Nearly eleven years ago Kennon Grose and I met for dinner. I was retiring as a staffer at the Dallas Morning News. Kennon suggested that we work together and presented a fascinating idea: Let’s create an Internet-based Registered Investment Advisory firm.
No mahogany walls. No dining rooms with china and silver. We knew the time was right for a low-cost management service. We also knew many people now believed in index investing. But they didn’t want to manage their portfolios on their own.
While many RIA firms had “brochure-ware” websites, we wanted AssetBuilder to go further. We would engage potential investors with trustworthy, quality content. We would provide absolute transparency. And we would provide risk-measured, diversified portfolios. AssetBuilder would do all this at an expense level that would challenge the industry.
Already advising a handful of friends on their portfolios, AssetBuilder was a great step forward for me. It would provide a long-term management solution. It would manage my friend’s assets and my own assets. And it would do it beyond my lifetime.
And here we are. Today, AssetBuilder manages $740 million for 1,200 clients in 43 states. We are proud that we were around years before the so-called “Robo-Advisors.” But we’ve always provided some high-touch along with our high-tech. We’re also proud that we’ve continued to search for ways to provide investors with a low-cost way to deliver what we all hope to have: greater income security in retirement. Later in this letter, we’ll introduce the results of that effort.
Now 76, I’ve chosen to retire. I will remain close to AssetBuilder as a client, as I hope you will, for many years.
Personal Survival Versus Money Survival
I’ve never been happy with the conventional measure of investment success, generally represented by annual return on your investment compared to a broad index of the stock market like the S&P 500 index. The measure should be less abstract. It should be more personal, closer to our immediate concerns, like having “too much month at the end of the money.”
For retirees, it’s a big deal. Our concern is outliving our retirement savings by years. All we need is a measuring tool. So, let’s try one. Let’s measure our portfolio returns against something we all face: required minimum distributions from retirement accounts.
This becomes more important by the day. The youngest boomers are now turning 70 ½. That’s the age we must make the first required minimum distribution. Many people are afraid to make these distributions. So, it’s important to understand them as they relate to our lives.
Here are some examples:
- —A conservative investor in our model portfolio 8 (50 percent equities) had a return of 7.22 percent in 2016. That return, repeated every year, means you could take your RMD through age 86 and the nominal value of your account would grow throughout the period. Financial planner Michael Kitces says many people experience asset growth well into retirement. (You can read Kitces’ article about this here.)
- —A traditional investor in our model portfolio 9 (60 percent equities) had a return of 8.53 percent. With a bit more risk, this covers required distributions through age 89.
- —An aggressive investor in our model portfolio 10 (70 percent equities) had a return of 9.91 percent. This return covers required distributions through age 92.
Many people are quick to announce they have no intention of living to 86, 89 or 92, let alone beyond that. It does no good to remind them that how long we live isn’t like deciding to reupholster a sofa. It’s not up to us.
A life probability table tells us that 65-year-old male has only a 33 percent chance of being alive at 86. The odds are 12 percent at 92. For a woman, the comparable figures are 47 percent at 86 and 21 percent at 92. There is only a 15 percent chance both will still be alive at 86. It’s only 2 percent at age 92.
So many retirees will experience the reassurance of rising assets ‘as long as they live.’
Is there a fly in this soothing ointment? Of course. We’ve only talked about the return for a single year. We haven’t mentioned the long-term rate of return. Nor have we considered the impact of the inevitable down years. As they say, “It’s complicated.”
What we’re doing is demonstrating a little known, and even less appreciated, fact. Taking money from your retirement savings doesn’t mean you are on the path to destitution. It also suggests a very interesting notion. If we can deal with the ‘flies in the ointment,’ the financial anxieties of retirement can be much reduced. As you will see, we’ve been working on that.
2016: Uncertainty versus Wishful Thinking
Last year was a rough ride. But despite all the surprises it was a much better year than 2015.
Uncertainty is a constant. The ‘Good Old Days’ didn’t look that way when they were ’good new days.’ Instead, people saw them as chaotic, uncertain and unpredictable.
Our benchmark model portfolio, number 9, returned 8.53 percent. That’s less than the 11.93 percent of the S&P 500, but portfolio 9 is 60 percent stocks while the S&P 500 is 100 percent stocks. If you took more risk by investing in a portfolio 10, 12 or 14, you earned a higher return.
