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Portfolio Strategies for the Individual Investor Charles Rotblut, CFA Vice President & AAII Journal Editor American Association of Individual Investors [email protected]
Portfolio Strategies for the Individual Investor
Charles Rotblut, CFA
Vice President & AAII Journal Editor
American Association of Individual Investors
Coronavirus Pandemic
Source: New York Times, data as of April 10, 2020.
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It Has Spread Rapidly in the U.S.
Source: Centers for Disease Control and Prevention (CDC), data as of
April 10, 2020.
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The Bear Came Quickly
Source: The Wall Street Journal, March 10, 2020.
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Past Bear Markets
Source: S&P Dow Jones Indices; Averages calculated by AAII.
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Beginning End Start Price End PriceDuration (Months)Bear Decline
Prior Bull Gain
09/07/29 06/01/32 31.92 4.40 32.8 (86.2%)
03/06/37 04/29/42 18.68 7.47 61.8 (60.0%) 325%
05/29/46 06/14/49 19.25 13.55 36.5 (29.6%) 158%
08/02/56 10/22/57 49.64 38.98 14.7 (21.5%) 266%
12/12/61 06/27/62 72.64 52.32 6.5 (28.0%) 86%
02/09/66 10/07/66 94.06 73.20 7.9 (22.2%) 80%
11/29/68 05/26/70 108.37 69.29 17.8 (36.1%) 48%
01/11/73 10/03/74 120.24 62.28 20.7 (48.2%) 74%
11/28/80 08/12/82 140.52 102.42 20.4 (27.1%) 126%
08/25/87 12/04/87 336.77 223.92 3.3 (33.5%) 229%
07/16/90 10/11/90 368.95 295.46 2.9 (19.9%) 65%
03/24/00 10/09/02 1527.46 776.76 30.5 (49.1%) 417%
10/09/07 03/09/09 1565.15 676.53 17.0 (56.8%) 101%
02/19/20 03/12/20 3386.15 2480.64 0.7 (26.7%) 401%
Average (ex. 2020) 21.0 (39.9%) 182.7%
Post WWII Average (ex. 2020) 18.5 (33.8%) 149.9%
So where are we now?
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Shelter-in-Place Orders
Source: The New York Times, data as of April 10, 2020.
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Record Demand for Business Loans
Source: St. Louis Federal Reserve, Commercial and Industrial Loans, April 4, 2020.
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Bond Issuances Soar
Source: Reuters Breaking Views, April 4, 2020.
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Daily Changes for the S&P 500
Source: Yahoo Finance, April 9, 2020.
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Upside Volatility
Source: Wall Street Journal, April 10, 2020.
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The CARES Act
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Tax Rebates
• $1,200 per individual/$2,400 for joint filers
• Plus $500 for each qualifying child
• Phased out for AGI above $150,000 for joint, $112,500 for head of household and $75,000 for single filers
• AGI limits are $198,000, $136,500 and $99,000 respectively
• Based on 2019 AGI (or 2018 if 2019 tax return not yet filed)
Retirement Savings
• RMDs waived for this year
• Unclear if RMDs from inherited IRAs are waived
• Up to $100,000 can be withdrawn penalty-free for coronavirus-related expenses
• Taxes on coronavirus-related withdrawals pro-rated over a three-year period
• 2019 IRA and HSA contributions can be made until July 15, 2020
Charitable Donations
• $300 of qualified donations can be deducted even if standard deduction is taken
• Cap on deducting charitable donations is removed; was 60% of AGI
Given all this,
what should you do now?
Let’s start with something simple.
Have a written plan for what your investment strategy should be.
Our Brains Predate the Financial Markets
• 1975 A.D.: Charles Schwab first opens
• 1792 A.D.: NYSE founded
• 1636 A.D.: Tulip mania occurs in Holland
• 10,000 B.C.: Settlements in Mesopotamia
What’s Rustling in the Savannah?
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Noise Affects Our Decisions
We Easily Lose Sight of What’s Really Important
Source: “My Personal Portfolio Four Months After the Correction,” AAII Investor Update, April 25, 2018.
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Checklists
Pilot checklist for engine failure; Source: “The Checklist Manifesto: How to Get Things Right,” by Atul Gawande, Metropolitan Books (2009).
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“Everybody Has a Checklist”
Southwest Airlines CEO Gary Kelly; Source: “At Southwest Airlines, the Minutes After Disaster Struck,” The Wall Street Journal, April 24, 2018.
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Process Helped Me Lose Weight
Source: National Weight Loss Control Registry.
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The optimal strategy is not one that maximizes return, but rather one that
helps you stick to your long-term investing plan and achieve your goals.
