Notes starting from December 13, 2008

Updated: December 29, 2008.

Forever Controversial

ADVDX continues to create controversy. If it even comes close to maintaining its income stream, it will be an outstanding high income investment for a dividend blend. But its price has fallen sharply, along with the rest of the market.

ADVDX is hard to characterize. It has not been around long enough for us to say what will happen during a recession. Remember: our primary focus is on the income stream.

Here is what I wrote previously.

A Special Kind of Investment
A Special Kind of Investment Sensitivity Study
A Special Kind of Investment Addendum

How about 8%?

I started my retirement practice portfolio just before the October meltdown. I checked the numbers on the Simplified Automatic Allocator. If you are starting today, your continuing withdrawal rate is 8.0% (plus inflation).

My practice portfolio consists of 50% DVY and 50% PFF. I assumed the S&P500’s 5.5% dividend growth rate for DVY, not DVY’s demonstrated 8%.

Practicing for Retirement
Something Simple

High Yield Alternatives in an Income Blend

I use DVY and PFF in my practice portfolio because they are both exchange traded index funds. They tell us what is typical. Using them is very simple. With effort, you should be able to do better.

PFF is currently sporting an 11.52% yield. This brings the continuing withdrawal rate for new investors up to and slightly above 8% (plus inflation) in my practice portfolio.

Alternatives include Vanguard High Yield Corporate Fund VWEHX at a 10.26% yield and John Hancock Preferred Income Fund II (HPF) at a 16.90% yield. Both sound extremely attractive. According my Simplified Automatic Allocator, when combined with DVY, they would provide continuing income streams of 7.6% (plus inflation) and 9.9% (plus inflation), respectively, assuming that their income streams hold up.

Will they hold up? I do not know. Look into the details to make your own decisions and be caution at these withdrawal rates. Remember that high yield bonds carry default risk and that closed end funds boost yield via leverage.

Take note, as well, that financial stocks dominate preferred stock holdings. I do not expect this lack of diversification to be as much of a problem with preferred shares as with common shares. Still, you need to be aware of this fact.

TIPS Opportunity Evaporates

TIPS yields to maturity have now fallen below 2% (December 17, 2008).

Banks and Preferred Shares

Several banks are cutting dividends to pennies a share. This applies to common stock. Preferred shares continue to receive their all of their dividends. They will continue to do so as long as the common shares pay anything.

Read Michael’s Latest Letter to the Editor

This is well worth reading. He presents “Further data questioning whether Valuation Informed Indexing is really the best.”

December 9, 2008 Letters to the Editor

Looking into the Future

This is what you need to know to prepare for the future.

I took some data on the Scenario Surfer to estimate what P/E10 is likely to be throughout the next decade. I started with P/E10=14 Bear Market.

Looking into the Future

Consistent with History

The Scenario Surfer generates training scenarios consistent with the historical record. Interestingly, it sometimes reaches extremes outside of the historical record.

History reports only a small number of extreme valuations, as it must. Underlying all of this are the probabilities that we can extract from the entirety of the historical record. Such probabilities showed that the Year 2000 extreme of P/E10=44 was consistent with the previous historical record. It was unusual. But it was not so unusual to exclude it from the reasonable range of possibilities.

As we look ahead into the next ten years, we could have a brief rally lifting P/E10 above 20. The odds are close to 20%. Yet, we are very unlikely to end the period with valuations as high as P/E10=15 or 16.

Similarly, the odds are about 15% that P/E10 will fall below 6 within the next ten years. It has happened before.

We should prepare for such possibilities.

The Year 30 SWR Retirement Risk Evaluator and the Year 15 SWR Retirement Risk Evaluator also produce results consistent with history. Yet, Switching A and Switching B are optimized for a starting valuation around P/E10=26. It will take many runs on the Scenario Surfer to come up with equivalents for today’s market. The upcoming Reality Checker will automate this process.

The Scenario Surfer allows you to train yourself today. You will be able to get even better results than any mechanically defined algorithm since you can alter your strategy as the future unveils itself. This too is consistent with history. With training, it was possible to do better than Switching A and Switching B.

Looking into the Future

Stock Allocations

Here are some preliminary findings using the Scenario Surfer.

The best stock allocation for today is around 60%.

The lowest stock allocation, when starting from today, is 50%.
Increase your stock allocation if P/E10 falls below 12. Decrease your stock allocation, but only slightly, if P/E10 rises above 18.

Cut and Run

Dividend investors should sell immediately whenever a company cuts its dividend. Every time that I have failed to follow this rule, I have paid a penalty.

Many banks are cutting their dividends. Do not hesitate. Sell the common shares.

In contrast, the preferred shares are safe so long as the common shares receive any amount.

Accumulation Today

It makes very little difference whether you invest entirely in stocks today or if you use a very simple form of Valuation Informed Indexing for the first twenty years. The difference is the ride. Simply take your money off the table if P/E10 rises above 20.0. Otherwise, remain fully invested.

This is during accumulation, when the best fixed allocation is 100% stocks. The story is much different when making withdrawals. Valuation Informed Indexing is vastly superior throughout.

Maintenance Stage Update

Varying allocations makes a lot of sense during retirement when you withdraw funds. But what about the maintenance stage, when you neither add nor withdraw funds?

The traditional advice is to maintain a 100% stock allocation. Is that always the best choice? The previous answer was YES until you get close to retirement.

Here is an update at today’s valuations, after the market meltdown.

Maintenance Stage Update

Mysterious Algorithms

How do I come up with my new Scenario Surfer conditions? I am not pulling them out of the air. I am checking out our next calculator, the Reality Checker. It automates the Scenario Surfer. After selecting a strategy, I run the Scenario Surfer itself to make sure that the Reality Checker is doing what it is supposed to do.

Fixed Stock Allocations and Valuations

I made a sensitivity study of fixed stock allocations and changes in valuations in terms of Safe Withdrawal Rates.

Fixed Stock Allocations and Valuations

RobCast #46 -- Investing Is a Science (When It's Not Science Fiction)

Rob Bennett correctly states that Passive Investing is no longer science. Rational investing is.

This is an interesting podcast in plain English. It is suitable for all. It is not limited to investing specialists.

Rob Bennett’s RobCast Page Six

Retirement Practice Portfolio Holds Up

My Retirement Practice portfolio is a dividend blend. It consists of equal allocations of Exchange Traded index Funds DVY and PFF. I do not rebalance.

DVY’s latest distribution is 0.5559 payable on 12/30/2008. This is an increase from 0.5540 in the previous quarter.

PFF’s latest distribution is 0.4248 payable on 1/2/2009. I do not understand the reason for this jump. The payout was 0.1900 in the previous month.

These are comforting results considering that both DVY and PFF are heavily weighted in financial services. DVY’s weighting is about 46%. It is in common stocks and many prominent banks have cut dividends. PFF is 78% in financials, but its holdings are in preferred shares, which are protected from cuts so long as any dividends are paid on the common shares.

Practicing for Retirement

Notes Index Starting from November 23, 2007