- —In model portfolio 14, for instance, the return was 12.56 percent. That’s more than the S&P 500, but the portfolio still had a 10 percent reserve in fixed income.
- —In model portfolio 12, the return was close to the S&P 500, 11.31 percent. But the portfolio had a 20 percent reserve in fixed income.
- —If you took less risk by investing in a portfolio 5, 6, 7, 8 or 9 you received a lower return. But even the most conservative portfolio provided a return greater than inflation.
The greater the risk you were willing to take, the greater the return. That’s the way it’s supposed to be. At all risk levels, returns have been high enough to sustain retirement spending. They’ve also been high enough to build real assets if you are accumulating.
The year also brought other things we liked. After years of lagging, emerging markets large value was neck-and-neck with the S&P 500. It earned 11.90 percent vs. 11.93 percent for the index. Still, there’s room for more return from emerging markets. Emerging markets could provide returns while domestic equities take a rest.
We’re not alone in this belief. Jeremy Grantham expects emerging markets returns better than developed world markets. So does Rob Arnott. We have a lot of respect for both.
They don’t come to this by gazing into a crystal ball. They say that emerging markets are cheap. Dividend levels are twice as high as domestic stocks. And domestic stocks are expensive by historical measures. When it comes to certainties in life, regression-to-the-mean is right up there with death and taxes.
But none of this has factored in the reversal of long standing trade policies or a major cut in corporate income taxes. Initiated by our new president, the results are unknown. We don’t predict, but we’re encouraged that one investor, Warren Buffet, has committed $12 billion to new equity investments since the election.
The Kaleidoscope of Investment Returns.
You’ve seen the illustration below before. It’s our annual randomness of returns graphic. In it, each asset class has a color and their returns are rank ordered in each of the last 15 years. Not a lot of pattern there. Most would call it a chaotic mosaic.
But let’s count some tiles. Over the last 15 years a fixed income asset class has been among the top five asset classes only 19 times. A fixed income asset class has been among the bottom five asset classes 30 times. Now consider. The period included two major market declines. Not to mention heroic efforts to lower interest rates. Yet, fixed income investment returns were still more likely to trail equity returns. That’s what theory predicts. That’s what has happened. It’s the pattern in the chaos. And it will continue as fixed income yields remain near their historic lows. Like it or not, fixed income will not be a strong contributor to portfolio returns for some time.
As always, this isn’t a prediction. But it’s very likely. That’s why we continue to believe broad diversification is basic. It’s important for portfolio growth and, yes, portfolio survival.
“Don’t just do something, sit there”: The Value of Constancy
High-expense active managers like to promote the notion of eternal vigilance. Combine it with global entrails reading. And add some crystal ball reading. That’s how they will grow our money and save us from indigence. All we need do is pay them handsomely for their effort. One tool they use to back their argument is the annual Dalbar report. It examines investor returns. The report finds that investor returns are lower than returns on the fund itself.
This happens because individual investors buy high and sell low. The report assumes that investors in individual funds are all common folks.
But that isn’t always true. Andrew Hallam, the Millionaire Teacher, demonstrates this on the AssetBuilder website. Investors committed to diversified portfolios enjoy higher returns than the underlying fund. Investors in hand picked asset classes underperform their fund. But 401(k) investors who choose diversified portfolios earn more than the underlying portfolio.
Here’s the data. Investors in Vanguard’s Target Date funds have earned returns as much as 2.05 percent greater than the underlying fund. This wasn’t over a single year. It was over a ten-year period ending August 31, 2016. Investor performance led fund performance in eight of the nine funds. We think that shows that diversifying is better than trying to pick the homerun fund of the week.
How does this happen? (Hint: it’s neither magic nor superior insight.) One explanation is old and simple: constancy and dollar cost averaging. If you are in accumulation mode, every market downturn is an opportunity. All you need to do is continue to reinvest dividends and interest. It helps even more to add new money.
As you may recall, there was a long, nasty downturn between 2006 and 2016.
