Retirement and Near-Retirement Investing Considerations

Safe Income

I have received a lot of questions from retirees and near retirement subscribers about how to invest and where to find safe returns.  This is an initial attempt to answer some basic questions as I contemplate the unique challenge of retirement income in an age of financial repression.  While interest rates are being allowed to rise from suppressed "emergency" below-inflation levels, I have no doubt we will return to low rates again at the first sign of real economic weakness.  But for now, let's look at some options for safe investments.


If you have reviewed our discussion on the Lifecycle funds you are aware that the professionals who constructed Lifecycle fund allocations know that retirees and those near retirement should go light on equities. The primary reason is if the market cycle turns down and you lose 50% in your stock funds, you do not have time to replenish your account.  If you have read my commentary you know that I do not think it matters if you are 65 or 35 because you never really make up those losses.  Sure you have time at 35 to adjust your lifestyle to save more, but you are not still down significantly in retirement from where you could have been if you avoided most of those losses.


A quick reminder on how TSP Retirement Lifecycle funds are allocated today is shown in the Fund Allocation graph. For TSP retirees, 74% of the Lifecycle Income fund is invested in the TSP G fund with 6% invested in the TSP F fund.  That means only 20% is invested in the stock market.  


The equity funds are allocated based on market cap weightings of the indexes the funds are invested in.  The SP500 holds 80% of the market value of the total US stock market and the non-sp500 companies (TSP S fund) holds the other 20%.  So to hold a balanced total US market you would need to hold 4 parts C fund and 1 part S fund.  Do the math and that 11.2% C fund allocation is 80% of the US stock market.  The International fund (TSP I fund) holds the largest 85% of the rest of the "developed" worlds public company's stock.  


Note: I am not a fan of International funds (TSP I fund) or the Barclays Aggregate US Bond Fund (TSP F fund) at this time.  The SP500 companies (TSP C fund) obtain 31% of their revenue from international operations and account for about 80% of the rest of the developed worlds tech stocks.  You have all the international exposure you need with a SP500 fund.


Non-TSP Accounts



A subscriber recently ask where he could invest outside of TSP to obtain a safe return like the TSP G fund.


I told him what I have been saying for years that there really is no low-risk fund to earn a return today and that holding funds in a FDIC insured account was better than holding a non-FDIC insured fund that was offering a measly return. This time I was wrong.


My answer has been true for the last 10-years of financial repression imposed by our monetary geniuses at the Federal Reserve as they bailed out the financial system. But as you will note, I have been writing about the Fed raising the Fed Fund rates and pushing up all interest rates.  


Most money market savings account are still in measly interest rate category, but some low risk funds are seeing signs of life. I still think it is a great idea to have an account that will let you "sweep" your funds out of your brokerage account and into a FDIC insured bank account (such as USAA asset management accounts and some brokerages).  


But you can now purchase some money market "funds" through your brokerage that actually have a return for your risk.  Here are a few examples as of 26 July 2018:


Prime Money Market Funds (SEC or 7-day)
    Your Yield Exp  Min Symbol
JP Morgan 3/6/2018 1.71% 0.56%  1K VMVXX
Fidelity 3/6/2018 1.86% 0.42%  2.5K SPRXX
Vanguard 3/6/2018 2.06% 0.16%  3K VMMXX
USAA 3/6/2018 1.63% 0.63%  1K USAXX
Schwab 3/6/2018 1.88% 0.47%  $1 SWVXX


I added USAA to the list since many military members have USAA accounts.  But also to highlight that they do not have low expenses compared to other low-cost brokerages.  You lose 0.43% in interest annually from their mutual fund fee compared to the lowest expense.  I am not meaning to beat up on USAA, they are a great company but they represent an example of many other banks with expenses that eat into your returns.  


If you have a self-managed IRA, you can probably buy the Vanguard mutual fund with the $3,000 minimum investment but you will have transaction costs that a Vanguard account will not.


I am NOT pushing Vanguard accounts and I am not affiliated with the company.  Since Vanguard was the only brokerage offering extremely low fees when Ravenstone Research Inc. started I would have pushed them at that time.  My belief is investors have given too much of their wealth to banks and brokerages over their investment lives - more than they know.  Today there are many low-cost brokerages to include the list above.  I would research carefully some of the new online companies before jumping in. But in the Prime Money Market Fund area Vanguard's low expense is still leading the pack.


