Putting the pieces together...

Emotion and Validation

1. I think emotion is predictable, that is certain kinds of emotions lead to certain kinds of outcomes and mass consequences. When people are stunned by losses they are immediately angry and then anger soon turns to quietude or depression. Nothing much happens for a while because personal conviction is gone and apathy reigns. People "get along" or muddle through on inertia instead of conviction. 1931-35 was like that, and 1938-42, and 1974-82 and 1988-1992.

 

The mania of 1996-2001 was re-energized after 9/11 and continued on in family safety cocooning and cocoon equity extraction as marketers figured out the national mood and served it too well. The safety cocoon mentality has been dealt a major blow since 2005/2006 and won't recover for a good while.

 

Every normal asset class in developed and developing economies was driven to overvaluation, from bonds and stocks to real estate and commodities and currencies, since 1982 and 2002. Cash is now the most undervalued asset class and gold is next. Values are developing in stocks and real estate but liquidation will continue. Even gold is being liquidated but it is needed to validate cash in an inflationary time. cash validated by gold allows us to shop patiently for bargains before the next flight.

 

2. The 90 year old, sturdy, San Francisco fund and private money managers at Dodge & Cox and many, many others fell into a deep mine shaft this past year after decades of success. Their office was down the street from me, and I knew a few of their management casually. But many retired and new analysts and in recent years partners of a contemporary bent came on in droves who thought that conservative value investment principles were a simple formula  of buying unloved stocks. I could see early last year that they were "losing it" and got out early. Their flagship Dodge & Cox Fund DODGX is down  41% on a total return basis on the past 12 months according to my FastTrack data base! Even more conservative operators over the past two decades like SGENX and LSBDX are down nearly 20% total return (including dividends)  for the past 12 months. That's totally devastating and inexcusable.

 

There is no way that investors over 35-40 years of age can just buy and hold indexes or  even solid managed funds and assume all will be well. We have to be diversified and we have to watch the investments like a hawk and cut them out when they start doing things price wise they haven't done before.  Fire them when they start "acting bad" by moving to cash followed by thinking and looking. If we lose 40% in a year we have to make 67% the next year just to get back to where we were, assuming no taxes which could make it even worse.

 

Skepticism and fear of losses can serve us well, not stop loss orders. Money managers don't want you to move your money since they will lose the fees we pay them whether in mutual funds or separate accounts. Fund super markets like Charles Schwab, Vanguard, Fidelity, T R Price and others let us manage our own money if we will learn to do it. Otherwise we are doomed to mediocre performance. Mediocrity may work over a 50 year period when we are working and saving, but not when we need to live on our money. Get those concepts clearly in mind.

It's Not Over, But It's Different

This is a period of careful watching and waiting for investors. A battle is raging between the strong forces of inflation and the potentially strong forces of deflation. The battle has been going on all year, but the ante has been raised with the Congressional action and the sudden deteriorating jobs and output statistics.  In the long run I firmly believe it is inflationary, but the concept of serious recession has just begun to set into most minds it this past week. Beliefs are not nearly as important as market action at such a time as this.

 

All year we have seen "inflation days" or weeks followed rapidly by "deflation days" or weeks. The 30 year US Treasury bond futures and US dollar are the deflation players and gold and crude oil have been the major inflation players. I have fairly successfully straddled this chasm, or hedged it, in my family investment accounts, and as of Friday I am down 0.52% on the year. This does not include bank accounts,  personal effects, auto, home. I consider it a triumph, but I could and should have done better.

 

My major mistake was staying too long with too large a position in LSBDX which I began reducing in mid August about the time of  this post  and I finally got LSBDX down to one-third of its previous size. The nearly 8% yield wasn't a great enough buffer against the fall of high grade or high yield corporates, nor did HSGFX hedge it as I expected. That Dan Fuss and Bill Gross took some similar hits as well is scant comfort. I put most of the proceeds into VSGDX which is about one year duration "Treasuries", formerly known as "Agencies". I still have a sizable piece of VFIJX which is four year GNMA's.

 

On the taxable side I have both the one year Vanguard muni fund VWSUX and 2.5 year muni fund VMLUX. Governor Schwarzenegger's apparent application to the FED for a $7 billion loan on Friday is making me move the second fund to the Vanguard muni money market fund and possibly to more gold if we don't see some positive response to the Congressional pork pie passed and signed on Friday.

 

In times like these, and even for retired people, income may need to take a back seat to capital preservation for a while. It might be better to spend a bit of capital out of a money market fund than lose it in something stupid, and to keep a lot more in gold. I had only been semi-joking when I told friends at the beginning of the year and before that I was assembling a "Hillary" portfolio of short term muni's and gold, on the basis of probable tax increases and inflationa in a democrat-controlled Congress and White House in 2009. Currently, however, events may depend less on politics than on economic and financial reality. There is wide-spread unhappiness on the right and left about what has happened last week, but at least "the plan" was done by concerted action of both the republican and democrat "moderates" under President Bush. I think they all recognized the potential for major social unrest if there wasn't a broad coalition or it was put off until February 2009 or later.

 

This is no longer the Roman Republic, folks. Julius Caesar and the traditional Senate are dead, and we're into the Empire. To crudely, but respectfully,  paraphrase President J. F. Kennedy, "ask not what your country can do for you, but what you can do for yourself". Use your ears and eyes and brain in all aspects of your finances and life.

 

 

The 50 year old lady with only $57,000 in her 401K

I've been haunted by the statistic I quoted from Rick DeBruhl in my last blog post that the average 50-something year old American has only $57,000 in her 401K (including IRA, I suppose). I've experimented with Hugh Chou's excellent calculator for accumulating a tax-deferred corpus and then dispensing it gradually, as required by the IRS, at age 70. The assumptions I made were that realizing how inadequate her savings would she would thereafter put $750 each and every month into the 401K or IRA, and it would earn, by choosing wisely, 7% per year until age 70 and then 6% thereafter.

$750/ month is $9000 per year but it compounds better if it's done monthly and it also becomes a routine like paying the mortgage or rent. Also 7% per year before retirement and 6% afterwards are conservative goals which can likely be met.

If she does this simple program, she will have $333,766 at age 70. Using the IRS required minimum withdrawal at age 70 (do it in 1/12's monthly!), it would start paying out at about $2000 per month or about 24,000 per year. By age 80 it is paying $37,407 per year or a bit over $3000 per month and at age 90 $54,962 or nearly $5,600 per month. There is also a column which shows the purchasing power results after an assumed 3% annual increase in inflation, the average since 1946. Add on $1000-2000 per month in Social Security payouts, and one could live a modest existence.

We can experiment and see how much we'd need to put in to make the payouts even larger, but I'd recommend leaving the annual earnings increases  fairly low in order to be realistic. If you find this was a helpful exercise which can change your future, think about making a small donation to Hugh Chou at his site. Here is the calculator I used: http://www.hughchou.org/calc/irawith.cgi

Bear in mind that I am an amateur myself, but this "is" something you can do at home.

(Click on the tiny image to enlarge to original size.)

Facing The Ultimate Life-Style Reality: Taxes and Planning In Retirement

Both words, taxes and planning--all of the words really--connote "totally boring" compared to the excitement of huge capital gains. But there comes a time....

Part One

Assume that you are at a point in life, retired or otherwise unemployed, willingly or not (disabled), and you begin to live off your assets. If you are retired willingly then you will have figured out what you have (in dollars) to live on and can see a way to earn the dividends and interest on those assets that you need to live in on. You will have, won't you? If not, you are living in a fantasy world. Be sure you included income taxes in that figuring. Unless you want to work part time at Wal Mart or daytrade eminis, be sure you can really live off your assets for twenty to twenty-five years. If not, you are merely taking a short term fantasy vacation from working for a living which will come to and end when the reality of your wasting assets versus the expected years of your survival becomes evident. If you are 35 or 45 years old and do this, you can reasonably expect to recover after you "get real", that is, after you realize you were completely wrong. Otherwise and especially over 55 years old, you struck out. In that case, get a copy of George Ure's "

How to Live on $10,000 a year (or less!)." http://peoplenomics.com/bookstore.htm#10k It can be done, but this also requires a life committment. These are extremely serious issues.

Part Two

If indeed you have enough dollar assets to live on without major life-changing down shifts in life style, taxes and planning are still very important. In the US it is common for people to have assets which are tax-deferred (IRAs or 401Ks, etc) and assets which are after tax: bank accounts, brokerage or mutual fund accounts, etc. The closer these assets divide into equal parts of tax deferred and after tax sources, the better off you are for planning.

On US tax-deferred accounts you really owe income tax on every dollar in the fund regardless of your age, and at 70 years old you have to take out an increasing amount each year so that the government gets its complete share before you die. Think about that for a while. Once you are withdrawing, willingly or not, I hope it is clear that capital gains in tax-deferred accounts make no sense at all. Capital gains taxes are, until 2010, as low as 5-15% in the US for long term gains, and short term gains are taxed at normal income tax rates. So why try to make long term capital gains in a tax deferred account in retirement when everything will be taxed at ordinary income tax rates? Is that crystal clear? It is riskier and less certain (redundant?) to get long term gains than to get interest or dividends, and the extra risk for capital gains in a tax-deferred account is punished by full taxation.

Think this all through again very carefully: for US tax-deferred accounts during voluntary (any age) or involuntary (over 70 years old or disabled) draw downs, capital gains, except for short term trading, make no sense, and you should be going for income from interest (bonds, etc.) and dividends. If you are the extremely rare person who can trade short term for tremendous gains, you are a rare exception. People who fall into that category will almost all have made so much money already in life that they don't have to do it during retirement! Your odds of learning to do it for the first time in retirement are similar to your odds of winning the PowerBall Lottery. I know people who are trying to beat those odds, and I wish them luck.

You really should not care about the total account balance of a tax-deferred account when you are in draw down phase. Seriously! What you need to do is insure that you have the best (the most reliable and hopefully high) income stream from the account. You are a joint owner of the account with the US IRS. You want to be sure that you don't pay the IRS stupid taxes, only taxes on income you are drawing down. At age 70 you have to take out nearly 4% per year or face further tax penalties for "failure to share with the IRS". Check out Hugh Chou's free calculator http://www.hughchou.org/calc/mdib.cgi for the realties. 1/"Divisor" is the percent of the total account which must be taken out each year to avoid further tax penalties of 50%. At age 71, 1/26.5 = 3.77%. So you need to earn at least 3.77% of your total tax-deferred account per year to avoid a partial liquidation of the asset base (total amount). You cannot assume you will make capital gains greater than that each and every year, and you would have to sell (take the capital gains) on take out. Get it? At age 80 you will have to take out 1/18.7 = 5.35% per year. Consider that. At the moment Vanguard's long term (20 year) US Treasury bond fund is paying 4.68% and their best money market fund is paying 2.21%. Panic!

There are several very important and normally totally misunderstood facts that may help. One is, as I have alluded to, is that the total value of our tax-deferred account isn't as important as the income it generates. If interest rates go up (see below) the value of longer term bond fund or funds goes down, but the income will stay the same or rise because of the higher interest rate. This is key. So we would get the same or maybe even higher interest income even though the total account balance goes down. If the total account balance goes down we have to remove less, according to the IRS formula, but the higher interest rate will make it last longer. (Look at the age 71 versus age 80 withdrawal rates as above.)

The second very important fact (or very strong probability) is that long term interest rates "will" be going up. Long term rates are very close to the lowest they have been for the last 28 years. Twenty eight years is about as long as interest rates decline, based on the past 200 years in the US and Europe. So rates will be going up. This means that when bond funds, or you, have to reinvest in new bonds as the older ones mature or come due and are cashed in, the new rates for bonds will be higher, not lower. This removes one of the worst features of bond investing, namely "reinvestment risk". Your income will be higher, not lower.

Both of these facts, and mandatory US taxes on tax-deferred accounts, explain why you should concentrate on income at this time and forget capital gains in tax-deferred accounts during withdrawals. Concentrate on the cash flow, not the total account balance. These are NOT conclusions that come easily or intuitively for most of us, unless we have been bond traders or fund managers. Think it through several times.

Part Three

I can hear your thoughts clearly. "But what about inflation??????" Depending upon whom you believe and your personal spending patterns, US consumer price inflation now is somewhere between 3% and 8% for the past year. "So I can earn 5% on my tax-deferred accounts and come out short after inflation?" Good question, and the answer is clearly "YES".

