Sunday, January 29, 2017

2017 Household Balance Sheet Updates


Saving Your Proforma Scenarios
Heading into the second year of Household Balance Sheet (HHBS) demo template project to provide a better retirement readiness assessment for the general public, Koch Capital has implemented several enhancements available immediately for HHBS demo template subscribers.

Source: Koch Capital

We added the ability to “clone” your current Proforma tab (sheet) if you wish to keep your old proforma data available for point-in-time review. This also comes in handy when transitioning into a new year. You can refer to previous year’s proforma values to set better values for the current year.

   
Source: Koch Capital

Contingency Asset Planning
This enhancement provides to ability to record a “contingent” future asset, but not have it impact your funded ratio calculation. The two most common types of contingent future assets are possible inheritance and life insurance beneficiary death benefit. It’s an
unexpected windfall that may or may not occur during your retirement. You can now choose not to include these contingency funds in your funded ratio calculation, but still note them in your HHBS demo template for future reference.

  
Source: Koch Capital

To take advantage of this new feature, go to the Future Savings (Step #10) section of the Proforma tab and enter the expected amount under the expected year in the new Contingency row. The HHBS demo template with create a matching liability entry in the Education & Legacy expense side to prevent this possible windfall from increasing your funded ratio value. On the other hand, if the expected $250k inheritance from example above is a sure thing (lucky you), then enter that value in your regular future savings row (Primary-2035) to be counted in the funded ratio calculation.

New HHBS Dashboard Web App
This new enhancement takes your HHBS demo template data and generates a personalized, one-page financial summary or dashboard of your household’s current ability to fund your desired retirement.

  
Source: Koch Capital
 
In the example above, this fully-functional web app runs on your favorite browser or mobile phone as long as you have internet access. If you are a Retirement Planning blog subscriber and HHBS demo template user, and are interested in trying out the new web app, please call me at 925-526-5624 or email me for your custom web app link.

Thank you for your consideration…...Jim   

About Jim Koch
Jim Koch is the Founder and Principal of Koch Capital Management, an independent Registered Investment Advisor (RIA) in the San Francisco Bay Area. He specializes in providing customized financial solutions to individuals, families, trusts, business entities and other advisers so they are better able to achieve their goals. Jim sees himself as an “implementer” of financial innovation, using state-of-the-art technology to provide practical investment management and retirement planning solutions for clients.

General Disclosures
This information is provided for informational/educational purposes only. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions. Nothing presented herein is or is intended to constitute advice to use or buy any of third-party applications presented here, and no purchase decision should be made based on any information provided herein. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable.
Third Party Information
While Koch Capital has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, timeliness, or completeness of third party information presented herein. Any third party trademarks appearing herein are the property of their respective owners. At certain places on this website, live 'links' to other Internet addresses can be accessed. Koch Capital does not endorse, approve, certify, or control the content of such websites, and does not guarantee or assume responsibility for the accuracy or completeness of information located on such websites. Any links to other sites are not intended as referrals or endorsements, but are merely provided for convenience and informational purposes. Use of any information obtained from such addresses is voluntary, and reliance on it should only be undertaken after an independent review of its accuracy, completeness, efficacy, and timeliness.

Tuesday, August 16, 2016

Don't Forget About Taxes and Inflation


The Silent Assassins
Rarely do investors factor in the impact of taxes and inflation on their portfolio returns. Given the current tax rate uncertainty—thank you, Congress—regarding both capital gains and ordinary income, it’s no wonder the typical investor has such a difficult time planning for taxes. But both taxes and inflation matter a lot because your “real” return, or the amount of money you have left over after paying taxes and accounting for inflation, is what pays the bills.   

Estimate Your Tax and Inflation Impact
I’ve provided a great chart below, courtesy of Ric Edelman, to help you quantify the amount of portfolio return you need to make just to stay ahead of taxes and inflation. It’s a scary chart given both state and federal taxes are probably, in my humble opinion, going to rise no matter who is in the White House. As for future inflation, who really knows? Medical, college and energy costs are above the long-term average inflation rate of 3.2%, but technology, productivity and cheap global labor keep other inflation items in check for now.

