Putting the pieces together...

Market Update

There has been little change in the low volatility US stock market walkup in progress since last summer. Everything seems balanced so that nothing gets terribly ahead of itself for very long. Sentiment gets reset each time it gets a bit too frothy. Buyers emerge whenever modest price pullbacks occur.

Minor indecision shows in the frequent alternation of "inflation days" and "deflation days", and they are rapidly reversed. Much of this appeaers to be based upon the daily betting line on the possibilities of a rate cut or rate increase by the Federal Reserve. Even FED spokesmen out on the speaking circuit give off different signals, sometimes in the same day. Bernanke has not put his mark on the Fed yet so positions are sufficiently fluid for the participants to speak their minds.

The primary indicators or systems I follow are still pointing upwards. After being cautious for a lot of last year, as you know, I cut loose some hedges in November/December. My quest has been guided in large part by re-positioning from an investment lifetime of accumulation and re-investment to one of post-retirement consumption via income vehicles. I am very eager to reduce volatility, but that also means reducing total returns. I saw too many people lose large portions of their assets early in retirement on several occasions over my lifetime, and I have an aversion to doing that to myself.

Therefore I am continually researching balanced funds and more exotic modern income funds. There are only a few of the exotics which have been through at least one full bull-bear-bull cycle (or more). I am not a derivatives crash freak by any means, but we don't really know what the current derivatives environment could do in a bear market, so I am sticking to funds at firms like Loomis Sayles who are "new era" bond specialists whose firm has been around since the 1920's. T Rowe Price is another nidus of modern bond experts as well as PIMCO. I am ending up with funds which have done well at least since the late 1980's and which have depth (or breadth) both in stock and fixed income.

Dodge and Cox, Wellington Management (Vanguard), T Rowe Price, and tiny Berwyn Funds consistently come out ahead of the pack in total returns and low volatility with their well-seasoned balanced funds. PIMCO's PTTRX and Loomis Sayles' LSBDX are my favorites for new era bond funds. PTTRX seems largely to be in eurodollar futures now which is a huge market that can accomodate this nearly $200 billion fund and simulate an unleveraged intermediate bond fund.

Sentiment of investors remains rather bullishly configured (they are bearish) even after this run up. I think this is due to the political warmup for the US presidential elections. The media and the opposition (is that redundant?) are magnifying the civil disruption in Baghdad into a much larger importance than it really has. Despite all the hype, it isn't really a war as much as a continuous civilian and criminal riot in Baghdad. Most of the rest of the country is fairly quiet.

However, much of the populace of the US (and elsewhere) is terrorized and wants the pain in their stomachs to stop at all cost. My fear is that al Qaeda will want to keep the terror level high ahead of the elections. That appears to me the greatest risk to the markets for the next two years.

I keep being drawn back to  biography and fiction about William Randolph Hearst who modernized and institutionalized  "yellow journalism" which persists to this day. His  goal was to influence and control the direction of governement for his own political advantage and wealth. He became governor of New York and had visions of the presidency. But for FDR, Hearst might well have been president. The Hearst family owned Homestake Mining, founded by George Hearst after his Viginia City NV glory days,  in addition to many, many newspapers, and it is clear in my mind that FDR raised the price of gold in 1934 partly to benefit and partly to silence Hearst. That move alone created enormous wealth in the 1930's when very few investments did as well as Homestake Mining.

So we must always ask ourselves who stands to gain when the media are braying loudly. I'm not quite sure I know yet in any detail, but the braying is keeping me awake some nights.

Investing During Retirement

With the proliferation of US exchange-traded funds (ETF's) and mutual funds now covering nearly every investment asset class and every sector within each class, much good information is available on making money for current living or in pre-retirement funds. But most of what I see about structuring a portfolio after retirement is banal or formulaic. It usually runs something like 50-80% in bond funds and the rest in stock indexes: one size fits all. But one size does not fit all, and most of the indexed bond and stock funds are rather volatile in price, not a comforting experience for a retired person. You don't want to retire, have a 1973-74 or 1987 or 2000-2002 experience immediately thereafter, and watch your volatile funds get decimated, as has happened to several people I know and many others.

