I was going through some work stuff, investing stuff and financial planning stuff in my head and concluded that the solutions or advice nowadays tend to be rather complicated.
So I would like to see if I can distil some of these things into some main points for us to focus upon.
This post should cover investing, wealth accumulation and certain aspect of retirement planning. This is probably more useful if you have gotten deep into the weeds on investing, managing money for a while.
If not it will just be a confusing mess.
Recently, I thought about the way that I invest. At this point, I am not sure if I have an edge in this investing world or not.
I am probably considered more sophisticated than most but that does not mean the result shows that sophistication.
I think I conclude that if I am my own fund manager for the next 20 to 30 years, I might cause more harm to my wealth than enhance it.
That statement “XXX% of portfolio managers do not consistently beat the market.” seems to be more relatable to me.
When I reflect upon my portfolio, what I have experienced, the axioms of investing that I came across, it might all boil down to the following simple things:
- My return is a function of risk premia that my money is exposed to. There are financial securities that return adequately for the risk that I subject my money to. The more risks I take, the greater my returns. Returns is a matter of how much equities/risky securities compared to how much cash/less risky securities you have.
- Higher risk usually means higher volatility. Some folks who are risk-averse would have to accept a lower return when their volatility is controlled. There are enough people seeking high returns who believed that what they invest in has low downside volatility. One day, they might learn a painful lesson.
- It is important to prevent large capital impairment of your capital. This is done by doing serious due diligence if you are concentrated on a handful of stocks or that you are broadly diversified enough so that you will not suffer from capital impairment.
- There are market regimes, circular trends. The market has a way of telling us we cannot guess correctly how each regime will play out and when they will happen exactly (and when they will end). As investors, however, there might be some metrics that tell us roughly whether things are turning.
- To build wealth you need enough optimism in the future. If not, it will be challenging for you to take risks.
- At the same time, to risk manage, you need enough scepticism that things will always work out the way people said they would.
I remembered some of the atrocious client portfolios that I came across at work. Strangely, my takeaway seem to be….the managers put the clients in this fund and that, invest in this stock and that.
But at the end of the day, over long periods, even these portfolio got some returns that are better than cash.
Granted, we can greatly advanced our wealth by doing a lot of things right. Chief among them is to be diversified enough, keep costs low and use fundamentally sound financial securities.
But in the end, a lot of time it boils down to how much exposure we have in risk assets, and how long we can sit with it.
Simplifying Wealth Accumulation and Retirement Planning with Decision Rules
My influence on accumulating towards financial independence and safely spending down wealth is heavily influenced by what I seen at work, what I read, and some heavy reflection.
I have a huge disdain for complex systems. Too many moving parts.
The biggest problem: Too many moving parts + uncertain future markets expectation, inflation expectation, spending and lifestyle needs will just increase the confusion.
For example, if your return is less than the target return today, and you are retiring in 8 years time, should you be concerned that your current portfolio value is less than where it should be? Maybe the returns will be better in a few years.
If not today, then WHEN should we start worrying?
If you have more moving parts in your retirement solution, you increase the number of pathways you need to think about.
I think end of the day we need to keep it simple.
The markets, inflation, and your future lifestyle is uncertain in different degree. These are the reality.
Your system should be designed around these uncertainties always being around.
It should be heavy on well thought out decision-rules or decision-trees.
Case Study: Planning for Mr and Mrs Tan’s Wealth Accumulation
Suppose today Mr and Mrs Tan spend $10,000 a month. We worked out that their retirement lifestyle 20 years from now would cost them $7,000 a month. In 20 years time, based on an inflation rate of 2% a year, they will roughly need $10,401 a month.
We ask a series of questions to find out out of this $7,000, what is the bare minimum they need to have, how willing they are to adjust their spending if markets are not favourable, and what is the frequency of adjustment.
