Saturday, January 9, 2016

Retirement Manifesto - Master Strategy

Please note that I am not an investment expert. This blog is simply my trading notebook with notes for myself and close family. Please do your own research and make your own decisions.

You can review the retirement presentation I delivered at SANS Security West 2013, or if you are planning to attending SANS Boston 2016, I will give an updated version there.

Retirement may come as a surprise. Update 1/9/2016

It is possible you will not see retirement or partial retirement coming. That is what happened to me. I had a high paying, high performance, job that entailed a lot of travel, deadlines, stress and so forth and started to have neuromuscular issues. This meant I was at risk of missing a deadline or failing to perform at par. The company was nice and understanding when I disclosed I was having problems; that meant I could not be counted on to be a "key man". However, they also moved rapidly to backstop since the show must go on. The first thing I learned about retirement is that not everyone has one of those situations where they are looking forward to age 65 being in five, four, three, two, one years; I was suddenly on a path to retirement.
NOTE: at least currently, I am semi-retired, I took a drastic financial haircut, but there is still useful work I can do from home and it means I do not have to sort out the health care insurance issue just yet. I spend hours each day managing my health primarily through diet and exercise and it is working slowly, but it is working.

We did some things right. Kathy and I have thought long and hard over the past decade about quality of life. Our vision is to spend summer in Seattle and winter, spring and fall in Hawaii. In both states we have ADA friendly houses. In Hawaii, the downstairs has an ADA shower and big wide door on the entrance. In Seattle, we have an elevator to get to the second floor and a master bedroom/bath on either floor.

We did some things wrong, or at least not optimally. Not saying I would do differently, but I wish I had thought things through better. When we were making money hand over fist, we gave some gifts to folks outside of our marriage, usually family. The gifts were given in love, but looking back, my advice to myself would be be careful about setting expectations. If you have given a family member $1,000 every Christmas for the past five years, they will expect that even after you are retired. I wish I had asked myself, if I was earning 10% of what I am earning today, would I have committed to that. It turns out that most extended families have someone who serves as the "banker". When a family member needs money, the "banker" gets asked. I have done some research and the experts say establish a gifting budget and have a set of ground rules, (is it a loan or a gift and so forth).

When one starts thinking about retirement, one thinks about money; a lot. When I was working, I didn't think about money that much. I had some, I knew some of my decisions might not be optimal, but I was moving fast. Whatever I did in the aggregate certainly beat trying to be safe and keeping the bulk of the money in a checking/savings/CD account; especially with the bull market that extended at least to April 1, 2015. Is it over? I do not know, a quick Google search indicates a lot of prognosticators think so. I do not care one way or another. Job 1 for me is to put together a budget, to be able to intelligently answer the question, how much money do we need to live on.

One thing that helps to avoid accruing debt is to put everything possible on a credit card that gives an insightful end of year report, (of course that only works if you pay the card off monthly). Since 2013, we used one credit card for all work related expenses and the other for as much as possible, (I also have the Costco AMEX for Costco purchases, (on Kauai, if you can figure out how to handle the huge portions), Costco is your best price for food).

It's all about a monthly income

I go into more detail about monthly income further into this blog post, but the short concept is that as you plan for retirement you need to make sure there is a monthly income stream. So, what are the sources of potential income?

At first it did not feel so good focusing on money, it seemed, non-spiritual, to really think about money including things such as when you might need to replace your cars. But I am coming to grips with the whole mess. I have come to the conclusion that money is, was, always will be a means to achieve goals. So while thinking money through is part of the governance process of a household, the really important question for Kathy and I is: what are our goals?

Stocks vs Bonds

The theological community will continue to debate pre-tribulation, mid-tribulation and post-tribulation all the way up to the second coming of our Lord and the financial community will continue to debate stocks versus bonds until commercial Babylon is destroyed.

The stocks camp can come up with studies showing over a decade that stocks will outperform bonds. However, we all know someone that got badly hurt in the stock market. Their 401k became a 200.5k in the dot-com bubble of 2000, the downturn of 2002, the great recession of 2008 and so forth. And these portfolios tended to shrink even for investors that did most things right.

