Living On A Dividend

From Ben Carlson;

Is it realistic? How realistic is it? What parts are realistic? In his blog post Ben talked about the mechanics of how dividends work. If you have $100 in stock and the company pays out $1 in dividends, you now have $99 worth of stock and $1 in cash. If you spend the dollar, then you just have $99 in stock and that's it. Maybe I misunderstood but he seemed to discount the idea because of these mechanics and needing to price appreciate that $1 in dividends back.

He did say that just living off the dividends without touching the principal was the "retirement dream." People like dividends/distributions so the better questions is can a dividend-centric portfolio in this context outgrow its yield? If so, then it is at least partly realistic.

Quite clearly is it possible. The above three funds' numbers go back to late 2011, those are price only returns. Whether owning one or more dividend ETFs is a good idea or optimal is another discussion but if the stock market goes up most of the time, it is a reasonable probability that dividend funds that are not crazy high yielders or NAV incinerators can have a growth rate that exceeds its yield. The next time we have a lost decade that might not be the case but then if we have a lost decade, growth for simple market cap weighting would also be lost. 

This mix allows us to backtest just over 20 years. I've owned JNJ and BNS for clients since 2004. I owned MO back then but switched to PM when the company split. 

Using BTAL speaks to the reader's concern about drawdowns. Having 10% in BTAL brings down the volatility and helps with drawdowns but there are some declines that portfolios can't hide from. 

But, 2008 was the only calendar year where the price only version exceeded a 15% decline. There were a handful of very fast declines though where the 15% level was breached. That could be offset with more than 10% in BTAL but the more in BTAL, the less that is producing income. There's a tradeoff here that the reader would need to sort out. 

Here's an updated version that swaps out 20% in IEF for 20% in SHRIX. This allows us to go back 10 years. 

We're getting far more income obviously which is what the reader wants but the tradeoff is a lower price only growth rate.

There's still 6.8% in growth after taking out the income versus an inflation rate of 3.39% for the period tested. The dividends for the stocks and ETF should be qualified but not the dividends from SHRIX. 

This can work with tradeoffs. Here's an example of something that probably can't work as a long term plan.

Funds like JEPI, SPYI or BALI have distributions in this neighborhood. 

That goes back to mid-2013 and actually is better than I expected as I was typing the previous sentence. Adjusted for inflation, SPXX compounded at a negative 0.48% and XYLD negative 2.33%. While this is not a great long term portfolio strategy, we've looked at this sort of thing in the context of a bucket strategy needing to last maybe eight-ten years to get someone to the next financial milestone like Social Security or RMDs. Success here is not riding out SPXX for 30 years but being willing to exhaust a smaller piece of money over a much shorter period. 

Success would be something like hoping make this type of bucket or bridge last for 10 years like I said, getting to ten years having depleted most of it but maybe having enough leftover for an emergency fund. In 2016 someone did this with $400,000, they've been taking a long term unsustainable $40,000 out per year and instead of having zero today in that account (which would be ok), they have $100,000 left over for a robust emergency fund. Saying it more plainly, you expect to deplete the account but instead you have some left over. That is plausible, counting on 11% forever is probably doomed because of longer term growth rates not being that high and loss of purchasing power.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Looking At Leverage

The Monday email from Finominal looked at whether there is any added benefit to leveraging up investment portfolios. My use of the word up is not fair, really the idea is whether using leverage for better diversification is additive. The following is what they studied.

We can't go back 100 years on testfol.io but I think we can go far enough back to be useful.

The result for 90/60 being better than straight S&P 500 is consistent with the backtesting done by WisdomTree to support their NTSX ETF. The next image adjusts the growth rates for inflation. 

A real return of 5% is a common target for endowments. Portfolio 4 obviously has the lowest growth rate but it also has the lowest volatility by far and a pretty small max drawdown when you think about all the crazy things that have happened since 1988 and the beta is only 0.18. All good but the differences in compounding is meaningful. Portfolio 4 has grown to $224,000 while simple 60/40 is $335,000. Yes 100% equities did much better than both but someone really needs to look themselves in the mirror about going 100% equities and being able to hold on no matter what. 