This is where the after tax asset base--bank savings accounts, brokerage and mutual fund accounts, etc. come in. You do NOT want capital gains in your tax-deferred accounts that you have to share fully with the IRS. But you do want them in your after tax accounts where capital gains can be taxed as low as 5-15% (until 2010) compared to up to 38% for interest and some dividends. For a retired person the best of all worlds is to make long term capital gains beating inflation (after tax) and add to your income-generating funds with the after tax gains. Whether the gains are from gold or commodities or stocks or commercial real estate, they are likely to beat inflation after taxes--historically they have--and you can put the gains into tax-exempt US municipal funds or other tax-favored funds. So you can add value to your income sources and increase your income during retirement or other voluntary or involuntary drawdowns.

This is obviously, I hope you see, not a miraculous way to make ten million dollars out of a thousand! It is a way to manage what you have saved and invested efficiently to maximize income and minimize taxes. The ten million or one million or half million dollars is what you need to make "before" you retire, in tax-deferred and in after tax accounts. There are two phases at least in an investment life: "making it grow" and "managing withdrawals". The younger you are when you recognize this, the better off your life will be at every stage. No investment magician can create wealth for you if you haven't done what only you can do. The two main things you need to do are to hate debt and to save. Always. There is no other legal way to begin to increase and maximize your assets.

Postscript: I wrote this article yesterday. This morning I saw an article by Rick DeBruhl at AZCentral.com http://www.azcentral.com/arizonarepublic/business/articles/0615biz-debruhl0616.html He learned last week at a National Press Foundation meeting in Washington DC that the average tax-deferred 401K account of Americans from 50-59 years of age is $57,000. At 5% interest that will get you $2850 per year. Oh my!

Closed End Funds in the Current Market

Closed End Funds in the Current Market

US stocks have headed down from SPX 1440, the 80 week moving average, and the 2CS reading in the 70's. I was shaving off stocks into that expected event, and raised some cash. At little more than 2% in a currently dubious currency, cash truly is trash, especially if you can find any reasonable alternatives.

Being retired and living off my assets, **every** investment has to pass two tests for me. The most important test is that it pay a dividend of 4% or better, tax-adjusted. So if a tax-free municipal bond or fund pays 3% and my overall US Federal tax is, say, 30% at the margin, then 3% /.7 = 4.29% and it passes. So I am always looking for good investments that have capital gains potential but which pay me to wait for the capital gains. This was why I bought four US, and one Canadian oil/gas, trusts last year for the major tax-deferred account. They are now paying monthly income at an 8-15% annual rate on original purchase price, and they really didn't make me wait very long.

I gradually began looking at closed end US funds. They are like ETF's in a sense, but are NOT indexes. They are managed, and they include all sorts of asset classes. When interest rates are low, US closed end funds have issued preferred shares or simply borrowed money short term to increase their leverage and their returns. I bought a few state-specific closed end municipal tax-free bond funds last year and two foreign sovereign bond funds which were and are paying 6.5-9%. But I didn't really have a feel for the power of these funds until I happened upon Steven Selengut's website http://www.sancoservices.com/brainwashingbook.htm and then his book: "The Brainwashing of the American Investor".

Normally I am turned off by and ignore people with book titles like that, but fortunately I didn't. Selengut is a money manager in South Carolina, and he has helped me to another quantum leap in my thinking and the practice of investing in retirement. I do disagree with one of his basic ideas, namely that you should never buy a mutual fund. HIs concept, as I understand it and agree with, is that mutual funds add to investing another big layer of expense at my expense, and that they are issuing new shares all the time which is diluitive to net asset value. In the case of many funds and fund managers I would have to agree. They are taking 1-2% of your assets each year and getting rich at your expense for very little or no value added to indexing. And many mutual fund managers become very, very wealthy with a lot of talk but  little value-added justification. Even Hussman! :)

But I spend a good bit of money for subscriptions and data and a lot of time finding funds which are run longer term by good people who either charge extremely little and/or who really deliver the goods. I own some Vanguard funds, as you know, especially municipals and Wellesley Income and the Energy and the Mining funds, which do an excellent job AND charge me tiny expenses. Then there are SGENX and LSBDX and PRWCX and RPSIX and PCRIX and a few others who keep delivering excess value in what they do within tolerable volatility bounds. But there is a lot of truth in Selengut's charge. The mutual fund folks want to keep you locked up, and they don't want you to trade. They problem is that THEY decide what is "excessive trading", not you or I. In my heart of hearts I really would like to buy and hold the ideal portfolio forever through thick and thin. I work at it, And I want to do it. But there are times when you have to make changes, for a host of reasons. Maybe you need extra money for a crisis or a special reward event, or because it's suddenly obvious that XXXXX fund is about to go down the tubes. I have had phone calls and paper work with apparent high school dropouts running "excess trading" desks at major mutual funds that caused me never to buy their funds again. Hey! It's my money, not yours!

Enter closed end funds. They don't care if you trade in and out of their funds ten times a day. They probably would like the increase in volume and liquidity. In case anyone from Vanguard reads this, "Don't worry. You guys will always have my vote for what you do best: very low costs and in highly specialized areas like municipals and special sector and income funds." But for money otherwise at the 2% money market margin, thanks to Chairman Bernanke, closed end funds, which you may not want to own forever, can increase your returns dramatically, and you can get out or in at any time of the day you want with no black stars on the management company's report card.

Selengut is teaching me that there are closed end funds in every asset sector which pay higher than normal yields and with long term gains. His approach is to look for quality: you don't necessarily want the highest yield as you may be buying junk. But you want something better than the average intermediate term bond fund, currently at 3.5-4% at best. He also teaches, mainly in regard to stocks but also in closed end funds, that you only buy funds that are down off their highs of the year, and if you get a really good gain, you cut it back and look for another or for multiple other down-on-their-luck funds. When I first read this I kept saying to myself, "OK, Steve, great idea, but where's the list of good funds?" But then it came to me that he is a money manager, so if I want his list he is going to have to manage my assets. I might do that at some point as he is younger than I am. But I'm still in the saddle for now.

If you have the time and interest you can use ETFConnect.com, Morningstar.com, and FinanceYahoo.com to develop some closed end fund ideas yourself for little or no cost. I will mention some funds that I buy, but I am NOT an investment advisor so these will just be "diary entries". Do read Steve's website and if he is your kind of person, buy his book. The book ranges a bit, and he's taking about his true love in the markets with some passion, but it is an eye opener compared to the usual investment junk advice that we retail peons usually get.

One gem I found on my own and bought today is Eaton Vance Tax Advantaged Global Dividend Opportunities Fund (ETO). This fund is heavily weighted to global inflation beneficiaries which pay decent dividends. Here is a list of recently reported holdings: http://eatonvance.com/mutual_funds/monthlyholdings.php?fund=ETO They are paying a monthly dividend at an annual rate of ~6.5% and are selling at a 10% discount to NAV on conservative 21% leverage. One thing Selengut preaches is that nearly all enterprises at all levels of business use some borrowed money to increase returns, and if done moderately and creatively it's good thing. 6.5% sure beats 2% in a money market fund right now, barring capital losses of course.

May I say once again that I am not an investment advisor, and I do not manage money except that of my family. This is my diary which may or may not be of interest to others. I have no connection with Selengut except as a reader, and no connection with the investment world except as a private investor

 

Stock Market Update

When you are right it always takes a long time  to gain your reward. When you're wrong, you are very wrong and often very quickly. Recently I've been right, and so it has been drawn out, ulcer-genic, and not terribly rewarding.

A lot of the news is more favorable now on the economy and the market. Not, mind you, in the press which is just now getting more bearish. But the press are always negative, especially in an election year when the those who control the press sense that negativism works  for them. On the other hand, some economic analysts of great skill see an economic bottom possibly being made. Market measures of sentiment such as the 2CS show that we are approaching a top. I tend to be early at tops, but I do trust market-based indicators far more than human opinion.

The 80 week moving average on the SPX is still rising and is just under 1440 now, and so is the December low. If SPX can crack through those levels and seem to stay it could be a new ballgame.  If not, I think there is another leg down to crush the bulls.

I have been lightening up in the stock allocation and adding in fixed income via closed end funds which are easy to unload if necessary. I don't really want to be trading, and I am looking at this as "re-balancing" or re-positioning. I haven't yet sold any natural gas trusts.  I haven't sold any physical gold. I have some more cash (paying nearly 0% now) which is available for buying.

As you can tell, I am leaning toward recession, or  at least a prolonged slowdown. Taking some profits and having some cash to buy bargains seems prudent for a retired person. Now if I could only find the perfect portfolio which never needs touching!! I'm 70-80% there.

Ground Glass and Guesses

Ground Glass and Guesses

CXO Advisory quotes Ed Fiedler on predictions: "He who lives by the crystal ball soon learns to eat ground glass." However, several times each year I try to guess what the current market may be saying about the intermediate term investment picture. Currently two market analysts I respect come to the same conclusions by quite different methods. Glenn Neely and Carl Futia both think, at least for the moment, that stocks, TNotes (10 year), gold and the Euro are headed for significant drops. Both think SPX 1430 is a probable high: Neely thinks it will be the high for a long time while Futia thinks the market will correct but go higher over the next year or more.

My own feeling (rightly or wrongly) also has been that 1430 is about tops for stocks, and I had been planning to switch more to bonds. The chart shows some of the reasons why I think 1430 SPX is important:

Most of the talk everywhere I've been is about recession and/or inflation. Recession without inflation would normally be a good time for bonds/notes and for dollars. Since gold looks down to me, inflation is going to slow. The only explanation I can see for all four classes (stocks, TNotes, gold and Euro) going down is a mildly inflationary but continued mild slowdown/recession in the US during which short term rates rise (FED sits on hands). At the same time, the rest of the world slows more and the Euro drops.

Putting it all together, we might do best under such a scenario by putting some of our investment money into the currently most hated of all assets: US dollar short term cash or money market assets. I'm not making any radical changes, just adjustments and profit taking in inflation favored investments. I have had 20% of assets in inflation hedges and have 20% in "deflation" hedges(fixed annuity and cash). Half of the inflation assets are in gold which won't be touched, but I have been and am cutting back on the other half. I think natural gas is a long term bullish story so I might cut back only a bit there if at all. Gold and other mining stocks will get another cut and so will energy stocks apart from the gas income trusts. I will also cut back a bit on "generic" stocks and longer term bond funds.

I do think that bond or "income funds" like LSBDX/LSBRX (Loomis Sayles Bond) and RPSIX (T Rowe Price Spectrum Income) have the smarts to keep the income flowing without taking a hit. I think I've got it right, and in response to Ed Fiedler's remark about eating ground glass, I'll quote Peter Cook's proud saying in Good Evening (in New York, with Dudley Moore): "I have learned so well from my mistakes that I can repeat them exactly!"

What To Do?

The key to investment survival lately has been wide diversification: all kinds of bonds, generic stocks and inflation stocks, commodities, gold/currencies, cash. Almost of the funds and stocks  I have discussed here I own and am holding.

The problem right now in prognosticating, as opposed to just surviving, is that WE DON'T KNOW. Normally, technical market analysis, sentiment analysis, and astute economic analysis are extremely important. In a financial crisis when banks don't trust each other enough to cross-lend overnight, none of the "usual" matters. We've seen the dramatic intra-day moves in many asset classses that clearly are due to massive liquidations of hedge funds and other large investors. Banks are calling in loans in finance far more than in housing. "Sorry Mr Z but your $2 billion loan we made to you which you leveraged up 15 times in mortgages will NOT be rolled over today. Sell and/or die. Have a nice day."

If there are twenty more Bear Stearns lined up to fail and bail, and insiders know that but we don't, all the technical and sentiment and economic analysis in the world won't give us insights on how to capitalize on it. It's important to understand how the FED works and why. It's important to know about the "rich man's panic" 0f 1907 and about 1987. This is not about a normal recession which we may or may not yet actually be in. If it's beyond us to grasp it, then  we just have to sit tight and not do stupid things which could make it worse. Those who are done in in this crisis are having to sell both their bad stuff and their good stuff, more or less at the same time. That's why it's so volatile.

If you had or have a decent and diversified portfolio, you might be better off doing nothing rather than selling the wrong thing or selling everything. Some times it's better to lose ten percent and have it come back rather than to sell out everything and not come back. This is just my opinion, and I work only for myself. I'm still ahead on the year a quite  modest amount, even after this brutal day today. I consider that a  major victory!

Year to Date Portfolio Update

Year to Date Portfolio Update

Previously I had not counted gold bullion into the total of all investment accounts, but it makes sense to do so. As of February 29, 2008, the accounts consist of the following asset allocations: 1. cash 19.3% (money market funds and the cash balances of mutual funds). 2. Bonds 50.9% (includes the bond holdings of VWIAX, RPSIX, LSBDX, PCRIX and HSTRX and short term municipal bond funds). 3. stocks 19.9% (includes the blue chip stock portions of VWIAX and RPSIX, the metals and energy stock holdings of HSTRX and VGPMX and VGENX, plus all the oil and gas royalty trusts, plus PCRIX and GCC) 4. gold (bullion) 9.9%.

