r2i forum

Author for what you see below is: vkrd

Some thoughts on where to invest and how much is needed to r2i Where to invest.

It is a given fact that stock market ( most major averages ) go up as time passes

Then it is fair to assume that markets go up given enough time ( 10-15 years ). Given that scenario, one needs to figure out how to invest and where to invest.

I personally think one should divide the portfolio in to 3 Pools

1) Main objective of this pool is to generate enough regular income.

This is the money you need on a monthly / yearly basis, or in near future.
In other words you will be taking money out of this account. So this pool needs to be
fairly liquid and secure. Although you are getting some return on your investment, your
primary objective is safety with some return.
I would get enough money to last for 7 years

If you need X each month then you need to invest Y
such that Y equals to principal + safe return on investment ( interest generated by
( Laddered Treasuries, Bank CDs etc )

By the end of 7 years you will have no money left over in this Pool. That is OK
since you are going to fill this with the money generated by Pool # 2

2) Main Objective here is to fill pool # 1 by 7th year and start over again.

Make investments in various instruments ( stock / bonds / Tnotes / Mutual Funds etc )
If history is any guide by the end of 7 years your investment will double.
At the end of the 7 th year take 50 % and transfer to pool # 1 Leave other 50 %
and start investing again in pool # 2

In other words
A) you were getting a refgular monthly income from Pool #1 for seven years
B) Your Pool # 2 doubled in 7 years.
C) Your Pool # has no money.
D) Take 50 % of Pool # 2 and transfer that to Pool #1
E) Leave the other 50 % in Pool # 2 and start the cycle again


One thing to keep in mind - There are some 7 year periods in the past that might make you think twice about this. ( is 7 years enough time to recover from lows ? )

3) Main objective here is to invest for long term needs ( House, Kids education, etc )
And Most importantly to beat the infaltion. By beating inflation I mean to add the returns to pool # 1, and pool # 2 to adjust for infaltion. Keep in mind inflation is working against you. Fortunately with proper planning time will be on your side compounding your returns.

Let us assume you have XXX K and want to implement this strategy how would you allocate your money to the pools above ?

This is an excersie to answer lot of questions on how much money I need when I go back.
Hopefully with some feed back from folks on the board we can answer this question.

I will post my thoughts soon.

Comments welcome



Part-II

Continuation of my previous post and more thoughts
Where to invest : This entirely depends on individual needs. What works for
me may or may not work for you or someone lese.

Here are some observations based upon my reaseach. I have picked lot of this data and
my previous posts data from a book by Prof Schiller's of Harvard, Burns ( columnist )
and numerous other sources.

To minimise the risk and to have steady and predictable income devide your total
portfolio in to 3 pools

Pool # 1 : Short term needs ( Regular Monthly income - to last for 7 years )
Pool # 2 : Intermediate term needs (Fill Pool # 1 Reinvest after 7 years 50 % in Pool # 1)
Pool # 3 : Long Term investment ( Add money to Pool # 1, and Pool # 2 to adjust
for inflation, Kids education, and other
long term needs etc )

The approach is simple and passive in nature as apposed to actively managing your self.

Pool # 1 : Laddered T Bills, Tax free Municipal bonds, Insured CDs etc

Pool # 2 : 50/50 Mix of Vanguard 500 index and Vanguard Intermediate Bond Index

Pool # 3 : 75/25 Mix of Vanguard 500 Index and Vanguard Intermediate Bond Index

Once a year rebalancde the portfolio by dividing the total value of the two funds
by two and moving enough money to have the portfolio balanced again to 50/50 for
Pool # 2 and 50/75 for Pool # 3


How well has 50/50 and 50/75 worked in the past compared to other investments and what
is the risk compared to other investments -

Think hard. How much risk you are going to take. What percentage in returns is worth
the risk you are taking going 100 % 500 index.

How is that for sleeping good at night and your investments working for you ?

If you started in 1973 equal amounts in 500 index, Tbills, 50/50 mix
cumulative returns on 500 index would not have exceeded the return on Treasury
bills until the 1980's and 50/50 mix until 1988

Here is the info

+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Period 50/50 75/25 Avg Bal Avg Domestic Equity


1 Year -1.80 -6.91 -4.01 -11.32

3 years 2.89 1.22 2.21 + 3.33

5 years 9.66 10.29 7.01 8.72

10 years 10.37 11.68 8.98 11.27

15 years 10.96 12.30 9.45 11.85


Standard deviation of various equities for last three years

Avg Domestic Equity Vanguard S&P 500 Index Total Bond Market Index
22.87 16.88 3.53

75/25 (mix of 500 Index and Total bond market index.) has 60 % less volatility
but comes pretty close in Avg Domestic equity fund returns for the last 15 years.


