ValueAverager - Official Blog

What a great "Lost Decade" it's Been!

2008-03-27T10:00:14-04:00

The Wall Street Journal yesterday declared the "20-oughts" a "lost decade" in the markets. Just look at this chart! We're right back where we started.

Of course, if you've been saving regularly and constantly throughout the period, you've done very well. Stocks went on sale, hopefully you bought.

"The Schiff Has Hit the Fan"

2008-03-18T13:14:53-04:00

Here's a little doomsday rhetoric for you, courtesy of the great Peter Schiff:

Fidelity Income Replacement Funds - Value Averaging?

2007-11-27T21:33:43-05:00

Is this article talking about Value Averaging?

Fidelity's Income Replacement funds are a bit like target-date retirement funds in that they have a diversified portfolio of stocks, bonds and cash that grows more conservative over time.

But instead of picking a fund with a date that corresponds to your planned retirement, you choose a fund with a date ranging from 2016 to 2036, based on the number of years you want to receive income.

After deducting annual expenses of 0.65% or less, the fund then pays you a rising percentage of your account value each year until the balance runs out in the target year.

Sounds a little bit like it to me (picking a date in the future - that's familiar). Here's some more:

It's important to understand these funds' limitations, though. While they can ensure that you'll receive income through the target year, they can't guarantee the size of the payments. That depends on the funds' investment performance. And as the table below shows, your income can drop if the markets hit a rough patch.

Are you catching on? This fund actually does something like Value Averaging, but in reverse. You start with a pile of money and a target date. Then, Fidelity systematically divests you from the market and sends you the cash every month. Over time, they adjust the amount of cash for inflation to preserve the real value of the cash flow. They also adjust it based on how well the underlying investments are doing. When your investments are doing well, they adjust your cash payment upwards. This requires them to sell more of the equities (at higher prices). When your investments are doing poorly, they adjust the payment downwards so that they are selling fewer shares when prices are low. One difference between the Fidelity fund and regular Value Averaging is that with the Fidelity fund, these adjustments occur only once per year, even though you receive the cash on a monthly basis.

With ValueAverager, you are basically buying-more-low, buying-less-high, and occasionally selling at extreme highs. With the Fidelity Income Replacement Funds, you are selling less low, and selling more high. The chart above shows how much the monthly payment might have varied from 2000 to 2007.

Here's a table comparing Value Averaging to the Fidelity Income Replacement Funds:

	Value Averaging	Fidelity Income Replacement Fund	Similarity
End Date	The end date is the date when you finish saving for your goal.	The end date is the date when you are finished spending your nest-egg.	Both are based on a target date.
Periodic Cash Flows	The amount of your periodic deposit depends on how the underlying investments are doing. If they are doing well, you deposit less. If they are doing poorly, you deposit more.	The amount of your periodic withdrawal depends on how the underlying investments are doing. If they are doing well, you withdraw more If they are doing poorly, you withdraw less.	Both systems require the investor to be flexible about cash flow. Value Averaging requires flexibility about deposits. Fidelity requires flexibility about withdrawals.
Inflation	The amount of your periodic deposit is adjusted for inflation using an estimate rate of inflation that you enter.	The amount of your periodic withdrawal is adjusted (automatically by Fidelity) for inflation.	Both adjust cash flows for inflation.

The bottom line is that this mutual fund has a similar objective to Value Averaging. In exchange for tolerating some unpredictability in your cash flows, you gain extra return on your investment. The extra return happens because the cash flow is modified to tilt out of equities when prices are high and tilt into equities when prices are low. This makes your cash flow somewhat unpredictable, but it increases your overall rate of return.

Homepage for Fidelity Income Replacement Funds is here.

A History of Risk

2007-11-19T15:54:33-05:00

I think this is insightful:

A naïve approach to risk might have been appropriate in an era when economic activity was almost totally agricultural. For most of human history, in fact, the main source of economic risk was the weather. But nobody can do anything about the weather. Risk management in those days was therefore a matter of religion, incantation or superstition. Rain dances in one area were matched by novenas in another. Appeals to God’s will or the fates seemed to be the only way to deal with the risks that weather could wreak.

