There are no "generic" stocks in the tax-deferred accounts. However, US corporate bonds (as in LSBDX) as well as many leveraged closed-end funds (GGN, GIM, ETY) and the oil & gas trusts trade a bit more like stocks than bonds. Thus I approached this weekend by putting on a partial hedge with the double short SPX ETF, SDS. I don't do options Greek, so I guessed that a 15% SPX exposure would work somewhat. It's sort of a test over the weekend. These accounts are paying nearly 8% at current prices, so asset value doesn't matter much in the short term as the payouts are fixed except for the oil & gas trusts which vary with monthly oil and gas prices.
The other part of the fixed income is the TIPs fund, VAIPX, with PIMCO's PCRIX as a "kicker" at 25% of the value of VAIPX. PCRIX is also TIPS-based but with an unleveraged always long CRB commodity index exposure. Longer term readers will remember that I had a sizeable amount of PCRIX in 2003-2005 and then again in 2006-2008 when it was a big winner. I cut down the weighting in HSTRX to add VAIPX and PCRIX. HSTRX does much the same thing as VAIPX and PCRIX together but the latter two give it a bit more punch and pay more of a dividend. HSTRX is more in the shorter end of the TIPS maturity spectrum, whereas VAIPX holds every single extant TIPS issue.
Looking at the chart of many of these holdings, I still count myself extremely lucky to have avoided taking the big hits I would have had by not cashing out and running into VSGDX last Summer, Fall, and Winter. Except for the oil & gas trusts, which I sold part of at the highs and added back on extreme weakness, I was almost totally in VSGDX and later partly in VFIJX. I was a little late getting back into LSBDX and some of the closed-ends as it took a while to lose my fear, or feel it reduced. That's another reason for the SDS partial hedge this weekend: most were not bought at the lows.
I don't really think SPX has "finally" topped for the year since the 2CS sentiment indicator is still nearly 130. A big bear market rally should take it under 100. But just in case I'm wrong...or in case we are going into a correction of the move up from March 8 but will then rally further thereafter into July, I'll see how this hedge works for a few days.
In the taxable accounts we still have the "Hillary/Obama Portfolio" with 62% in short term municipals (VWSUX) and the rest in gold bullion, CEF, GDX, RGLD, SLW, and the long/short Trader Vic Sperandeo monthly-rebalanced commodity, financials, and currency futures fund, RYMFX. It is the red line on the chart above from its date of inception.
Arnott is opposed to indexing of all asset classes on a capital weighting basis because of the fact that when bubbles occur the biggest of the bubble assets within an index take over the index. For just one well-known example, the "internut" bubble stocks in 1999-2000 became a huge part of the NASDAQ. People holding the indexes got creamed. This can also happen in bond or commodity indexes. But this is just a minor part of Arnott's work. He has also done major work on stock and bond long term returns....I mean REALLY long term as in since 1801 in the US!
As readers know I switched from equity to fixed income and alternative assets from 2006 to present, and I am still there. Partly my thinking was to reduce actual and potential volatility as a retired investor. Partly also it was to increase actual income payouts from my assets, since payouts are more assured than possible capital gains on stocks. I did this in the somewhat generic sense of switching from stocks to bonds and commodity exposure as a inflation hedge. Largely I owe my outlook to years as a commodity futures speculator. In futures you learn to respect the price history of every asset and know what each can do. Equity-centric people are normally deficient in this regard. They may think of bonds or commodities as ways of reducing correlation or volatility but have no idea what their real characteristics and sector varieties are. An example is Marc Faber, whom I admire, but who is almost totally equity-centric except for a gold bias no doubt acquired at his mother's breast in Switzerland. Faber has recently announced the beginning of a 25 year bond bear market. And this is very probably true for intermediate to long term US nominal Treasurys. But there almost as many bond and bond-lke sectors as there are stars in the galaxy, so being anti-bond is not really helpful in the big picture.
Rob Arnott shows that over very long periods of US history, including current times, bonds have outperformed stocks. And even on their own, based on price alone, stocks can go for many decades without making a gain in real inflation-adjusted terms.
Seriously read Arnott's five part essay on these issues first and then his slideshow, both available here at this excellent site http://tinyurl.com/pknt69 . My personal view is that various bond and bond-like investments plus inflation hedges are the way to go in these perilous times.
http://screencast.com/t/Tg4uwGizyXd PAUIX is Arnott's vehicle at PIMCO for putting some of these ideas into practice. It has a rather high overhead as a fund of funds, and I think I can do as well or better on my own, but PAUIX, which can be long or short stocks and in a number of bond and inflation investments, is a long term package for some investors looking for simplicity amidst complexity.
In an on-going search for funds with high yields, I find a fruitful crop of them at Eaton Vance's closed-end (CEF) group. For the time being I am ignoring their municipal bond CEF group and looking at the "alternative" investment funds.
In general the funds achieve high yields in one of two ways. The first uses leverage, wherein they borrow or issue preferred shares at a lower rate than they can earn. This works well for fixed income vehicles from straight bonds to bank loans and for high dividend-paying stocks.