Click on the image below or here to view a larger version

Determine Your Investment Hurdle Rate
In an earlier blog post, I introduced the Portfolio Cost Analyzer (PCA) application to help you determine the impact of advisor fees, fund fees and transaction costs on your portfolio returns.
For example, say your advisor charges you 1.00% per year on assets under management, the expense ratio for all your mutual funds, ETFs and individual stock holdings totals 1.25% and you incur another 0.25% in active trading costs. All that adds up to a 2.50% per year fee drag on your portfolio returns. If you include another 1.00% in hidden opportunity costs, internal fund churn and bid-ask spread loss, your total pre-tax, before-inflation costs average 3.50% per year.

Now include your tax and inflation costs on top of the portfolio fees and it gets truly ugly. For example, if your combined state and federal effective tax rate is 40% and you expect 3.00% annual inflation, then your portfolio must earn at least 5.00% to stay ahead of taxes and inflation. Combine this 5.00% rate with the 3.50% in portfolio fees, and your investment hurdle rate is now 8.50%. This means your portfolio must earn at least 8.50% or more annually to provide you with any real, take-home spending dollars. Koch Capital’s free Household Balance Sheet template, which is available here for those serious about retirement, will help you determine your minimum real return (a.k.a. Discount Rate) that your household asset base needs to generate annually in order to fund your desired retirement lifestyle.       

How Lucky Do You Feel?
The figure below is an unsourced, frequency distribution of historical S&P 500 returns by year, overlayed with my crude 8.50% investment hurdle rate line. The investment hurdle rate line divides whether you made real money (green area) in a given year or lost value (red area) to portfolio fees, taxes and inflation.

Past performance is not indicative of future results
Source: Unknown, Koch Capital

If your long-term investment goal is to retire someday, then you need increase the size of  the green area in order to reduce the frequency of hanging out in the red area. There are basically two ways to accomplish this. You can move the red fees, taxes and inflation (hurdle rate) line to the left by reducing portfolio costs and taxes. Alternatively, you can increase your average annual portfolio returns so your personal long-term “mean” moves to the right and further away from your hurdle rate line (a.k.a. increase margin of safety). The former requires good financial planning and discipline while the latter requires substantial investment skill and luck, especially with the current high stock market valuations and low interest rates. So if you choose to pursue just the latter strategy, then you need to ask yourself one question—how lucky do you feel?


About Jim Koch
Jim Koch is the Founder and Principal of Koch Capital Management, an independent Registered Investment Advisor (RIA) in the San Francisco Bay Area. He specializes in providing customized financial solutions to individuals, families, trusts and business entities so they are better able to achieve their goals. Jim sees himself as an "implementer" of financial innovation, using state-of-the-art technology to provide practical investment management and retirement planning solutions for clients.

General Disclosures
This information is provided for informational/educational purposes only. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based on any information provided herein. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable. Past performance is no guarantee of future results.

Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Under no circumstances does the information contained within represent a recommendation to buy or sell any particular security or pursue any investment strategy. There is a risk of loss from an investment in securities.  Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Please refer to the Site Disclosure page for additional information.
Nothing contained herein should be interpreted as legal, accounting, or tax advice. Any tax statements contained herein were not intended or written to be used, and cannot be used for the purpose of avoiding U.S. federal, state or local tax penalties. Tax issues can be complicated. Please consult your tax advisor for personal tax questions and concerns.

Use of Calculators, Planning Tools, and Other Devices
The use of any calculator, tool, or similar device contained within or linked to this website is subject to your acknowledgement and understanding that the projections or other information generated by any such tools is not, and should not be construed, in any manner whatsoever, as the receipt of, or a substitute for, personalized individual advice from Koch Capital, or from any other investment professional. The projections or other information generated by such tools regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, are not guarantees of future results, and may not reflect the actual growth or costs of your own investments. These tools are designed for informational and educational purposes only and should not be considered investment advice. No reliance should be placed on any such information when making an investment decision. Koch Capital makes no warranties of any kind, and disclaims liability to any person for any actions taken or omitted in good faith with respect to such tools. Koch Capital obtains the information provided via these tools from third party sources believed to be reliable but not guaranteed. Koch Capital is not responsible for the consequences of any decisions or actions taken as a result of information provided by such tools and does not warrant or guarantee the accuracy or completeness of the information requested or displayed. Please refer to the Site Disclosure page for additional information.