New Project:
AAII Way
(Not the official name)
A Series of Worksheets Followed by a Book
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AAII Way (Version 1)
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Assess need for
Portfolio Growth vs.
Wealth Preservation
Implement and follow
investment strategy
Systematically Review
and Adjust as
Necessary
AAII Way (Version 2)
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Both Are Based on a Simple Premise
• Know who you are as an investor
• Identify and follow a strategy that’s right for you
• Review and adjust as necessary
*Lots of details behind these bullet points
Let’s talk about who you are.
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What Are You Investing For?
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Goal Years Away Priority
Retirement Now 1
Kids' (Grandkids') College 5 2
Inheritance 20(?) 3
Other ? ?
What’s Your Tolerance for Risk?
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Time Horizon Wealth/Cash Flow
Low Mid High
Very Conservative
Conservative
Moderate
Aggressive
Everyone’s Tolerance for Risk Varies
• Some investors are unfazed by downward market volatility
• Others worry whenever a correction occurs
• Sequence of returns is a big threat for those who need to take withdrawals
• Not being in the market consistently for a very long period of time is a threat to younger investors
Hypothetical Couple
• Bob and Jane are 66
• Both just retired
• Guaranteed cash flow is $100,000 per year
• No debts
• $1.5 million in savings
• Have kids and grandkids
What should their investment plan look like?
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What Do We Know?
• They are affluent
• High level of guaranteed cash flow
• Likely to live for many years
• Inheritance may be a consideration
What Investments Do They Need?
• Equities for long-term growth in wealth
• Cash and cash equivalents to avoid selling equities during down markets
• Intermediate-term bonds? Depends on their lifestyle and psychological tolerance for risk
Rationale
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Negative
Returns:
1999–2008
2000–2009
1929–1938
1930–1939
1949–1958
1950–1959
1989–1998
1947–1956
1990–1999
1988–1997
Good Long-Term Odds for Stocks
Source: Roger G. Ibbotson and Duff & Phelps, “2019 Stocks, Bonds, Bills, and Inflation Yearbook” (Duff & Phelps, 2018). Data from 1926 through 2018.
Odds of Losing Money
Source: Roger G. Ibbotson and Duff & Phelps, “2019 Stocks, Bonds, Bills, and Inflation Yearbook” (Duff & Phelps, 2018). Data from 1926 through 2018.
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Years Invested
S&P 500
Small-Company
StocksCorporate
BondsU.S. Gov't
BondsTreasury
Bills
1 27% 31% 22% 27% 0%
3 16% 23% 9% 10% 0%
5 13% 13% 3% 7% 0%
10 5% 2% 0% 1% 0%
Recovery Time From Stock Market Drops (1945–2020)
Source: “Stock Market Retreats and Recoveries,” by Sam Stovall, October 2017 AAII Journal. Updated April 2020.
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Type of Decline Number
Average Drop from
PeakDuration (Months)
Time to Recovery (Months)
Pullback (5.0-9.9%) 58 –7% 1 2
Correction (10.0%-19.9%) 23 –14% 5 4
Bear Market (>20%) 12 –33% 14 25
“Garden Variety” Bear (20%-40%) 9 –26% 11 14
“Mega-Meltdown” Bear(>40%) 3 –51% 23 58
Bob and Jane Could Live Longer Than Expected
Source: Stanford Center on Longevity.
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A ”safe” bucket can prevent them from selling equities during a down market
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Level3 Defensive Strategy
Source: “Optimizing Retirement Withdrawals Using the Level3 Strategy,” September 2019 AAII Journal.
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What If Bob and Jane Had LessGuaranteed Cash Flow?
• Sequence of returns would matter more
• Psychologically, they might prefer less volatility in portfolio returns
• The argument for including a bond allocation would be stronger
Bob and Jane Might Prefer a 3-Bucket Approach
Source: “For Bucket Portfolios, the Devil Is in the Details,” by Christine Benz, AAII Journal, July 2018.
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They Could Also Opt for 60/40
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It has a record of reliability, it’s suitable for a large number of people and while it can’t fully protect you from a crash, it will hold up a lot better than many other strategies.
Allocation Is Personal
• We can give insights on what has worked well historically, but personal circumstances must be factored in
• Even within allocation strategies, there can be customizations (e.g., incorporating small-cap stocks in the equity side of a 60/40 strategy)
Tactics to Consider
• Do you want to manage the allocation yourself?
• Do you want to pick stocks and bonds, or would you prefer mutual funds and ETFs?
• Is active management or indexing preferable?
• When will you adjust your portfolio?