Someone could put it all in NTSX, so levered up, but that would have meant being down almost 30% in 2022 versus 18-19% for SPY/IEF. The math checks out of course but enduring 30% requires enduing 30%. There's not a tidy this is best for everyone answer here. We talk frequently about understanding our own emotional limits for our investment portfolio as well as the tradeoffs to whatever we decide. Going full NTSX should result in a better long term result but with more pain along the way. Portfolio 4 is very unlikely to keep up with the others but I would expect very little anguish along the way. 

Where this exercise is quadrant inspired, the Permanent Portfolio Fund PRPFX compounded at 7.08% for the period studied with a volatility of 8.94%. I feel like most of the investment industry would consider the permanent portfolio idea to be valid but clearly not always optimal but then nothing is always optimal. 

I don't think it is that difficult to assess the pros and cons of most of the portfolios we explore here. With today's example, a portfolio with a 25% weight to equities might be all weatherish, I would say Portfolio 4 fits that bill, it's not going to keep up with a portfolio that is 60% equities. 

The other day, we used a Twitter fight as an opportunity to look at a new (to us) ETF that fits in with some of other funds that we've looked at over the last few weeks. Over the weekend, the Twitter fight drew a lot more attention, really a lot. I think this screenshot gives some context of how the instigator engages on Twitter.

The Hedgeye company that McCullough runs is a research shop, they have some ETFs and there is a very active trading service. Hedgeye's runs a lot of ads about learning their process which includes a universe of 140 ETFs that allows them to "go anywhere, not everywhere." 

Based on all the back and forth I read over the weekend (I couldn't help it!), the success is very questionable but there are plenty of people (or bots maybe, I don't know) that were very supportive of Hedgeye. But the 140 ETFs and I also believe there are individual stocks involved too, is interesting to me. 

The trading appears to be very active and if they exercise all 140 ETFs frequently, that is going to be hard to keep track of. This all helped me crystalize a couple of things we do here that I hope are productive for readers but that I know helps me.

You have probably noticed that when we explore portfolio theory we use a much narrower universe of funds. I am very much a believer in holding long term when possible. By using far fewer funds for blogging purposes I think it creates the effect for regular readers to get a sense how these funds do through various events. I first started writing about SHRIX for cat bonds three years ago. Cat bonds are a core holding, the weighting is small though, and most portfolios we experiment with include SHRIX. Love the idea or hate it, if you're reading this blog regularly you are getting a sense of how they do. 

There are others too of course, cat bonds is just an easy example. Clients own EMPIX, not SHRIX, SHRIX has a much longer track record which makes for better backtesting. EMPIX is managed to have even less volatility than SHRIX which is why I prefer that one. 

The continuity makes it much easier to learn versus being all over the place with very frequent trading changes. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Twitter Fight!

A skirmish broke out on Twitter.

I don't know the starting point of the beef but the Hedgeye guys went after Ryan who responded with the following.

Then Corey jumped in and based on the screenshot and the thread, there's ongoing beef there too.

The HECA ETF is a new one to me. Based on the factsheet, it is a multi-asset strategy, based on a proprietary process for evaluating macro factors related to increasing/decreasing GDP and increasing/decreasing inflation. The four conditions are referred to as quads so maybe it is quadrant inspired? It seems like it performs an analytical assessment versus just maintaining an allocation to all assets relying on at least one of them doing well no matter what is going on which is what PRPFX does. HECA is trying to get out in front of macro changes and PRPFX is trying to be ready for whatever comes.  

The fund's website includes the term all-weather and the factsheet says HECA could either be a core holding like some of the mutli-asset funds we've looked at recently or a satellite holding as a diversifier. The primary objective appears to be never going down more than 15% and then providing growth when possible. 

This backtest provides some good context.

Why is HECA doing poorly this year? 

The holdings don't tell the story. Gemini says the turnover is 671% which is very high and that the fund got caught wrongfooted on equity trades including thematic ETFs earlier in the year. The way this is framing itself, HECA reminds me of BIVIX and DYMIX in terms having no idea what to actually expect from the fund. 

