August 20, 2015


Dear Friends,
The answer to the subject line question is: they’re included in this newsletter! As the summer is winding down, I hope you’re taking some time to enjoy with friends and family. I’ve loved spending time with my 20-year-old daughter. We even spent time talking about saving, budgeting, investing and the current election cycle. Her boyfriend graduated with a degree in economics so I thought it might be good if she learned a little bit about the subject. I didn’t want to get too serious, so we started with an internet piece that periodically makes the rounds. Maybe you have a young one that will find this humorous and might learn a couple of quick economics lessons.
You have two cows” is an almost 80 year old piece (with periodic updates) of political satire involving variations of scenarios of two cows and how the ownership of these two cows work within various economic systems. It has been used as a joke in entry-level economics courses, whereby the professor uses the two cows as metaphors for currency, capital, property, and their relationships. Here are the major world economic theories, explained with two cows.
This is not the best learning tool for young people, but in the coming months I will share an online tool that really helped my daughter learn about the process of investing.
Roth IRA Conversions – Digging Deeper
I receive many questions about Roth conversions – you can read one below in the Q&As. (As always, all Q&As are archived at my website). Most of these questions require a lot of details and often are outside my expertise. I recently referred my readers to James Lange, a CPA who has written extensively on the Roth conversion topic. For investors who like to go deep into the weeds on the subject, let me refer you to the work of Michael Kitces. His recent article, “How To Do A Backdoor Roth IRA Contribution (Safely)” is great, but filled with details. If you find it overwhelming, I suggest you share it with your advisor and get their feedback.
To your success,
Questions & Answers

Can I be more aggressive in my retirement distributions?


Q: I have enjoyed your recent podcasts regarding fixed/flexible distribution strategies. After seeing how well the aggressive (6%) distribution schedule performed, I was wondering how high one might go with this approach and still be able to sustain a reasonable distribution/balance. 7%? 8%? Even higher? Do you have any data on how even more aggressive distribution schedules would play out?
A: I think it’s possible to take out more than 6% but that would suggest having over-saved by a substantial amount, or not having a need for the savings in retirement. When I was an advisor, I had many clients who received enough from pensions and Social Security to cover all their costs of living. Those people had a lot of flexibility in choosing their distribution rate because their savings were not the source of their immediate income. Also, lots of clients took more than 6% the first couple of years of retirement. If there is a question about how much to take out of your investments, I strongly suggest you spend a few hours with an experienced advisor to check your numbers. When we update the tables next year we will consider runningthe 7% and 8% flexible distribution numbers.
What do you think of Alpha 15?
Q: I’m curious about the Alpha 15 approach, and wonder if it’s really practical for the average uninformed investor? The trading in and out and oversight required seems a little much for the average guy. However, the gains are off the chart, so the system seems worthy of a look. I am a follower of your portfolios and like the ease of knowing I’m in a fund for the long term. Just wondering what you think of Alpha 15.
A: I can’t find enough information on Alpha 15 to make a serious judgment about their hypothetical studies. From all I can find there is no real-time track record for the strategy. I hope they can convince The Hulbert Financial Digest to track their results, as it is the only way we are likely to discover the actual outcome of applying their system. Data mining is an art that can make a strategy look very smart on paper and very dumb in practice. Remember, there is no risk in the past. We know exactly what we should have done.
We have more than 80 years of data on most of the asset classes recommended by the academic community. Plus, in most cases there are decades of real time results. Before I would comment on the viability of Alpha 15 I would want to see some long-term real-time results.  10 years would be a start. When I was looking for their results in The Hulbert Financial Digest, I did notice the AlphaProfit Sector Investors Newsletter has a very fine 10 year track record. If you’re looking for something more aggressive, check it out.
By the way, I have reviewed the track record of every newsletter followed by The Hulbert Financial Digest. I will write about this in the coming months but here is one interesting result: The more aggressive (risky) the newsletter strategy, the lower the actual returns.
Why don’t you recommend any natural resource funds?
A: I think natural resources are an important part of a diversified portfolio. In fact, in the equity portion of my recommended portfolio you will find about 10% of the indexes are oriented to natural resource companies. If you are interested in the breakdown of industries held in the mutual funds you own, follow the Morningstar link to your fund and then to “Portfolio.” Scroll down and you will see the industries under “Sector Weightings”.

What’s the best way to rebalance various accounts?


