Much has been written about determining safe withdrawal rates. From Bengen’s early studies to later ones from Evansky, Guyton(pdf) to Kitces.

Unfortunately, each one has a number of glaring weaknesses.

• What if you are significantly older or younger than these studies used?  In other words what if your planning horizon isn’t 30 or 35 years?
• What if you are not willing to invest in the aggressive stock allocation these studies all recommend?
• How do fees affect the withdrawal rate (e.g., mutual fund expense ratios, advisor fees, etc.)?
• How do market conditions affect the safe withdrawal rate (Kitces starts to address this).

I attempt to address these issues by taking the following approach

• Assume bad things will happen at the beginning of retirement (.e.g, dividends drop by 25% and PE drops to 9,  interest rates go slightly higher than their historical average)
• Assume we might live to age 100
• Perform an amortization calculation to determine safe withdrawal amount

If you want to see how this works you can play with the safe withdrawal spreadsheet I have set up for this purpose.  I’ll be releasing the full justification for this method in the future.   Have fun and feel free to leave me comments.

It has been a while since I posted about commodities so I thought an update would be helpful.

First we have the following graph showing the relative size of the actual commodity and futures/derivatives about the commodity.  As you can see, the futures market exploded over that last few years.  This is why I say that the historical returns and lack of correlation of the commodity market is a thing of the past.  At this point there is so much investment money (as opposed to hedging money by commodity consumers) going into this market that its correlation and volatility are going to rise substantially.

Furthermore, contango (when future prices are higher than spot prices) is going to be much more common than in the past which creates a drag on performance.  To see how bad this can be check out the following chart which shows spot oil prices versus an OIL ETF which is using futures.  The difference in performance is because of contango in oil future contracts.

So at this point, I reiterate my recommendation to look elsewhere for alternative investments.  Unless you can time the bubble properly (and who can promise that?), this will probably not provide investors what they were hoping for.

Source: http://www.creditwritedowns.com/2010/05/the-commodities-con.html

It is pretty amazing the spread is so large among developed nations.  As countries get into more debt I wonder whether the countries at the bottom of the list will be forced to migrate their average retirement ages significantly upward.

People are starting to be affected by the changes so I thought a review might be helpful.

The Housing Assistance Tax Act of 2008 changed the rules around capital gain exclusions for homeowners.

The qualification for the exclusion remains untouched.

• You must meet the ownership test (2 of last 5 years)
• You must meet the use test (2 of last 5 years)
• And you can’t have used the exclusion in the last two years.

And the maximum amounts of the exclusion remain untouched: $250K single, $500K married.

What has changed is what amount of the gain gets to make use of this exclusion.

To figure this out you need to understand qualified and non qualified use. Non qualified use is when you and your spouse are not living in the home with the following exceptions (i.e., the following constitute qualified use).

• All periods before 2009 are considered qualified use.
• Period from when you move out to when you sell the house
• Absence up to two years due to job change or qualified illness
• Absence up to 10 years if deployed for the military or US foreign service

You then take the qualified period and divide it by the total period of ownership. This is the fraction of the gain that can make use of the exemption.

Example

Bonnie buys an investment home in 2008 for $300K and rents it for 2 years. In 2010 she moves in to the home. Two years later she moves out and rents it for a year and then sells the home for $500K.

How much of a gain does she have to pay taxes on?

• She meets the use test and ownership test.
• Ownership period was 5 years
• Qualified use period was: 1yr before 2009 + 2yrs living there + 1yr before sale = 4yrs

So 4/5ths of the $200K gain ($160K) can make use of the exclusion and she will need to pay capital gains tax on $40K of gains. (as a side note there would also be depreciation recapture but since that doesn’t qualify for the exemption anyway, I left it out).

Example #2

Mary and Bob bought an investment condo for $200K in 2009 and rented it for 18 years. They then lived there for two years and then sold the condo for $800K.

• They meet the use and ownership tests
• Ownership was 20 years
• Qualified use period was 2 years

So 2/20ths of $600K gain ($60K) can make use of the exclusion so they will pay capital gain on $540K of gains.

Why did congress make this change? They needed some additional revenue to help pay for some of the stimulus package and they wanted to close the loophole that allowed real estate investors to move into a rental property for two years and wipe out the taxes on their gains.