Two thirds of the stocks should be considered "inflation hedges" plus the gold, together totaling 23% of the total portfolio assets. That's a little high, and I may cut back a bit as the inflation hedges are more volatile than the rest and have had a big run. However, I'm "bullish" on inflation for the long run, so this will only be a minor "trim".

Year to date this portfolio, including dividends, is up 3.26% which, if continued, would give 19.56% for the year. I'm not counting on that. The Vanguard Admiral Short Term Bond index (VBIRX), with a duration of 2.5% (close to mine), is up 2.99% year to date. The Vanguard Admiral SP500 Fund (VFIAX) is down 9.06% year to date. Gold is up 16% year to date. Gold is thus responsible for 1.6% of my total gains and therefore 50% of my total gains. This is a good hedge. But if we look at the trade-weighted US Dollar Index, it is down 3.9% on the year. So in effect I have lost 0.64% in purchasing power year to date. Hmmmmmmmmm...maybe I'll keep all the hedges after all.

Hussman Revisited & what and When to Buy

John Hussman is an economist and fund adviser I have featured here before.  I agree with Hussman on most of what he writes, including his post today on long term stock Price/Earnings (P/E) ratios. Hussman writes very clearly and explains market economics in terms we can all grasp and understand. And he writes often enough that one can get to know his approach very well, compared to many epic mutual fund gurus who rarely convey information to retail investors, and if they do, only do so very cryptically.  Like most stock market-centric people---that is, about 98% of the entire investment community, which includes small private investors as well--Hussman is what I describe as generic stock-centric, which is short hand, and not meant at all in a perjorative manner, as it is a classic and quite legitimate preoccupation.

Hussman's universe consists of stocks divided into normally convenient capitalization sectors. He prefers mid cap US stocks as they are, or have been, likely to give larger gains over time than large caps do. I do think I once saw a foreign stock in his HSGFX: a Korean utility, I believe. I might have missed some others. But even if he covered and routinely invested in foreign stocks, my appraisal of him as a sectoral or generic stock-centric analyst would stand. He does avoid some industry sub-sectors and he favors others from time to time, but generally he sticks to his universe and looks for the best value candidates within it to own at all times, hedging with broader stock index futures (SPX and RUT) and/or options. This can, and did, work quite well in bear markets, as from 2000-2002 when value stocks (the longs) outperformed the generic stocks (the hedged ones). Value stocks had been undervalued relatively after 1997. Hussman also says, quite consistently and believably, that under conditions of longer term undervaluation (low P/E's and other measures), he could and would be largely net long (unhedged in his case).

As Hussman shows, the generic stock-centric universe has undeniably under-performed T Bills on a total return basis over what will be the past ten years as of July 2008. However, Hussman's own largely hedged Hussman Strategic Growth Fund (HSGFX) has itself under performed Vanguard's Prime Money Market Fund over the past four years ( see chart). Also we know that, when adjusted for inflation and US dollar depreciation over the past five years, the US generic stock-centric universe at large has actually lost money. I want to point out that Hussman's approach to income vehicles in his other fund, Hussman Strategic Total Return (HSTRX), which I own and have discussed, is pleasantly different in its returns.

One problem with exclusive attention to the generic stock-centric universe is that the long term generic stock Price/Earnings Ratio cycle is not always synchronized with the long term inflation/deflation cycle. In fact there is sometimes a humorous disconnect in generic stock-centric people, who readily believe in the seemingly esoteric but easily understood long term P/E Cycle but who often deny even the possibility of a Long Term Economic Cycle as nonsense or perhaps mythical. Oddly, no one argues about the causation of the P/E cycle, but it's usually all that is asked about when the Long Term Supply & Demand Economic Cycle comes up for discussion. In truth, the long term supply and demand cycle causation is much more understandable than the P/E cycle.
 
The long term supply/demand cycle for the crude goods, consumer goods, and the credit economy, often discussed at this blog, exists and is prolonged in time because of the long lead and lag times required to observe, diagnose, plan, finance, build, equip, and roll out new supply and its transport and/or storage to meet increased demand.*(see below) And there is a similarly long period of time during which demand and prices fall before the older supply chain becomes exhausted (for stockpiles), and  physically  deteriorates or otherwise becomes inadequate (for infra-structure) for the then current demand. We saw the peak of the demand half cycle in the 1970's--when over-supply was finally achieved due to over-investment in commodities and much else--and then we saw the  nadir of the supply half cycle in the late 1990's and early 2000's when supply had finally run down below demand due to chronic under-investment caused by falling prices. What could be simpler to understand?

Why is this important to us? Partly because P/E cycle reversals in generic stocks do not often synchronize with supply/demand cycle reversals. When the stock market starts up from depressed P/E levels, it's best to own good candidates in the generic stock-centric universe. 1949 was an excellent time. 1982 was an excellent time. Even 2002/3 was a good time. One didn't even need to be very selective intitally at times like those as all ships rose in the undervalued tides when they reversed. But when P/E's are into historically high ends of the cycle, it is better to look at stocks (and/or some bonds) which benefit from the asynchronous Inflation/Deflation Cycle. Even though 2002/3 was a decent time to buy generic stocks, even by Hussman's standards, and generic stocks have doubled, on average, it wasn't a great time since P/E's (based upon peak earnings) were 15 rather than being preferably under 10. 

One would do, and many did do, much better by buying stocks or other vehicles with the exposure to benefit from rising inflation and inflation growth rather than buying into the generic stock-centric universe in 2002/2003. So we buy generic stocks when P/E's are very low, as close in time and price to the price lows as we can, since they nearly all rise for quite a long time. And we buy inflation-favored or other vehicles with similar attributes when market lows occur and when P/E's are then relatively historically high at these important market lows.

At such lows, as in 2002/2003, generic stocks were OK, but one needed to buy stocks which benefit from higher commodity prices: selected mining companies, agricultural companies, and energy producers. Also gold bullion coins and direct commodity funds which are now widely available, as I have detailed on this blog. Also one then bought stocks in nations which are massive commodity producers and exporters, whose economies are geared to rising commodity prices: Canada, Russia, South Africa, Australia, and Chile come quickly to mind. Then one looks at stocks in rapidly developing nations, particularly in their infra-structure stocks and their own commodity-favored stocks. Infra-structure is favored during this long term expansion phase. Since interest rates will also be rising at some point in the inflation half cycle, financial stocks such as banks should be avoided except perhaps in commodity-favored nations. Also bonds are not favored except for income generation at the very short end of the duration curve: 1-3 year maturities. There are some exceptions at such times to a "no long bond" portfolio, such as high yield corporate bonds and high yield bonds of developing nations. Their credit ratings will be rising and hence the interest rates will be falling with economic improvement, and their bonds will go up. Such bonds are in effect "quasi-stocks".

As we saw, the generic stock-centric universe hasn't outperformed US T Bills for nearly ten years, nor has it since the 2002/2003 lows. But inflation-favored stocks, as outlined here, have far out performed: many commodity and developing world stocks have risen ten fold or more since 2002/2003.

Close readers will have  noticed that I've left out one  possible investment point in the stock-centric P/E and Inflation/Deflation cycles matrix, namely what to buy when generic stocks sport very low P/E's and commodity prices are very high? Obviously, as discussed above, buying generic stocks makes sense then, but this will also generally be when interest rates are high, so longer term bonds make sense as well. Instances like these occur only about twice per century, 1932/33 and 1981/2 being the last such cycle intersection points. After such points both bonds and stocks do well for long periods of times since both are then "undervalued" in terms of P/E ratio and interest rate.

What do we do right now? As Hussman points out, both generic stocks and generic bonds are now expensive or over-valued in terms of P/E's and interest rate coupons. We know that historically it's going to be a relatively long time before either or both return to good value points with low P/E's which will start to rise and with high interest rates which which will then be about about to start declining. At this time, commodity prices and developing nation stocks have been rising for 5-8 years, depending upon which commodity and which nations. They are still the place to be, but we have to be more selective and judicious now in buying abroad. If you have exited or cut back on generic stocks and bonds, as I have over the past year, you want to keep those inflation-favored stocks or funds you may already have: energy funds, natural resource funds, gold funds, and direct commodity funds. If your allocations to these are slight to nil, you may want to buy into such funds on a small basis now, or whenever you are ready, and add to positions on pullbacks. They will likely have ten or more years yet of continued bull markets. Naturally nothing goes up every day or month, but the shortages of many commodities and the current rather low interest rates support continued commodity inflation for quite a long time.

With commodity funds, which I like, one avoids many of the stock selection hurdles such as inflation of costs or shortages of utilities now plaguing some commodity industry sectors and nations. Also many of the developing market nations have not been severely tested in terms of business law and accounting adequacy or scandals as in developed nations. And we are seeing creeping nationalizations or squeeze outs of commodity producers by some grasping sovereign governments. Investing in the product rather than the producertherefore has a real place in current portfolios.

The key point of this post is that when people say that the stock market is "over-valued or due for a fall", ask which "stock market" are they talking about? As a rule they are talking about the generic stock-centric universe of US and foreign developed nations. As Hussman makes clear for the current case, over-valued generic stocks may under perform for years as the P/E cycle unwinds and reverts to long term undervaluation. Right now, and for some time to come, that should not be true with commodities and with stocks that benefit from inflation.

As always, bear in mind that I am not an investment advisor and invest only for myself and for family members. I am connected in NO way to the investment industry or any corporation in any way except as an owner of exchange-listed stocks and funds or mutual funds. My writings are my own analysis except where referenced to others, and conclusions are simply my own amateur opinions.

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*Just as I finished writing this today, I, along with two million other people, received an email from John Mauldin which elucidates perfectly what I described for the supply catch up phase for the price discovery to new production pathway for commodity producers--in this case gold miners--after demand picks up. This is by David Galland of Casey Research, Doug Casey's firm:

"Consider: as recently as the year 2002, gold was still trading near $280. Against that number was a cash cost of around $250 per ounce for a typical company. That cost figure is about as low as the number could go, and it was the response of an industry beaten down and huddling in a trench.

"Caution lingers after the reason for it has gone. As gold began its upward move in 2002, it did so against the backdrop of an industry still in mothballs and still run by managers whose primary skills were cost cutting and frugality. This is important on a number of fronts.

"1) Having been trained in the acid bath of razor-thin margins, management was intensely skeptical about gold's rally. They suspected it might be just another bear market trap, ready to punish unwary optimists who parted with cash to ramp up production.

"2) In the hunkered-down years, miners focused on the higher-grade, easy-to-mine material that gave them the best shot at turning a profit, however small that might be. And being in survival mode, they were extremely cautious about buying new equipment or maintaining a large workforce. Employee rosters were reduced to the bare minimum.

"3) Because staying in business was such an urgent goal, they were willing, even eager, to sell future production at a set price -- a perfectly rational strategy in a bear market, because it at least assured they would receive a price that covered the known costs.

"With all these factors taken together, it's easy to understand why the industry was slow to respond when gold started rising. In fact, it was only in February 2003, with gold trending over $350, that Barrick Gold Corp., the world's largest gold miner, began the expensive process of unwinding its hedges. And it wasn't until November of that year that the company announced it would stop forward selling altogether and would eliminate its entire hedge book.

"Once the turning point came - when management finally realized the bull market was for real -- the industry began to scramble to catch up. Which, in a choo-choo industry like mining, means hiring and training lots of people, buying or refurbishing the equipment needed to reestablish production on second-tier deposits, upgrading facilities, building expensive new mills, etc., etc. And, of course, dealing with the challenge and expense of unwinding hundreds of millions of dollars worth of forward hedge contracts.

"The rebuilding of the gold mining industry, in short, really only began in earnest over the past few years.

"The Ugly Duckling Years

"As would be expected, the costs associated with rebuilding the industry sent big hits to the bottom line, resulting in the kind of ugly financial metrics that repel institutional investors.

"The metrics were not at all helped by the shift away from high-grade ore, because the lower the grade, the more the material you have to dig, hoist, haul and process, meaning increased production costs. In addition, the industry rebuild occurred against a backdrop of generally rising inflation and a falling dollar, which helped push the cash cost of production up by more than double from the mothball years, keeping the miners unattractive as investments.