Mr and Mrs Tan need their money to last for 45 years. On a conservative basis, they should accumulate $4.1 mil based on a 3% withdrawal rate. However, we may be able to make the plan work in a baseline scenario of $3.6 mil based on a 3.5% withdrawal rate.
20 years is a long time and a lot could change. Mr and Mrs Tan may double their income and can increase their contribution, they might get divorced, they might get one more kid, one of them could quit work. The markets may be favourable to them, or less favourable to them as well. Inflation could run at 0.5% or 4.5% a year.
Whatever we plan today is at best… a weak projection.
We should work upon ensuring Mr and Mrs Tan efficiently uses their income, to optimize spending, ensuring other financial goals are taken care of. Any excess is funnel to their financial independence portfolio contribution.
Every year, we will evaluate
- Market performance of the portfolio
- Increase surplus contribution from work in the portfolio
- Potential retirement lifestyle changes
All these will affect the portfolio value required for financial independence. Better sensing of their lifestyle may mean that Mr and Mrs Tan needs $6,500 a month today instead of $7,000. The amount Mr and Mrs Tan need to accumulate to will be $3.8 mil (conservative) or $3.3 mil (baseline) compare to $4.1 mil and $3.6 mil as originally computed.
This is done periodically.
Perhaps due to career progression, sound cash flow planning, and reasonable market growth, Mr and Mrs Tan would have accumulated $3.8 mil in 15 years.
$6,500 a month in 15 years is $8,750 a month. With their portfolio, Mr and Mrs Tan would be spending a conservative 2.7% of the portfolio in the initial year.
Technically, Mr and Mrs Tan can retire 5 years earlier. Whether they choose or not may be decided based on other aspects of their life.
How Should Mr and Mrs Tan Spend Down their Wealth?
How should Mr and Mrs Tan spend down their money?
Over the years working with them, we would have found out their lifestyle preferences and how much flexibility they have over their income preference.
The sensible spending system is one where we can adjust the spending based on Mr and Mrs Tan’s longevity, spending, portfolio value such that Mr and Mrs Tan can tighten their spending to make the money last or spend more (or divert to other aspirations) when the portfolio has more.
Every year, we will be consultative about what is the income Mr and Mrs Tan can take out.
We will work out a few figures for Mr and Mrs Tan to focus on.
For example, the portfolio starts off at $3.8 mil.
- Mr and Mrs Tan can spend $133,000 a year or $11,083 a month if they with to.
- If the portfolio value is between $3.2 mil and $4.8 mil, they don’t have to worry about their spending.
- If the portfolio value falls below $3.2 mil, it is recommended that they adjust their income down to $119,700 a year or $9,975 a month.
- if the portfolio value rose to $4.8 mil, we can recommend them to go a little crazy to spend $146,300 a year or $12,191 a month.
So if the year’s performance is not really good and their portfolio value fell to $3.6 mil, they can still increase their spending with inflation adjustment.
I find that this wealth accumulation and retirement spending to be sensible and realistic because it is a system created to tackle problems with a lot of uncertainty.
We need to factor in our experience, financial math that does not change, historical results into well thought out decision trees.
Tackling wealth accumulation and retirement spending is closer to flying planes then doing some routine work.
I believe that the framework for investing, wealth accumulation and spending that I have presented are sound and flexible.
They are easy to maintain.
Less moving parts and not overcomplicated.
The problem is that you would only accept financial plans like this is not everyone would be able to understand them.
For example, most clients would prefer to believe that your solution gives them a degree of certainty in this uncertain world.
Some of you may notice that my view’s presented today on investing and retirement spending is built around uncertainty, not knowing what will happen in the future.
This tends to be very unacceptable especially if you are paying money for it.
The hard truth is that the solutions that you find out there overpromised you. The real solution is the one that treat uncertainty as reality and helps you navigate through an uncertain world, with enough sophistication, in the best possible way.
I think in the next few days, I may cover simplying work and life portion.
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