On the other hand one sees a lot of retired people on the internet, and elsewhere, who have to trade to supplement inadequate income from pensions, Social Security, IRA's/401k's and private investments. Most of us would rather not do that nor could most of us actually make enough money regularly to make it work out. It's hard to imagine very many octagenarians day trading for fun and profit. So seriously make your money while working and invest it.

The real goals of post-retirement investing are to keep volatility low, gain as much income as one needs, and have some inflation protection. Inflation in the US has compounded annually at 3.5% per year since World War II, and then there are taxes. (See my post below from January 21, "Perspectives on sixty-one year investments", for more on taxes and inflation.)

Individual indexed bond and stock funds do not work well in retirement because they leave one entirely at the mercy of the market, which is a volatile beast at best. Also the income produced from passive indexed funds fluctuates with the market entirely, and their inflation protection is uneven. Indexes have no selection brains behind them and only give you exposure to the whole market, warts and all. However, over very long periods of income accumulation and during regular investing by working people who know little and care less about investing, putting your funds into indexed stock and bond funds and leaving it there can work out. But not when you are relying on the income during retirement, in my opinion.

What is far better I think is to find funds with long records (at least a decade, preferably two or three decades) and with a proven brain committee that has added value consistently through all kinds of markets. It takes some work to find these funds, or you have to hire someone to do it for you whom you have thoroughly evaluated. It could be the most important person you ever hire, if you don't do your own work. So spend a lot of time and thought and questioning on it with a clear view of what you really want out of an adviser. They will be working for you, not you for them. Don't let yourself be putty in their hands!

If what you really want is a steady stream of income each month with no change ever in the amount until you or both you and your spouse die, you might want to consider an immediate cash annuity from Vanguard or other low cost seller instead of what comes next in this discussion.

 

I don't manage money except my own money and that of family members, and I'm not for hire. But I want to show you a portfolio of six funds I put together for a retired family member which does all the things I said were valuable. It has low volatility over bull and bear markets, a good income stream, and inflation protection. It is an income portfolio with every asset class in it. And all the funds have been operating since at least the early 1990's.

The veteran of the group, Wellesley Income Fund (VWINX), is managed by Wellington Management for Vanguard. Wellington has been around since the 1920's and is an excellent adviser. VWINX contains about 70% bonds and 30% stocks, but both the bonds and stocks are chosen for safety, income, and modest appreciation, as you will also see with the rest of my six funds. The stocks in VWINX are both US and foreign blue chips with high dividends. If you really wanted to simplify your life, you could put 90% of your money into Wellesley Income and 10% in a money market fund and forget it. It's that good a fund.

As you can see from the chart, VWINX has returned 8.45% compounded annually (with dividends reinvested) over the past ten years of way up, way down, way up markets. And since Wellesley began in 1970 it has compounded at 10.72% per year. Naturally you will not be reinvesting dividends in retirement. But last year Wellesley Income threw off 7.4% in cash and capital gains dividends and increased in value by 3.5%, which happens to be the long term inflation rate. This proves my point, but if you want a little more inflation protection, add perhaps 5-10% of another of my funds, Permanent Portfolio Fund(PRPFX).

Permanent Portfolio Fund grew out of the inflation investing ideas of the late 1970's and early 1980's when inflation was in full flower. It was and is composed of gold and silver, Swiss Franc bonds, US T bills and bonds, and US growth stocks. But it is a very sturdy and reliable fund which has passed the test of time in every way. Since it follows inflation so very well, it did not do very well (although it was up every year) in the 1980's and until late in the 1990's. Since 1999 it has done extremely well as inflation heated up again. Think of this fund as your inflation insurance policy. It adds very little to current income, but it will help to maintain the value of your total account after inflation. This fund may be held in taxable accounts as it throws off very little taxable income.

