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Safe Withdrawal Rates For Retirement Income Portfolios Using Vanguard Mutual Funds

Summary Investment portfolios with good withdrawal rates can be constructed with Vanguard mutual funds. From January 2005 to December 2014, a Vanguard portfolio with fixed allocation could produce a safe 5% annual withdrawal rate and 1.14% annual increase of the capital. Same portfolio with rebalancing at 25% deviation from the target allowed a safe 5% annual withdrawal rate and achieved 1.25% compound annual increase of the capital. Better performance could be achieved using adaptive asset allocation. Same portfolio could have produced a safe 10% annual withdrawal rate and 1.97% annual increase of the capital. The drawdown of the portfolio increases with respect to any increase in the rate of withdrawal. At high withdrawal rates the equity increase reduces substantially. In a previous article , I reported an experiment of the Chicago South Suburban Investment Club with a monthly asset rotation strategy applied to a hypothetic IRA account using five Fidelity mutual funds. The selection of the Fidelity funds was made because many members of the club own IRA accounts with Fidelity. There are many other families of mutual funds that can apply the same methodology to create profitable investment portfolios. In this article, I attempt to build a similar portfolio using Vanguard mutual funds. In the future, I plan to also investigate the applicability of same methods for other mutual fund families such as American Century, Janus, Northern, Schwab, T Rowe Price, Wasatch, etc. To review what was presented in previous articles, the rotation strategy is as follows: on the last trading day of each month, the funds are ranked by the previous 3-month return. All equity is invested in the fund with the highest return, as long as that return is positive. If all the assets had negative returns over the previous 3 months, then all equity is moved into CASH. The five mutual funds considered for investment are the following: Vanguard Intermediate Term Investment Grade Income (MUTF: VFICX ) Vanguard Short Term Investment Grade Income (MUTF: VFSTX ) Vanguard Explorer -small cap growth (MUTF: VEXPX ) Vanguard Windsor II – large cap value (MUTF: VWNFX ) Vanguard Morgan Growth – large cap growth (MUTF: VMRGX ) In this article, three different strategies will be considered: (1) Portfolio is initially invested 20% in each fund without rebalancing. (2) Portfolio is initially invested 20% in each fund and is rebalanced when the allocation to any fund deviates by 25% from its target. (3) Portfolio is at all times invested 100% in only one fund. The switching, if necessary, is done monthly at closing of the last trading day of the month. All money is invested in the fund with the highest return over the previous 3 months. The data for the study were downloaded from Yahoo Finance on the Historical Prices menu for the five tickers, VFICX, VFSTX, VEXPX, VWNFX, and VMRGX. We use the monthly price data from January 2005 to December 2014, adjusted for dividend payments. The paper is made up of two parts. In part I, we examine the performance of portfolios without any income withdrawal. In part II, we examine the performance of portfolios when income is extracted periodically from the account. Part I: Portfolios without withdrawals In table 1 we show the results of the portfolios managed for 10 years, from January 2005 to December 2014. Table 1. Portfolios without withdrawals 2005 – 2014. Strategy Total increase% CAGR% Number trades MaxDD% Fixed-no rebalance 92.50 6.77 0 -35.40 Fixed-25% rebalance 101.80 7.27 3 -35.40 Adaptive 267.36 13.90 48 -14.16 The time evolution of the equity in the portfolios is shown in Figure 1. (click to enlarge) Figure 1. Equities of portfolios without withdrawals. Source: This chart is based on EXCEL calculations using the adjusted monthly closing share prices of securities. From figure 1, it is apparent that the rate of increase of the adaptive portfolio is substantially greater than the rate of the fixed allocation portfolios. Part II: Portfolios with withdrawals Assume that we invest $1,000,000 for income in retirement. We plan to withdraw monthly a fixed percentage of the initial investment. That amount is increased by 2% annually in order to account for inflation. In table 2, we show the results of the portfolios managed for 10 years, from January 2005 to December 2014. Money was withdrawn monthly at a 5% annual rate of the initial investment plus a 2% inflation adjustment. Over the 10 years from January 2005 to December 2014, a total of $535,920 was withdrawn. Table 2. Portfolios with 5% annual withdrawal rate 2005 – 2014. Strategy Total increase% CAGR% Number trades MaxDD% Fixed-no rebalance 12.00 1.14 0 -39.19 Fixed-25% rebalance 13.24 1.25 4 -39.96 Adaptive 144.46 9.35 48 -20.98 The time evolution of the equity in the portfolios is shown in Figure 2. (click to enlarge) Figure 2. Equities of portfolios with 5% annual withdrawal rates. Source: This chart is based on EXCEL calculations using the adjusted monthly closing share prices of securities. To illustrate better the advantage of the adaptive allocation strategy and the effect of withdrawal rates on the evolution of the capital, we give in Table 3 the results of simulations for the following withdrawal rates: 0%, 5%, 6%, 8%, 10%, and 12%. Table 3. Adaptive Portfolios with various annual withdrawal rates 2005 – 2014. Withdrawal rate % Total increase% CAGR% MaxDD% 0 267.36 13.90 -14.16 5 144.46 9.35 -20.98 6 119.88 8.20 -22.53 8 70.72 5.49 -25.88 10 21.55 1.97 -29.70 Important observations can be made by analyzing the results posted in Table 3. At the safe withdrawal rate of 5%, the increase of the equity of the account is still significant resulting in a CAGR of 9.35%, a reduction of only 4.55%. On the other hand, by increasing the withdrawal rate by another 5% results in a CAGR of 1.97%, an additional reduction of 7.38%. The maximum drawdown increases quickly with any increase in the withdrawal rate. At the safe 5% withdrawal rate, the resulting drawdown increases with 6.82% which is comparable with the withdrawal rate. At higher withdrawal rates, the increase of the drawdown becomes dramatic, leading eventually to the quick depletion of the account. Conclusion The adaptive allocation algorithm performed substantially better than the fixed allocation algorithms. The fixed allocation strategies allow a safe withdrawal rate of 5% at any time horizon between 2005 and 2014, without a substantial decrease of capital. The adaptive allocation algorithm allows a 5% annual withdrawal rate while assuring a substantial increase of capital. In fact, the momentum-based adaptive allocation strategy allows a safe 10% annual rate of withdrawal without any decrease of capital.