Period 500 Index 50/50
Long Cycle (73-91) 11.5 (17.9) 10.9 (10.7)

Bull Years (82-91) 7.6 (12.1) 15.2% ( 8.0)
Bear Years (73-81) 5.2 (22.1) 6.3 (11.9)

*** Look at the returns and volatility. Is mere 0.6 percent more returns worth 80 percent more
volatiliy ? This data is for 18 years
Also look at Bull and bear years return. You will sleep good with 505/50 and 75/25


Period Cash Int. Govt. Bonds Large Stocks
1966-1981 6.8% 5.8% 5.9%
1982-1997 6.4 10.6 17

Period Cash Int. Govt. Bonds Large Stocks
1966-1981 6.8% 5.8% 5.9%
1982-1997 6.4 10.6 17

I will post more thoughts on how much money you actually need to generate US $ 1000.00 per month.
safely and beat inflation for XX years.

Comments are welcome.

The advantage of this approach is purely psychological - financially it would not make any difference. There are a rather large set of financial advisors who do use this method - but the psychological benefit is based on mental accounting, so it does give comfort, even if it is misplaced.

VKRD should have trademarked this. There is a book called "Buckets of Money" that pretty much does very similar breakup and it is published after VKRD has posted about this.

Vinod

vinod,
thanks for sharing your thoughts. Yes, it is mental accounting, but it does give great "comfort of mind". For my own use, I am devising a "two pool" system. One for long term and another for short term needs.

It is interesting to know that "pool" has become "buckets" in the book. With subprime issue killing the investments, there is no surprise, pool would shrink to bucket.

After the dot com bust, the joke was my 401k has become 4k. Now we can say our pools have become buckets. ;)

vkrd, pls go for copyright before the buckets become glasses..

RRK;64607It is interesting to know that "pool" has become "buckets" in the book. With subprime issue killing the investments, there is no surprise, pool would shrink to bucket.

After the dot com bust, the joke was my 401k has become 4k. Now we can say our pools have become buckets. ;)

vkrd, pls go for copyright before the buckets become glasses..

LOL!!! Good ones, RRK!!

soomdy;64644
Nice thread.
Also I was thinking of other silly rules like
2) On daily basis, If DJIA gain > 3 %, move 3 % equities into bonds on the same day. And
If DJIA losses > 3 %, move 3 % bonds into equities on the same day.

What say?

Your costs from bid-ask spreads and other transaction costs eat up a lot of the perceived advantages of this approach. In addition asset classes have tended to have short term momentum and long term mean reversion that further negates any rebalancing "bonus". David Swenson of Yale does this for individual stocks, but then he has a billion dollar ++ base, but for individuals this is not a practical approach.

If your portfolio is around 7 digit level you MAY be able to get some significant tax alpha by going individual stock route for large cap US stocks using tax loss harversting.

Vinod

RRK,

LOL

I take it you are going to copyright the "Two glass" method.

Vinod

[quote]
I will post more thoughts on how much money you actually need to generate US $ 1000.00 per month.
safely and beat inflation for XX years.
[/quote]
Great post! Looking forward to your additional thoughts on the above US$ 1000 pm.

Desi;9756Author for what you see below is: vkrd

Some thoughts on where to invest and how much is needed to r2i Where to invest.

In other words
A) you were getting a regular monthly income from Pool #1 for seven years
B) Your Pool # 2 doubled in 7 years.
C) Your Pool # has no money.
D) Take 50 % of Pool # 2 and transfer that to Pool #1
E) Leave the other 50 % in Pool # 2 and start the cycle again

Comments are welcome.

Excellent Strategy!! Will certainly work for many folks, but there are some issues. If Pool #2 is going to double in 7 years, it is very difficult since it should be after-tax adjusted return of approximately 10% p.a. (Before tax it should return 11.77% per annum, assuming max capital gains tax rate @ 15% ). I am not taking inflation into consideration. Getting a return of 11.77% p.a. in US Stocks/Bonds Mix is extremely difficult at all times. Probably in the mid of bull market it might happen but over a long period of time say 15 years, the max we can expect wll be 9% p.a. pre-tax return. Post tax, it boils to 7.65%.

Assuming post-tax return of 7.65%, pool #2 can double in approximately 10 years(Close to 9 and half years). So the strategy can be bit changed as:

(A) You were getting a regular monthly income from Pool #1 for ten years. Let's say $50000 post-tax.
B) Your Pool # 2 doubled in 10 years. Pool #2 now has $100,000 post-tax.
C) Your Pool #1 exhausts after 10 years
D) Take 50 % of Pool # 2 and transfer that to Pool #1 which is exactly doubled money (Transfer only half which is $50000)
E) Leave the other 50 % in Pool # 2 ($50000) and start the cycle again. You might have some additional money left over since we are going to sell only 50% and pay tax only for 50%. The remaining appreciated 50% amount will still be in the pool which is unsold and we might gain a bit in this pool.

If we want to start the strategy today, we need $100K right now.

For all these strategies to be implemented, the bottomline is we need MONEY. Money goes to people who already have money and that's how god has designed our system:-)

UPDATED LATER: It seems IRS is going to eliminate Capital Gains Tax for 2008 and 2009. In that case, we can avoid the 15% tax rate and even if we earn 9% per annum with '0' tax rate, we can follow the above strategy where money doubles in '8' years. Hopefully congress keeps the same law after 2009 with no capital gains tax and the above strategy can be implemented in '8' years.