The second way to get higher yields is to buy stocks and write call options against them, the "buy/write" approach. Savvy investors have done this for generations and now it is possible to do it with a single fund and at fairly low cost.
I own ETG which is in the first group. It holds a quality global stock dividend-paying portfolio and leverages it about 30% for higher yield. Also many of these CEF stocks tend to trade below net asset value (NAV) which further leverages the returns. I started buying this fund in October and November in small pieces at a time on big down days. Given the leverage and the fear, many of these stocks got crushed and were paying over 20% annualized. ETO is up 50% since late November (total return basis). I plan to take part of this holding off the table if and when a correction seems likely, but I will want to re-buy it later. At current prices, ETO is paying a monthly dividend equivalent to ~12.5% annualized.
In the buy/write stock group I am thinking of buying ETY which holds an unleveraged quality global portfolio. It sells calls on the SP500 and Nasdaq and sometimes Nikkei and FTSE up to about 80% of the long stock holdings. So they can get capital gains if the stocks they hold go up more than the indexes they've sold plus they are exposed net long 20%.
ETO and ETG did very well during the bull market to 2007. ETY didn't start up until the end of November 2006 so it had no meaningful bull market exposure. Since November 2008 all three have done quite well.
These funds are for the tax-deferred IRAs, and I plan to manage them in much the same way as I have managed the oil & gas trusts. If they go up, say, 25% above my purchase price I will sell enough to bring them back down to the total purchase level. If they fall 25% I will buy some more up to the original level. It's very easy to do this with limit buys and sells and just "let it happen". I started this approach after reading Steve Selengut's book "The Brainwashing of the American Investor" last summer.
About 70% of the IRAs is in Vanguard, Hussman, and Loomis Sayles bond funds and the rest in the oil and gas trusts and some of these Eaton Vance CEFs. I'm generating over 8% yields from day one with a good bit of inflation protection.
I still may either totally cash out the IRAs and pay the taxes at 2009 rates or partially cash them out as I have written before. I'll await events between now and November or December to decide. But in the meantime I'm being paid more than 8% to wait.
Here's part of what I wrote about my IRAs two months ago: "...for someone in my position, the IRA is a looming tax obligation since every dollar coming out of an IRA account is taxable at ordinary income tax rates. So this modest proposal is a personal "diary entry" on my private blog which is totally non-commercial. This is only what I am thinking, and I am not recommending this to anyone else.......... The reasons for emptying [cashing in] a regular IRA in 2009 and/or in 2010 are 1. you're retired or may soon be; 2. taxes will be going up so you will pay more tax on IRA withdrawals later if you wait; 3. you will avoid tax bracket upwards creep due to the always increasing IRS-mandated Required Mandatory Distributions (RMD's) after age 70; 4. you want to avoid even the remote chance that private pensions could be nationalized; and 5. you want to take advantage of a one-time removal of limits on conversions to a Roth IRA and the two year tax payment option available in 2010."
Since I wrote this the Obama administration has vowed to repeal the one year Federal estate tax holiday for 2010, so I wouldn't be surprised if the 2010 one year Roth conversion tax advantages were also repealed since democrats hate Roth IRAs almost as much as they hate rich people and zero estate taxes. If so, the main remaining advantages to cashing out in 2009 are 1-4 above.
Further background is that I have 35% of my invested assets in tax-deferred accounts and 65% in fully taxable accounts. So the tax-deferred accounts are significant but not the whole banana. And I am not including Social Security payments received in this discussion, but one could conceivably capitalize them at 5% such that if you were to receive $25,000 per year from SS its estimated annuity value would be $500,000.
The disadvantages to cashing out your IRA in 2009 are paying a one time fairly high income tax rate and getting bumped into other various "tax the rich" traps affecting Social Security, Medicare parts B and D costs,etc. Fortunately we can wait until much later in the year to make the decision and see how the tax planning and gains and incomes are going, and wait to see what other plans Obama has for us.
Putting this all together, what could I do with the 35% in self-directed tax-deferred funds and 65% in taxable funds to save the bacon and legally pay as little tax as possible IF I don't close out the tax-deferred fund entirely this year? Everything that comes out of an IRA or 401K is 100% taxable at US Income tax rates, whether it was a long term capital gain or ordinary income or gold profits, and after age 70 there is a mandated yearly increasing stream of required withdrawals. Therefore in my case it makes no sense to have gold or stocks in the tax-deferreds, and I don't. Up until mid year 2008 a good bit of the IRA was in US and Canadian oil and gas trusts paying 8-12% with a lot more in Loomis & Sayles Bond Fund (LSBDX/LSBRX)paying ~7% on average. As I grew frightened by what was starting in the markets I cut way back on the trusts and eliminated LSBDX and went to very short term Vanguard Agencies funds VSGDX and VFIJX. That preserved capital and avoided sleepless nights. As the trusts fell in the fall, I began buying them back on huge declines which were pretty easy to find and am break even to ahead on them now.
