%
BBVA Compass 0.50%

While there are higher rates available from some local and internet banks, it is surprising how many investors automatically renew and do not search for a better return. Others have parked their CD money in short-term products or cash, hoping that the Fed’s intention of raising rates in 2016 will soon bring the return of higher CD rates.

Unfortunately, it’s not a given that the economic conditions will be strong enough for the Fed to continue to raise rates in 2016 as planned. This week, the 10-year Treasury yield dropped below 2%, which is not strong endorsement of the likelihood of CD rates having a major rebound in 2016.

This is the new normal of low interest rates and slow growth. While rates could be nominally higher in 12 months, it seems very unlikely that we will see 4% or 5% yields on CDs anytime in the immediate future. Waiting out in cash is a sure-fire way to not keep up with inflation and lose purchasing power.

What do I suggest? You can keep your money safe – and earn a guaranteed rate of return – with a Fixed Annuity. I only recommend Fixed Annuities with a multi-year guaranteed rate. Like a CD, these have a fixed interest rate and set term. At the end of the term, you can take your investment and walk away.

Today, we can purchase a 5-year annuity with a rate of 2.9% to 3.1%, depending on your needs. I know that’s not a huge return, but it’s better than CDs, savings accounts, Treasury bonds, or any other guaranteed investment that I have found. Since an annuity is illiquid, I suggest investors set up a five year ladder, where each year 20% (one-fifth) of their money matures. When each annuity matures, you can keep out whatever money you need, and then reinvest the remainder into a new 5-year annuity.

The beauty of a laddered approach is that it gives you access to some of your money each year and it will allow your portfolio to reset to new interest rates gradually as annuities mature and are reinvested at hopefully higher rates. In the mean time, we can earn a better return to keep up with inflation and keep your principal guaranteed.

Issued by insurance companies, Annuities have a number of differences from CDs. Here are the main points to know:

  • Annuities typically have steep penalties if you withdraw your money early. It’s important to always have other sources of cash reserves for emergencies. Consider an annuity as illiquid, and only invest long-term holdings.
  • If you take money out of an annuity before age 59 1/2, there is a 10% premature distribution penalty, just like a retirement account. A 5-year annuity may be best for someone 55 or older.
  • Money in annuity grows tax-deferred until withdrawn. If you rollover one annuity to another, the money remains tax-deferred. Most annuities will allow you to withdraw earnings without penalty and take Required Minimum Distributions (RMDs) from IRAs. Always confirm these features on an annuity before purchase.
  • While CDs are insured by the FDIC, annuities are guaranteed at the state level. In Texas, every annuity company pays into the Texas Guaranty Association, which protects investors up to $250,000. If you have more than this amount to invest, I would spread it to multiple issuers, to stay under the limit with each company.

If you have CDs maturing and would like to learn more about Fixed Annuities, please contact me for more information.

Are Your Retirement Expectations Realistic?

Wood Pile

While many individuals have very realistic ideas about retirement, I find that some people may be significantly overestimating their preparedness for funding their financial needs.  Here are three specific mistakes which can hurt your chance of success in retirement, and a realistic solution for each issue.

Mistake #1: Thinking you can live on a small fraction of your pre-retirement income.
Occasionally, I’ll meet someone who is currently making $100,000, but who thinks that they will need to spend only $40,000 a year in retirement to maintain their current lifestyle.  On a closer look, they’re saving about $15,000 today so they are really living on about $85,000 a year.  This is a key problem with creating a retirement budget: when we add up projected expenditures, it is very easy to underestimate how much we need because we often forget about unplanned bills like home and auto repairs, or medical expenses.  And don’t forget about taxes!  Taxes do not go away in retirement, either.

Realistic Solution: Even though some expenses will be lower in retirement, most retirees find that they need 75-90% of their pre-retirement income to maintain the same lifestyle.

Mistake #2: Taking too high of a withdrawal rate.
20 years ago, William Bengen published a paper that concluded that 4%, adjusted for inflation, was a safe withdrawal rate for a retiree.  While this topic has been one of the most discussed and researched areas in retirement planning, most financial planners today remain in agreement that 4%, or very close to 4%, is the safe withdrawal rate.  However, many individuals who have a million dollar portfolio think that they might be able to take out $60,000, $70,000, or more a year, especially when the market is performing well.

There are two important reasons why it’s prudent to use a more conservative 4% rate.  The first is market volatility.  The market is unpredictable, so we have to create a withdrawal strategy which will not excessively deplete the portfolio in the event that we have large drop, or worse, a several year bear market at the beginning of a 30-year retirement.  The second reason is inflation.  We need to have growth in the portfolio to allow for the increased cost of living, including the likelihood of increased medical costs.  At just 3% inflation, $40,000 in expenses will double to $80,000 in 24 years.  And with today’s increased longevity, many couples who retire in their early 60’s will need to plan for 30 years or more of inflation in retirement.

Realistic Solution: At a 4% withdrawal rate, your retirement finish line requires having a portfolio of 25 times the amount you will need to withdraw in the first year.

Mistake #3: Assuming that you will keep working.
Some people plan to keep working into their 70’s or don’t want to retire at all.  They love their work and can’t imagine that there would ever be a day when they are not going to be working.  They plan to “die with their boots on”, which in their eyes, makes retirement planning irrelevant.

Unfortunately, there are a number of problems with this line of thinking.  The Employee Benefits Research Institute 2014 Retirement Confidence Survey found a significant gap between when people planned to retire and when they actually did retire.  Only 9% of workers surveyed plan to retire before age 60, but 35% actually retired before this age.  18% planned to retire between 60 and 64, versus 32% who actually retired in that age range.  The study cites three primary reasons why so many people retire earlier than planned: health or disability, layoff or company closure, and having to care for a spouse or other family member.  The study also notes that one in 10 workers plan to never retire.  Even if you’re willing to keep working, the statistics are clear: most people end up retiring earlier than planned.

For a healthy 65-year old couple, there is a good chance that at least one of you will live into your 90’s.  If you still think you don’t need a retirement plan because you will keep working, do it for your spouse, who might have 25-plus years in retirement if something were to happen to you.  Don’t make your plan’s success dependent on your being able to keep working in your 70’s and 80’s.

Realistic Solution: Make it a goal to be financially independent by your early 60’s; then you can work because you want to and not because you have to.

A comprehensive financial plan addresses these concerns and establishes a realistic framework for funding your retirement.  And whether you’re 30 or 60, it is never too early, or too late, to make sure you are on track for financial independence.