"By contrast, the base metals companies, which had hit bottom earlier, near the end of 1998, had already emerged from the mothball stage, thanks to increasing demand from China and elsewhere. They were, as a result, well on the road to recovery when the big price increases for base metals kicked off in 2004. So, while the gold miners have been widely shunned as ugly ducklings in recent times, the base metals sector has been enjoying salad days, reflected in multi-billion mergers and acquisitions and, of course, sharply higher share prices.

"The Golden Years

"Here at Casey Research, we are of the firm opinion that, now that the biggest costs related to restarting their industry are behind them, the big gold companies are poised to take off. The proof should come in rapidly improving margins which, lo and behold, we have begun to see in the quarterly reports now being released......"   

See here for John Mauldin's direct version of this post by Galland and reference url's therein for Casey Research.

http://www.investorsinsight.com/otb_va_print.aspx?EditionID=657

Commodity Funds: Some Tax and Selection Issues

Needless to say, commodity funds of all kinds have been doing well recently. The weekly chart of DBC shows the general commodity market over the past two years, represented by crude and heating oil, gold and aluminum, wheat and corn. Until August 2007  there was a flat consolidation range after the rises into 2005/2006. Then with the central bank lowering of interest rates, and with strong suggestions from them of further reductions, both the hopes of avoiding deep recession, and the fears (or bets on) further inflation. led to upside breakouts in many broadly-based liquid commodity markets.

This year I have posted two articles on some of the commodity funds available to ETF and ETN stock and to mutual fund investors: January 27, 2008  and February 10, 2008. In the more recent article I showed a chart which was forwarded to me and whose origins I do not know. It lays out the sector weightings of the major US commodity Indexes which are often used as benchmarks and actual allocations by ETF. These indexes are key to choosing one's own preferred commodity exposure. Commodity Index Allocations

I've explained my own biases, or preferences before: in tax-deferred accounts (IRA's and 401k's in the US) there is little to be gained by putting funds in which generate no income. With tax-deferred accounts everything coming out eventually will be taxed at ordinary income tax rates of up to 35% and tax rates are virtually certain to rise in 2009/2010. With commodities we are primarily looking for  capital appreciation, not income. So commodity funds which give you only capital appreciation should be in taxable accounts, in my personal opinion.

For commodity exposure inside tax-deferred accounts I am using two mutual funds I have discussed in the January and February posts above: HSTRX (Hussman Strategic Total Return) and PCRIX (Pimco Commodity Real Return). Both use US TIPs as their income-yielding base. HSTRX gets an exposure to gold (and some minor exposure to other metals) through trading gold stocks around a basic allocation of approximately 15%. PCRIX (or PCRDX with lower minimums) overlays its TIPs with a commodity-linked note tied to the Dow Jone-AIG Index, a broad-based index based on US commodities and three London metals (see the allocation gif).  Both of these funds paid dividends over 5% last year and the TIPs of course are adjusted for US CPI inflation. Since TIPs taxation can be an extra issue in taxable funds, I prefer to avoid it by carrying funds with TIPs in tax deferred accounts. So for PCRIX and HSTRX (I own both) I like them for my tax-deferred funds and they give commodity/gold exposure with an income kicker.

For taxable accounts I prefer the commodity exposure with  potentially the lowest capital gains exposure and little if any income exposure. In my view the worst funds for this scenario are the gold and silver ETFs which actually hold bullion: GLD, SLV, and CEF (Canadian) and other physical holders of commodities (gold). First of all they do not permit you to convert your shares to gold (or other  holdings) unless you convert very large amounts (see individual prospecti for limits and fees), so in owning them you do not really own the gold, only share certificates for that gold which you can sell or buy. So these ETF's are in effect "derivatives" in a generic sense. However, the IRS regards their holdings as "collectibles" whose gains are taxed at a flat rate of 28% even if you were in a 10-25% normal Federal income tax bracket. So I can see no advantages to owning them either inside or outside a tax-deferred account.

CEF has another disadvantage in that it can and may be deemed by the US IRS  to be a "passive foreign trust". That designation requires you to file a "special election"  form with the US IRS, with your first annual return after purchase of CEF (and its all gold sibling GTU), on which of two possible tax statuses you wish to adopt  with regard to passive foreign trusts. Then too, CEF holds physical gold and silver which you cannot get in redemption, as with SLD, SYL and others, and you will be subject to Canadian taxes as well. If you own enough of it to make having an accountant and possibly a tax lawyer's time be worth while on these issues, these funds may be feasible holdings. But I'll skip them. If I want physical gold, I buy physical gold.

Since those funds are in fact derivatives and not your own segregated gold or silver, why not use real exchange-traded regulated derivatives in an unleveraged manner? I'm talking about unleveraged US futures contracts which are taxed at a much more favorable US tax rate. With futures, all capital gains, no matter whether a day trader or of a long term investor are taxed such that 60% of any gains are considered long term and 40% short term. With current long term rates of 10-15% and maximum short rates of  33-35%, you come out far ahead with futures-based derivatives rather than with collectible ETF derivatives. As an example, on $200,000 taxable joint filing income, collectibles gains would be taxed at a flat 28% rate while futures gains would be taxed at 18.04% , a sizable difference! Keep in  mind, as always, that I am not a tax adviser, and this discussion is just my amateur tax payer opinion. Do the math yourself, or ask your own tax accountant and/or tax attorney. Also I am not a licensed investment adviser, just an amateur investor of my own family's accounts, so none of this should be considered as advice, merely my own analysis for my own sake.

There are several ETF's which do invest in commodity futures in an unleveraged manner. They deposit their dollar assets as US T Bills (or similar money market instruments) and buy commodity futures contracts whose values are not to exceed the face value of the contract. ZERO leverage. I have looked at the iShares DB funds:

DBC (gold, aluminum, crude and heating oil, corn and wheat); DBE (light sweet WTI and Brent crude oil, RBOB gasoline, and natural gas); DBO (light sweet WTI crude oil only); DBP (gold 80%/silver 20%); DGL (gold); DBS (silver); DBB (aluminum, zinc, copper);  and DBA (corn, wheat, soybeans and sugar). These may fit a niche need for some portfolios or work as good trading vehicles. I do not own any of these funds but DBC does track the large commodity universe quite well. DB's futures traders have a long and admired history, so managing indexed and re-balanced portfolios is like falling out of bed for them. The volumes of their trading should/could result in lower than average commissions and other transaction costs.

My favorite to date in the tax-favored, futures-based a category is Greenhaven Continuous Commodity Index Fund (GCC). The CCI is a previous incarnation of the famous CRB Index and has 17  US-traded commodity futures in it with equal weighting for each. So crude oil and cocoa are equally weighted. In a long term commodity bull market, which I believe we are in, every commodity will have its day in the sun, and I want to be there and own them all. Volatility should also be lower in a fund with 17 equally-weighted holdings than with two to six commodities. So I will feel safer carrying a larger position in this rather than an energy or metals heavy fund. This fund is new and is the only listed fund of its management. But they have led public commodity pools for a long time.

As a former commodity futures trader for decades I feel cvery omfortable with the commodity futures, with the US futures exchanges, with their clearing houses, and with CFTC and SEC regulation. US futures have been around for 150 years and have a splendid record of safety and regulatory excellence. And with  zero leverage I feel these are safe for me with modest amounts in order to hedge against inflation and achieve additional diversification in a complete portfolio. I own this fund, and made my first purchase on their third day of existence.  As always let me assure you that I have no other connection with these people or any of the others of any funds. I am totally and only a private investor with no personal or family ties to the investment industry. These are simply my own opinions which may be of interest.

There are a number of other commodity funds not covered here as I haven't looked at them as deeply, so leaving them out does not necessarily imply I find them wanting, and I might include some of them in future . 

   

Commodity/Inflation Funds: Update

Inflation funds had a good week from February 4-8, 2008. I have looked closely at six funds with at least 20 months of operating history, including several with two decades of history.

FastTrack fund data base charts are always "total return" with all paid out dividends reinvested. I own HSTRX, PCRIX, and VGPMX in various family accounts. I also own GCC which has only been in operation a few weeks and not shown on the chart.

Recently I have discussed HSTRX and PCRIX in some detail on this blog site. The base of each one is US TIPS (Treasury Inflation-Protected notes). HSTRX has a fairly short maturity/duration (<2 years), PCRIX somewhat longer. HSTRX trades the duration spectrum of its TIPs as well as a position varying from 10%-25% in gold stocks according to proprietary indications. PCRIX overlays its TIPs with a note linked to the DJ-AIG Commodity Index. Since both pay a decent dividend (2.93% and 5.48% respectively for 2007 per Morningstar) I have them in tax-deferred retirement accounts. As you can see, HSTRX is far less volatile than the rest.

DJP is an ETN or exchange-traded note based on the same DJ-AIG Index that PCRIX uses. PCRIX has outperformed DJP since last August due to the fact that PCRIX's TIPS were in a bull market as well as were commodities. DJP uses a TBill rate "assumption" in its note. I have not read the prospectus for DJP, but I would advise doing so as always for any ETN, ETF or Fund purchase.  (I do not know the source of the Commodity Index sector weight chart)

Two mutual funds which are also "inflation funds" are CGMRX and VGPMX. I own the latter one. VGPMX I have discussed many time on the blog. It is Vanguard's Precious Metals & Mining Fund advised by Graham French in London. It has French's substantial skills and Vanguard's low costs which makes it hard to beat. CGM Realty is fascinating because of adviser Kenneth Heebner's concept of real estate: namely commercial real estate of all kinds including forests, mines and wells. Take a look at the portfolio at CGM's,  Morningstar's, or other fund website. As you can see from the FastTrack total return chart, the return shapes and annualized rates of CGMRX and VGPMX are virtually identical for the past 20 months. Since VGPMX is closed to new investors,  CGMRX would be a viable alternative for new investors. Also CGMRX can switch back to more traditional real estate holdings if and when they seem better to Heebner. Heebner has been managing CGM funds for 30 years, so I would be watching for any signs he might be getting ready to retire. I can say that traders as good as Heebner often never retire since they are having so much fun. Martin Whitman at Third Avenue Funds is over 80 and going strong.

Either or both of these funds would be a good complement to a commodity fund and physical gold in an inflation portfolio sector.

GCC (Greenhaven Continuous Commodity Index Fund) has only been trading for 11 days and is up 13%! I own it and now wish I'd bought a lot more, of course. GCC and DBC (PowerShares DB Commodity Index Tracking Fund) have a different structure than the mutual funds or ETNs above. First of all GCC tracks the equally-weighted CCI-TR which was the old CRB index, NOT the newer Reuters-Jeffries CRB Index. Each commodity is 1/17th of the value and it is re-balanced frequently. You can see from the second chart how diversified CCI is compared to GSCI and DBC: it is the entire US physical commodity market excluding a few grain, soy products (meal and oil) and energy items. DBC has just six commodities based on liquidity and some other rules: gold, silver, crude and heating oils, corn and wheat.

So there are many choices for people with different goals. GCC and DBC are also structured as grantor trusts who elected to be taxed as partnerships. This is a great format in my personal experience with it in real estate investments. Since both of these funds use unleveraged futures contracts fully collateralized with TBills, and do not pay taxes, the stock share owners are limited partners who receive the gains and losses and interest b net of expenses. Since futures contracts receive favorable tax treat for gains which came from the great 1982 tax law compromise, even a day trader will pay long term capital gains tax on 60% of her gains and short term cap gains tax on 40%. IN my case I prefer to hold these funds/Trusts/partnerships in taxable accounts for that reason. But you will need to keep track of your BC or FCC tax basis if you are holding them for long periods of time. This can be simply an annual thing to do at US tax time.

I just read the prospecti on both these funds. They are virtually identical except for their indexes. They sound daunting when read for the first time, but fortunately for me I was familiar with the concept from long experience.

Please understand that this is my own thinking out loud, and my own research and opinions. I do not manage money except for my family, and I am not an advisor. One should always do the work oneself or have a licensed professional advise us.

Inflation-hedging Smaller Income Portfolios

Last week I updated my own model income fund portfolio in  The Tax-Deferred Income Fund Portfolio post. Since then I have looked a bit more into "inflation insurance" vehicles.

In tax deferred accounts in the US, such as IRA's and 401K funds, I still believe that PCRIX or PCRDX is the best choice. PCRIX/PCRDX is Pimco's Commodity Real Return Fund  whose collateral base for its broad commodity  exposure consists of US TIPS (Treasury Inflation Protected Secutities). So there is a variable cash yield based upon the  bond yield and a quarterly inflation adjustment.

