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I am revisiting a topic I wrote about in 1986, 1993 and again in 1999.  I have discussed this topic with many of my clients over the years.  I buy a book from Ibbotson Associates every few years called Stocks, Bonds, Bills, and Inflation 200X Yearbook of Market Results for 1926-200X.  It allows me to check that the passage of time has not created the need to revise my thinking.  It hasn’t. 

The book is 300+ pages of tables that measure market results many different ways.  The tables I look at show the results of holding large company stocks (their measure is the S&P 500 Index) and fixed income (using U.S. Treasury Bill returns) over five and ten year holding periods (1926-36, 1927-37, or 1927-32, 1928-33, etc.).  The five year tables show that you would have had better results in 61of 75 five-year rolling periods if you invested in stocks.  The ten-year tables show that you would have had better results with stocks in 60 of 70 rolling ten year periods.

My conclusion is that money that you need to spend in a seven year (an arbitrary number somewhere between five and ten years) window should be in fixed income.  Money that can remain invested for more than seven years should be in the stock market. For the purpose of this discussion, I am referring to your serious money: the money you are saving for retirement, college savings or to buy some big ticket item at some future date.

A disciplined approach to asset allocation with a very generous use of index funds is as sure a road to riches as you will get.  Mutual funds are the most efficient way to invest.  Using index funds guarantees you will get the same result as measured by that index.  Buying managed funds that attempt to do better than the index is not a proven strategy.  A managed fund may or may not do as well as the index. 

Based on where you are in life, there is an appropriate mix of assets for you.  The asset classes include fixed income, large company, and mid-size, small, and international stocks.  Finding and maintaining an appropriate mix is most important in a long-term investment program.  Using mutual funds instead of selecting individual stocks works best for most people.  Within each class of assets, up to 75% should be invested in an index fund that mir­rors each of these market segments.  Use mutual funds sold by companies like Vanguard (no load companies with a strong record of integrity).

Discretionary money you can lose without affecting your financial security can be invested more aggressively.  Since I am not a stock picker, private equity investor or a hedge fund picker, I leave the discretionary investing to you and whomever you might trust.  Real estate definitely should have a place in your long term plan.  You can own the actual real estate or buy stock in a real estate trust or in a mutual fund that owns real estate trusts.

When I meet with a client to do financial planning, the first thing I do is schedule his portfolio on a spread­sheet that allows me to look at his current asset allocation and his use of index funds.  Next, we devise a goal for each asset class.  Finally, we move his investments to achieve our desired asset allocation and re­place inappropriate investments with more suitable in­vestments, aiming for about 50-75% in index funds.

To the extent that we are diligent in maintaining the portfolio’s balance, we reduce the risks associated with equity investing.  If you have a large undirected portfolio, it is probably a good idea that we meet and review your asset allocation.


August 22, 2006

I wanted to get a note out to you about two items that came up this week.  One is good news, and the second is no news.  The good news is that the Guaranteed Return for TDA Fixed Program was extended through June 30, 2009.  Based on recent action by the New York State Legislature, the current 8.25% annual rate of return for TRS Fixed Annuity Program has been extended for three years—through June 30, 2009. The rate is guaranteed to never fall below 7%.  We have talked about how great it is to get a guaranteed return of 8.25% if you have money in the TDA.  How can you pass up a guaranteed 8.25% compared to a risk-based investment, even though Variable A has the potential to yield a greater return?  You must also consider what other fixed investments pay, which are smaller than 8.25%.  This is an offer you can’t refuse.

The second item relates to an article in THE NEW YORK TIMES on Sunday August 20 by Mary Williams Walsh and Michael Cooper.  The article discussed the pension plans in NYC, including the Teachers Retirement System.   The writers wrote about possible shortfalls in the funding of the pension plans that could lead to problems in the city’s meeting obligations in the future.  I received a whole bunch of calls today and decided I should write this letter. 

I have no expertise in pension accounting or actuarial sciences.  Anything can happen.  With those two disclaimers out of the way, I am telling you there will be no default problem for any current retiree.  There will also not be a problem for any future retiree.  You will collect the pension you were promised.  I say this because there is plenty of money in the plans for us and under the New York State Constitution, the pension obligations would have to be met by the general funds of New York (I am not sure if it would be city, state or both).   This is not the case in the private sector.  That sector has other protections.

What the article explained is that pension funding is an exercise in making mathematical computations based on assumptions about the future.  When an actuary decides how much money an employer needs to contribute to meet future obligations, he must assume a rate of return on invested money, how long people will live, and how much their final average salaries will be.  This is an impossible task.  When investment returns are high and people die young with low final salaries, pension plans are very solvent.  When investment returns are low, people live long and final salaries are high. Employers must either put in more of their own money, ask employees to contribute more or reduce benefits to employees not yet retired or in the retirement system.  The writers of the article are saying that the latter is the situation now.  The article did not say that retirees should worry about bankrupt plans.  If you are retired, you will get you promised benefit.

I hope you are not worried, that you are enjoying your retirement, and you are making 8.25% in TDA.  The fact that the summer is over should mean nothing to you anymore.  For us, it should be summer all year long.   If you know people who didn’t receive this letter, feel free to pass it on.