Nevertheless, there are some macroeconomic factors that have changed. After the great recession, Ben Bernanke forced interest rates low so that investors had only one rational choice to chase returns; get into the stock market especially dividend stocks. The new Fed, Janet Yellen, may be slowly changing that policy, but the operative word is slowly. Retirees and pre-retirees need to consider the impact of that. Then at the beginning of 2013 they changed the tax code and increased the tax on dividends

Taxes and interest rates both factor in to the stocks versus bonds discussion. Taxes are especially important for the high income investor. Who is a high income investor? I would assert that a married filing jointly household with income over 72,500.00 qualifies. If part of your income stream comes from tax free municipal bonds then you do not take that 25% hit for anything above the floor. And of course when it comes to taxes, there is federal, state, payroll tax etc, so it can be a big, big bite. Others may come to different conclusions, there is a place for municipals in my family's portfolio.

If you agree, the question comes down to what percent should be stocks and why. There are some famous rules of thumb: "An old rule of thumb is that your stock allocation percentage should be 100 minus your age (this is the same as “own your age in bonds”). More recently, others have altered this to a more aggressive “110 – age” or even “120 – age”." I am currently 40% fixed income from multiple sources, 60% equities. Not everyone is going to agree with that. In fact, one of my financial advisors ( we will discuss financial advisors in a bit), told me twelve years ago: "The day you retire, I want to have you out of equities and totally in fixed income". Last week he said: "Things have changed, the things that worked yesterday, don't work anymore, we have to find new ways to chase returns." Did he flip flop or did things change? I think the answer is yes to both. But it would not be wise to be totally in municipals at this juncture, I think we can all agree on that.

Bonds or bond funds?

In 2016, a large number of pundits were recommending bond funds.

(Of course you can find an article that supports just about any assertion a person can make on the Internet). However, the primary argument for bond funds is that they spread the risk around.

In a bond fund the failure of an individual bond would not hurt as much. Whereas if you have an individual bond valued at $35k and it defaults, that is real pain. A second advantage is that these funds that have been around for a while may have long term bonds they purchased before the great recession and may be paying decent yields. If you are buying individual bonds short term today, then on a good day with the wind at your back your non-tax adjusted return might be 1.2%,  but I had some bond funds in a basket that were returning 4% and still tax free.

A third advantage of bond funds OUGHT TO BE that since their income stream is stable, they should be free from market bounces. In theory, they should have even weathered the great recession, after all as long as the municipalities do not default, the interest payments keep coming in. But many people learned the hard way that Mr. Market is speculative and the value of the bond funds did go down ( possibly making them a good buy).

There is one other factor related to the speculative nature of bond funds, I call it the dirty secret of bond funds. That bond fund may be going up for one reason only and that is because people are investing in it. Smart investors track these inflows and outflows. I have held bond funds in the past and will consider them in the future, but in 2013 largely moved away. My thesis was they are going to start drifting down for the simple reason there is no decent inventory of bonds to buy out there, so as the older bonds come due or get called in, there is only junk to replace them with. Since then, a number of them have bounced around. Sometime in 2016 or 2017 I may want to put some money back in to a tax exempt bond fund. Here is a 10 year chart on VWITX.

In 2013, where I had bond funds, the action that I took was used my Google calendar to monitor them weekly. Kathy and I agreed that if a bond fund went negative over a 30 day period we would eliminate it. We held them all for over a year so capital gains was not an issue. We did keep a TIPs fund, (SCHP), which went into negative territory in 2015, (worth less than what I paid for it). As counter-intuitive as it sounds, at that point I will probably start modestly adding to that position since it is considered a hedge against inflation. With Schwab and Vanguard you can add to their funds on their web sites for free, no commission. So if it dips in a day, you can add a modest amount. It is a great strategy assuming you have the time and energy to invest this way.

What Kathy and I are doing is creating a basket or portfolio of individual bonds that are rated A or better, have a stable outlook and are short term, no more than three years. My hope is that as these come due, I will be able to refresh my bond ladder at more favorable terms and if I can get a better yield to maturity, I am willing to go out to five years.

TIP: give the fixed income desk of your online broker a chance to shine. The basket where we have individual bonds is largely the work of the bond desk. They find much better yields than I can find and they can get them slightly cheaper than I can simply using the online interface. They also have access to a Bloomberg terminal, so they can get more information about the offering than I can. Kathy and I have had our best luck with Ameritrade, we have had two great fixed income desk people, one left and another stepped in. They do not scalp us with high fees which is important since the Yield to Maturity in January 2016 is marginal at best. BTW, I work to teach myself patience in investing, but right now I am not the only guy out there trying to acquire highly rated, stable bonds that are short term. There are so many baby boomers retiring, partial retiring, thinking about retirement that these come off the table pretty quickly. About 1/3 of the time while the broker is telling us about the bond someone else buys it our from under us. When you hear the stats you are looking for in the current environment; buy it; right now.