• The answers should be included in your investment policy statement
Portfolio Withdrawals
• The government requires RMDs from most retirement accounts
• Roth IRAs are exempt
• If Bob and Jane needed the distributions to live on, they would have to watch how much they took out
• Required distributions in excess of what’s needed should be allocated to taxable savings/brokerage accounts
Bengen 4% Rule
• At retirement, withdraw amount equal to 4% of the portfolio value
• Each year, increase that amount by the rate of inflation
• An allocation of 50% stocks and 50% in intermediate-term bonds lasted over all 35-year periods tested
• Can have an equity allocation up to 75%
Source: “Determining Withdrawal Rates Using Historical Data” by William Bengen, Journal of Financial Planning, October 1994.
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Bengen’s later research found a 4.5% safe withdrawal rate could be
supported with a diversified portfolio of equities.
He now suggests an allocation of 45%–55% to stocks, 35%–45% in bonds
and 10% in cash.
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Source: “Insights on Using the 4% Withdrawal Rule From Its Creator,” by Charles Rotblut, CFA, and William Bengen, AAII Journal, January 2018.
Withdrawal Rates — 30 Years
Source: AAII; Roger G. Ibbotson and Duff & Phelps, “2019 Stocks, Bonds, Bills, and Inflation Yearbook” (Duff & Phelps, 2018). Data from 1926 through 2018.
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Allocation
Withdrawal Rate as a % of the Initial Portfolio Value
3% 4% 5% 6% 7%
100% Stocks 98% 92% 75% 65% 57%
75% Stocks / 25% Bonds 100% 95% 75% 59% 46%
60% Stocks / 40% Bonds 100% 98% 71% 49% 41%
50% Stocks / 50% Bonds 100% 98% 63% 44% 25%
40% Stocks / 60% Bonds 100% 98% 56% 35% 17%
25% Stocks / 75% Bonds 100% 87% 38% 22% 11%
100% Bonds 83% 40% 24% 11% 5%
4% Rule Observations
• Portfolios often, but not always, ran out of money if returns early in retirement were bad
• Having less at Year 9 in retirement than at the start was often a warning sign
• During many of the successful periods, ending balances were significantly large
• Periodic adjustments can help
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Adjust Withdrawals Up or Down
Source: “Vanguard’s Dynamic Spending Strategy for Retirees,” by Colleen M. Jaconetti, Francis M. Kinniry Jr., Michael DiJoseph and Zoe B. Odenwalder, AAII Journal, January 2017.
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If four years of expenses exceed the amount suggested by Bengen’s research, a problem exists. Bob and Jane would either need to reduce spending, consider working
and/or risk outliving their savings.
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Bob and Jane’s Strategy
• Mostly equities, with four years of expenses in cash/cash equivalents
• Self-manage their portfolios
• A mix of index funds to keep costs low
• Check allocations once per year to ensure portfolio weight in any single fund is no more than five percentage points off-target
Bob and Jane’s Strategy (continued)
• Update spending forecasts and compare against Bengen strategy to ensure withdrawals aren’t excessive (if they didn’t have enough cash flow)
• Reduce spending during down markets to preserve portfolio
• Should portfolio returns exceed expectations, set aside portion in a separate account for heirs and charity
Estate planning should be part of their investment strategy too
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Did They Set Up?
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Yes No
A Will
Medical Directives
Trusted Contacts
A List of Accounts
A List of Important Contacts
Within the Last 12 Months, Have They?
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Yes No
Checked and Updated Their Beneficiary Information
Verified Their Trusted Contacts
Updated Estate Documents for Any Family Changes
Notified Their Family of Any Changes in Accounts, Advisers, Attorneys, Etc.
Communicate Final Wishes
*Includes funeral arrangements, what their tombstones/obituaries should say, who to notify, the handling of online accounts, etc. They should preplan their funeral.
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Bob and Jane’s goal should be to create a comprehensive investment policy statement
that guides their decision process, keeps their estate in order and provides much-
needed direction during periods of market turbulence.
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A Few Final Thoughts
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Bear markets happen. They’re painful but they are shorter than bull markets.
Plus, new bull markets emerge out of bear markets.
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Nervous? Look Less Often
Source: “The Best Financial Advice I Ever Got;” The Wall Street Journal, June 16, 2019.
AAII Investor Update
(www.aaii.com/investor-update)
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2 Rules for Investing Success
• Rule #1: Develop a consistent, well-defined approach to investing
• Rule #2: Stick to Rule #1
Source: ”Adherence to Rules Helps Model Shadow Stock Portfolio’s Performance,” by James Cloonan AAII Journal, October 2012.
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Portfolio Strategies for the Individual Investor
Charles Rotblut, CFA
Vice President & AAII Journal Editor
American Association of Individual Investors