Even at these current very low gas and oil prices the trusts are paying about 7% average. VFIJX is paying about 4.7%, but LSBDX is now paying 8.5% and has rallied strongly from the lows along with stocks. My plan is to wait for a stock market drop, which I expect soon, in May, and which LSBDX will join in sympathy since its largely high yield corporate bonds trade more with equity expectations than with vanilla bonds. Then I will get rid of the VSGDX, VFIJX, and money market funds and buy LSBDX with about 75% of the funds apart from the oil and gas trusts. The latter will serve as an inflation hedge, but the whole portfolio could earn 8% annualized from day 1! All the withdrawals are taxable, but they would be 100% taxable even if not in the IRAs and at the very same tax rate. 8% payouts exceed the required withdrawal rates (RMD) for some number of years, so part of the current income would be sheltered and re-invested. If you are seriously interested in this subject or maybe just curious, take a look at Hugh Chou's excellent and very simple calculator for IRA and 401K required minimum withdrawals (RMD) after age 70. Vary the expected annualized returns and inflation assumptions for some surprises and ideas. http://www.hughchou.org/calc/irawith.cgi
Who cares if the capital value of the IRA or 401K fund goes down due to a bond bear market or stock decline during payout RMDs? We're only interested in the income stream from this source, not capital gains. But if inflation rises, as it will, the price of oil and gas will fly again and the trusts' prices and payouts will rise. So if I am starting the new plan with only 25% in the trusts, and with oil gas prices low, they could become 50% of the IRA at some future date. (To quell that ever-nagging question about the trusts, Mesa Royalty Trust had an estimated reserve life of about ten years when the trust was distributed by T Boone Pickens in 1979. Now Mesa has a 13 year estimated reserves life! Several others of the trusts have also increased their remaining reserves lives in the past year. Due to re-drilling, horizontal drilling, in-filling with new wells, better extraction, and other advances, reserves can and do grow for these "wasting assets".)
So if I have rationally secured a fabulous stream of earnings which will be taxed no higher from the IRA or 401K than if held in a taxable fund, and add in the also taxable Social Security payouts, I can then address the taxable 65% of funds. This comes back to the "all cash portfolio in retirement" but also to what in 2007 and 2008 I was calling the Hillary portfolio. At that time I assumed a democrat victory in 2008 and that Hillary Clinton would be president. It was a slam dunk idea then, as it is now, that taxes would rise in 2009 or 2010 and probably rise significantly. The Hillary portfolio was short term municipal bonds and gold, preferably as gold bars or coins. This is what I think should be the primary function and goal of the 65% of assets held in taxable accounts or privately vaulted. Right now I have only about 20% of those assets in gold related items and nearly all the remainder in Vanguard's municipal money market fund VMSXX and short term muni fund VWSUX. (I recently sold all of the large holding of my home state long term municipal bond fund which had been paying nearly 6%, for a taxable equivalent of 8.5%. It served me well, and I was able to sell it for a gain equal to over three years of interest from it. I worry about long term rates and also about municipal finance, and wanted to stay very short term. I also have sold off some other assets which do not fit the current plan, all at break even or with fine profits. So the cash and near cash is there for re-deployment.)
With municipal short term rates so low at this time, VMSXX and VWSUX are places really only for "lazy money". Therefore I see this as yet another reason to add more gold to the "taxable side", along the lines of the "all cash portfolio in retirement". Forget gold in the IRA or 401K under my current conditions, and load up on gold, on pullbacks, on the taxable side where it won't be taxed unless and until sold. At some time in the future when inflation begins to bite hard, whether next year or in five years, take out of the bank as many gold coins as you need for that month's budget which is not covered at that inflationary stage by other income (above), and toddle off to your local coin shop to convert them to cash. This is a practical solution to financial needs, and is it is very simple but sensitive to taxes and reality.
So in the end I am funding most of my income needs from IRAs yielding, hopefully, 8% and partially inflation-hedged with at least 25% of the fund in oil and gas trusts also paying 8%. Add to that Social Security monthly payouts, partly inflation-hedged, and an unhedged monthly annuity payment of which only 39% is taxable. Additional non-taxable municipal income comes from the taxable account, but at only about a 2% rate. Then there is the gold and a long/short physicals, bond, and currency futures fund, RYMFX. The gold is "insurance", a "just in case" holding, which can be cashed in if and when needed for the monthly budget.
Let me quote something smashingly fresh about gold that I've just read:
"Gold is more than just an inflation hedge. If it were just an inflation hedge, it would be a very poor one; people would have given up on it long ago. Remember, gold is not a financial asset; it cannot go poof. TIPs, inflation swaps, and even stocks can go poof. They depend upon the existence of a financial system and the liquidity to trade out of the position.
"Gold makes no such assumption. Gold will be here today, tomorrow, and if a nuclear warhead lands on our soil. It has been a medium of exchange much longer than any single currency has been, and it may be once again [a medium of exchange]....
"Gold not only hedges inflation risk, it hedges political risk. You see, the benign, demand-driven inflation that occasionally reaches five or seven percent is not the kind of risk that gold hedges. Gold couldn't care a darn about that kind of inflation. Gold hedges the kind of inflation that comes from quantitative easing. When a country turns its currency into walking, talking joke, gold is there as an alternative.... And what a big joke the dollar has become......"