To sum it all up, of all our fixed income streams, municipals and dividend stocks are what I have the most of, but as we will see later, there are other streams.

It is more about the asset base than the yield. I wrote this paragraph in March 2013 when the Dow Jones was setting new records ( unless you factor in inflation). Stocks were the place to be then and money was flowing into the market. However, we know that what is going up will be going down at some point in the future. Over the past few years, I have been concentrating on the asset base, a portfolio of stocks that I understand as well as fixed income assets. Right now the bond yield is terrible, as I already said, I keep the maturities short looking for better days, but I am still investing in bonds.

NOTE: As I re-read this section doing both and update and re-programming myself to follow my strategies, I realize it sounds like I am anti-bond fund. That is not correct. I do want to have some bond funds when they make a bit more sense. I like to use BND as a proxy for the total bond market since I do not have access to Wall Street's analysis engines. This is a ten year snap shot thanks to Google Finance. The red is SPY which is my proxy for the S&P 500.  I don't want to make more of this than I should, but three points:

  • The beta is -0.04 which means nervous nellie's like myself can sleep at night.
  • It is over-all up
  • Keep in mind that this chart does not factor in in flows and outflows for BND, taxes, trading fees and other cost of doing business issues. Vanguard has a low management fee, so they take less off the top than many other investment vehicles.

Chart created 1/9/16. It compares BND and SPY which are my proxies for bonds and US stocks. Over ten years BND is up 8.5% SPY is up 33%. Clearly SPY is the better choice right? Two things to consider: BND is far more stable. More importantly if you are part of a household spend some time with a qualified tax focused CPA and factor in your tax liability, both federal and state. Intuit has a handy chart, but I will tell you this, if I lived in California or Hawaii I would be sorely tempted to increase the part of my portfolio devoted to that state's municipal bonds.

A couple words about famous stock investing mistakes

Upfront caveat, I am not a famous stock picker and never will be. I blog about financials for one reason only, for me. When I write stuff down, I remember it better. My hope is that one day, people will actually read some of this stuff and comment and I will have the advantage of their thoughts, but this is me thinking about retirement and these are mistakes I do not want to make.

  • Getting in at the top of the market after there has been a long bull run, and the corollary, staying out after a crash until it is "safe" again.
  • Buying stocks in companies I know nothing about.
  • Reading that a company just increased its dividends and having that be the primary reason I buy the stock.
  • Hunches and intuition. This is a big problem for me, I am an intuitive person. My countermeasure is to use baskets ( trading strategies) and every basket has a set of rules and I follow the rules.
  • Ignoring the numbers. I had been discounting P/Es a bit after reading Fisher's Debunkery, (Bunk 26), but I saw a table put out by the Motley Fool Special Ops service showing what an investment in any of the S&P 500 equities in 2002 with a P/E of 100 or higher were worth today. My holding in Facebook (FB) was sold in a New York Minute, but I made a profit.
  • It may be that Kathy and I are the only folks I know that factor debt into investing decision, but we monitor both the debt to assets and the debt to equity ratios and favor companies with a ratio of less than 20.

The secret advantage known as

The company that I worked for during my high income years was called SANS. It was an amazing cyber security research and education company founded by a true visionary named Alan Paller. During my time there, I learned a lot about the security business. I had the opportunity to invest in a few startups: SourceFire, Tenable, Savant Protection, Soter Partners and Zimperium. They didn't all pan out, but some of them hit big time and the jury is out on others. It was nice to watch the founders of each of these working hard to really make a difference.

Now that I am headed for retirement, I can never invest in a startup again, the risk is just too high. However, sometimes you get a chance to be on the advisory board of a company and they give you a bit of stock for doing so, who knows?

Financial advisors the good, bad, and the ugly

Don't get me wrong, I love working with financial advisors. They spend the week studying the market while I study security at least till I fully retire, so they know a lot more about trading strategies than I do. And the successful ones seem to like people.

Another advantage of a financial advisor is that they act as a sounding board. Every human suffers from correlation bias, "my last pick is making money, so I must be smart and my next pick will be good as well". We each need someone to question our so-compelling logic.