Through the end of December 2007 PCRIX paid a trailing 12 month (TTM) dividend of 5.9%, and had total returns for 2007, including those dividends plus all realized and unrealized capital gains, of 23.91%.  Due to the taxable dividends and the fact that some unrealized gains in TIPS are taxed under US IRS rules, whether received or not, holding PCRIX makes most sense in a tax-deferred account. PCRIX uses the Dow Jones-AIG commodity Index as the basis for its unleveraged commodity exposure.

Since the costs of PCRDX are 0.5% greater than PCRIX, and it still requires a $5000 minimum to purchase, I have used another approach in one family member's small IRA account. I mentioned HSTRX last week. It is John Hussman's Strategic Total Return Fund which also holds TIPS with  shorter maturities/durations than in PCRIX: about 2 years, plus a few other income-yielding securities. HSTRX also holds from 10-20% in gold stocks and varies both this percent and the duration of TIPS according to proprietary valuation models. HSTRX paid dividends of 7.9% (TTM) and had total returns including dividends of 12.66%. For each $4000 of HSTRX in this smaller IRA I bought $1000 of USAGX which is USAA Precious Metals & Minerals Stock Fund. USAGX holds a portfolio similar to Vanguard's same nmed fund VGPMX. I hold the latter in some other accounts but it is closed to new investors

Basically, adding a bit of USAGX to the "mix" with HSTRX  gives HSTRX a bit more vigor or "ooomph". USAGX had total returns of 27.80% last year. I could have used one or more of the commodity funds I'll talk about next in place of or in addition to USAGX for the  broader commodity exposure that PCRIX has.

The potentially most useful commodity fund is one which went public just last week: The Greenhaven Continuous Commodity Index Fund (GCC). The Continuous Commodity Index (CCI-TR) is maintained by Reuters,and  its history is a grand one in US-based commodity history.  CCI-TR is the successor of the famous Commodity Research Bureau's futures index of all US exchange traded physical (non financial or currency) commodities. It's the old and revered CRB Index in new clothes.

The CRB Index goes back at least into the 1940's, so there is a long daily data series for price research. CCI-TR.  " The CCI-TR is an equal weight basket of the following 17 commodities: wheat, corn, soybeans, live cattle, lean hogs, gold, silver, platinum, copper, cotton, coffee, cocoa, orange juice, sugar, crude oil, heating oil, and natural gas. Each commodity is assigned a 5.88% (1/17) index weight and rebalanced daily. The CCI-TR is calculated daily according to the daily changes in the CCI spot index, the roll yield implied by rolling selected commodity futures forward to the next defined commodities contract on specific dates, and the 90-day T-Bill yield for a single day. The index uses a system of averaging all futures prices six months forward, up to a maximum of five delivery months per commodity." So this index is like the equal weighted SPX  for stocks wherein each of the 500 stocks makes up 1/500 of the total, as opposed to the capitalization-weighted SPX.  During inflation, most commodities will go up although not all at the same time. So this gives broader exposure and perhaps lower volatility due to equal weighting.

GCC's first day of trading was Thursdsay, and it only traded 21,000 shares on Friday. Start up expenses also may impact initial earnings. I have not yet read the entire prospectus, which one should ALWAYS do before buying any fund. There may be  some "give back" by Greenhill in the first months or year to neutralize the start up costs. This is quite common in new funds.  Many index data vendors carry either the CRB or CCI-TR index intra-day. If I get into buying it soon, and I'm leaning that way, given the low start up volume, I'll sure  try to get an intra-day percent change on CRB or CCI-TR indexes and put in limit orders for an appropriate GCC price.

There are several other commodity ETF's or ETN's  which use different commodity indexes and which have been around longer:

DBC  includes the six most liquid trading world commodities: gold, aluminum. crude oil, natural gas, corn and wheat.

GSG is heavily weighted to energy futures.  "The GSCI is made up of 24 futures contracts and is primarily an energy play with 74% of the portfolio invested in oil and gas,"  wrote SmartMoney in September 2006.

DJP uses the same Dow Jones-AIG commodity index used by PCRIX, so one can see the value added by PIMCO's underlying TIPS. But in a taxable account one may not want the income dividends or tax reporting hassle of TIPS, so DJP would be a good choice in that situation.

On the chart I have GSG, DBC, DJP, HSTRX, USAGX and VGPMX and their total returns since July 2006 only because GSG only then began to have coverage in my data base. Also in the chart we see that HSTRX has much lower volatility (day to day price variation) and compared pretty well to the others for that period. Over long periods of time DBC, DJP, and PCRIX have far out-performed HSTRX. But I really like the low volatility in all of my income funds, so I really like HSTRX for smaller tax-deferred accounts I oversee. In those family retirement income accounts I am hedging only with 5-15% of total funds devoted to these funds mentioned.

There are, of course, many other ways to hedge or to bet on inflation. I have limited myself here to simple and affordable ways to hedge income portfolios against inflation in a modest way. Of course, using balanced and stock funds in an income fund is also an inflation a hedge in the long run.

Morningstar.com is a good place for basic looks at most US mutual funds, and ETFconnect.com does the same for ETF's, ETN's, and managed closed end funds. If you use a search engine you will turn up a great many other information sources.

The Tax-Deferred Income Fund Portfolio

My currently favored portfolio in larger retirement accounts (IRA's and SEP Ira's) I oversee (family only) consists of four mutual funds, each of which paid over 5% over the past year including 2008 to date. They are VWIAX, LSBDX, PCRIX, and RPSIX. I have owned all four of these myself  for some time, and I have discussed them in depth recently several articles down the blog page from here. For purposes of keeping track here, one would divide the total cash available for such an account by six. I have two 1/6ths (1/3) in both VWIAX and LSBDX, and 1/6 each in PCRIX and RPSIX. For smaller accounts one could use the lower entry minimum fund classes of VWINX, LSBRX and PCRDX. For RPSIX there is only one class. I will re-balance these funds periodically, and I plan to hold these funds  unless any fund suffers an adverse outcome like a key manager departuture or a unusual performance failure.

Using the FastTrack total return data base and chart service, the above allocation's total return for the past year to January 18, 2008 was 10.89% including both capital appreciation and with all dividends re-invested. Since in my own accounts I am drawing down retirement income, I do not re-invest the dividends, but have them put into the Vanguard Prime Money Market fund which in turn deposits a fixed amount I have chosen for each month this year into my bank checking account.

The 1/6th contribution of PCRIX to the combined account's real return was enormous this past year as inflation in commodity prices accelerated and US Treasury TIPS rose for the same reason. This fund has both a commodity and a TIPS exposure. The fund also paid over a 5% cash dividend, largely from TIPS interest.

Since December 31, 2007 to January 18, the portfolio is up at an annualized rate of 5.995%, up again due to the contribution of PCRIX.

On the chart I also show VWALX the Vanguard High Yield Municipal Fund which is one of several muni  funds I use in my own taxable accounts. I do not reinvest the interest in the muni funds which keeps bookkeeping and taxes simpler and far less. Right now municipals are coming back into favor as people contemplate both the 2008 US elections and the scheduled expiration of quite a bit of the Bush tax cut package.

For purposes of comparison only I also included on the chart the Vanguard Admiral SP500 fund VFIAX, also with total returns after dividend re-investment. I do not own this fund. It is down -5.47 over the year, most of that of course in 2008. VFIAX is down at an annualized rate of -86.08 since December 31, 2008.

The four fund  income portfolio  may not be a portfolio that everyone in or near retirement would feel comfortable with, but it does and has thrown off good income while preserving enough stocks (14.7%) and commodity and TIPS exposure (16.7%) to try to stay ahead of inflation. Consider the portfolio as an example of what one can do. The stocks in VWIAX are partly large foreign stocks as well as US stocks in its 35% stock allocation. PCRIX could be a drag in a disinflationary environment. Two thirds of the account is in bonds of all sorts as I have also discussed recently down the page.

My goal of investing near or in retirement is not to accept much risk of a major loss of capital while still having some protection against inflation. PCRIX or its higher cost but lower required minimum cousin  PCRDX will help and so will the small exposure to dividend-paying global  stocks (but largely US stocks) in VWIAX and RPSIX.

There is another risk in retirement that I have covered on the blog several times in 2007. Namely, that is the risk of falling interest rates. Obviously if rates go down over a period of time, your bonds will increase in price, but you need the income too to live on. For myself and family I purchased an immediate annuity (NOT a variable annuity) with some after tax cash  which guarantees a fixed payment per month for the life of my spouse and me, regardless of interest rates. It's like a traditional corporate pension. Read the article back a few months ago for details. It's only a partial solution, but it locks in an interest rate on part of your funds just as PCRIX guarantees to try to protect you from  inflation on your income account. If you buy an immediate annuity with after tax dollars, a large portion  of the payments are tax-free. With the funds in an immediate annuity you are on autopilot. The mutual funds income account can be changed for as long as you wish or are able to continue management.

Income Fund Update

Mutual funds designed primarily to produce income are a much larger subject and group than one would suppose. Over time here I have covered money market funds, bond funds, oil and gas royalty funds among others. One of the basic secrets in evaluating income funds is to look at their costs passed on to us. When  you are talking about 4% to 5% cash dividends, there is a dramatic difference between money funds which charge costs of less than 1/2% and those which charge over 1%. The math is, of course, quite clear and can represent a difference of 1% or more in your earnings. 1% may not sound like a lot, but 1% of a million dollars is $10,000 per year. The other factor in a low cost environment versus a high cost environment is safety. A fund with very low costs does not have to "reach" or hunt for the highest yield short term money market instruments in order to compete for your business. They can stick with the highest rated and historically reliable issuers and get paid a reasonable rate. The high cost fund managements may have to go to riskier issuers or go longer term. Without naming names in the"reach for yield" category (you can use a search engine to find them) there have recently been, and will possibly be more, money market funds which have had to be "rescued" by their backers in order to keep their price firmly cemented at $1 per share. These losers apparently got sucked into the "reach for yield" game and ended up in the sub-prime loan commercial paper debacle.

Even if you keep a lot of money in money market funds for safety, do not to go sleep. Look at the yields which are normally found in some  daily and most Sunday newspapers or on internet sites. One site is: http://www.money-rates.com/moneyfunds.htm Yields are sinking, of course, due to the Federal Reserve's cutting of the overnight inter bank rate (Fed Funds) from 5.25% to 4.25%. All other short term rates are adjusting to this large change according to their safety rating. Get in the habit of looking at the current rate of your money market fund and look up its annualized cost on its website or in its prospectus. If this cost is over 0.5% per year and it is paying out a higher than average yield to you, get suspicious of a possibly dangerous "reach for yield" which could cause problems for you. The yield to you plus the cost to you is what the money market fund is taking in on its investments. My personal favorite is Vanguard's Prime Money Market Fund which charges 0.24% annually for management and is paying 4.47% (annualized) for a total of 4.81% on their investments. There are money market funds which are currently paying more than 4.81% to their investors and charging far more annually than $0.24. So you need to know what they are investing in and for how long. The average maturity of the investments in money market funds cannot normally exceed 90 days.

This isn't rocket science, but I'm amazed that so few money market fund investors "know where their money is" in terms of interest rate paid to them, the annualized cost to them, and average maturity of the money fund holdings (0-90 days). The fourth factor is the "quality rating" of the holdings which you need to read about. Briefly, there should be a lot of Aaa and Aa issues and NOTHING with a B in the rating. Learn these four vital numbers for your fund, write them down with the date you looked and do it at least every month.

As of Friday the 3 month Treasury bill annualized rate was 3.09%, another number you should write down each time you check the interest rate, annualized cost, average maturity, and quality rating of your money market fund. That is quite a bit less than even the safest of money market funds, and  even bearing in mind that with T bills you pay no state or local income taxes, so the markets are factoring in some nervousness about non-treasury money market instruments. That "nervousness" should at least make you aware and make you LOOK.

Another time I'll discuss standard income funds of longer maturities than money mark funds: short term (up to 1-2 years), intermediate term (2-7 years); and longer term (over 7 years). The same principles apply to such funds as to money market funds: know the yield, annualized cost, maturity, and quality rating. Also use a search engine and familiarize yourself with the concept of bond duration as it relates to bond maturity. These funds and money market funds traditionally have been managed in the sense of balancing the four factors to meet a specific maturity need (short, intermediate, or long term) and a specific type of bond  (Treasury, GMNA, corporate, a mix of these, municipals, or foreign).

Another type of bond fund which has been growing in popularity and success over the past 25 years is the actively managed fund whose managers change their bond profiles just as stock mutual funds (other than indexed funds) do. You can think of traditional bond funds as indexed funds to a specific bond sector and the newer funds as actively managed, although even indexes require expert management.

