April 29, 2013: Goal Based Financial Planning And Investing

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Re-balance Cycle Reminder

The next re-balance will be on Monday, May 13, 2013. You can also find the re-balance calendar for 2013 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Goal Based Financial Planning And Investing

When it comes to real life personal finance, it is often more complicated than just setting up an investment portfolio. Many websites or tools just emphasize long term investing while they totally ignore what in real life people need for their personal situations. In the following, we discuss how to setup portfolios based on your financial goals, instead of a once for all risk profile based portfolio.

Financial Goals

A goal based financial planning works backward: you first find out several financial goals in the future. It then works on each goal to come up with a solution. In the situation where no easy solution can be found, you have to scale down or rework your goals and then iterate the above process.

The following are typical example of personal finance goals:

The most basic daily life expense: based on your current or desired life style, you work out your basic daily spending need. In personal finance, it is also called daily budget.
College or high school education: Junior 1 is going to college in 5 years while junior 2 will be in college in 8 years etc. Each one would require some amount by the time he goes to college. Don’t forget to factor in inflation. Furthermore, You can assume this is a lump sum need for the first year of college and then turn the money into some short term investments for a 4 year college expense.
Buying a house or selling a house: if you have a plan to do so, this is yet another source of cash in or out flow.
Retirement or semi-retirement: this is one of the most important life events as it can change your cash flow (earnings) completely. You can work out your retirement needs by using some online tools or just use some rules of thumb such as you’ll need 11 or 12 times your current annual pay when you retire at age 65, just to maintain a current life style compatible retirement life (see this link).
Long term care: this has become increasingly more important recently as more and more baby boomers are retiring, life expectancy is increasing and long term care cost has risen dramatically.
Estate planning: you would like to leave out money for your heirs.

Though you might be overwhelmed by many many details, do not be intimidated. Focus on the big events first and work out or leave out smaller ones later. As in any practice, an 80-20 rule also applies here: you can get 80% of work done with 20% efforts! That 80% of goals are much better than completely blind and just simply wait and see.

Goal Based Portfolio Setup

We can further classify goals into the following categories:

Emergency/daily expense: experts say you need at least 6 month cash. In the event you are working and your income covers the expense, there is little need to have that much cash at hand. However, if you feel your job is very insecure or if you are retired, you’ll need some form of cash or cash equivalent for daily expenses.
Lump sum need for each life event goal such as college funding, buying a car or a house etc.
Long term retirement need if your retirement is 10 years or longer away.
Perpetual estate for heir.
Investments during retirement or near retirement

One can see daily expense and investments during or near retirement require special treatment. Other goal oriented investments have a clear lump sum need and a fixed time line.

For investments during or near retirement, one way to do that is to divide the needs into three or four buckets (or parts): cash or immediate (6 month or so) need, short term investments (5 years or so), intermediate term investments (6-10 years or so) and long term needs (10+ years). You then convert each into a portfolio that will glide down risk as time goes (i.e. you adjust portfolio risk profile every year). You can do so in two ways:

Every year, you move one portion of a higher risk portfolio to the lower risk portfolio. So called refill the buckets.
Every year, you reduce your risk for each bucket a bit (i.e. gliding down risk path). You wait till 5 years or to reclassify your buckets again. The advantage of doing so is that for the long term (10+ year) investments, you might not need to immediately move a portion out of the bucket to the intermediate term bucket. This is especially useful if you have a down or bad year: you can wait markets to recover before you are forced to do so. Nevertheless, you still need to dial down your risk a bit for the portfolio.

Regardless which way you use, one can see that you will need to reduce risk exposure as time goes (other than the long perpetual part, even that, you might have to think about it when it is approaching). This is again illustrates how important it is to have a sound portfolio that has acceptable drawdown or risk level. A severe portfolio damage or loss and scaling down the risk at the same time is the worst combination that can seriously impacts one’s overall finance. Limiting severe damages to a portfolio, being an intermediate or long term, is paramount to retirees.

A word of caution: by no means we endorse the so called buckets of money strategies. We believe the ones touted out there are not scientific enough (lack of back testing or analytics such as simulations) and lack of details (no precise step by step guidance instead of just vague instructions). Conceptually, however, we believe further classify one’s ongoing needs into short, intermediate and long term categories can help to setup portfolios better.

Cash, Short, Intermediate and Long Term Portfolios

Now that we divide investments into the above categories, one can use MyPlanIQ’s portfolio setup tool to find their risk profiles and set up corresponding portfolios.