A third thing to consider is that I need more help than just someone helping me make investments. For instance, one of my online brokers introduced me to their bond desk. Now I have a relationship that is working out well for me. He can get bonds cheaper than I can with his tools. If you are considering any online broker that charges a commission over 5.00 or any investment firm start asking:

  • What else can they do for me? 
  • Who else is on the team?  
  • Can I get the same services cheaper ( or free ) elsewhere?
Those are the advantages of a Investment firm financial advisor. Now let's look at the other side of the coin. Can they actually be objective? After all, they need to get paid, how exactly do they earn their money? They all point you to the fact they charge 1.5% ( or whatever) of the total they manage, but is that all of it? Ever wonder why they keep wanting to put you in mutual funds? It is very likely they get a kickback. If you trade an equity it costs you less than ten dollars for the commission. However, if they help, you might be paying a commission of 30 - 50 dollars. In addition to the hidden costs there is the problem of opaque reporting. Investment firms are happy to tell you that you are up fifteen percent for the year. Most even have an online web page that show you the baskets they manage for you. Some will even let you drill down into the individual equities. However, being able to track the date an equity was bought at what price and the thesis for the investment is much harder to find.

Mutual funds and ETFs are actually financial advice

Actively managed funds are funds where the people in charge do research and make decisions about what to buy, an example would be TMFGX ( which I hold). Passively managed funds ( also called index funds) are generally tied to an index such as the S&P 500 and the ETF SPY. Many people believe that passive funds outperform active funds so in the spirit that you can find something to support almost any assertion on the Internet:

If you own a mutual fund or ETF, you have yet another financial advisor. This is even true, though to a lesser extent, with an index fund. After all, someone had to figure what equities to include in the MSCI All World Investable Market index. And that mutual fund advisor needs to get paid; this is why you want to carefully consider the expense ratio of any mutual fund or ETF as part of your analysis.

To sum this up:
The worst thing you can do is sign up with an investment bank financial advisor and let them put you into an expensive mutual fund after a long bull run.
Next worse is any expensive actively managed mutual fund UNLESS that is the only way to play a position you want to be in. For instance, this is the only way I could find to get into the floating rate asset class( SAMBX).
1/9/16 SAMBX has lost money for the past 12 months. As I get time I want to revisit that thesis.

A good choice is to find some well run inexpensive mutual funds based on indices you think make sense for your investment (try Vanguard to see what is possible).
Possibly an even better choice is an inexpensive ETF based on indicies you think make sense for your investment (try Vanguard to see what is possible).

They trade like equities, (mostly): REITs, LLCs, MLPs, BDCs

If one has a buy and hold investment strategy, then taking a moment to think about the tax advantages or disadvantages of certain asset choices is worth the time invested. If you are in a high tax bracket they may not be worth the bother.

Where municipal bonds may have low yield, they tend to be tax free. At the other end of the scale are the investment vehicles in this section. The short answer is if you are in a lower tax bracket, these may be to your advantage. For calendar year 2015, tax returns due April 15, 2016, if you make over $189K filing singly or $230K filing jointly, you want really thank about this. Not only is it possible to have to pay the tax on ordinary income for the three bands, (33%, 35%, 39%) if the investment is an MLP or LLC, you have have to report it on a different form. As an example, our CPA increased the cost of preparing my return when we invested in an MLP.

Let's start with Real Estate Investment Trusts, (REITs). I do have two, both ETFs. I understand there is a tax hit, according to investopedia: "The IRS requires REITs to pay out at least 90% of their incomes to unitholders (the equivalent of shareholders). This is similar to corporations, and means REITs provide higher yields than those typically found in the traditional fixed-income markets." But someone has to pay the IRS and that is the investor. So why do we bother with a REIT? It is the hope that since they are based on real estate when stocks are going down, in theory, they could be going up. Needless to say  that did not happen in the great recession. Before Kathy and I considered buying REITs, we did a lot of reading. There is more than one kind of REIT and each has its own peculiarities.

Limited Liability Corporations, (LLC), are fairly easy to understand. If we are investor/part owners and the LLC is making money and transferring some of that money to us, then we must record it on an IRS form K1 and it is generally treated as ordinary income, (or at least a chunk of it).