Despite my admiration for Vanguard due to its very low costs (and ONLY because I use it for that reason, and  I receive NO other benefit from them, or anyone else, whatsoever), I am not a fan of index funds. I believe there are managers of all kinds of stock and bond funds who are simply better than indexes. An index, after all, lumps the good, the bad, and the ugly together so that you don't miss what the market  has to offer. Simply said, I want to invest with someone who has a record of picking the good and leaving out the ugly. You do not get a valid feel for who is very good by looking at who did best last year or even for the last three or five years! You really need to see AT LEAST ten years of total return charts (with all dividends reinvested) to see who is best through all kinds of markets. The stock market has certainly been "up and down and all around" in the past ten years, and bonds have bear markets too. I wouldn't judge a stock fund by how it did only in the past five years of a bull market, and the same goes for bond funds.

With internet access you can find such charts. http://Finance.yahoo.com is one. http://Moneycentral.msn.com/ is another. http://Morningstar.com has some free features and others for subscription and is an excellent source. http://FastTrack.net has the best total return mutual fund charts I know of, and you can look for free at some charts of specific fund companies for free or subscribe to their service as I do. I'll show you a five year FastTrack chart of six income funds, four of which I own and two (PAAIX and HSTRX) that I may buy soon, and  a nearly 17 year chart of the four of them that have been in operation since mid 1991.

VWINX is Vanguard's Wellesley Income Fund, one of the earliest of the stock and bond balanced funds, about 30-35% in stocks and the rest in bonds, mostly corporate bonds of an intermediate maturity as a rule. VWINX currently pays 4.31% as a cash dividend plus capital gains and charges only 0.25% per year. VWIAX with a $100,000 purchase minimum pays 4.41% cash dividends plus capital gains and charges only 0.15% per year and is managed by legendary Wellington Capital. Look how it sailed through from 1999 to 2003. Being a value investor VWINX did worse in 1999 than in 2002! Steady, safe, simple, long term record.

RPSIX is T R Price's Spectrum Income Fund which is a mix of several Price Funds chosen by its managers to meet its goal of a steady, safe income producer. It's relative lack of volatility beats even VWINX as it has half or less the percentage of stocks, usually 18% or less and a wider (and therefore shorter) exposure to bond maturities. You pay for low volatility with a lower payoff, but RPSIX is currently paying 4.65% annualized cash dividend on a monthly basis plus capital gains.

BERIX is Berwyn Income Fund whch is similar to VWINX long term in overall yield. In contrast to VWINX, BERIX is tilted more toward small and mid caps in stocks and to preferred stocks and higher yield corporate bonds, when justified, as opposed to VWINX's solid mega-caps and high grade corporate bonds. Berwyn had cut back on high yield corporate bonds this year which served them well. BERIX is yielding 4.70% and charges 0.73%.

Last of the "oldies" is the king of the managed bond funds, LSBDX, also available in smaller minimums as LSBRX. You can see that VWINX, BERIX, and LSBDX tracked one another pretty closely until mid 2002. LSBDX took off as they are a "go anywhere" bond fund and so were into foreign sovereign bonds "early and often". The management has won the Morningstar Bond manager award of the year many times, beaten out this year only by Bill Gross. But LSBDX's returns are far greater every year. So for the excess yield, this is where I have been. If Dan Fuss and Kathleen Gaffney, there since the start in 1991, retire or leave I'll have second thoughts. They each also have a major part of their own wealth in the fund. This fund is currently yielding 6.16% and charges 0.67%. As you will see on the five year fund chart, LSBDX is beginning to slow down as they have trimmed their sails this year wisely and ahead of the credit crunch this past summer. They did very well in Canadian Treasuries this year, and I expect that if the recession truly develops this year, they will have been cutting back more to US Treasuries and outperform less than usual.  Given their history and method I trust them to "get it right" unless at some point they do not.

PAAIX and HSTRX are income funds I have not mentioned before. If you invested through Vanguard and some other fund companies (perhaps Schwab?) which clear trades through Pershing, you can buy many of the PIMCO institution grade of funds for a minimum of $25,000 instead of $5,000,000. The "retail" versions are the same but with higher annual costs, supposedly to compensate for the extra cost of many smaller investor's traffic instead of fewer but much larger accounts. Rob Arnott does at PAAIX what the T R Price team does with RPSIX. He picks and actively changes which of many PIMCO managed funds are represented in PAAIX. Current trailing 12 month  yield on PAAIX is 7.66% with a 0.86% cost, and with PASDX (retail) 7.09% and 1.46% cost. PAAIX/PASDX are more volatile than the others but may be worth the diversification for some. I am looking at it for possible purchase since I can get in for $25,000 through Vanguard and Pershing.

Last, but not necessarily least is, John Hussman's HSTRX. It is an eclectic income fund based upon the idea of beating inflation, at least judging by its holdings. Mostly they are fairly short but variable maturity TIPS (Treasury inflation-protected notes), a few high dividend stocks, and 10 to 20% in gold stocks. Both the TIPS and gold stocks are traded, with trading for the golds based on gold stock relative strength compared to gold bullion and other undisclosed factors I am sure.
HSTRX had a modest record from inception until the past 24 months since when it has taken off in relative terms. I told you earlier that short term records of three or five years really do not test the mettle or long term abilities of managers, and Hussman may certainly have merely been lucky to ride both TIPS and gold bull market spurts of the past two years. He has shown great skill in his long/short mid cap stock fund (HSGFX) using very conservative principles, and he is still relatively young for a successful independent manager. So I feel I may be seeing in Hussman someone like Dan Fuss and Kathleen Gaffney were in their approach before they really hit pay dirt in 2002. I would like to see how he does when gold pulls back and/or TIPS do if a deeper recession occurs than most people expect. Since I own gold I do not need Hussman to give me the exposure, but as I get older I may need to simplify further and allow others to do more of my work for me.

Start simple, get a few basic facts and some history, use your head, narrow it down, simplify further.

Investing in Natural Gas

Unless you've just returned from an isolated tropical island, you've already been told that gold is approaching the high of the last Kondratieff commodity bull market in 1980 which was $850. The chart doesn't show that whole history. There were three phases starting with the crash from the 1980 commodity tops--some commodities topped in 1973/74 along with some economies, but most in 1980. Then the "flatline" of the 1990's at the new lower levels below 1980 prices until 1996/97 when the bottom fell out in a deflationary scare exacerbated by the Asian collapse and the Russian bankruptcy debacles. After the double bottoms of 1999 and 2001, commodities were off to the races with shortages of supply in everything.

Gold and natural gas (and others like copper and other metals) accelerated their climbs in 2005 before collapsing last year. The CRB Index, which represents all   commodities futures trade in the US, shows the general pattern of the past two years: a three phase correction which ended recently in August. Crude oil and gold have led the charge thereafter, but the CRB inset shows that all commodities have joined the parade with their own patterns. (Click for a larger chart.)

NYMEX natural gas resembles gold in its long term chart shapes although with leads and lags and exaggerations. NG is lagging now but beginning to make its move which happened to start at its normal seasonal low of late summer and early fall. Gas is the "clean fuel" and gives the US nearly 25% of its energy needs right now, but gas is subject to distribution and storage constraints and has had its wings clipped a bit as well by the short-sighted rush into the grain alcohol "gasoline" which requires as much energy to produce as we get from it.

We have heard the reports of two new liquified natural gas ports to be built on the Sonoran coast of Mexico "not in California's back yard" but close enough for short pipelines to Arizona, California, and possibly El Paso, Texas. Gas is still being flared off from oil wells in many areas of the world, but that is going to stop in a big way as liquified natural gas finally comes to North America and Europe. The 21st century is the gas century. Russia is the gas colossus, so get used to Mr. Putin's swagger and finger-pointing.

US-sourced natural gas is widely assumed to be on its last legs, but an elegant study of the giant Hugoton Basin by the  Kansas Geological Survey and University of Kansas concludes that the Hugoton Basin of Kansas and Oklahoma will remain a major producer at until at least 2050. My guess is that the import of liquified natural gas  (LNG) through the new mega-ports like those in Sonora will finally put a world price floor under US gas which was a political victim of price controls for so long that exploration and distribution infra-structure has lagged.

At first glance the specter of massive LNG imports coming in a few years would seem to be bearish for US natural gas. But I suspect it will be bullish, especially given the long term Kondratieff bull cycle we are in. World gas will be priced on the same energy output terms (BTU) as is crude oil.

A wise acquaintance of mine looks for inevitable cases of supply shortages which will cause price gains and tries to buy it in some sort of vehicle that "pays you to wait" until the inevitable comes to pass. As part of my retirement income research it seemed advisable to look for one income vehicles in addition to bonds. I believe Loomis & Sayles Bond Fund (LSBRX or LSBDX) is the finest fund in the land available to me. It can go anywhere with any kind of bond or any duration, and it has done so for over 16 years. It is beating accelerating inflation for the past few years. However it seemed prudent to look at income vehicles which are directly involved in commodity areas. One simple way is to buy Pimco's Commodity Real Return Fund (PCRDX or PCRIX)and I have it. I discovered that PCRIX normally requires a $5,000,000 committment to buy, but at Vanguard Brokerage Service one can get in for a $25,000 minimum presumably because a lot of Vanguard investors buy Pimco. The difference in trailing twelve month dividend yields is 5.43% for PCRIX ($25,000 minimum) and 5.02% for PCRDX ($5,000 minimum). Both pay their dividends from their underlying TIPS bonds, which I have recently discussed, and  structured commodity notes. I hadn't written about these funds for several years during the "rest period" we saw in the chart, but now is a good time to look.

But getting back to natural gas, there are at least four US gas royalty trusts which trade as stocks and pay rather nice dividends. I started accumulating them on price declines. They do not trade in huge volumes so you have to use limit orders and be patient. Owning them  is also all about patience as you are collecting 6-9% annually in monthly payouts while waiting  for the great gas bull market. No taxes are paid by the trusts, only by you. San Juan Royalty (SJT) gets its income from the New Mexico San Juan field and Hugoton Royalty (HGT) from the Kansas field. These two are nearly 100% natural gas with just a bit of petroleum distillate. Mesa Royalty (MTR)--the grandaddy of US trusts founded by T. Boone Pickens--and  Cross Timbers Royalty (CRT) started by the same parent as Hugoton Royalty--give us approximately a 70% natural gas exposure. SJT and HGT pay between 6% and 7% due to trailing lower gas prices and MTR and CRT pay over 8% due to ~30% crude oil/distillate components.

These are "wasting asset" holdings in the sense that they are not renewing their assets except by modest in-filing between wells, whee permitted, and reworking of current wells, both by their underlying operators. They have conservative reserves equal to at least ten years each, but if one looks back at these reserve life numbers four or five years ago, they were similar then. The Kansas University Hugoton study lends weight to the idea that there will be additional extensions to current estimates.

Younger investors and/or those not looking for yield may want to consider Russia's Gazprom (OGZPY) and US-based XTO Energy as a long term gas holdings. An independent and free, but delayed release, website for continued updates on many energy companies is Kurt Wulff's McDep Oil and Gas Investment Research.

Quasi-Annuities: A New Approach

As if in answer to some of the issues I have been posting on retirement income, Fidelity and Vanguard have just announced a simplified wayto draw down your mutual fund net worth during retirement. They are somewhat like fixed term variable annuities but with an attempt to pay out a fixed monthly income. In other words they are not guaranteed either in amount or for life, but will help you level out your monthly income by withdrawing both income and some part of your principal. Also unlike annuities  is the feature that if you die before you have wihdrawn everything, your heirs will have something left.

Fidelity has quickly put up a decent website section on these new funds: http://personal.fidelity.com/products/funds/funds_frame.shtml.cvsr

I'm sure Vanguard won't be far behind. Warketwatch.com has an introductory post today by Robert Powell on the subject: http://www.marketwatch.com/news/story/retirement-income-products-reduce-guesswork/story.aspx?guid=%7B00FBB2C1%2DA77E%2D48D0%2D96B4%2D8D09F961ECEA%7D

This is a good development, at least in concept, and I will be posting more later on.

Retirement Income Considerations

Very few advisors talk about how to be invested **in** retirement, mainly about how to invest **for** retirement. If we buy into the progressive age target maturities concept of Vanguard Funds (and similar plans at all the major US mutual fund families), we start in our 20's to 40's with a fund containing 70-90% stocks and eventually end up with a bond fund or funds plus a small residual portion of stock funds. If you are young, making money, and very busy with life, just sticking the money into a target maturities plan is an excellent idea to get started, e specially in 401K or IRA plans.

