Some time back, I wrote a book review on my main site for Zvi Bodie’s “Worry Free Investing“. I’ve recently been drawn into an online conversation asking about this author’s strategy of investing all of one’s portfolio in TIPS (Treasury-Inflation Protected Securities).
When Professor Bodie wrote his book, TIPS had a real rate of 3% (TIPS have two components - they are tied to the CPI and will rise in value tied to that rate, and also have a ‘real yield’ which is adjusted every 6 months.) and the spreadsheet he offers advises a saving rate of 21% with an eye toward replacing 70% of one’s pre-retirement income using TIPS. Now, as we move to the present, we find TIPS sporting a real yield of 1.2% which, when entered in Bodie’s spreadsheet, now councils us to save at a rate of 34%! As I state in my book review, this hardly seems ‘worry-free’ to me, as someone who was on the plan at 21% now needs to bump his savings by over 50% or miss his target retirement goals by as much.
I also need to mention that the entire return is taxable. If one is in the 25% bracket, 1.05% of that total 4.2% is lost to taxes and leaves a real return of only .15%. To be fair, he does state that these securities be held in tax-favored accounts. I find it curious that in a recent Business Week interview Prof. Bodie maintains his TIPS focus, although he does suggest an S&P call strategy which presumably will juice yields a bit. Such a strategy is not for the feint of heart.
I sent him a question, through his Worry Free Investing Site, I don’t know if he monitors the blog there, or will offer a reply.
As an alternative to this strategy, I’d offer DVY, the iShares Dow Select Dividend ETF which currently yields near 3.7%. That dividend is taxed at favorable rates, 0% if you are in the 10% or 15% bracket and 15% if higher. So 3.15% worst case. I have every reason to believe the stocks in this ETF will keep up with inflation, and for this strategy, that’s all we are asking of it.
JOE
A short sale of one’s home is different than we use the term ’short sale’ when referring to stocks. When you sell a stock short, you sell a stock you do not own, and hope it goes down so you buy it back at a lower cost.
A short sale of a house is when the sale price is not enough to cover the mortgage balance and the bank just accepts the sale price forgiving the balance owed. I wrote back in November that the unfortunate seller still had another issue. He had to pay tax on the forgiven amount. Now, thanks to the Mortgage Forgiveness Debt Relief Act of 2007, there is a three year exclusion for this situation, and no tax is due.
JOE
Well, the truth is, my head is still spinning.
Of course Bernanke must be a smart guy, and I have to acknowledge that too much was already in play at the beginning of his term. Watching Maria Bartiromo interview Greenspan and I was floored at his lack of awareness regarding the quantity and quality of the subprime mortgages there were out there. So I think Ben came in to this as an accident waiting to happen.
Given that it takes X months for a rate drop to have any impact on the economy (economy, not the market) we will likely still have a bagel, but as the cheap money once again floods the market, it may be short lived. As far as the 3/4% drop, I think that was a sign of weakness and panic, and the market reflected that.
In a few years this should be seen as any other dip, a buying opportunity. And the next cycle up is where I shift allocation to the mix I’d have at retirement, as I’m looking 5-7 years out.
Enjoy the weekend,
JOE
In 2008, the (long term) capital gains rates dropped. If you are in the 10% or 15% marginal bracket, your capital gain rate drops from 5% in 2007 to 0% (yes, zero!) from 2008-2010. For those in the 25% bracket or higher, the rate remains 15%. In 2011, these rates revert back to the pre-2003 levels of 10%/20%. See the charts at Fairmark to understand what bracket you fall into. As always, one should not let the tax tail wag the investing dog, it’s just good to know how these laws impact your investments.
JOE
If you haven’t read it recently, read the I have a Dream Speech.
Enjoy the day.
JOE
A quote from “The West Wing“:
Larry: “If the economy is heading into a recession–”
Josh: “No, no, no. We don’t ever use that word around here.”
Ed: “What word? Recession? …What should we call it then?”
Josh: “I don’t care. Call it a boat show or a beer garden or a bagel.”
Larry: “So if it is a… bagel, the Fed thinks it’s gonna be a mild bagel.”
I think that’s the path we are on, a mild bagel with a risk of renewed inflation concerns. The subprime meltdown or whatever you wish to cause the current crisis, has caused liquidity to dry up. The Fed, although a bit late, will need to drop rates and pump money into the system. This may very well pull us out of the, er, bagel, but it will touch off a bit of inflation. Just my thoughts on this. Enjoy the weekend, don’t lose any sleep over the market.
JOE
Edit - If you go to Google and search on “mild bagel” (I’m feeling Lucky) you get my blog.
I recently read Richistan, by Robert Frank and found it somewhat entertaining, although maybe not too surprising. Back in September when I wrote “You are Rich!” I talked a bit about U.S. income, and followed up with a post, “But the 400 are Really Rich” which focused more on the world’s poor. Now, in Richistan, I learned that the Richistanis are broken out into three Net Worth ranges:
- $1 million to $10 million - 7.5 million households
- $10 million to $100 million - more than 2 million households
- $100 million to $1 billion - thousands of households
Beyond my amazement regarding this concentration of wealth, I was intrigued by some of the anecdotes this book offered. The middle richistanis don’t consider the lower richistanis rich at all, they are merely affluent. Other stories contained detains of the lives of the middle to upper richistanis, and talked about how many people were employed just to run the households of these people, a hundred in some cases. But just like (some of) the anecdotes of “The Millionaire Next Door” I suspect this book doesn’t necessarily reflect ‘typical’, but those whose stories were most interesting.
I was also reminded of the CNBC interview with Warren Buffet during which he was asked if he had a boat. He replied that he did need one, he had enough invitations to go on the boats of others, he didn’t need the hassle a boat brought, the need for a crew, and all the other headaches. This book had no examples such as this, the people interviewed were from the big spending club.
I don’t know, but I can offer one strange symptom.
A friend showed me the receipt from his HMO. He had gone for a test recommended when one passes age 50, and received the statement advising his copay. The bill from the hospital was $1200. The HMO allowed only $200, and so they paid the hospital $180, leaving my friend with a $20 copay. What’s wrong with this picture? If someone with no insurance received the same test, they would be stuck with the original $1200 bill. Worse, they might not get tested at all, and potentially face a life threatening illness that could have been avoided.
I’m used to seeing HMOs discount a $150 doctor visit to $120 or other bills reduced by 10-30%, but this just seemed to be over the top. I don’t have the answers on this issue, I just recognize the system is broken.
JOE
Starting in 2008, you are no longer required to first roll your 401(k) to an IRA to then convert it to a Roth IRA. You should still be in tune with the taxes that will be due upon conversion and do the math to see if converting makes sense. See Fairmark’s website to understand the tax bracket you fall into and at what rate the conversion will be taxed. The Roth conversion works best when you are in a lower bracket at conversion than you will be in upcoming years, or when the extra income from 4019k) or IRA withdrawals will force you into the Phantom Social Security Tax brackets.
JOE
Last year (2007), the IRS permitted the company controlling a 401(k) to allow a non-spouse beneficiary to roll it over to a beneficiary IRA. Now that option is mandatory. If you are the non-spouse beneficiary of a 401(k) you may demand that it be rolled to a beneficiary IRA and you may then stretch out the withdrawals over your lifetime. This is an important option for those whom it impacts. Prior rules allowed a forced withdrawal within 5 years of the account holder passing on.
JOE