Master Limited Partnerships, (MLPs) almost certainly force us to abandon Turbo Tax and seek

According to this Seeking Alpha article: "Business development companies (BDCs) were created by an act of Congress in 1980, in response to “stagflationary” pressures that had eroded the supply of investment funds available for small and mid-size companies in the 1970s. Like real estate investment trusts (REITs) and master limited partnerships (MLPs), BDCs are regulated by the Securities and Exchange Commission (SEC) and are required to distribute the vast majority of profits to shareholders. In return, BDCs pay little or no income tax themselves – they pass the tax burden to individual investors, who typically have lower marginal tax rates than corporations. The mandatory distribution of tax-free profits makes BDCs – like REITs and MLPs – attractive substitutes for yield-oriented investors amid the low-interest rate environment.

Well that is clear as mud, but the key takeaway is that the investor pays the tax. The good news is there are ETFs that are built entirely on BDCs. A few Google searches like "invest BDC" or BDC ETF" will yield a good starting set of information.

Alternative sources of advice

There are any number of free blogs offering financial advice. Some, such as Seeking Alpha, want you to subscribe and share a bit of info about your portfolio. Now how good they are is anyone's guess. But, if I get an idea from one, I list the source in my trading notebook, not just the website, but the author. Hopefully over time, I will start to understand how actionable their advice should be.

Online brokers often have a research tab and some of them are quite interesting. They have stock screeners and trading ideas. Some even have the ability for individuals to access investment newsletters that would normally not be free, but they are included as part of the online broker service.

I am sure you have heard of the Motley Fool. Interestingly enough they were early adopters of SANS security training so I have always had a bit of soft spot in my heart for them. And you may have seen their free newsletter with all the titillating titles and ALL of the stories end with an invitation to receive a free report. They are trying to get you to subscribe to their paid investing newsletter subscriptions/email alerts. And it worked in both senses of the word, my two best performing baskets are based on subscriptions to the Million Dollar Portfolio (MDP) and Million Dollar Portfolio Deep Value).
1/29/15 Ron Gross has left MDP, so that basket is being closely watched.

The trader's notebook

Keep in mind the subject of this blog post is retirement and for my family, our investments are an important part of retirement. One of the things I try to always remember is that I am spending real money that we need to live on. So there are two questions that I try to keep in mind: how long does it take to earn 10k of investable money now while employed and how long will it take to earn 10k when I do not have a salary and it is all done off of investing.

Keeping a trading notebook takes time, but I need to understand what I did, when I did it and why I did it. Until November 2012, I have used a Moleskin notebook. However, I made a change a couple months ago and started keeping the kind of records and analysis that I used to do with my paper notebook using this blog. I expect most of the posts will be way too far in the weeds for anyone but me. But as I said earlier I hope over time other investors will read and leave comments.

The importance of baskets or strategies

We have already talked about the danger of emotion or "intuition" in trading. The problem is compounded because when I do pull a rabbit out of a hat, I have the risk of correlation bias. If I  pick a stock out of thin air and it goes up, I am far more tempted to do this again.

If I want to avoid Kathy and I outliving the money our investments provide (mission, (the purpose of this master strategy)), I need to be disciplined (values). I need to have a strategic plan looking forward at least for five years and far better, ten (vision).  The way to create a strategic plan is to have strategies and the strategies are implemented by the baskets. The rules of the baskets are in place to help drive the outcome and prevent me from using emotion or intuition or at least keep it to a minimum.

TIP: Online stock brokers at least the ones I am familiar with do not penalize the small investor. So, I use one online service per basket, so that all the equities in any given basket have the same strategy. This allows me to do some of the red/green analysis I do since I am comparing apples to apples. I do allow more than one basket to have the same equity, IBM could be in a tech basket and a dividend basket as an example, but try to make sure I do not reach a core stock level accidentally.

Core stock definition: to a large extent, since the commission of the online brokers I use is fairly low, less than eight dollars and several are less than five, I am comfortable having some significant diversity. However, there are some equities (Amazon, Apple, Google, IBM, Visa, UPS) that I have a much bigger allocation than the others. These are the core of my equity portfolio and they have the biggest impact. If they have a good run such as Amazon and Google, money flows into the retirement portfolio. If they hit a rough patch such as Apple, then the value of the portfolio is diminished.