The funds aren't necessarily bad or good. it's just that at times they look like the broad market and at other times they look nothing like the broad market. If they never look like the market then ok, low correlation diversifier. But if the correlation changes by a lot and does so frequently, that's tougher to implement. 

The 15% max drawdown sounds like a 15% buffer which is why I included BJUL in the first backtest. Unfortunately for HECA though it has lagged far behind BJUL and done so with much more volatility. Here's some harshness from Gemini.

The idea of a fund that solves all problems is intellectually appealing so I am always going to want to dig in but whatever someone wants to get out of HECA, there are probably better ways to get it. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Expensive Mistakes

Barron's wrote about how retirees spend down from their accounts versus when they take Social Security but they asked some interesting questions and made a couple of interesting points. This post won't tie it all together, hopefully we all come away with some good questions to ask ourselves for our own situations. 

First, Barron's always leans into waiting to take Social Security. I am not in the camp of trying to persuade anyone to take it early or late. It is crucial to understand the tradeoff of either approach to make an informed decision. I've been clear about my intention to wait until 70 because my wife is six years younger and she would get a larger survivor benefit if I die early. Anything could happen to change that plan of course but if I started taking any time after I turn 69, I will consider that as having been able to stick to my original plan. 

First, a "recent Vanguard analysis of more than 125,000 retirees ages 60 to 72 with balances of more than $100,000 found that nearly 80% hadn’t tapped their retirement accounts." The $100,000 number isn't helpful. We've talked about that at some number, someone had more of an emergency fund not a retirement account. Where that point is can certainly be debated but, sorry to say I think $100,000-$125,000 is more of an emergency fund than a retirement account. I appreciate that might be harsh.

The big argument being made in the article is wait to take Social Security until 70 and use your IRA in the mean time so you have smaller RMDs when the time comes. What do you think your RMDs will start out at if you're not already taking them? If you have $1 million in your IRA at 75, your RMD would be $40,650. At $2 million it would obviously start at $81,300. The percent of IRA holders with an RMD of $150,000 or more is less than 1%. Only 1.8% of households have an IRA worth more than $2 million. 0.65% of Americans 65 or older are in the 37% federal tax bracket and there's maybe 2% that age in the 32% federal tax bracket. Surprisingly, 35-40% of retirees have income streams beyond Social Security, pensions and investment accounts. 

The median income from these other sources is about $45,000. The point of all these numbers (from Gemini) that the idea of waiting to take Social Security to have smaller RMDs may not impact too many people. There's no reason not to run your numbers to solve for this question though. 

We are all entitled to our beliefs about taxes. If someone can avoid having too many of their dollars in the 22% tax bracket up from 12%, that's probably a good idea. 

Keep in mind that a gross income of $120,000 will have a low effective tax rate even if they pay 22% on a few dollars. The effective tax rate for $150,000 married filing jointly is 10.6%. In today's dollars, what do you expect your Social Security to be? Do you want to shave 24% off that number in case Congress blows it? What are you're RMDs likely to be? Will you have other sources of income? And of course, most importantly, how much are you likely to need for your preferred retirement lifestyle? With all of that, what are the odds you avoid having meaningful dollars in the 22% bracket? If it's borderline, then yeah maybe you should run your numbers in the context Barron's talking about. 

My own belief is that I am not likely to turn myself inside out to avoid having a few dollars in the 24% bracket versus 22%. There's no reason for you to agree with me on that, it's my belief. If I can avoid the 32% bracket though, that's something I would try to do if I ever got close. I am not close and there is no visibility for me to get close. I don't know if I will still have an active income once I hit RMD age but if not, then between Social Security and RMDs and if we get out of the vacation rental business, I might not have many dollars in the 22% bracket. 

Barron's also brought up IRMAA which is the extra fee or tax that higher earners pay for Medicare Part B.

We know from the above about incomes that very few couples are paying the upper end of the IRMAA scale. Is your RMD likely to be the difference maker for whether you have to pay IRMAA? I don't live some place that is expensive so if we are making more than I expect at RMD time, then I am unlikely to spend a lot of time being upset about the extra $81 times 2. If you live some place expensive, like $20,000/yr on property tax, then that might be worth spending time seeing if there is a strategy that helps you avoid IRMAA. 