Third Party Information
While Koch Capital has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, timeliness, or completeness of third party information presented herein. Any third party trademarks appearing herein are the property of their respective owners. At certain places on this website, live 'links' to other Internet addresses can be accessed. Koch Capital does not endorse, approve, certify, or control the content of such websites, and does not guarantee or assume responsibility for the accuracy or completeness of information located on such websites. Any links to other sites are not intended as referrals or endorsements, but are merely provided for convenience and informational purposes. Use of any information obtained from such addresses is voluntary, and reliance on it should only be undertaken after an independent review of its accuracy, completeness, efficacy, and timeliness.

Wednesday, May 18, 2016

Sailing Through Retirement


A Sequential Random Journey
In this recent blog post, Dirk Cotton of the Retirement Cafe blog explains why retirement planning is never a set and forget type of endeavor. He uses the metaphor of a sailboat on a long journey. At the end of each day, the sailor needs to correct her course to account for drift. Of course, this also assumes that the sailor has a planned destination in the first place?

At Koch Capital, we agree with Mr. Cotton’s analysis and appreciate his symbolism of a sailboat navigating a big ocean. For retirement seeking investors, the destination is to safely fund retirement throughout their lifetimes while maintaining enough flexibility to adapt to life’s unplanned course changes.

Click here to view the full image
Source: Koch Capital

By viewing your retirement journey through the lens of a series of sequential, discrete moves, you can better monitor, in my opinion, your progress and adapt to the “unexpected” throughout your retirement lifecycle.

For example, the state diagram above tracks a household’s level of retirement fundedness (funded ratio) at discrete points in time, usually age related. Having this simple funded status dashboard available to monitor, gives the household a clear picture of where it’s heading and how much drift to correct for.

Monitor and Adjust Course, Then Repeat
What is being described here is a discrete-time Markov chain, where all that matters is where you are now and what life throws at you next. Typically, these processes are memoryless, meaning how you got to your current state is meaningless, and all that counts is where you are heading next. However, when budgeting for future retirement expenses, the past is good place start even if you need to adapt the plan going forward.

The funded ratio, while not a perfect measure of your ability to support your retirement lifestyle at any given moment in time, is a simple and intuitive metric to gauge if your current household asset mix can support your anticipated future retirement expenses. I’m using funded ratio in this hypothetical example as a real-time retirement compass to help you gauge the degree of course drift and in which direction. Please see this post for more details on managing your personal assets and liabilities if interested.

Source: Koch Capital

Mr. Cotton also points out the absurdity of forecasting future risky asset returns beyond the near term as well as the necessity of a frequent retirement plan monitoring and updating. Please consider that as much as you may believe you can control your lifespan, stock market returns, consumer inflation, the economy, what Congress will regulate next as well as all the other unexpected life events that get randomly thrown at your household, you have very little actual control beyond your spending, taxes, when you retiree, level of investment risk and your emotional state. This is why planning for what you can control and budgeting a little extra for those things out of your control are key to your retirement funding success.

What Makes a Retirement Plan Good?
In my opinion, the typical retirement journey is series of forward-looking, sequential moves often responding to life’s unexpected “drifts”, some good and some not. But the destination is the same for all of us, so get a retirement plan that provides the appropriate funding security so you can enjoy the journey. A plan that identifies the drifts early, adapts to life’s course corrections quickly, and keeps your rational brain informed, is a plan that will support you in making the right financial decisions for your household.  

Source: Koch Capital

Stay vigilant, my friends, and enjoy the journey......Jim   



About Jim Koch
Jim Koch is the Founder and Principal of Koch Capital Management, an independent Registered Investment Advisor (RIA) in the San Francisco Bay Area. He specializes in providing customized financial solutions to individuals, families, trusts, business entities and other advisers so they are better able to achieve their goals. Jim sees himself as an “implementer” of financial innovation, using state-of-the-art technology to provide practical investment management and retirement planning solutions for his clients.

General Disclosures
This information is provided for informational/educational purposes only. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions. Nothing presented herein is or is intended to constitute advice to use or buy any of third-party applications presented here, and no purchase decision should be made based on any information provided herein. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable.
Third Party Information
While Koch Capital has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, timeliness, or completeness of third party information presented herein. Any third party trademarks appearing herein are the property of their respective owners. At certain places on this website, live 'links' to other Internet addresses can be accessed. Koch Capital does not endorse, approve, certify, or control the content of such websites, and does not guarantee or assume responsibility for the accuracy or completeness of information located on such websites. Any links to other sites are not intended as referrals or endorsements, but are merely provided for convenience and informational purposes. Use of any information obtained from such addresses is voluntary, and reliance on it should only be undertaken after an independent review of its accuracy, completeness, efficacy, and timeliness.