But whether you go on auto-pilot, learn to invest, or use an advisor, how do you live off the money you've accumulated and invested when you no longer have employment income?  "Retirement" is not my favorite word. I know people in their 20's who are retired in the sense they have no employment income and are living off their net worth. If you won a large state lottery at any age or inherited a large estate, you would also likely be "retired". A better title than "retirement income" would be "living off your net worth", and this can occur at any age if your net worth is sufficient to generate enough income for life. So the basic issues for us are: 1. Living off 2. sufficient net worth 3. for life.

Right now in early October 2007 you can earn a bit over 5% per year in a conservative money market fund (MMF) in which there is very little risk of ever losing any principal of your net worth. My favorite is Vanguard's Prime Money Market fund paying 5.03%. This rate is NOT guaranteed and in fact has been dropping several basis points (one one-hundredth of one percent, or 0.01%) per week since the FED dropped its rates by one half percent to 4.75%. MMF rates will slowly continue to decline as their assets are rolled over to newer short term fixed income instruments. But for purposes of this this discussion, assume you could make 5%. A  million dollars in a MMF would get you $50,000 per year with virtually no risk of dollar loss at any time but with the risk that your interest rate, and hence income, could decline.

Right now bank Certificates of Deposit (CD), government insured up to $125,000 per account per bank, range from 4.45% for a six month CD to 4.66% for a five year CD. These rates dropped from 4.52% and 4.82% respectively two weeks ago. http://www.bankrate.com/brm/search/story-investing.asp So your million dollars would get you $46,600 per year for five years had you bought an average five year CD on Friday last week. And it would be fully taxable. Which brings up the fact that municipal bonds are a great comparative value right now. They are government bonds of cities and counties and states, and governments  have the power of taxation to pay their bonds. Vanguard's AAA insured municipal fund (6.9 year duration and with no AMT bonds) currently pays 4.62% on current price and is totally free of US Federal income tax and partly free of state income taxes. $46,200 per year Federal tax free is equivalent to $54,118 for someone in the 15% tax bracket or $61,600 in the 25% bracket. Vanguard also has an AA and an A muni bond fund with higher yields and slightly higher risk. I have been buying some of each of the two latter funds this year on bond market plunges.

So that's what you can get on a million dollars without too much effort or risk. If you also have US Social Security retirement payments or a corporate or government pension, this may be sufficient. A million dollars sounds like a lot of money, but $45,000-$50,000 per year of investment income doesn't sound like enough to many people and their budgets. If you are older, have no debts, have good health and other insurance, and either own your home or have a low long term rental lease, it may be enough. Otherwise you may have a problem.

But there are other risks. I see the world currently in a longer term inflationary period for probably at least another decade, perhaps two decades. We saw gold going over $750 recently and the  US dollar sinking to a new all-time (modern) low. (The US dollar had its all-time low during the US Civil War when it was virtually worthless for several years.) The real challenge for someone living off their capital in this current era is to retain purchasing power after inflation, currency debasement, falling interest rates, and taxes. US Federal income taxes are now at very low historical rates, due to policies of Presidents Reagan, Clinton, and Bush. That is likely to change after next year's elections. Given inflation, a falling dollar, falling rates, and the likelihood of higher taxes in the future, $50,000 on a million dollars of capital may not be sufficient.

It is much harder for someone living off their capital to keep purchasing power into the future than it was for the generation which retired  in the early 1980's. Twenty to thirty year US Treasury bonds at that time paid 14% or more, not 4.5% as they do now, and inflation, though high, was then falling and would fall for years. We are at the other end of the interest rate and inflation spectrum or cycle now.

Look at an inflation calculator to get a feel for what future inflation would require you to earn per year to give you the same buying power as $50,000 will buy you in 2007. http://www.calculatorweb.com/calculators/inflationcalc.shtml Assuming an average 3% rate of inflation, you would need $67,196 ten years from now. Since we are in an inflationary era and will be for quite some time, the rate could be higher. An annual rate of 5% would require $81,445 income ten years from now. That would be quite a challenge for someone living on income from capital!

So now we recognize that we have investment risk, interest rate risk, tax increase risk, currency risk, and inflation risk.  I seriously recommend reading my post on annuities.http://twocents.blogs.com/weblog/2007/08/annuities.html   My family has an immediate annuity using approximately 20% of our total invested net worth.  Annuities are a simple and effective way to invest some part of your money if you are near to or in retirement, since you can insure against part of all of the listed risks with an immediate annuity, even inflation risk, for a cost. Today you could buy a $999,999 annuity (the highest amount Vanguard's annuity calculator will permit on-line http://www.aigretirementgold.com/vlip/VLIPController?page=RequestaQuote) for a male who would be 65 years old next January 1 which would start monthly payments for life on January 3, 2008 and be inflation-protected for your entire remaining life. The monthly payment would be $5,150.93 or $61,811.16 per year, and it would be adjusted for inflation each January. 81% would be tax-free, if after tax money is used tobuy the annuity, as that amount would represent return of capital.  All income wouyld be taxable if purchsed with tax-deferred IRA or 401K funds. As you will see in my annuity post, the drawback of annuities is that you will not be able to leave any of your annuitized capital to an heir. Your only risk is  that the insurance company issuing the annuity goes bankrupt. For a single person with no heirs at age 65 or older, the inflation-protected annuity is appealing for its simplicity, risk protection, and tax savings if purchased with after tax money.

Including your spouse so that whichever of you survives the other would have the same inflation protection for his or her lifetime reduces the initial monthly payment dramatically to $3,333.69. So unless you have an insurance policy for the spouse that would enable her or him to buy an annuity upon your death, this won't work for a married couple. But the example above shows what an annuity can do. I have chosen to use only about 20% of my funds to purchase an annuity, at least for now.

One can always buy additional annuities as one gets older depending upon interest rates and estate matters. And the older you are, the higher your annuity payment monthly since your life expectancy is less. If you are 70 when you buy the $1,000,000 inflation-protected annuity for yourself, you would get $6,381 per month for the first year, and for 100% joint survivorship benefits for a husband and wife, both aged 70, you would get $4,687 per month the first year. Bear in mind that annuity payouts vary with your age at the time you buy the annuity and vary with the interest rate at the time you buy it, so the numbers I mentioned are for illustration only, as of this past week.

We've looked at money market funds, five year CD's, municipal bond funds, and annuities as uncomplicated ways to generate income to live on from one's capital. Right now we can get from $45,000 to $62,000 per year on these methods with a million dollars of capital. Is there any way to get more than that? Could I get $100,000 per year? Yes, maybe, but it will take a lot of skill and effort and increased risk to do so compared to the uncomplicated methods, especially if you need the income THIS YEAR. You could increase the income part by judiciously choosing higher yield income funds with long term success rates, and you could get some tax protection with higher yield municipal funds and some inflation protection with careful selection of proven low volatility stock funds augmented with some smaller portion of specifically inflation-proof sectors such as energy and metals funds.

US stocks as measured by the Dow Jones 30 Index have historically returned 8.04% capital gain since 1932, as of Friday, and another 3% with dividends, while the US compounded inflation rate as measured by the Consumer Price Index is 3.51% annually since 1932. This is why we buy stocks: to beat inflation. But stocks don't do it every day or every month or year or put after tax income on your table in the same amounts as needed. Gold has returned 4.27% compounded annually since it was revalued at $35 by President Roosevelt in 1934. So gold has kept up with US inflation, at least before taxes and holding costs, but not as well as the Dow Jones 30.

However, in an overtly inflationary period gold does better than inflation: from January 1, 1975, when it became legal for American citizens to own gold for the first time since Roosevelt's early first term, through the end of 1980, the compounded rate of inflation (CPI) was 6.11% and gold compounded at 22.3% for the same period. This is not to say that gold will always do that. But gold has compounded at an annual rate of 15.70% since January 1, 2001 to Friday while the US CPI has compounded at a rate of 2.69%. Of course, changes in the dollar also impact the value of our dollar-denominated assets, and the US Dollar Index (versus the currencies of our trading partner nations) has declined at a compounded yearly rate of 4.93% since January 1, 2001! For simplicity's sake if we add 4.93 to the CPI rate of 2.69, we get 7.62% for currency and inflation risk from January 1, 2001 to Friday, September 28, 2007. But the Dow Jones 30 only rose 3.83% or, with dividends reinvested , 5.91% per year (before tax, if applicable) which is 1.71% per year less than the inflation and currency loss!

This is precisely why I said above that for inflation/currency insurance we need a "careful selection of proven low volatility stock funds augmented with some smaller portion of specifically inflation-proof sectors such as energy and metals funds". We want funds that have demonstrated they can go through a bear market without losing or perhaps even gaining, and we want exposure to sectors which benefit from inflation and currency loss of purchasing power. You can get this insurance very simply with US Double Eagle one ounce gold coins which you can keep at your bank or in a safe at home or your office. You could have bought them for $255 in 2001 and Friday before last they could have bought for $785. I wouldn't recommend going out and buying 100 of them all at once for $78,500, but if the idea of owning the coins appeals to you, buy one or more a month from now on no matter the price. There are reputable coin sellers in all major cities and the prices are available to you over the internet so you know the going price.

Vanguard Precious Metals & Mining Fund, which I also own, is now closed to new investors unless you have an account at Vanguard over $500,000 and commit to buying $100,000 of VGPMX. For the past 14 years VGPMX has a compounded annual increase of 13.1% despite a devastating bear market for metals between 1996 and 1998-1999. If you look at the rate for VGPMX since the 1998 low, the compounded rate is 30.25% per year, and from the beginning of 2001, as above, it is 33.70% per year. That is double the rate of increase for the metal gold in bar or coin form.

I prefer the full range of metals companies to gold stocks alone, something I learned to treasure from the late Paul Sarnoff in the 1990's. If you can't buy VGPMX or don't want to, look at USAGX Precious Metals & Minerals which has a similar approach to VGPMX. USAGX has risen a bit more than VGPMX since January 1, 2001 (37.19%). I also own VGENX (Vanguard Energy Fund) which has compounded at 23.21% per year since January 1, 2001. My gold metal, the metals fund, and energy fund are currently approximately 10% of my total assets, but even that small percentage (10%) increases the total return over my complete assets by 2-3% per year. It may not sound like a lot, but if you look at a compound interest rate table over long periods, several percentage points really makes a difference. However, owning them removes 10% of your funds from earning interest for you, so that is a limiting factor if you are living off your capital. It is an insurance policy for inflation and currency loss, but the insurance isn't free of cost.

You can also increase your return above inflation and currency losses by including several stock sectors  and by foreign country stock or fund selection. From 2000 to 2007 US small caps and mid caps outperformed large caps, and most international stock markets outperformed US markets. One of my favorite long term funds is SGENX (First Eagle Global Stock Fund). It holds both US and foreign funds and has a splendid record going back to the late 1980's. Using the same date of January 1,2001 it is up 17.62% compounded while the Dow Jones 30 with dividends reinvested is up 5.91%.  This is just one example of how sector selection can increase long term returns, but you have to know when to make a sector change. Right now US large caps are a bargain, especially for someone from outside the US, and foreign stocks are not generally the bargains as they once were. However,as with metals and energy stocks, different US sectors and foreign stocks go through periods of favor andf disfavor and often at different times. So some diversification can help. Or if you are lucky or a good speculator and want to spend some time doing that in retirement, it can help. Of course if you aren't good or lucky you can lose. Unfortunately I see more and more retired people compelled to try to speculate to increase yields for current living.

My goal is simply to show that sector selection can help. In the 11 years that both the Vanguard Total US Stock Market Fund (VTSMX) and Vanguard Total International Stock Fund (VGTSX) have been available, VTSMX has compounded at 9.32% and VGTSX at 8.75%. VGTSX did much better from 1996 to 2000, and VGSTX has done much better since 2003. You could try to time when to emphasize US stocks and when to emphasize foreign stocks, or you could always own some of each fund in whatever size or percent of total funds you see as appropriate. Vanguard and other fund families have "funds of funds" which will even do that for you at fairly low cost. VFIFX has this makeup:

1 Vanguard Total Stock Market Index Fund 72.1%
2 Vanguard European Stock Index Fund 10.5%
3 Vanguard Total Bond Market Index Fund 9.8%
4 Vanguard Pacific Stock Index Fund 4.7%
5 Vanguard Emerging Markets Stock Index Fund 2.9%
Total — 100.0%

This fund even pays a 2% dividend.This fund is just an example of how taking it easy would work toward "insuring" against inflation and currency and sector risk, and is not a recommendation as such.

I'll show you how I deal with the yield or income dilemma of how to increase yield above money market or muni bond levels in a larger part of my total retirement portfolio. I have written about this before, but this is my current thinking over the past few months as living off income from capital looms. The chart shows six specific funds that are easily bought, and the table shows some statistical information on those funds compared to a universe of interesting funds and in which funds identified by a red arrow are owned by me to some extent.