One point not discussed in the article and one we should probably spend more time on here is the the huge jump in taxes when the first spouse dies. The IRMAA threshold cuts in half while income wouldn't go down as much. The lower Social Security payout goes away but not the RMD income. Income tax brackets cut in half too.

On its face that is an argument for digging in to see whether trying to reduce RMDs makes for good tax planning. That's not a blanket statement for what anyone should do in terms of SS filing, more like a suggestion to do a calculation that you might not thought of doing. Roth conversions address this issue too but those numbers and tradeoffs are also tricky.

There's a lot to matters related to Social Security, the order of accounts to draw from and other parts of retirement planning that are easy to get wrong. Mistakes in this realm are probably not ruinous but can be expensive all the same. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Did Anyone Get The License Plate?

Markets got runover on Thursday after a nice lift on Wednesday as we all try to sort out how the election results might impact AI, the war, energy prices and anything else you think is relevant. Since the market got shellacked, it might be worth looking at how some of the alts and niches we review did in the face of a brief (?) market panic. 

First autocallable funds.

A good starting point of understanding is that the higher the yield the more volatile the fund is likely to be. If the S&P 500 had the food poisoning on Thursday, some of the autocallable funds had flesh eating disease. The way they have high yields is by referencing leveraged up versions of S&P 500 or NASDAQ depending on the fund.  

Managed futures certainly held up better on Thursday, it was generally down on Wednesday too. There was a sharp decline in energy prices after the election and managed futures was likely long coming into the election.

Managed futures builds positions based on longer term trends than just a couple of days. The Covid Crash is an example where as a matter of luck, many of the funds were positioned the "right way" going into that event but that's more the exception than the rule. 

Next up, the multi asset funds we looked at earlier this week.

BTA didn't trade and the fund's website hadn't updated the NAV for November 5 when I looked. Impressive from AQRIX and a solid showing from THCR, maybe better than solid. 

This chart could be instructive for whenever the next bear market starts if it hasn't already.

We've talked frequently about not wanting anywhere near the 40-50% tech and tech adjacent exposure that is currently in the S&P 500. Semiconductors have had a phenomenal run and while no exposure would have been a bad idea, so too would a market weight. Bloomberg reported that semi's weight in the S&P 500 has gone from 20% down to 14% with this decline. 

There's clearly been an excess in tech and semiconductors, we talked about that many times. There's no way to know when or if there will be a consequence for that excess but we can observe it and decide not to take on that full exposure. Having just 20-30% in broad tech is still a lot and can provide a lot of growth without feeling every basis point on the way down. The last few days in the chart are a useful microcosm for what a tech-driven true bear market might look like. 

I can't stress this enough. No tech is a bad idea. Anyone investing narrower than the broad indexes can easily be underweight, just own less tech. For someone only using broad indexes, there are factors with less tech, there are hedges like BTAL to dial down exposure. It is valid to not believe in any of this too. Whatever happens, all bear markets end, recover and make new highs. Holding on for all of that is difficult but it is valid. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

A Completely Different Allocation Strategy

Christine Benz wrote about four dangerous assumptions that could hurt your retirement plan. The four were overestimating market returns, underestimating inflation, that you'll be able to retire when you want and whether you might get an inheritance. The article was fine but I want to home in on overestimating market returns in some period relevant to your retirement planning. 

Testfol.io can backtest simulated S&P 500 back to 1885 and for the entire 141 years, the index compounded at 9.63%. For the last 15 years, the S&P 500 has compounded at 14.80%. 

Five hundred basis points above the long term trend is huge. That's a long time and a lot of basis points. It's right to wonder how long it can last and think about what to do if it doesn't continue. Again, this is not about predicting anything, it's about trying to look around a corner at what could go wrong and be ready if it does go wrong. There's a big difference between those two. 

All of the time we've spent looking at replacements for traditional fixed income has been driven in part by the belief that bonds with duration are no longer reliable diversifiers. Put slightly differently, we're relying less on traditional fixed income. Should we rely less on traditional equity exposure too, especially if after years of growth above trend, equities go on a run where they compound below trend? 