Wellesley Income plus 5-10% Permanent Portfolio and 10% money market cash is a realistic, viable, and total investment program during retirement, with brains behind it. You can see the annualized total returns of each fund on the right hand side of the chart introduced by "Ann = x%". If you are buying more than $100,000 of Wellesley get VWIAX which has an even lower Vanguard annual cost than VWINX but with exactly the same porfolio. It is very hard to beat Vanguard's low cost structure and service and Wellington's wise long term advice.

If you have over $500,000 to put to work in retirement, and I sincerely hope you do, since $500,000 at 8.45% will get you $42,250 per year to add to, say, $20,000 from Social Security, you should add the other four funds. Keep in mind that this assumes you never touch capital until very late in the game of life. Recently, $500,000 would buy an immediate cash annuity at Vanguard for the remaining life of a 70 year old couple. The annuity would pay ~$36,000 per year but you'd be leaving nothing to your heirs or charities, which may or may not be OK with you. But you couldn't outlive it. (Keep in mind also that the annuity does not vary with the markets, but is not protected from inflation for which you'd have to pay an additional premium or receive less.) However, with a bit of brains from Wellesley Income, Permanent Portfolio, and Vanguard's Money Market Fund, you increase your yield and still have your capital to leave or use.

You can add value, yield, and even lower volatility by adding the other four funds. Dodge and Cox Balanced Fund (DODBX) is somewhat like Wellesley Income Fund except it is 65% stocks and 35% bonds and bills. Its advantages are adviser diversification (different from Wellington but just as good) and a higher proportion of stocks. They too go with blue chips and safe bonds, and they also have been doing this since the 1930's. Right now DODBX is closed to new investors, so you could wait for a large stock pullback when they may re-open, or you could buy T. Rowe Price Capital Appreciation Fund (PRWCX) which has an almost identical long term perfomance record. Vanguard's grand daddy Wellington Fund (VWELX) is also a possibility, but it hasn't done as well during bear markets as the other two. All of these also have 10-20% of their stocks from abroad, as does Wellesley Income, so you have foreign exposure.

Two more stock and bond funds are Berwyn Income (BERIX) and T Rowe Price Spectrum Income (RPSIX). These two have 20% or so each in stocks. Berwyn Income specialises in convertible stocks and bonds for the income part and Price Spectrum Income, beyond its small stock position, picks and chooses from among Price's excellent specialty bond funds, including high yield and foreign bonds. What you are gaining with these two funds is the diversification of additional proven advisers and exposure to investments other than plain Jane bonds, and in specialities of these two firms.

Loomis Sayles Bond Fund (LSBDX) is the last of the group, but it is far from least. It is a powerful bond fund from a high grade bond adviser. What I said about Price Spectrum goes in spades for LSBDX. The advisors put together LSBDX from all the excellent higher yielding bond funds at Loomis Sayles. You get brains picking the brains of Loomis but for no added cost above what the basic funds would be if you were to buy them yourself. You will get some foreign bond exposure here too if they deem it worthy of current investment on safety and yield grounds. LSBDX goes back to 1991, so it is the baby of these six funds, but it is a valuable addition to an income portfolio. If you are investing less than $100,000 in LSBDX you will get LSBRX which has a modestly higher annual cost but with the same portolio.

To sum up: long term records, consistent performance, low volatility, yield, low operating costs, reputation of excellence in all ways. Berwyn and Permanent Portfolio come from smaller advisers, but they are demonstrated specialists and their funds have the same qualities as those funds from the bigger firms. All these funds can be bought through most brokerage firms. My choice was to buy them all through Vanguard since Vanguard has the best and highest paying money market fund and perhaps the widest choices.

If you have a lot of money left over and want to keep taxes down due to a high tax bracket, consider one or more of the very, very low cost Vanguard municipal bond funds.

One to six or eight of these funds can do everything you need during retirement and leave you the time to enjoy your retirement. But do your own investigation even if you end up hiring an adviser. A good place to start, free of charge, is:

http://moneycentral.msn.com/investor/research/fundwelcome.asp?Funds=1