Examples of baskets

Low cost ETFs/mutual funds. Keeping in mind I am not an expert financial advisor or investor, but if you asked me for advice about that actual investing process for retirement, I would tell you to open an account with Schwab or Vanguard and take advantage of their low overhead cost, free to trade ETFs. Kathy and I eat our own home cooking as well. Take your time, build your portfolio use lots of limit orders or buy on dips. Try to get at least one bond fund and cover small cap, mid cap, large or mega cap even if you buy just one share. Get something that doesn't include the US, (ex - US). Then from time to time, visit your account and if one of these ETFs got slammed that day, add to your position. It will all even out in the wash.

Limit order sidebar ===================
Using limit orders is a critical strategy for investors that do not have a bank of supercomputers on Wall Street. The market can swing wildly in less than a second. If I set a market order, especially when the market is closed, I have a serious risk of paying 1 -50% more than I expected when I put in the order. Having a successful equity portfolio is a matter of picking the right stocks and ETFs and paying the right price when I open or add to a position. I use limits in two ways:

  • Controlling the price I am going to pay. If the equity is trading at $10.00 and I set the limit at $9.95, I know I will not pay more than 9.95. Again this is critical for after hours trading, (did I mention I live in Hawaii part of the year where we are six hours behind NYC).
  • A place to park money sitting on the sidelines. Maybe an online broker keeps our non-invested  money in a money market where it earns .000001% interest, maybe it is 0%; either way this is not the path to retirement. I like to place an aggressive limit order for a couple of the best companies in the portfolio, or a company on the watch list for that strategy or basket. Aggressive means anticipating a drop of 10% or more, (the kind of thing that happens when a company misses earnings, releases forward looking guidance Wall Street does not like, or those whacky events that roil the broader market).
The downside of limits is they may not hit. If I want to open or add to a position, I need to choose a realistic limit. One thing is certain, eventually we all experience setting a limit that never hits. That pesky equity just keeps going up. We smack ourselves in the head and say, "I should have set a market order". Danger Will Robinson! We need to avoid correlation bias and single data point management. Take a deep breath, go to YouTube and play "Too many fish in the sea" and the madness should pass.

All municipal bonds. We still have some lovely bonds from "the good old days" when you could actually get some yield. However, more and more these are A rated or better with a stable outlook, 1.2% yield before factoring in taxes minimum with a maximum investment an any one bond, with a maximum time frame of three years. And these are in great demand, almost half the time while I am going through the due diligence process with the bond desk, by the time we are done, the bond has already been snapped up. My hope is that when these start coming due, it will be a more favorable time to buy bonds.

All dividend stocks. After, I am no longer drawing a salary, this will be a source of money to live on. Since I am still working, every equity that supports a Dividend Reinvestment Plan (DRIP) has that enabled, so the number of stocks that I have grows with every dividend payment.

All CDs (well mostly, at this writing there are two energy "orphans" in the account). Obviously with the current interest rates this can't be but so much of the portfolio, but I have them short and with luck, I will be able to reinvest at a higher rate of return. The good news is they are safe and stable, the bad news is the return on investment. I probably would not do this at all, but I have this memory from undergrad, (1977 - 1981). I do not remember the exact year, but I do remember being behind my dorm mother in line at the bank across the street from the college. I heard her ask, what is the interest rate if I roll over my CD, the answer came back 10.25%. Wouldn't you love to have a few of those in your portfolio pegged for 30 years? Man has to have dreams. BTW, buying a CD from your local bank is the next best way to through money away, (the best is buying a boat). I get mine from an online broker, (new issues and occasionally the second hand market), there are also websites to find the most highly rated bank issued CDs.

Two other baskets are the Motley Fool Million Dollar Portfolio (MDP) and Million Dollar Portfolio Deep Value). When these services say buy, I buy, when they say sell, I sell.

One last basket to mention as an example is Ts. I may spend way too much time on this one, but it is my own actively managed mutual fund.

TIP: Bullets versus Cannonballs. Since the commission of the online brokers I use is fairly low, less than eight dollars and several are less than five, I don't tend to make really large trades. Also, there are some online brokers that allow commission free trades. Then, I can go as low as five shares per trade. Yes, it takes time, but I am trying to fine tune my portfolio in the period of life before I move away from salary, so it is an investment of time I am willing to spend.