Friday, March 4, 2016

Should You Be 100% Invested in Stocks?


Warren Buffett, For Sure — You, Maybe Not
Recently, an Investment Management client of Koch Capital asked me to review this NY Times article regarding the author’s recommendation that individuals with a sufficiently long holding period should be 100% invested in stocks. You may be wondering why am I discussing asset allocation in a retirement planning blog?

In this post, I’ll demonstrate why the two disciplines, investment management and retirement planning, should be integrated to achieve financial security for savers aspiring to retire some day. Also in this analysis, we’ll provide guidance on whether you should be 100% invested in stocks in your pre-retirement and post-retirement portfolios.  

Are You In or Near Retirement?
If you are retired or near retirement and are taking regular distributions from your portfolio(s) to fund living expenses, then you are subject to sequence risk. If you draw down a portfolio during a multi-year bear stock market, then your future portfolio distributions plans may be in jeopardy if your portfolio cannot recover during the subsequent good times. The asymmetric nature of compounding works against you when recovering from a portfolio loss; taking distributions in a down market just exacerbates the problem.

Click here to access the full screen view of this image
Source: Koch Capital

Many financial advisors make the distinction between accumulators, or households saving for retirement, and decumulators who are basically retirees taking distributions. If your household is in accumulation mode, then NY Times author makes a good argument to stay 100% in common stocks as long as you can stomach the volatility. The problem with this advice for accumulators is the transition period from accumulation (saving) mode to decumulation (distribution) mode.

As uber financial researcher Michael Kitces points out in this article, sequence of return risk impacts accumulators too, not just decumulating retirees. For example, if you are planning to retire in four years and if you experience a major bear stock market in three years from now, then you may find that your 100% in stocks nest egg will be insufficient to fund your future expected living expenses.

Ignore Current Stock Market Valuations at Your Own Peril
Since it is impossible to perfectly time the stock market (when to buy and when to sell), investors can still strive to better understand the true intrinsic value of the stock market, and the probabilities of future stock market returns based on current valuations.

You have a higher likelihood of future stock portfolio outperformance when valuations are low (and you buy) versus when the stock market is pricey (unless you’re selling). A collective reader duh is warranted here.

In my opinion, it doesn’t matter if you consider yourself a passive investor or not. You WILL become an active investor, whether you mean to or not, during your personal accumulator-to-decumulator transition journey. Failure to plan for this critical transition period may result in pushing back your retirement date in order to cover any savings shortfall. Likewise, your transition period may be a non-event if the market valuation gods are on your side.

Source: Multpl.com, Robert Shiller

The Shiller Price-to-Earnings (PE10) ratio is one of many valuation measures to help you evaluate whether the stock market is expensive or cheap. While this measure does not possess short-term predictive powers, it is helpful for planning your retirement asset allocation when transitioning from investing for accumulation to investing for decumulation where income consistency and sustainability rule the day. Thus, retirees and near retirees may not want to be 100% in stocks when the Shiller PE ratio is significantly above its long-term average of 16 (red line).

Your Risk Capacity Matters More Than Your Risk Tolerance
So far we haven’t mentioned risk tolerance, the common investor behavioral measure of whether a particular portfolio allocation is “appropriate” for you in terms of volatility. Simply put, your portfolio risk “preference” doesn’t mean squat if your capacity for risk can’t support your tolerance for risk. Warren Buffett can afford to be 100% invested in stocks. If he loses a billion dollars in any given year, his lifestyle remains intact. Mr. Buffett’s high capacity for risk affords him this high level of outcome certainty regardless of his tolerance for investment risk. It’s good to be Warren.

At Koch Capital, we use the straightforward concept of retirement fundedness (a.k.a. the funded ratio) to measure your risk capacity in terms of a simple ratio. The funded ratio measures your total current savings against your future expected retirement living expenses. The higher your funded ratio, the more risk capacity you have. A funded ratio greater than 1 means you have sufficient assets to cover your liabilities. I’m guessing that Mr. Buffett has a 1000 or higher funded ratio which is why the question of his risk tolerance associated with his 100% stock allocation is moot.

