Einstein Portfolio Review – 27 June 2011

It is again time to review the Einstein Portfolio and below is the Dashboard worksheet from the TLH spreadsheet.  This screen shot lays out the Strategic Asset Allocation plan for the Einstein.  Note how the percentages are skewed toward value and small-cap asset classes.  We do not hold international bonds in this portfolio as it is not a very large portfolio. 

The Dark Red background indicates the asset class is over 25% above the threshold target range and the Purplish background indicates the asset class is more than 25% below the threshold target.  The Blue-Green coding indicates the asset class is in balance.

Limit orders were placed many weeks ago for the out-of-balance asset classes and we are patiently waiting for the market to readjust and pick up the orders.


Part of the Dashboard worksheet includes a rebalancing data table.  Below we see what is required to bring every asset class into balance.


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Benchmarking The Portfolio

Establishing an appropriate benchmark for a portfolio is essential if one is serious about investing.  Avoiding portfolio benchmarking is an act of self-deception, but all too common with the average investor.  Exactly what is the purpose of a benchmark and what are the requirements for a fair and reasonable benchmark.  Here is one definition of benchmarking.

In the investing world, the S&P 500 is frequently used as a benchmark for portfolios made up of U.S. equity holdings.  Even though the S&P 500 is a common benchmark, it is not the most appropriate standard and it does not satisfy all the benchmark requirements listed below.  Here are six standards for benchmarking.

1. The benchmark must be investable.  If one is using the S&P 500 as the benchmark, then an investable vehicle is the VFINX index fund as it closely tracks the performance of the S& P 500.

2. The benchmark must be identified in advance.  It is unfair to set up a benchmark after the fact so the portfolio shows up better with respect to the benchmark. Establish the benchmark along with the Strategic Asset Allocation (SAA) plan.

3. The benchmark must be objectively constructed. Many investors will use a simple benchmark such as Vanguard's Total Market Index ETF, VTI, or the index fund, VTSMX. These are certainly objective benchmarks as one can easily understand their construction. It becomes more difficult to meet this requirement when one begins to put together a customized benchmark.

4. A good performance benchmark has an unambiguous composition. This is why the S&P 500 is frequently used. Once more, it is difficult to establish a benchmark that is customized to a portfolio that holds an array of asset classes such as emerging markets, international REITs, commodities, etc.

5. A good performance benchmark is easily measured. 

6. The benchmark will also include a risk measuring metric. A strong portfolio tracking tool provides the user with a means for measuring portfolio risk. While risk, or portfolio uncertainty, is not frequently thought of as part of the benchmarking process, due to the intimate relationship between return and risk, an added calculation should be available for both the user and an outside evaluator. 

Why do investors avoid portfolio benchmarking? 1) It takes time to learn, understand, and implement. Most investors do not have the time or inclination to set up portfolio benchmarks. 2) There are few affordable tools available for the small investor to adequately benchmark their portfolio. Even the affordable commercial programs have gaps when it comes to meeting the above standards, particularly when it comes to accurately measuring portfolio volatility or uncertainty. 3) Investors are unsure whether they really want to know the truth about the performance of their portfolio. 4) Investors insist in setting up their own standards of portfolio evaluation, well outside the accepted standards of the industry.

What is needed to increase portfolio benchmarking? While there are a few quality software programs that do a good job of measuring the Internal Rate of Return (IRR) for the portfolio, missing is the capability of setting up a customized benchmark that matches the asset allocation makeup of the portfolio.  In addition, it is rare to find a program that will measure portfolio volatility or uncertainty using a semi-variance calculation rather than the standard mean-variation.  The investor also needs a visual picture to see if the portfolio is meeting the Strategic Asset Allocation plan.

What Does It Take To Retire?

Retirement Requirements

What does it take in savings to live during retirement? Here is data that readers may find of interest as they think about portfolio development and eventual retirement.

Assume a couple, nearing retirement, anticipate they will need $80,000 after taxes per year to live during their first year without employment. Between them they will receive a pension of $2,000 per month or $24,000 per year. These are all after tax dollars used in this example. Social security will provide another $2,500 per month or $30,000 per year. Eighty thousand minus $54,000 leaves them $26,000 short and this money needs to come from a savings plan. The question then comes down to what will it take to generate $26,000 in after tax dollars each year. I tend to be quite conservative when it comes to thinking through these numbers. Many advisors will tell clients they can withdrawal 5% per year from their retirement funds. My preference is to lower it to 2% so the portfolio has a greater chance to grow and fight off inflation should it raise its ugly head during the anticipated 30 years of retirement. $26,000 = X * 0.02 or X = $1,300,000.

To some, this is a shocking figure. This simple calculation helps one think of the value of a $24,000 pension or a $30,000 social security benefit. There is a considerable amount of money sitting behind those payouts, even if one uses a 6% figure. William Bernstein writes about this in his “Four Pillars” book. If withdrawing only 2% seems too conservative, then move up to 3% or 4%, but my recommendation is to not plan on withdrawing a higher percentage. If one pulls out 4% of the savings, then the required amount of savings is $650,000, still a substantial amount. If one does not have a pension, it places a greater burden on the individual to save more during a lifetime or cut down their living style, or both. The next issue facing this couple is to lay out an asset allocation and savings plan that will put them in a position to withdrawal the equivalent of $26,000 to $30,000 in today’s money sometime in the future. Planning for retirement becomes very complex when one adds in inflation and taxes as both are going to vary a great deal. This is why I tell couples to plan on saving between 1.2 million and 1.5 million in today's dollars. That seems like a very high bar to meet, but it can be done with discipline and frugal living.

Photograph:  The Arches National Park in Utah, USA

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