Inflation is a blessing and a curse

My thesis is that inflation is irrationally low. I also believe the number is contrived. Though it is a little bit gloom and doomish, the best site I have found is So, a smart investor wants to be familiar with hedges against inflation and some that I use are:

  • TIPS. I do not buy actual treasury inflation protected t-bills in current market conditions. They aren't worth anything in terms of yield, other than the fact that if you can believe the inflation metric they are still not worth anything at a higher rate of inflation instead of being worth less. So right wrong or indifferent, I have some money in SCHP, a Charles Schwab TIP fund. I try to buy on dips (today was a dip). I am being very patient, but added five shares market after the dip and am currently up 6% with this strategy.  Of course, this goes straight back to the bond fund versus bonds discussion, if the market suddenly got the heebee jeebees about this it would drop and all my work would be hindered. On the other hand, if the market got spooked about inflation, it could be time to profit take. 
  • GTIP. No idea where the idea for this came from, suspect someone dropped the ball on keeping careful notes in his trading notebook, but it seems to be a hedge against global inflation. It is the only thing in basket Ak that is not a bond.
  • Commodities. In an inflationary period things cost more so investing in commodities and basic materials is considered a hedge against inflation. I have some ETFs and such but not as much as I should, this is an area for future research and consideration.
  • Floating rate funds. This may be something you do not have in your portfolio and at the right time it could make sense. Interest rates are artificially low because of our friends Ben Bernanke, so floating rate funds ( buying packages of loans ) are not earning as much income as they could. So maybe, just maybe, if interest rates start to climb these funds will go up. And here is the trip, maybe, just maybe if Mr. Market *thinks* interest rates are going to go up, these funds will go up, just remember to get out after interest rates really do go up or we could get caught in the down draft.
  • Mortgage backed securities. This has certainly been nice to have since the Fed and artificially low interest rates. I use VMBS, don't have a monster position, but it is part of the portfolio.
  • Real property. The debt discussion is coming up shortly, but my personality is not suited to leverage, (use debt to buy properties to rent out, or speculate). However, real property is a hedge against inflation. Many people own a home, there are those who say it is financially better to rent, but there are those who will say anything :). However, whatever choice you make, look into taxes, maintenance and liability before executing on your decision. And yes, we own our home and will soon, (hopefully), have the vacant lot next to it.

Debt and inflation

Kathy and I have aspired to live a debt free life for over thirty years. And as we stand at the cusp of an unplanned retirement, this is very comforting. But debt can impact, probably will impact our retirement even if we do not have any debt, how is that?

Some genius decided to create a tax deduction for mortgages. Amplified by leverage and greed, this led to the bubble that nearly destroyed us all in the great recession.

But the ten gazillion pound elephant on the table is the US national debt. I am not a political man and tend to be pretty balanced between the parties, but it is pretty clear President Obama does not have reducing the US deficit as a priority and he was probably the last guy that had a shot at it. We will be in so much debt four years from now there is no way to recover. Well, no, there is a way. Inflation.

Inflation could be used to reduce the deficit because the dollars we owe would be worth less. But this would not be a good scenario for almost anyone that lives in the USA ( or foreign countries that hold our debt). So we come back to the importance of understanding hedges against inflation. And the emphasis is on hedges.

Money markets

Many online brokers will allow you to keep cash on the sidelines in a money market. There is nothing whatsoever exciting about a money market, but if you have the cash on the sideline you can move in a moments notice when there is opportunity.

Other sources of retirement income

If you are starting to think: "I don't know, I am not sure I want to trust my future in stocks and bonds", you are very wise. They should almost certainly be part of our retirement portfolios, but they probably should not be our entire portfolio.

Owner financing. We have a Frank Lloydesque house on a canyon on Kauai. We had been renting it, but those folks left, so we gave it a paint job and put it on the market. This will still during the time when house prices were decimated by the bubble. In order to get our price, we put it up with an option of owner financing.
NOTE: 5/1/14 A friend of mine says that this is about to get much more complex, so I Googled it and she is right!

Reverse mortgage. Each of my houses is high end. Currently they do not appraise like they should because of the market, but I am patient. Much later in life, it may make sense to do a reverse mortgage on one or ( depending on the tax laws at the time) more than one of them. The wonderful thing about this is it will make the job of whomever has the task of liquidating our estate when we both pass on to heaven a bit easier.

Many of the people in my trade write books. This leads to royalties. I will never get rich off computer security books, but while I have been salaried, this has allowed me to open and contribute to a SEP IRA.