Q: I am a regular reader of your articles and I read and re-read every one to make sure I do not miss any points you are making. I get the concept of rebalancing, but I need to see a concrete example to be able to do it on my own. My husband and I have IRAs, 401Ks at work and some investments in ETFs. Do I rebalance individual accounts or look at the entire portfolio as one 60/40 account?
Please enlighten me on this and if you could give an example, it would be greatly appreciated.
A: I’m glad you have found the articles helpful. I think most investors find it easiest to set up each account with the basic balance of all of the asset classes. I know it becomes more complicated to deal with a number of small accounts. Since you are still working, and adding to 401ks and IRAs, a lot of the rebalancing can be done with your new contributions.Investopedia has a decent discussion of the topic and may find enough examples for your needs.
Should Social Security be considered a bond position?
Q: It seems like Social Security should be part of my bond allocation. If I make it part of my bond portfolio, how do I decide what value to I give it?
A: I disagree that Social Security is the same as a bond. I suggest you read this Yahoo Finance article.Here is an important part of the article but I encourage you to read the entire article: “While it’s a guaranteed income, (politicians notwithstanding), Social Security is not an investable asset. It is a guaranteed source of income, like a pension. You can’t add more to it by contributing more, as you can with retirement savings accounts. But experts say you can add to your potential Social Security income by making strategic decisions, and you can make decisions about the rest of your savings by taking the nature of Social Security into account.”
I would agree that investors, who can meet their cost of living with Social Security, and other guaranteed fixed sources of income, are in a position to take more risk than those who depend on most of their income from their investments. But that’s different than considering Social Security the equivalent of a bond.
How do you handle losses in your short-term investment fund?
Q: I’ve heard you mention a few times that at the beginning of each year you take some money out of your investment accounts and put it into the Vanguard Short-Term Investment Grade fund in order to fund your yearly living expenses. It looks like the Vanguard Short-Term Investment Grade fund lost money in 2008, about 4.7%. Did you have to withdraw more money from your investment accounts in 2008 for your living expenses, to make up for the loss? Do you still follow the strategy of placing living expenses for the year in that fund?
A: Great question!  First, I would like to look at the last 10 years performance for the Vanguard Short-Term Investment Grade Bond Fund. The average return was about 3.7%. You are right to point out the 4.7% loss in 2008. And of course I’m sure you are aware the fund went up 14% in 2009. I was not retired in 2008 so I didn’t have to deal with the loss. But I did learn a lesson that has been addressed in retirement. My wife and I agree that we will make the annual distribution cover our cost of living for the year. The biggest item on our budget is “charitable contributions.” After what happened in 2008 we agreed to make the last part of our charitable contributions in December as that is our last distribution from the money that was invested in the short-term bond fund at the beginning of the year. That allows us to adjust for any decline in the value of the account – up or down!

Should I use a Back Door Roth IRA?


Q: I’ve learned a lot from your podcasts! Really enjoy learning more about each asset class. I’ve told my mom, brother and sister in law about you as well. I’ve heard about doing a “back door Roth,” which I understand is a way to move money from a traditional IRA to a Roth IRA, since I am currently in the highest tax bracket and over the Roth income limit. Is this something you would recommend? I am also about to start a safe harbor 401k with profit sharing at my dental office and will be able to max that out as well. Is a back door Roth something I should/could consider?
A: I’m pleased you have found the podcasts helpful. Thanks a million for passing the information along to others. I would be happy to help with your question, but you are getting into tax advice that I realize needs a professional response. Let me introduce to you to James Lange’s site. I have known Jim for years and find him one of the best sources of public information on Roth conversions. Here is a link to his site. Let me know if you find it helpful.  If so, pass it along to others. Plus, if you trust the information and need personal guidance, Jim works for investors on an hourly basis.
Money market funds vs. bonds?
Q: With all the risk in bonds, why not use a money market fund instead of bonds as a protection against a decline in the stock market?
A: I have no problem with using money market funds, instead of short-to-intermediate bonds, to lower the risk of loss you might experience in the equity part of your portfolio. If you think even short-term bonds are putting your money at unreasonable risk, then money market funds will suffice. I have said investors should never take a risk for which there is not an expected premium in the long term. I have continued to maintain my positions in the bonds I recommend in my buy-and-hold portfolios. They have produced a nice premium so far this year. This is about the 7th year in a row they have done okay in the face of dire predictions of pending loss.

Why do you choose one short-term fund over another?


Q:  I note you use the Vanguard Short-Term Investment Grade Bond Fund for your annual expenses. I assume you are in a high enough tax bracket that the Vanguard Low Duration Tax Exempt Bond Fund would make better sense. What’s up?
A: Because my investment is over $50,000 I would qualify for both the Vanguard Limited-Term Tax-Exempt Admiral Shares (VMLUX), paying 1.04% tax free, or the taxable Vanguard Short-Term Investment Grade Bond Fund Admiral Shares (VFSUX), paying 1.85%. If I assume a .35% marginal tax rate, the after-tax return of VFSUX is approximately 1.2% vs. the 1.04% tax exempt. So I make about 1/5th of a percent more with the taxable fund. It’s worth the time to do the calculation periodically.
Q: What do you think of the Vanguard Personal Services?
A: I am noting this here as I hope you will listen to an upcoming podcast that discusses these services. Here is a link to the Vanguard page on this service. The bottom line: 1. A great service for those who are not trying to get the best returns but want a simple approach with professional help. 2. The service has a low minimum ($50,000) so you can try it with part of your portfolio  3. You can get about the same return with a target date fund. 4. They do a fairly good job of creating a plan for future cash flow. Please watch for the announcement on my podcast on the topic.
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