I own a fairly large portion of both VWIAX/VWINX (Vanguard Wellesley Income and LSBDX/LSBRX(Loomis Sayles Institutional Bond), both of which I have written about on several occasions at this blog. These two come in greater than $100,000 and less than $100,000 minimum versions. The only difference between the two versions is that the greater than $100,000 versions get a reduced cost fee since they are said to cost the fund less to administer in one lump sum than scattered amongst many smaller accounts. The differences are not great. you can read about these funds and most others at http://www.morningstar.com .

Vanguard Wellesley is about 68% intermediate term domestic and foreign corporate and Treasury bonds and 32% higher dividend blue chips stocks  with a few foreign stocks. Wellesley's current yield is 4.55% for the $100,00 version which is about that of a CD, but its 14 year compounded return is 8.67%. This is an income fund which generates capital gains in excess of the long term inflation rate. Since it began in 1970, Wellesley returned a compound annual return of 10.66%. That is during some horrendous bear markets and some great bull markets for both stocks and bonds. It's a rock.

Likewise, Loomis Sayles Bond Fund LSBDX has been around since May 14,1991 (in my data base) and has compounded at 11.32% per year! It suffered a maximum draw down of 9.18% during its existence and Wellesley 10.17, compared to the  Vanguard S&P500 Fund which had a maximum draw down from 2000 to 2002 of 47.51% with a compounded annual rate of 11.10! 20% of the volatility with the same return allows me to sleep better. The current yield of Loomis is over 6% with a fairly defensive posture in this year of interest rate danger. Loomis Sayles is a bond house and this fund covers the whole bond universe from US Treasuries to emerging market sovereign bonds and corporate bonds, with high yield domestic bonds as well. The managers have most of their own assets in this fund, always a good sign. So this is a bond fund with capital gains potential even during recent years when capital gains have been rare in bonds.

A third major holding of mine, but not as large as Wellesley and Loomis Sayles, is T R Price's Spectrum Income Fund (RPSIX). This is somewhat like Loomis Sayles but more conservative and with 15-20% in stocks. It is less volatile than the other two with a smaller long term return (7.16%) and currently yielding 4.47%.

Another area of bonds I have researched over the past few months is US closed-end foreign income funds. Closed ends (CEF's) trade like ETF's and some have been around for decades. Unlike ETF's they are not index funds, and they often trade at substantial discounts to their net asset values, unlike ETF's. To investigate these interesting funds, look at http://www.etfconnect.com and click on closed ends or use the search function. I've found three funds which are unleveraged (no preferred shares) or lightly leveraged, have relatively low costs for managed funds, are  discounted to n.a.v., and pay a decent yield. Two of them pay monthly, and the other quarterly. They are Alliance Bernstein High Yield Global (AWF, 7.52% yield), Templeton Global Income (GIM, yield 5.27%), and Templeton Emerging Markets Income  (TEI, yield 7.18%). GIM is obviously the most conservative and least volatile of the three. The advantages are higher yield and the currency hedge against the US dollar. I have small positions in these and would only buy more on future pullbacks. I wouldn't buy a whole lot of these as Loomis and T R Price and Wellesley do a very good job with far less price volatility.

The chart shows the major income funds and their total returns (with dividends reinvested). The table shows a number of funds ranked in decreasing order of their annualized returns since 1993. The six income funds I have discussed are in the colorized boxes, and other funds I own are only noted by the red arrows. These are either income funds or "inflation protection" funds with excellent records during bull and bear periods. Note that the "ulcer index" measures downside volatility or "sleep-ability" when owning them. The lower the UI the better one sleeps. UPI gives you some idea of how well the managers "add value" given the risk of their own ulcer index rating.

With a mixture of these funds in retirement plans plus some of Vanguard's municipal bond funds and other inflation protection funds in post tax accounts, I am able to generate approximately 5% total income returns. Then as time goes by, I plan to cash in annually some part of the inflation protection funds and stocks and gold, as needed.

A Change in the Wind

Everyone is aware that there are some shifts going on this year in asset allocation. One way I get a better grasp of potential shifts is to look at simple relative value ratios over a long a period of time.

Recently I wrote here http://twocents.blogs.com/weblog/2007/08/2cs-sentimeter-html about "range shifting" in stock market sentiment this year. The 2CS Sentimeter (5 day running total of the daily product of CBOE VXO and CBOE Put/Call ratio) not only made a higher 2CS low (less exuberance) than it has done at an interim high the past few years; but 2CS also made a much higher high (more bearish exuberance) than at any time since the 2002 lows at the July/August lows. The is a dramatic change in sentiment. We could normally look at this and say that the bears are just being even "dumber than normal". But sentiment is sentiment, and when the indicator ranges shift, as they did in March 2000 and in March 2003, they may be heralding a longer term reaction or direction change. So 2CS is a hint. But I am looking further.

An even earlier clue of change this year was in real estate. We all know about the residential realty debacle, but commercial realty had seemed immune. REITs had been zooming up for years, outperforming nearly all domestic stock sectors, even energy. But REITs hit the wall in February, well before other sectors. The Vanguard REIT Index fund (VGSIX) is down 20% from its February high and down 10% year to date. The Dow Jones Wilshire Index of real estate operating REITs and operating non-REITs has dropped 25% from its high and on a monthly a basis has fallen below several simple trend measurements for the first time since 2003.

The SP500 Stock Index, using the same trend measurements as with realty companies, hasn't quite broken down, but the "early warning" MACD could do so this month unless it rallies and closes higher than where we are today. Even more likely to break down is the ratio of the SP500 (SPX) to the ten year US Treasury note (UST). SPX has done better than UST since April 2003, but the ratio's MACD is signalling a reversal of that trend unless either UST drops quite a bit and/or SPX rallies quite a bit by the end of the month.

The same thing is being hinted about the rest of the world's stocks. The FTSE All World ex-USA Index is begining to slip the same way, and the Dow STOX50 Euopean Index (not shown) looks virtually identical to the SPX when compared to the US ten year Treasury.

More surprising is the ratio of the traditional CRB futures index to the ten year US Treasury note. The traditional CRB Index is not weighted as heavily to crude oil as most other indexes are, and it has been around far longer than the rest. It includes all US-traded physical commodities plus three metals traded in London. So it is a good index of true overall commodity futures prices. Spot or current prices may be higher but futures say that prices will be lower "in the future". The chart with the same parameters as the charts above shows that the ratio of the CRB to UST broke down last year and is still falling.

Even more surprising is that the US Dollar Index has outperformed the CRB for the past year. Only modestly so to be sure, but its trend strength, measured by the MACD, has been improving for several years.

And even the US Dollar Index is stabilizing versus the ten year Treasury on a trend strength basis! This brings up the crucial issue for all of these investment asset allocation comparisons: is the US dollar making a bottom after a nearly seven year slide? I won't get into that question in any depth except to say that the trade-weighted US Dollar Index is near 80 which has been support for thirty years. Nor do I wish to discuss Elliott Wave which is out of favor currently, and probably rightly so. But take a look at the cash EUR/USD daily chart for the past seven years. There are credible ways to label that chart suggesting that a reversal of fortunes is in the making for the Euro and the Dollar.

If the reversals mentioned here, in real estate, stocks, bonds, commodities and the the dollar, come to fruition, what are the implications? For investment it would mean lower interest rates and a higher dollar which says one should emphasize US Treasury notes and bonds above other classes. Implications for the economy would be that the economy slows meaningfully which probably means a recession. We shall see.

Portfolio Re-Allocation

The mutual fund hedging program with Hussman Strategic Growth Fund (HSGFX) and Prudent Bear Fund (BEARX) was undertaken this year partly because of my suspicion we'd get a larger pullback and also because of the need to reposition assets in several IRA retirement funds nearing mandatory RMD's, as explained in the annuity article below. My six weeks of a planned summer vacation absence played a role as well.

The maximum draw down for all invested funds was 1.78% from the market close on July 19 to the market close on August 15. Between the same two closes the Dow 30 was down 6.9% and the SP 500 was down 8.15%. The current US Treasury Bond was up 1.86% in the same time frame. As I said last time, I was nearly 50% in cash (Vanguard Prime money market fund) as well.

This past week I sold one half of the HSGFX and BEARX hedging funds on Tuesday's close and the other half on Wednesday. At the same time I sold some of the funds which had been hedged, which came out to approximately 50% of the dollar value of the hedging funds. This accomplished several things. I took the profits on HSGFX and BEARX since the market appeared to be getting grossly oversold, and I wanted to redeploy the money tied up in those funds in a manner that I decided will work better for income generation for the RMD era of the IRA's I've mentioned and some others.

After researching long term returns and agonizing over them, I sold all of the Dodge & Cox Fund (DODBX). It's a fine fund and has served me well, but having three or four separate balanced funds (stocks and bonds) in the same portfolios was inefficient. Also T R Price Capital Appreciation (PRWCX) has a better long term return (18 years) with nearly identical low volatility. Despite having 30-40% in cash and bonds, DODBX also only yields 2.6% compared to PRWCX at 2.15%. I'm redeploying some of the liquidated funds into other types of income funds as I'll get to below. I also sold several smaller holdings in real estate and real estate income, which have had a lousy year, and a few specialty sector funds.

With the freed up funds I added to Wellesley Income (VWIAX/VWINX) and will be gradually buying the following income or bond funds: LSBDX, RPSIX, PRRIX, PTTRX, and VFIJX/VFIIX). Wellesley Income managed by Wellington Management goes back to 1970 and has a real return with dividends reinvested of 10.62% compounded annually and 10.18% compounded annually since 1988 when my data base starts. It does this with very prudent selection of solid dividend-paying blue chips (including some foreign stocks) and excellent bond selection. Just seeing it on the chart tells you it is low volatility, and it's currently returning 4.45% cash dividends. You know my thoughts on PRWCX, on FAIRX, and on First Eagle Global (SGENX) which Jean-Marie Eveilllard has come back to run.

The bond and other income funds include the low cost plan vanilla Vanguard GNMA fund (VFIJX/VFIIX) which Daniel Wiener describes as a money market fund on steroids. GNMA's tend to be somewhat defensive in that their top drawer mortgages tend not to get refinanced when mortgage rates increase which reduces volatility or effective duration. Since 1994 it has compounded at 6.24% and currently pays 5.37% on the $100,000 minimum VFIJX or 5.27% on lower minimum VFIIX. PRRIX is PIMCO's inflation protected TIPS fund which has compounded at 7.74% since my data on it start in April 1999. PTTRX is Bill Gross's flagship total return intermediate term bond fund which has returned 6.83% since 1994, currently 5.01%. These four funds reflect the US bond market but are all fairly low volatility funds for various reasons I've hinted at. RPSIX is a T R Price low volatility fund of Price funds with a long history. It also has about 20% in large blue chips, so it is somewhat like Wellesley but even more conservative. Since 1994 it has compounded at 7.23%, currently paying 4.66%.

The last income fund is Loomis Sayles Bond Fund (LSBDX/LSBRX). This is a rarity in that it is a fairly low volatility high yield fund which can and does invest in every sector and many countries. Fuss and Gaffney who are the primary managers have most of their own wealth in this fund. If they ever leave, so will I. There is some risk here, but the record back to its first day in 1991 is solid. It has compounded at 11.15% since 1991, 10.56% since 1994 and currently pays 6.14%.These income funds cover the whole gamut of the bond market except munis which of course have no place in a tax-sheltered IRA.

LSBDX and RPSIX are hybrids which tend to have both the chart shape of bonds and of equities in that high yield corporates and foreign bonds tend to trade with the economy while pure bonds may trade opposite. So there is some purposeful cross-matching in the funds selection to reduce interest rate volatility somewhat.

Since VWINX and RPSIX have both a bond and a stock component, if I separated out their bond and stock components. The new portfolio (when it's done) will have ~36.4% in stocks, ~56.4% in bonds, and ~7.2% in money market funds. This is close to the usual advice for retirement fund composition. The bond components are to generate the income and the stock components to neutralize inflation, and hopefully the withdrawals, over time. The new funds have averaged ~7.12% since 1999 which is slightly less than VWINX. I only have full data for FAIRX from August 25, 2000 which was just before the Labor Day top of the SP500, but FAIRX, SGENX, and PRWCX have compounded average returns of 15.37 over a troubling chasm from 2000 to 2007 when Vanguard SP500 Index Fund total return was 0.99% per year!

These returns should beat the annuity and give some inflation protection, but the future is unknown and the past doesn't predict the future, as they say.