Talking About Value Investing And Fed Policy (Video)

Here is the second part of my interview on RT Boom/Bust. It was recorded while the FOMC was releasing its statement, so I had no idea at that time as to what the announcement had been. The interview covers my view of Apple (NASDAQ: AAPL ) (not one of my strong points), Fed Policy, and what should value investors do in this low interest rate environment. Note that not all of my opinions are strong ones, and that in my opinion is a good thing. Often the best opinions are not controversial. If you are interested in these topics, or listening to me, then please enjoy the above video. My segment is about seven minutes long. Disclosure: None Share this article with a colleague

The Income Buyer’s Guide To MLP ETFs

Master limited partnerships, or MLPs, are a unique corner of the energy sector that produce high yields without the strict ties to interest rates. I like to classify MLPs as an alternative income asset class because of these unique properties. There are currently a total of 25 MLP ETFs and ETNs trading on U.S.-listed exchanges. Master limited partnerships, or MLPs, are a unique corner of the energy sector that produce high yields without the strict ties to interest rates. These dividend-generating machines are allowed to pass a majority of their profits to shareholders through distributions, which make them attractive for income seekers. In addition, they don’t follow the same price patterns as traditional stocks and bonds, which is a bonus for those looking to diversify or balance a broad mix of assets. I like to classify MLPs as an alternative income asset class because of these unique properties. MLPs don’t operate like a traditional energy company. Rather, they offer a toll road-style business that operates pipelines, storage facilities, and other infrastructure needs for oil and natural gas commodities. This makes their business models less susceptible to the whims of the commodity markets, and offers a steadier stream of reoccurring revenue. Many investors like to own MLPs directly within a taxable account because there can be some tax benefits available for sophisticated shareholders. Each direct investor in an MLP is considered a limited partner, and thus, is sent a K-1 at the end of the year according to their proportionate share of the financial outcome. However, there are also a number of ways to own these securities through a diversified and liquid investment vehicle that offer their own benefits and risks. There are currently a total of 25 MLP ETFs and ETNs trading on U.S.-listed exchanges. While many of these funds show similar characteristics, there are often very unique index construction techniques that set them apart from each other. The largest fund in this space is the ALPS Alerian MLP ETF (NYSEARCA: AMLP ), which has over $9 billion in total assets. AMLP tracks the 25 largest MLPs by market cap, and has a current 30-day SEC yield of 7.04% as of the end of 2014. Its top holdings include: Enterprise Products Partners LP (NYSE: EPD ), Magellan Midstream Partners LP (NYSE: MMP ), and Plains All American Pipeline LP (NYSE: PAA ). As you can see on the chart above, AMLP has been guilty by association with regards to the deflation in energy prices over the last six months. This ETF has seen a marked increase in volume and volatility as a result of the downgraded expectations for energy-related companies. However, on a relative basis, this MLP index has held up far better than traditional oil producer stocks. One of the differentiating factors in owning AMLP versus a direct investment in a master limited partnership is that you will not receive a K-1 at tax time, which can be a headache to deal with. Instead, all distributions will be reported on a 1099 like most conventional ETFs. It also means that AMLP incurs a hefty expense ratio – about 8.5%, according to some calculations – most of which is to cover tax liabilities. If you are looking for a more diversified MLP ETF with defensive properties, you may want to consider the First Trust North American Energy Infrastructure ETF (NYSEARCA: EMLP ). This actively managed ETF selects both MLP and traditional utility companies operating in the U.S. and Canada. EMLP has a wider base of 66 holdings and total assets worth over $1 billion. The benefit to this unique strategy is the broader diversification into the utility space, which is often a stalwart sector during periods of stock market volatility. However, the trade-off is that EMLP has a watered down 30-day SEC yield of 2.76% compared to the much higher income from AMLP. If a high income stream is a priority, the Yorkville High Income MLP ETF (NYSEARCA: YMLP ) should be on your radar. This ETF follows the Solactive High Income MLP Index, which selects holdings according to rules-based criteria for the current distribution rate and historical growth of the distribution. YMLP has a current 30-day SEC yield of 11.59%. The fund has 25 holdings that vary significantly in structure and asset allocation from the industry benchmark. This ETF may be an opportunity to supplement AMLP as a tactical holding for broader coverage of the MLP space or used to enhance the overall yield of an income portfolio. If cost of ownership is a core tenet of your screening criteria, the Global X MLP ETF (NYSEARCA: MLPA ) and Global X MLP & Energy Infrastructure ETF (NYSEARCA: MLPX ) are worth consideration. Both funds have one of the lowest expense ratios in this sector, with management fees of just 0.45%. MLPA follows a more traditional asset allocation to the industry benchmark with 35 holdings, while MLPX has exposure to 41 securities that are geared more towards energy infrastructure corporations. No matter what index you ultimately choose, these ETF options can help strengthen your dividend stream and enhance the capital appreciation potential of a balanced income portfolio . With many of these funds currently well off their highs, the opportunity for new capital to be incrementally added is worth consideration. However, because of the heightened volatility, I recommend that you pair new positions with a stop loss or sell discipline to manage downside risk . Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.