That model of risk management changed radically during the Industrial Revolution. As more and different kinds of goods and services came to market, a wide variety of risks replaced the longstanding and single-minded concerns about the weather. What will our suppliers charge? Will customers pay the prices we set? Will they want the new products we are developing? Will our competitors beat us to the punch? Will they start a price war? Should we raise our employees’ wages, and, if so, by how much? Can the engineers rearrange our production to be more efficient? Will our bankers smile or frown when we seek credit? Will our interest rates rise or fall?

The whole thing here (NYT).

What if the Income Tax were Repealed?

2007-11-18T20:52:20-05:00

I talk a lot about tax shelters on this site for one simple (and obvious) reason: We all have to pay an excessive amount of our income in taxes.

But will that always be true? Some candidates in this year's presidential primaries are proposing to get rid of the income tax.

As unlikely as that outcome is, I thought it would be interesting to riff about what the impact of this would be for people who currently hold different types of tax-sheltered accounts. Because most of the tax shelters still involve paying tax in some circumstances, they differ in terms of how they would perform if the income tax were repealed. Below is my list:

Account Type	When Taxes Typically Get Paid	Remarks	Repeal Results
401(k)	On withdrawal, typically in retirement.	401(k) investors get a tax break when they contribute and owe taxes when they withdraw. If income taxes are abolished at the time of withdrawal, then they avoided paying tax completely.	Big Winner
Traditional IRA	On withdrawal, typically in retirement.	Same as 401(k)	Big Winner
Roth Accounts (IRA and 401(k))	On year of deposit. Roth contributions do not create a tax-deduction, meaning that the tax is paid in the year when the money is contributed.	Roth investors pre-pay their taxes. They get handsomely rewarded for this by not owing tax on the much larger amount of money that they will withdraw in retirement. However, if income taxes are going to be repealed, then pre-paying is a really bad idea. Roth investors will be the big losers.	Big Loser
Health Savings Account	Taxes are never paid if the funds in the account are used for medical expenses. Tax are paid on withdrawal if the money will be spent on anything else.	The outcome will depend on how much medical expenses you're likely to have over your lifetime. This is not easy to predict. If you spend every dime in your HSA on medical expenses, than an income tax repeal won't affect you at all. If you take the money out for other purposes, than the repeal of the income tax means you get to avoid taxes you otherwise would have paid.	Draw/ Modest Winner
529 Plans	Taxes are paid on the year of deposit. 529 plans are like Roth IRAs, but you must pay tax if you withdraw money for purposes other than education.	529 Plans involve pre-paying taxes, so they would not benefit from the repeal of the income tax. However, it is unlikely that most 529 investors could find other tax-shelter alternatives for their 529 investments because most parents put their kids through college before they retire.	Draw

Of course, I wouldn't bet on the income tax going away anytime soon. If it were to happen, the law might include provisions to even out the results. In other words, they could give Roth holders a break by refunding the tax that was paid. Or they might require 401(k) holders to pay back taxes on their contributions. You can be sure there would be many heated debates about this topic before Congress would move on abolishing the income tax.

Want some Zen reassurance?

2007-11-14T02:41:02-05:00

Check out David Leonhardt's article in today's NY Times.

Stay "cool," or stay "even keeled," or there's a "silver lining" or, whatever. He's right, in any case.

To Prove My Point. . .

2007-11-13T12:29:06-05:00

I just saw this link on the NYTimes homepage

Bank of America to Write Down $3B in Debt

I didn't write about this yesterday. Those were different billions.

A billion here, a billion there. . .

Is this Subprime Stuff Ever Going to End?

2007-11-12T16:14:27-05:00

Every single day there is a new story about some huge loss or write-down resulting from the subprime debacle. This morning was no different:

I wonder if people realize that each day's news of subprime losses is usually separate from the previous day's. They all sound the same, so I can imagine that many people out there are thinking that it's just the same story being repeated every day. Not so. It's all adding up to HUGE losses.

Many people thought the subprime correction ended in August, but the crisis has continued. We are almost back down to where we were in August:

(Screenshot taken from NYTimes.com at 4:05 EST Nov 12)

All of this volatility makes me happy that I discovered Value Averaging, which lets me take advantage of the highs and lows to purchase shares at a lower average price. What could be better in today's topsy-turvy market?

