The Importance of Courage, Patience, and a Margin of Safety
If you are a long-time client of Mirus Planning, you know the importance we place on buckets in our planning framework. With current market volatility, I thought it would be prudent to send out a refresher on the approach.
In a nutshell, we believe our clients should have assets allocated into 3 succinct buckets. Each bucket containing investments with a variance of risk specifically for different purposes and timelines. We refer to them as our green, yellow, and red buckets.
Range of Temperatures & Asset Price Movement
We like to use a temperature and climate analogy to describe the “environment” of each bucket and the typical price movement of the assets included as part of each bucket.
Green = Climate controlled, room temperature. Let’s say you set the thermostat in your home for 70 degrees. Assuming you have both heat and air conditioning, if the temperature rises to 75 degrees, your system might turn the air conditioning on to get the temperature back to 70. If the temperature lowers to 66 degrees, the heat might come on to get the temperature back to 70. While there is some movement in temperature, most of the time, the range of temperature is tightly controlled, predictable and safe - very much like the typical price movement of the assets within the green bucket. Generally comfortable and predictable.
Yellow = Honolulu. It turns out the average daily temperature year-round (24/7) in Honolulu is 77.6 degrees. However, that doesn’t mean it is always 77.6 degrees. The highest high for Honolulu is 92 degrees and the lowest low is 62 degrees. While the temperature range isn’t as narrow as being inside a climate-controlled house, the range of temperature is reasonable and comfortable. This range of temperature is comparable to the typical price movement of the assets in the yellow bucket.
Red = Death Valley. Most are surprised to learn Death Valley has almost the same average daily temperature as Honolulu - slightly lower at 77.15 degrees. However, unlike Honolulu, which has a comfortable range of temperatures within 30 degrees, (15 degrees above and 15 degrees below the average), Death Valley delivers a more severe experience. With the highest high being 135 degrees and lowest low being 15 degrees, the range of temperature varies widely and can be uncomfortable. Price fluctuations of growth stocks and other things we consider red bucket assets are comparable to the temperature changes in Death Valley - disconcerting at times.
We initiated this bucket framework with clients after 9/11 and the tech bubble experience. We believe that shaping a portfolio like this affords our clients time to allow riskier investments to recover and to be positioned to succeed in both good and bad economic times. This framework can help people sleep better at night and feel more confident about reaching short, medium, and long-term objectives.
At the end of the day, we believe it helps to increase thoughtful decision making (and responses) throughout full market cycles (from recession to expansion & from expansion to recession).
Shaping Portfolios: An Example
Let’s say we are working with a client who has a moderate tolerance for risk. During stable and “normal” economic times, our target portfolio shape would include 30% of the portfolio in green bucket assets, 40% in yellow bucket assets and 30% in red bucket assets.
Besides having a certain percentage of assets in each bucket based upon traditional risk tolerance (as noted above), we also believe in having minimum dollar amounts in the first two buckets for clients is particularly important for those who are nearing retirement (2-3 years before) or who are already retired due to the need of predictable withdrawals from portfolios.
We find that by incorporating a “years of income” dollar amount for both the green and yellow buckets it can help maintain stability, improve comfort (sleep at night), and enhance courage during challenging times like today.
In our example below, we will assume our moderate investor needs to withdraw $50,000 from the portfolio each year. Let’s review our bucket framework for this situation.
2022 has been a challenging year for various investment assets.
It has become clear to most that the FED needed to begin raising rates to curb inflation in the summer of 2021 instead of waiting to pivot earlier this year. Consequently, they are having to play catch up, raising interest rates rapidly, with three consecutive 0.75% rate increases in recent months. We expect rates to continue to increase until inflation begins to wane and even decline.
In recent days, we have participated in calls with City National Rochdale, JP Morgan and Blackrock hearing their viewpoints. Each firm has unique beliefs; however, all seem to agree that the FED is focused on getting inflation under control by raising interest rates.
What does that mean as an investor and for planning through year end?
Cash Management - As Kyle noted in July, this is a good time to consider upgrading your cash into interest bearing investments like T-Bills, CDs, money market accounts and short fixed income investments. Interest rates have risen and are providing interesting opportunities for cash management with more interest possibilities.
Systematically Investing - Keep systematically funding your retirement plans, your college funds, your systematic investment savings. Assets are much cheaper to buy today than they were 10 months ago - both stocks and bonds. You are effectively buying more shares at lower prices with the same dollar amounts (dollar cost averaging).
Rebalancing - Make sure your retirement and tax deferred investments are set to rebalance at least annually. Different assets move differently throughout the year and when a portfolio is rebalanced to an allocation, the portfolio is adjusted back into shape and often results in selling high and buying low while maintaining risk expectations.
Tax Planning - When values fall like they have in 2022, it can be an opportune time to lock in capital loss to help offset capital gains for this year or into the future. Within taxable portfolios, there can be opportunities to do so.
Roth Conversions - In addition to tax loss harvesting as noted above, lower values in accounts can also help with converting IRA assets to Roth IRA assets. Due to share prices being lower, you can effectively move more shares from tax-deferred to tax-free assets.
As always, we thank you for your trust and relationship with Mirus Planning. We hope this note finds you enjoying the Autumn season and looking forward to the last few months of the year including the holidays.
Warmest regards,
Chad Parmenter
CFP®, CLU, ChFC, CDFA®, RICP®, BFA™
