Saving Adds Up

Most Americans will work for 40 or more years before retiring. Hopefully, they save enough money along the way, so that they can maintain their lifestyle for the remainder of their lives.

If a person started off earning $40,000, had 3% annual salary increases, saved 10% per year, and earned 8% on the amount saved, she would have just over $1.5 million at retirement. Her salary at retirement would be $130,000.

If she then retired and drew 4% per year from pool of savings, she would be able to received distributions of $60,000. These withdrawals could be increased for inflation and she would never run out of money.

You might note that $60,000 is less than half of her final salary. She would have Social Security. She might have a pension.

Planning for a Long Trip

The Employee Benefit Research Institute's Retirement Confidence Survey was released last week. It found that more than half of those surveyed are "not at all confident" or "not too confident" that they will be able to afford the retirement they want.

Only 42% have tried to calculate how much money they'll need for retirement. Imagine getting on a plane for a long trip. If you were the pilot would you want to know how much fuel will be required to reach your destination? Would you want to make certain the plane had that much fuel and perhaps an emergency reserve in case you needed it?

Americans enter retirement for a journey that will typically last 20-40 years. Most of them don't bother to determine how much money will be required to make sure that the journey will be pleasant. Some of these people will eventually realize that they will have to work longer, save more and spend less. Others will not wake up to the reality of their financial situation until they have run out of money and are forced to make radical changes in their lives.

It is too bad our education system does not teach financial literacy. Too many people enter their working lives with little understanding of how much money is required to maintain a standard of living over several decades. If our schools taught this, more Americans would enjoy the retirement they envision.

CWM Model Portfolios

I recently reviewed all of CWM's model portfolios. I started by looking at all of the asset class I thought might be appropriate for our portfolios. I considered 30 distinct asset classes:

ultra short bond fund
short term gov bond
short term bond
inter term gov bond
inter term bond
multi sector bond
world bond
emerging markets bond
inflat protected bond - short
inflat protected bond
intl inflat protected bond
large cap growth
large cap value
large cap blend
small cap growth
small cap value
small cap blend
micro cap
foreign large growth
foreign large value
foreign large blend
foreign small cap growth
foreign small cap value
foreign small cap blend
emerging markets large
emerging market small-mid
frontier markets
REIT - US
REIT - Foreign
commodities
Cash

I then searched for the no load mutual funds and exchange traded funds that are currently available for each of these asset classes. One asset class had no options. Other asset classes had several to choose from. I select 2-3 funds for each asset class and added them to my preferred list. My selections were based on the size of the fund, the cost of the fund, and the composition of the fund.

Next I reviewed the broad weighting of each of CWM model portfolios. I tweaked the level of stocks, bonds, and cash in each model. I broke down the amount of domestic and international exposure for both equities and fixed income.

Finally, I allocated specific weightings to each of the funds I placed in each of the asset classes. I ended up with 18-25 funds in each model portfolio.

I then used Morningstar's data to determine the expected return and risk associated with each portfolio. I also established a benchmark for each of the seven portfolios.

In comparison to the prior version of the CWM models, the revised versions are
• more tilted to international in both equities and fixed income
• include no long term or intermediate term bond funds
• include asset classes for which there were not fund options a few years ago
• no longer contain high yield bonds
• no longer contain preferred stocks

I believe these portfolios are well positioned for the future. When interest rates rise, the impact on these portfolios will be muted. As emerging markets develop, these portfolios will benefit.

One Star Funds Shine

Morningstar recently found that nine of the top 10 stock funds over the past 24 months are one star rated funds. This is Morningstar's lowest rating in its five star scale. The system considers historical returns and risk.

What are we to make of this? Did the managers of these funds find some new method to dramatically improve their performance? Are there new managers running these funds? Were these funds in sectors that suffered poor performance in past years? Were the fund managers, among the thousands of funds tracked by Morningstar, just lucky after a stretch of bad luck?

There is probably no way to know for sure. But my first thought is of "reversion to the mean." This is the theory that performance eventually moves back to the mean or average. These top stock funds had performed well below the mean for several years. Perhaps they were simply due for a correction back to the mean.

We have recently seen this phenomenon with one highly acclaimed fund manager. Legg Mason's Bill Miller bet aggressively on financial stocks during the recent economic crisis. Unfortunately, the financial sector suffered massive losses and Miller's fund took a beating. As a result, his overall performance went from stellar to dismal. Recently, however, Miller's fund has recovered and is among the strongest performers in the past 2 years.

Again, I ask , is it luck or is it skill?