Some useful tips here:

Cash investment: we suggest you to utilize CDs to increase your interest payments. However, for those who have much larger amount of cash some of which will be only needed in other years (such as year 2, 3, 4 or 5), we suggest you consider using a CD/bond ladder portfolio (see below).
Short term investment: you can further break this into the following

If you only need the whole amount in 5 years, no need in the middle. You can use

a short term bond fund such as Vanguard short term bond fund (VFSTX: Vanguard Short-Term Investment-Grade Inv, VCSH: Vanguard Short-Term Corp Bd Idx ETF) or
a total return bond investment portfolio such as P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year`s Funds Monthly listed on Advanced->Advanced Strategies page).
customize portfolio with risk profile 100 for a particular plan in a brokerage such as Fidelity Extended Fund Picks Bond Trend Following.

If you need money every year, you might want to consider using fixed maturity bond ETFs to build a bond ladder (example: a bond ladder of 5 years consists of 20% each in a bond ETF that is mature in 1, 2, 3, 4 and 5 years). Refer to Put Your Cash To Work: Defined Maturity Bond ETFs Can Help.
We are currently working on a solution package for cash and short term investments. Watch this space.

Intermediate term investment: many conservative portfolios fit into this category. Risk has to be strictly controlled in this category to avoid immediate loss. We favor Tactical Asset Allocation conservative or all weather portfolios.

P No Load Conservative Mutual Funds Upgrading Quarterly on Advanced->Advanced Strategies page.
TAA conservative portfolio for Retirement Income ETFs.
All weather portfolios: Bridgewater All Weather Portfolio, Bridgewater All Weather Portfolio Risk Parityor permanent portfolios: Harry Browne Permanent Portfolio.

Long term investment: Even in this category, one should further select portfolios based on personal situations. For people who are tight in budget, risk has to be the most important factor. For people who have leeway or room to withstand loss, strategic asset allocation (SAA) can be used. In general, we favor core-satellite portfolios with core being SAA and satellite being TAA. You then adjust weights of SAA core and TAA satellite to reflect your risk factor. Some of our favorite portfolios:

Harry Browne Permanent Portfolio Core Satellite (50% permanent portfolio and 50% Vanguard ETFs TAA moderate).
P Goldman Sachs Global Tactical Include Emerging Market Diversified Bonds (on Advanced->Advanced Strategies page).
On FolioInvesting.com page: MyPlanIQ TAA Growth

To summarize, we believe goal based financial planning should be used to drive investment portfolio setup. Furthermore, risk should be strictly controlled when one approaches or is at retirement.

MyPlanIQ is currently working on several projects to provide better solutions in the areas mentioned above. Our goal is to provide easy to use effective solutions for various investment needs.

Portfolio Performance Review

We show the performance for various portfolios mentioned above:

Portfolio Performance Comparison (as of 4/26/2013)

Ticker/Portfolio Name	1 Week Return*	YTD Return**	1Yr AR	1Yr Sharpe	3Yr AR	3Yr Sharpe	5Yr AR	5Yr Sharpe	10Yr AR	10Yr Sharpe
P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year`s Funds Monthly	0.5%	2.6%	11.9%	3.76	7.1%	1.7	10.0%	2.12	10.0%	186.6%
Harry Browne Permanent Portfolio Core Satellite	1.0%	2.6%	6.4%	1.24	8.3%	1.15	7.7%	0.92	9.8%	106.5%
P No Load Conservative Mutual Funds Upgrading Quarterly	1.0%	2.6%	6.9%	1.91	5.0%	0.95	7.7%	1.38	8.9%	139.3%
VFSTX	0.1%	0.6%	3.3%	2.79	3.3%	2.07	4.1%	1.63	3.8%	119.0%
Retirement Income ETFs Tactical Asset Allocation Conservative	0.4%	4.2%	12.9%	3.01	9.7%	1.21	7.8%	0.88	9.5%	101.9%
PTTRX	0.4%	1.5%	7.7%	3.3	7.0%	2.11	8.1%	1.8	6.7%	130.5%
Fidelity Extended Fund Picks Bond Trend Following	0.4%	2.2%	11.0%	4.83	9.3%	2.35	9.4%	1.85	7.0%	128.0%

*: NOT annualized

**YTD: Year to Date

Detailed comparison >>

One can see our total return bond investment portfolio Fidelity Extended Fund Picks Bond Trend Following out performed the famed PIMCO total return bond fund PTTRX in 1, 3, 5 and 10 year category. All other conservative portfolios have very reasonable returns. Vanguard’s short term investment grade bond fund VFSTX, a short term investment favorite of ours, has done also a good job in the current low rate environment.

Market Overview

In general, equities are either hanging there (US stocks and international stocks and US REITs) or recovered a bit (such as emerging market stocks). There isn’t a noticeable trend change at the moment from the major asset trend ranking table on Asset Trends & Correlations (for other detailed ranking, see 360° Market Overview). However, we can only say that investors are relying on central banks’ further easing to boost a sagging economy. For now, fundamentals are not the main driving force behind risk asset euphoria.

We again copy our position statements (from previous newsletters):

Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible.

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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