Source: http://www.irs.gov/pub/irs-pdf/p523.pdf

Another month has passed, so I thought I would share some unemployment graphs that look at things a bit differently.

Employment-to-Population Ratio: Men (25-54 Years)

Clearly there is a long term structural trend of men participating in the workforce less and less (for women it has been the reverse).  I don’t think the culture has fully digested this reality yet.

A lot of attention has been given to how this recession has more long term unemployed than in any time since the depression.  It is interesting to see that Canada had two bouts of this kind of unemployment.  Notice that it took them 10 years to really get it under control.

Lastly, unemployment is not being uniformly felt.  Those with less education are bearing the largest brunt of the economic woes.  If this sticks around for a long time, I’m not sure how that will affect the political landscape in the US, but I would think it would do something.

I’m not sure how accurate the numbers are for actual percentage holdings, but the relative changes that have occurred over time should be fairly accurate.  If you were to plot PE10 on this graph you would find a VERY high correlation.  Unsurprisingly, as people become more fearful of stocks, they own less and drive the PE10 ratio lower.

Given the economic shock we are going through, fear clearly hasn’t taken hold yet.  If another recession hits in the next year or two, I would expect this to get worse.

One of the arguments for big banks is that their size allows them to scale and be more efficient.  Unfortunately, it looks like what they become more efficient at is extracting money from their customers.

Here is the most disturbing quote for me.

But rather than allow the evidence in favor of smaller banks to guide policy, Congress decided to get rid of the evidence. At the urging of then Fed chairman Alan Greenspan, Congress ordered the Federal Reserve to stop publishing its annual report on bank fees.

Source: http://www.newrules.org/banking/news/move-your-money-and-save

A study cam out analyzing the funding status of each state’s pension funds.  It is not pretty.  And these are funding levels using assumptions like 8% or 8.5% portfolio returns.  If the returns are lower, the funding shortfall will be worse.

NPR has a nice graphic of the data you can play with here.

And the Center on Budget and Policy Priorities has published a table of state budget shortfalls.

This shows that the states are facing a shortfalls a little more than twice as bad as the previous recession.  I haven’t found numbers for earlier ones to give it a greater context.  But it seems clear that the main danger is if these shortfalls continue beyond 2012.  I predict this will result in higher volatility for municipal bond funds than we have seen historically.

Daniel Kahneman gives a great TED talk helping people understand there is a difference between “in the moment” happiness and the happiness of your memory of the moment and you cannot optimize them both.  He goes on to say that people more often try to optimize their memory happiness (would you go on a vacation where you were guaranteed to have a great time but would remember none of it?).  But he questions whether this should be people’s bias.  After all, how much time do you spend consuming your memories versus living in the moment?  A very thought provoking talk.  I recommend watching it.

Here are some fun charts on happiness as we age and in different states.  I’m going into the nadir of happiness age wise, but at least I live in a happy state!

And if you needed any additional information on the negatives of smoking, here is some data broken out by income.  Also not how little increase there is in happiness after income goes above $60K.

Source

• http://economix.blogs.nytimes.com/2009/10/05/americans-in-their-50s-and-80s-are-least-happy/
• http://economix.blogs.nytimes.com/2009/08/12/hawaiians-are-the-happiest/
• http://economix.blogs.nytimes.com/2009/11/19/rich-or-poor-nonsmokers-are-happier/

Since the latest unemployment number of 9.7% came out today, I thought I would send some of CalculatedRisk‘s wonderful graphs to help put it in context.

In terms of percentage of lost jobs compared to previous recessions we have the following updated graph.

Besides the clear trend of more and more drawn out job recoveries, this past recession was also different in how many people lost their jobs for a long time.  The following graph show the percentage of people who have been out of work for over 26 weeks.

Related to this problem is that normal unemployment benefits stop after 26 weeks.  Congress, however, has been extending those benefits greatly tempering the effect this large unemployment has on individuals and the economy.  However, unless Congress creates even longer extensions over $5million people will lose their unemployment benefits by June.  This will be a negative shock to the economy which will likely push economic growth down in the 3rd quarter.  With the recent extension, the March numbers in the graph below are pushed into April.