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Letters to the Editor

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To the Editors:

Regarding Mr. Danahy’s letter in the January 2007 AAII Journal relating to the cost of an IRA conversion, the flip side of this is the consequences of not converting. I made this mistake years ago and now as a senior, well into the minimum required withdrawals from my IRA, I’m getting a huge tax bite each year and increased Medicare premiums due to the withdrawals. Belatedly, I’m now converting a goodly amount to a Roth each year in order to lower my required distributions yearly and in a few years hope to lower my Medicare premiums and taxes. In addition, when my children inherit the remains of the Roth IRA, they won’t be required to take distributions

Stefanie Kranzler
Via E-mail

To the Editors,

In the November 2006 article, “Withdrawal Strategies to Make Your Nest Egg Last Longer,” by William Reichenstein, the author illustrates a 3.5% initial withdrawal rate of retirement funds based on a 30-year longevity. Does this suggest that the retiree’s expenditures should not exceed 3.5% of only principal plus Social Security? Or, does this mean that the retiree may expend 3.5% of principal plus income plus Social Security

Jay Gordon
Via E-mail

William Reichenstein Responds:

The article was not intended to be the guide for the maximum sustainable withdrawal rate. However, the 3.5% was the aftertax withdrawal amount of the aftertax value of the portfolio. This might be a 4.2% withdrawal from the traditionally defined financial portfolio. On top of that withdrawal, a retiree also receives and can spend Social Security benefits and perhaps benefits from a defined-benefit plan. The maximum sustainable withdrawal rate from a traditionally defined portfolio is usually considered to be 4% to 4.5% the first year plus an inflation-adjusted equivalent amount each year thereafter.

I discuss the aftertax portfolio in my February 2005 article, “Tax-Efficient Investing and What It Means to Your Portfolio.” Basically, take your pretax balances in 403(b), 401(k), and traditional IRAs, etc., and convert them to an aftertax value by multiplying by (1-t), where t is the expected tax rate in retirement. Then use this aftertax value plus aftertax values in Roth IRAs and taxable accounts to calculate the asset allocation using all accounts expressed as aftertax values.

To the Editors:

Is it possible to build a “balanced” mutual fund portfolio for a conservative investor if it excludes fixed-income/bond funds?

Consider, for example, a portfolio that includes an equal weighting of the following five stock funds: large-cap value, large-cap growth, mid-cap value, small-cap growth, and large-cap foreign. This portfolio’s RiskGrade is about 50, which classifies it as a balanced investment plan on the “RiskGrade Suitability Scale.” Yet the portfolio has an equity weighting of almost 100% (no bond fund exposure at all). Traditional asset allocation planning would typically require about 40% exposure to bond funds in order for the portfolio to be considered “balanced” and would classify the described portfolio as “aggressive.”

For conservative investors with long-term time horizons (seven-plus years) is there anything wrong with ignoring bond funds and simply using RiskGrades (with consideration given to fund size and style for diversification purposes) to build risk-based portfolios? Could such a portfolio as the one described be considered appropriate for a conservative investor, even if that investor is age 70?

I have never heard a professional investment advisor or other credible source ever argue for an all-equity portfolio, except for the most aggressive investors. But I don’t see why an all-equity portfolio couldn’t be used for even the most conservative investors if the risk characteristics of the portfolio are conservative. Am I missing something?

Rick Spillane
Via E-mail

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AAII Chairman James Cloonan Responds:

I am of the opinion that the pre-computer allocation rules, which continue to endure, are silly. Allocation to stocks, bonds, real estate, and cash as some way to control risk is, I feel, like estimating a person’s weight from their height when you have a scale. Overall portfolio volatility is what matters and it doesn’t matter whether you get it from diversifying within an investment class or between classes. It is certainly smarter to do it in the way that maximizes return—which is generally with equities (equity funds) and real estate (REITs). Typically, you will only need bonds or cash if you need your volatility to be very, very low—standard deviation of below 9% long term or a RiskGrade of below 45 long term.

 

 

 


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