Retirewell® Part 3: Low Cost, Consistent Results

Christopher Tan

Low costs, consistent results – what’s there not to like about index funds?

While there are still managers who can beat the markets, many are unable to do it year after year.

In previous months’ articles, we talked about how we helped our 59 years old retiree client, David, to have a reliable income stream in retirement using our proprietary tool called RetireWell. David’s retirement objectives are:

  1. $10,000 per month for the first 5 years
  2. Reduce to $8,000 per month for the next 10 years
  3. Finally, to $6,000 per month till age 83

At the end of age 83, he wants to have $1 million to leave behind for his loved ones or use it for himself if he lives longer.

Very briefly, based on what David wants, we allocated $1.479 million of his money, together with his rental income and proceeds from his insurance policies into various “buckets” shown in table 1. These “buckets” are really different portfolios with different risk and expected returns invested over a different time horizon. (Do read the previous articles for a detailed explanation of the allocation)

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Table 1: How RetireWell®  Optimizer Allocated David’s Resources

  1. From age 59 to age 83, David will receive a monthly income (adjusted for 3% inflation). A portion of it will come from the income bucket which provides the safe retirement income floor. The rest of it will come from drawing down from bucket 1.
  2. Bucket 1 will contain enough cash to drawdown for only 5 years. Once the cash is depleted, cash from the rest of the buckets will be transferred in, at the end of their investment period.
  3. At the end of age 83, all buckets (except income bucket and bucket 6) will be depleted. If David passes on at that time, bucket 6 will have an amount of $1 million to be left behind as a legacy. If David lives on, monies in bucket 6 and income bucket will be drawn down to meet his needs.

The “buckets” or portfolios are invested as shown in table 2.

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Table 2: How the various buckets are invested

The way the portfolios are invested is based on the principle that for portfolios with higher expected returns and risk, you need a longer time horizon. Our near 2 decades of investment experience also tells us that the best way to get these returns is to stay invested and not time the markets. As such we do not change these allocations in the short term to react to market news, like the recent Brexit and US Elections. These decisions have served our portfolios well.

In executing such a philosophy, we also need to find suitable instruments to execute it. We mentioned in our previous article that we primarily use Vanguard funds and Dimensional Fund Advisors. In this article, I will explain why we use index funds from Vanguard.

Most Active Managers Cannot Beat Market

Why index funds? The simple reason is: It works! Tons of literature has shown that most active managers cannot beat the market. Below are just some of them.

Percentage of U.S. Large Cap Equity Funds in the U.S. that Outperformed the S&P 500 Benchmark

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Source: S&P Dow Jones Indices LLC, CRSP. Data as of June 30, 2016. Chart is provided for illustrative purposes. Past performance is no guarantee of future results.

Percentage of Emerging Market Funds in the U.S. that Outperformed the S&P/IFCI Composite Benchmark

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Source: S&P Dow Jones Indices LLC, CRSP. Data as of June 30, 2016. Outperformance is based upon equal-weighted fund counts. All index returns used are total returns. Chart is provided for illustrative purposes. Past performance is no guarantee of future results.

Why risk your money in retirement?

But the above charts also show that there are still managers who can beat the markets. The problem is, they are unable to do it consistently.

The latest data compiled by S&P Dow Jones Indices shows the persistence of U.S.  equity fund performance over the past five years. The data and the conclusions we can draw from it could not be clearer: out of the 664 funds which were in the top 25% of U.S. equity funds in March 2012, only 11.90% remained in the top 25% in the very next year. By March 2016, only 0.30% – 2 out of the initial 664 funds – was still in the top quartile. This shows the inconsistency of active fund managers, and how a strategy of simply looking for the best fund performers in any given year is likely to fail.

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Source: S&P Dow Jones Indices LLC. Data for periods ending March 31, 2016. Past performance is no guarantee of future results. Table is provided for illustrative purposes.

So why risk your money in retirement by trying to find managers that can consistently beat the market when it is so difficult to find them?

Low Cost

One clear reason why active managers fail is fees. Eugene Fama, Nobel Laureate in Economic Sciences, pointed out that before costs, an active investment must be a zero-sum game, in which active investors who have positive returns must have made it at the expense of other active investors. After costs, however, in terms of net returns to investors, an active investment must be a negative-sum game. We like index funds because it is low cost.

The Spirit of Vanguard

So why Vanguard? Besides the fact that it is the top 3 biggest fund managers in the world and there is strength in size, it is because our values are aligned with them. John Bogle, the founder of Vanguard simplifies these values into one word: “Enough”. In his book “Enough”, Mr Bogle talks about what enough means in money, business and life. In the world of finance, he argues that it is marked by too much cost, and not enough value; too much speculation, and not enough investment; too much complexity, and not enough simplicity. In the business world, it is focused too much on counting and salesmanship, and not enough on trust and stewardship; and our society at large is too obsessed with charisma and wealth, and not enough with character and wisdom.

This mindset of having “enough” is aligned with the approach we have used to help retirees retire. It is about not taking unnecessary risks, not incurring a high cost so that we get enough returns to give a reliable income stream in their retirement.

The writer, Christopher Tan, is Chief Executive Officer of Providend, a Fee-only Wealth Advisory Firm. Besides being financially trained, he is also an Associate Certified Coach with the International Coach Federation. The edited version has been published in The Business Times on 4 February 2017.

Here are the links to the other 10 parts of the RetireWell® Series:

We do not charge a fee at the first consultation meeting. If you would like an honest second opinion on your current investment portfolio, financial and/or retirement plan, make an appointment with us today.

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