Let’s look at an example of risk capacity in action. The year is 2007. Wilma and Fred Flintstone wish to retire in 2008. They are currently 100% invested in stocks across all their investment accounts (IRAs, 401ks, brokerage, etc.) for a total current financial asset value of $2.2 million (see balance sheet summary below). This asset balance represents over 50% of Wilma and Fred’s total asset base.
Click here for balance sheet image field descriptions   
Source: Koch Capital

The Great Recession hits. Wilma and Fred’s $2.2M aggregate balance is cut in half to $1.1M. Their original plan to start regular distributions in 2008 to fund their living expenses is now in question, and potentially unsustainable over their expected lifespans.

While the exact unfortunate timing of Wilma and Fred’s desired retirement date occurs infrequently in real life, the consequence is severe. The good news is that this scenario is fixable. Households can reduce their chance of an extreme portfolio loss event (see max drawdown definition) affecting their retirement plans by reducing their 100% stock exposure prior to retirement. Alternatively, households can also choose convert part of their current financial assets to safe(r) pension assets like guaranteed annuity contracts and individual Treasury bond ladders, as well as maintain a cash reserve to cover living expenses in a downturn allowing their portfolios to recover.

While Wilma and Fred may have exhibited an aggressive risk preference for a 100% stock allocation, their recalculated funded ratio value of 0.84 (reduced risk capacity) may prove insufficient to keep them on their original retirement track. They may have to consider delaying retirement to save more and allow their portfolios to recover. Ideally, we prefer to see their funded value rise to 1.2 or higher, our overfunded status before commencing with retirement (see Terminology page for further explanations).   
Decision Considerations for the 100%-in-Stocks Investor
In my opinion, evaluate your expected retirement date, risk capacity via your funded ratio, and current market valuations before considering your risk preference when determining your portfolio’s stock allocation.

If you are years away from retirement, go ahead with a 100% stock allocation, preferably implementing a broad global asset class approach using low-cost index funds as your core holdings. Remember that your ability to earn income during your pre-retirement years raises your capacity for risk.

If you are nearing retirement and current market valuations are rich, consider dialing back your stock allocation to maintain a sufficient reserve to fund living expenses for one to two years in case of a severe market downturn, or to potentially re-invest in stocks when valuations are more favorable.

If you are very near retirement, current market valuations are favorable, and your funded ratio is already over 1.20, then you’re in the catbird seat. In this case, you can base your stock allocation decision on your risk preference, and get a good night’s sleep whether you are 100% in stocks or more conservatively invested.

Obviously, there are thousands of subtle permutations regarding your proximity to retirement, the fluidity of your risk capacity over time and the degree of current market over or under valuation, which is why I love being a financial advisor. Every household is different, every retirement plan is unique, and every engagement is opportunity to help families in a meaningful way.

Thank you for your continued support and interest......Jim   


Additional Resource Links

New York Times 02-12-2016 stock allocation article:

Michael Kitces Shiller CAPE Market Valuation article:

Russell Research: Adaptive Investing paper:

Zvi Bodie 10-90 Retirement Investing: A New Approach paper:

Michael Kitces Sequence of Returns Risk for Accumulators article:

My Retirement Income video which demonstrates sequence risk:



About Jim Koch
Jim Koch is the Founder and Principal of Koch Capital Management, an independent Registered Investment Advisor (RIA) in the San Francisco Bay Area. He specializes in providing customized financial solutions to individuals, families, trusts, business entities and other advisers so they are better able to achieve their goals. Jim sees himself as an “implementer” of financial innovation, using state-of-the-art technology to provide practical investment management and retirement planning solutions for clients.

General Disclosures
This information is provided for informational/educational purposes only. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions. Nothing presented herein is or is intended to constitute advice to use or buy any of third-party applications presented here, and no purchase decision should be made based on any information provided herein. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable.
Third Party Information
While Koch Capital has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, timeliness, or completeness of third party information presented herein. Any third party trademarks appearing herein are the property of their respective owners. At certain places on this website, live 'links' to other Internet addresses can be accessed. Koch Capital does not endorse, approve, certify, or control the content of such websites, and does not guarantee or assume responsibility for the accuracy or completeness of information located on such websites. Any links to other sites are not intended as referrals or endorsements, but are merely provided for convenience and informational purposes. Use of any information obtained from such addresses is voluntary, and reliance on it should only be undertaken after an independent review of its accuracy, completeness, efficacy, and timeliness.