The Other Side of the Coin
Unfortunately, the same benefit doesn’t work for retired investors. Their portfolios are in distribution— money leaves their accounts. That adds an element of danger to retirement investing. The technical name for what happens is “variance sink.” Dollar-cost-averaging adds return by automatically buying low. Retirement distributions reduce returns by selling low.
That can be a big problem, particularly in a major market downturn. You would not have known this from financial services literature until recently. In the mid 1990s investor Peter Lynch wrote that retiree investors could put 100 percent of their money in common stock and withdraw 7 percent a year. They would never run out of money, he wrote. He was dead wrong.
Since then, “portfolio survival” has become a major topic, and for good reason. Increasing longevity makes the dismal math of portfolios in distribution a major worry.
Is there a solution?
Most solutions are an illusion. The insurance industry, for instance, markets a “fix” for the portfolio survival problem. Their solution: adding guaranteed lifetime income benefits. These costly riders first appeared on variable annuity contracts. Today they are sold with fixed index-based contracts.
They’ve been successful products for the insurance industry and its sales force. They may have reduced retiree anxiety. They guarantee that you will have an income as long as you live. But expenses are high. One research firm called them good tools for transferring your assets to a life insurance company.
That’s why we’ve been working on a “cure.” We’ve been designing an investment solution that will secure a lifetime income— but without the costs and liquidity limitations of insurance products.
A Nobel Approach to Retirement
Revolutionary change takes a lot longer than most people think. The idea for index investing is at least as old as John Bogle’s Princeton University thesis. (Bogle is 87.) But index mutual funds didn’t exist until the mid-1970’s. They didn’t grow much in their first decade. But today index mutual funds and index exchange-traded funds dominate investment flows.
Another slow idea will come to fruition on the shoulders of these low-cost investment tools. Building a lifetime income without an annuity traces back to papers by Robert Merton. Written in the 1970s, two decades before he won a Nobel Prize, the concept of Life Cycle Finance Theory can now become a useful tool. We’ve been working on this for two years with two economics Ph.D.’s. Both having worked with Professor Merton.
In limited release, we are pleased to release our patent pending solution designed to target retirement income – abri. The practical outcome is more important than the math that makes it possible. With this portfolio design, retirees can enjoy a stable lifetime income. That income can start years earlier than required minimum distributions. It can also start at a higher level. And it isn’t fixed for life. You can change it.
Abri is designed around the concept of a “Retirement Health Index” which is a benchmark that measures a retiree’s joint or individual capacity to generate retirement income. Put another way, it is a measure of how well funded a person is for their desired retirement. With one quick glance, the Retirement Health Index provides a clear understanding of how retirement savings translate into retirement income.
For example, a 60-year-old couple with a $500,000 nest egg may be wondering when they can retire, or how much they can spend when they retire.
To answer this question most online calculators ask people questions about life expectancy and anticipated market returns--as if anyone knew! We start by asking our clients about things that they actually can control. For instance, how much do you currently spend on transportation, food, shelter, and other common expenses? We use your current known expenses to determine your lifetime expenses.
Once this lifetime of liabilities has been established, we begin to match these expenses with the appropriate investment strategy for each type of expense. We implement appropriate investment strategies that allow the client to maintain the retirement lifestyle that they have defined.
Unlike traditional solutions or online calculators abri allows our clients to:
- Receive a monthly payment in retirement
- Measure their retirement health status with an intuitive scoring system
- Ensure allocations and spending is tax advantaged
- Make sure all accounts are working together towards your goals
- Gauge the impact of major financial decisions such as when to take social security
- Model the impact of changes in lifestyle and spending
- Modify spending as needs change
Sophisticated planning tools have been available to advisors for years. With abri, we put the solution in your hands so you feel confident in retirement. You can test, experiment and see the immediate impact of the decisions you make for yourself. This doesn’t mean though that you are alone; our advisors are always available to walk with you through your decisions and help you execute on your retirement.
Every month, we look at your custom allocations and compare them to your goals. We determine whether these goals are still attainable and whether the allocation is still appropriate for your retirement goals. Before any money is rebalanced, we evaluate the economic advantages to ensure that all adjustments are financially prudent.
Abri is a holistic, flexible and personalized approach to convert the wealth you have today in to a monthly payment that will last through retirement for you and your spouse.