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Strategies & Market Trends : The Residential Real Estate Crash Index -- Ignore unavailable to you. Want to Upgrade?

To: TheStockFairy who wrote (93842)	11/5/2007 7:34:34 PM
From: Wyätt Gwyön	Read Replies (1) \| Respond to of 306849

OK, i admit it, i don't get why they call it a "High Yield" fund even though the yield's under 5%. i guess it falls under the rubric of "return-free risk". but that aside: if you put all your 5 million in this fund and get a 4.74% return, and even if some of those stellar credits in the fund like "Brazos Riv Tex Hbr Nav Dist 5.2" never default on their payments, if you spend the entire 237K (4.74% of 5 milllion) every year, then you will experience an ever-diminishing standard of living. you will get 237K this year, and next year.... and 30 years from now. but in 30 years, 237K will be worth much less. this is why, if you want to have a constant real drawdown, you can only draw down the amount by which your long-term returns exceed the long-term inflation rate. of course, nobody knows what inflation will be in advance (much less what portfolio returns will be), but if you assume a low 3% inflation and 7% portfolio return, then that leaves 4% left over. this 4% would be on 5 mil in year 1, but in year 2 would be 4% of 5 mil * 1.03 (since you're only consuming 4 points of the 7 points of return--the other 3 serving to pad your portfolio against inflation). a long-term 7% nominal return is no mean feat. you can't get it from risk-free T-bills, and it's hard to get even from very risky low-quality bonds. as for equities, they are approximately where they were 7 or 8 years ago, which is to say they haven't helped at all. on top of that, most people with appreciable assets will rely on an asset mangler, who will extract their own pound of flesh. call it a point on average (though you don't have to try hard to find places that will milk you for two or three points). so that means you need an 8% gross return instead of 7%. all this is to say that even people with 5 mil cannot easily dismiss risky assets from the PF if they want to have a 4% drawdown and keep up with inflation. going back to your example of VWAHX, quality of the asset aside, if you draw down 4% you are only leaving 0.74% to hedge inflation, which even believers in the core CPI will acknowledge is losing the fight against inflation. there are different arguments about the safe drawdown level. personally i consider 4% on the high end. Bill Bernstein argues for 3%. of course, it's easier for somebody with 100 million in assets to choose a lower figure than somebody with a million or two. if you believe the government's inflation figures, then you could put the 5 mil in TIPS and have a real before-tax draw equal to the yield. unfortunately, the TIPS yield is not too exciting these days: November 2007 Date 5 yr 7 yr 10 yr 20 yr* 11/01/07 1.74% 1.92% 2.00% 2.13% 11/02/07 1.62% 1.83% 1.92% 2.06% 11/05/07 1.61% 1.84% 1.94% 2.07% ustreas.gov

To: TheStockFairy who wrote (93842)	11/5/2007 7:34:34 PM
From: Wyätt Gwyön	Respond to of 306849

OK, i admit it, i don't get why they call it a "High Yield" fund even though the yield's under 5%. i guess it falls under the rubric of "return-free risk". but that aside: if you put all your 5 million in this fund and get a 4.74% return, and even if some of those stellar credits in the fund like "Brazos Riv Tex Hbr Nav Dist 5.2" never default on their payments, if you spend the entire 237K (4.74% of 5 milllion) every year, then you will experience an ever-diminishing standard of living. you will get 237K this year, and next year.... and 30 years from now. but in 30 years, 237K will be worth much less. this is why, if you want to have a constant real drawdown, you can only draw down the amount by which your long-term returns exceed the long-term inflation rate. of course, nobody knows what inflation will be in advance (much less what portfolio returns will be), but if you assume a low 3% inflation and 7% portfolio return, then that leaves 4% left over. this 4% would be on 5 mil in year 1, but in year 2 would be 4% of 5 mil * 1.03 (since you're only consuming 4 points of the 7 points of return--the other 3 serving to pad your portfolio against inflation). a long-term 7% nominal return is no mean feat. you can't get it from risk-free T-bills, and it's hard to get even from very risky low-quality bonds. as for equities, they are approximately where they were 7 or 8 years ago, which is to say they haven't helped at all. on top of that, most people with appreciable assets will rely on an asset mangler, who will extract their own pound of flesh. call it a point on average (though you don't have to try hard to find places that will milk you for two or three points). so that means you need an 8% gross return instead of 7%. all this is to say that even people with 5 mil cannot easily dismiss risky assets from the PF if they want to have a 4% drawdown and keep up with inflation. going back to your example of VWAHX, quality of the asset aside, if you draw down 4% you are only leaving 0.74% to hedge inflation, which even believers in the core CPI will acknowledge is losing the fight against inflation. there are different arguments about the safe drawdown level. personally i consider 4% on the high end. Bill Bernstein argues for 3%. of course, it's easier for somebody with 100 million in assets to choose a lower figure than somebody with a million or two. if you believe the government's inflation figures, then you could put the 5 mil in TIPS and have a real before-tax draw equal to the yield. unfortunately, the TIPS yield is not too exciting these days. put all your money in the 5yr TIPS and you have a pre-tax income of 5mil * 1.61% = $80,500. and to top it off, you have to take the government's word for it that your principal will keep up with inflation. November 2007 Date 5 yr 7 yr 10 yr 20 yr* 11/01/07 1.74% 1.92% 2.00% 2.13% 11/02/07 1.62% 1.83% 1.92% 2.06% 11/05/07 1.61% 1.84% 1.94% 2.07% ustreas.gov