The SEC Yield or 7-day yield is a close approximation of what you will receive on the date provided.  Those with lower expenses, offer higher yields to you.  Those expenses wiped out any yield prior to the Fed Fund rates first couple of hikes.  As the Fed normalizes rates from their emergency (transfer wealth to the banks from savers low rates) monetary policy, we should see even higher returns.  You should be able to buy any of these funds in any self-managed brokerage account but their will probably be transaction fees unless you are buying your brokerages prime money market fund. 


It is important to understand there is a difference in a money market "fund" and a money market account at a bank.  Bank savings accounts and money market rates are much lower.  Some online-only banks are offering similar rates as seen above but you have to look at all of their fees to know if they are worth it.  Bank accounts are FDIC insured but brokerage accounts are not.  Brokerages have their own insurance, but chances are the government will make sure the FDIC can meet its obligations. I doubt this will be true for brokerage accounts and Money Market Mutual Funds can incur minor loses in a crisis.


The no-risk TSP G fund is earning approximately 2.88% annually as of May 2018 for comparison.  The TSP F fund which invests in the Barclay's Aggregate US bond Index has a similar yield to the TSP G fund but is incurring capital losses as interest rates rise like most bond funds.  It's 30-day yield was 2.92% as of May 2018 but its year-to-date loss was -2.32% due to capital losses on rising rates.


Here is a simple run of thumb for bond funds.  If you look up the effective duration of the fund, the years of duration is approximately equal to the movement in price for every 1% change in interest rates.  If a 7 year duration fund's interest rate moves 1% higher, the fund sustains 7% in capital losses. It still earns that yield but you have to subtract the capital losses from the yield to get total returns for that year.


Recommendation Today


As of this writing, we are in a rising interest rate environment so I recommend staying in very short duration bond funds such as the ones listed above to obtain yield but not capital losses of significance.  The TSP G fund does not incur capital gains or losses by its construct and is a great safe investment choice if you have that option (TSP account).  


Since retirees need to preserve their capital above all else, you need to invest in safe low risk investments. 


As for that 20% in stocks, the Lifecycle funds are buy and hold funds that do not take into account the type of market risk I am concerned about - large unrecoverable losses.  You need a strategy for your stock allocations too that takes into account changing market risk. Our seasonal strategy is our baseline strategy that has eliminated much of large losses in the past.  


But as of early 2018, we are sitting on top of the most overvalued financial markets in history for both bonds and stocks.  Bonds are starting their descent and as smart investors exit bonds for their reset some of these funds have flowed into stocks extending the stock markets melt-up.  Add in corporate tax breaks that are going into reckless stock buybacks instead of investments in future profits and we have a built in delay in the stock markets reset.  The delay should end by the end of 2018 and no later than 2019.  


A bear market will begin regardless of corporate "profit" growth unless the central banks come to the rescue again.  I expect the total return on the US stock market to be near zero over the next 10-12 years with large losses in the interim.  Short-term is harder to predict, but I am defensive based on valuations and the recent halt to a market melt-up.  The melt-up made selling difficult from many money managers.  That selling is easier now and sell-the-rally will probably overcome buy-the-dip investors this year.




A Quick Look at various rates as of March 2018 for comparison


Again TSP G fund interest is 2.5% at the time of the snap shots below.  All of the Money Market Mutual Funds listed above are better options.  Vanguard's is the best simply because they have the lowest expense and will always earn about 0.3% more.  Schwab's is the next lowest expense. There returns partially make up for the lack of FDIC insurance, but under market stress it would be nice to have a sweep account that allows you to move to an FDIC account. 


Note: Some online only banks are now offering rates comparable to the Money Market Mutual Fund rates listed above, but you would need to really research all the account fees and issues of this accounts. 


  


Average savings account rates are pathetic but FDIC insured





Average money market bank account rates are equally pathetic, but FDIC insured




Average 1-year CDs are better but not great but FDIC insured




Lock your money in for 5 years for 1.7% today - not a great option (wait) but FDIC insured



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