I have a bit of understanding how to create and run a business and a bit more on how to market a business. It might be that I can use some of the money I have earned to finance and start a business, preferably one that does not require me to be present all of the time.

Annuities. There is no way to define annuity, there are as many of these as grains of sand on the beach and so many different kinds. At its simplest they are an investment contract with an insurance company. I got the first one we own from NY Life, out of an advertisement in AARP magazine so that Kathy would have an income stream regardless of what happened to our stocks and bonds. Since then we have added several others from different insurance companies.

How much do you need in retirement and how do you know?

When you get to the place in life where I am and make no mistake, you will; it is the very rare person that is able to work into their nineties. You can bet they will ask you how much you need in retirement. You will find that is an important question to be able to answer. Twenty five years ago Kathy and I could have done it, we were using the Larry Burkett envelope budgeting system. Then the SANS blur happened, and there was plenty of money because we were working all the time, but we lost control of expenses. Now we are trying to regain control. We have designated one credit card for all travel expenses and another for everything else. So we can separate the craziness of being on the road all the time from living in a house like a normal person. It is not perfect, but it is a start.

In the same way, we use an online bill pay, but we will never again use that account for any business travel expense. This will put us in the hunt to understanding our expenses.

The biggest wildcard in retirement is medical care. Everyone believes they are mostly healthy, but look up how many knee and hip replacements happen. In my case, neuromuscular problems caused me to retire early. Does long term care insurance make sense?  Don't know, need to research it. Can one even still get it? Many of the early entries into the long term care market are getting out. Maybe an option is a medi-vacation to India? I have always wanted to ride that luxury train.

4% rule

Nothing is perfect, but for planning purposes, the 4% rule ( if you take no more than 4% of your investments you can preserve the principal) is a working rule of thumb. Of course you have to factor in recessions, but hopefully they are balanced by good times. The wonderful thing about single payment annuities and royalties and rents is that they do not stress your primary stock and bond investments.

Wealth redistribution to children/charities etc

For all the harm to our retirement the 2013 tax code poses, we are thankful that Washington seems to be understanding the importance of portability of estate to the surviving spouse. I am not a tax expert so research this for yourself, but we have years of trusts and receiver trusts and maybe, just maybe that will not be the case in the future.

As I understand things, in the 2013 tax code, you can leave 5M indexed for inflation to others such as you children. I do not personally intend to leave 5M to my kid, he would buy an expensive sports car and wrap it around a tree. But we do want to think through what we can give.


I hate to be the one to break it to you, but we will all die. If we are the last surviving spouse, we need to make sure the estate can be dissolved. Never will it be more clear that money is simply a vehicle to accomplish our goals. We all have to trust someone ( and a backup) and it is up to you do decide how to make this work. There are two use cases a smart investor is aware of:

  • What if I perish tomorrow and there is no time to prepare
  • What if I perish after a long illness in which I am cogent until the last few months and there is a lot of time to prepare
Maybe I am a nut case, but in my efforts to diversify so that no single bank, investment bank, or online stock broker could wipe me out, I leave a complicated legacy. How can our trustee shut down our empire after we and our spouse are gone? I have started keeping a list of every account in an encrypted container, but have not yet solved the problem of how to make that available to the account's trustee. But I am thinking about it.

Every couple years we review our trusts, living wills and so forth with a law firm that has both estate and CPA/Tax expertise. I shared my "letter from your dead husband" with them, (I deleted the account numbers). They said something that really rocked my world. They said, "Nobody keeps these sorts of records, this is the first time we have seen this." Whether your estate is great or small, it is complicated when someone dies. Take the time, make it as simple for your spouse or the executor of your estate as possible. Go read that link and get busy.

The bottom line: There is so much to think about and so little time. A lot of ground has been covered here, but I was investing before I had a driver's license. The biggest takeaway of all is to realize the future is unpredictable. None of us know when we will retire for certain, unless perhaps it is the afternoon of this day. Even if we are in perfect health, one auto accident can change everything. I have a friend that also lives in Hawaii and Washington. He got mowed down by a car in a crosswalk with the "walking man" sign on. Fortunately for him he was in top shape, an athlete with amazing balance. Still, flying 40' through the air and landing on pavement is going to exact a cost. He is recovering well, considering, but he had to retire earlier than he had planned. The good news is that he had been planning for retirement all along so while it hurt, the accident did not destroy his future. With apologies to Luke 10:37, "Go ye and do likewise".