There are many types of alternative strategies that we look at, one type seeks steadier returns with less volatility like some long/short, macro and multi-asset. These types of strategies won't keep up with 14.80% compounded but be meaningful sources of return if equities spend a while below trend. 

I put the following together to start this conversation. 

AQRIX is an AQR fund that used to be risk parity and is now multi-asset which doesn't seem that different. It has a decently long track record and although it has not been perfect, it's had a good return without relying on simple equity or bond exposure. 

Anchoring around a fund like AQRIX is what I'm talking about. Actually putting 60% into one fund is a non-starter versus dividing that 60% anchor among several funds but it will do for Portfolio 2 for this post. Portfolio 3 is a little closer to reality splitting the anchor between equity long short and managed futures. 

Both 2 and 3 rely some on simple equity exposure but it is more of a satellite exposure than the alternative core. The volatility and drawdown characteristics of Portfolio 3 are attractive but if the S&P 500 continues above trend it will not keep up. It might stay closer by splitting SCHD, pairing it with a tech sector ETF but that will probably change the volatility and drawdown numbers. 

The THOR Conservative Risk Dynamic ETF (THCR) just started trading this week and might turn out to be one to include in the 60% alt core we're working with today. It's an active fund so what it looks like now could be very different a month from now or a year from now but the basic idea is it's a "multi-strategy ETF that seeks capital appreciation using a risk-first allocation framework targeting a 5% standard deviation."

Its holdings are very differentiated. Its largest position in the Energy Sector SPDR (XLE) at 21% and BTAL at 19%. That's a huge overweight to energy and that much BTAL should suck a lot of volatility out of the rest of the holdings as follows. 

It's easy to backtest the current allocation but again, if the turnover ends up being very high, this may not be much help.

I included AQRIX, LCR is another multi-asset fund that is willing to do some different things and that we've looked at once or twice. BTA is a new risk parity type of fund that we dug into a couple of weeks ago. None of these have a lot of equity beta which is preferable for this project. 

We can keep an eye on THCR to see how frequently it makes changes. XLE was down a ton on Wednesday based on the idea that the election results could bring a faster end to the war in Iran. I don't know whether that is a reason to back off of 21% in XLE or not but I will be curious to see what they think about that. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Diversify Your Income Sectors

Jeffrey Ptak wrote favorably about bonds at current levels noting that yields are at decent levels and that the risk versus reward are pretty close to being balanced which was not the case when yields were at 2% or less. He references iShares 7-10 Year Treasury ETF (IEF) a couple of times so presumably he was talking about duration. 

Here's a concise version of the bond math he was talking about courtesy of Gemini. I assumed ten year treasuries now at 5% and what the price decline would if the prevailing yield went to 6%.

The chances of 4% aren't impossible if something bad happens but I don't think 3% could happen anytime soon. I doubt we'll see 7% anytime soon either but that seems more plausible than 3%.

For a while I have been framing this as being about adequate compensation. Is 5% adequate compensation for the risk and volatility of going out ten years? That's up to each of us to figure out for ourselves. My answer is an easy no. There are many ways to get similar or better yields with nowhere near the interest rate risk or volatility. 

The ETFs above track 3 year, 10 year and 20 year treasuries respectively. I included their yields in the green box and you can see the volatility numbers off to the right. Again, this is for each of us to decide, is the extra yield worth the extra volatility.

Collateralized loan obligation ETFs have become a huge income market niche. I've been using JAAA for a while but here are a couple of I've never heard of that look pretty similar.

They both yield around 6% and sticking with phrasing from previous blog posts, I think that is what people want their bonds to look like. 

At about a 5% yield, it's safer to add some exposure to duration but not 40%. I wouldn't put 40% in CLOs either. I wouldn't put 40% in any income sector. We talk a lot about owning different income sectors to help mitigate the risk. Anyone comfortable with the risk and volatility with ten year treasuries doesn't have to load up on them. 

Diversify your diversifiers? Diversify your income sectors. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.