The Taxman can be Unfair to 401(k) Investors

2007-11-08T15:59:26-05:00

401(k) accounts allow you contribute pre-tax funds to a retirement account and they allow the funds to grow tax-deferred. You probably already know this.

While these accounts are advantageous to millions of investors, there are situations where the tax treatment of 401(k)s is actually worse than than it is for taxable accounts. This is because when you withdraw funds from a 401(k), the entire amount that you take out is taxed as income.

To the casual observer, this seems reasonable. The tax deduction for contributions and tax-deferred growth are such huge benefits, so it makes sense to tax the withdrawals. Otherwise government would never get its take.

The problem is this: Income tax rates for most people are significantly higher than the tax rates on dividends and capital gains. When your portfolio grows in your 401(k), in what form does that growth appear? You guessed it, dividends and capital gains.

So think about it You would be paying a flat 15% on your gains if the funds were held in a taxable account, but you will ultimately have to pay 25-35% on those gains that occurred inside a 401(k). What gives?

Well, it's actually a little more complicated. Most investors will still come out ahead with a 401(k).

A 401(k) account is better if you are many years away from withdrawing the funds. This is because of all of the tax-free compounding that will occur if you leave the money in there for many years. If you have a lot of time to go, your gains are likely to be large enough to overcome the fact that you will pay a higher tax rate in the end. However, if you're over 50 years old, this disparity in the tax rates may be an issue for you. (I have not tried to pinpoint exactly when you should stop contributing to a 401(k). I'm guestimating.)

I've created a spreadsheet (download here) that demonstrates the principle at work here. DISCLAIMER, this spreadsheet should only be used to see how taxable accounts are sometimes more advantageous than 401(k)s. Please don't use it to make your own financial plan. It has serious flaws that make it unable to do that.

A few other points:

If your employer has a matching contribution, you should always take advantage of it. There's no tax problem that can't be solved with free money from your employer. However, if you're over 50 you might not want to contribute beyond what is necessary to get the match.
Corporate bond interest is always taxed at the income rate, so there's no reason not to put bonds into your 401(k) at any time.
While Traditional IRAs also have this issue, Roth IRAs and Roth 401(k)s do not.
Tax rates can change. This analysis may no longer be relevant in a few years.

The bottom line is you should not put money into a 401(k) or Traditional IRA for a short period of time. If you only have a few years to invest, put it in a taxable account or a Roth.

[UPDATED 11/16/07: I've created a new version of the spreadsheet as a result of comments on this post on Blueprint for Financial Prosperity. ]

ValueAverager Site Update

2007-11-04T06:00:00-05:00

Two long overdue features to the ValueAverager website are finally here: a Knowledge Base and a Search Engine.

Neither of these features is perfected yet, but I'm making them live because I think they will be useful even in their current, incomplete states.

Knowledge Base
I have wanted to get a Knowledge Base going for a while. It has been delayed by the fact that after I did a thorough search of all of the options available, I purchased a software package that turned out to be completely unreliable and buggy. After I got my money back, I was back to square-one in my Knowledge Base project.

But, after moving the ValueAverager blog to TypePad about a month ago, I hit on a pretty good solution. I decided to use TypePad as a platform for hosting the Knowledge Base. This costs nothing (because I already have a TypePad account that allows for unlimited blogs) and it allows for most of the functionality and features I wanted.

So after about two days of fiddling with TypePad, I think I've worked it into a reasonable Knowledge Base. I've started populating it with articles. I'll be adding content at a pretty fast clip over the next couple of weeks so I can get all aspects of the site covered. If there are any articles you'd particularly like to see, please let me know and I'll get them up.

Search Engine
I've also implemented Google Custom Search Engine as the site's search engine. This was pretty easy because it just uses Google's index of the site to provide a site-specific search which is contained totally within ValueAverager's look and feel. Implementing this was a snap. The search engine is available on the right-side of most public pages on the site.

There are a few issues to work out. Not all of the pages are indexed. For instance, the Free Value Path Tool does not show up in the search results. I need to figure out why that is. Also, the Knowledge Base is not indexed yet, but I expect it will be within a few days. Also, the search results page displays Google's AdSense advertising, which is something I'd rather not have. But, considering how quick and easy the setup of the search capability was, I think I can work through or live with most of these limitations.

As always, please drop me a line if you have any questions or comments.