Author Topic: Sequence of Returns risk and Muni Bonds  (Read 1908 times)

ol1970

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Sequence of Returns risk and Muni Bonds
« on: June 09, 2016, 08:12:29 AM »
Ok, just looking for some smart people to shoot holes in a plan I'm considering executing:

Retired early 18 months ago, currently 45.  I'm planning to go off sailing the Caribbean (maybe farther if I really like it) for a few years (4 lets say for talking purposes).  My nest egg is sufficiently large for my lifestyle.  To mitigate overall risk and give myself a safe comfy landing when/if I get back to a land based life.  Here is my current thought of a plan:

1) take 35% of my net worth and purchase a laddered Municipal Bond portfolio (not a fund, but the actual bonds).  This amount would throw off what is essentially 100-120% of my annual estimated living expenses.  I completely understand that I'll be eroded by inflation and lose out on potential market gains, but I'll have my living expenses deposited directly into my checking account while I'm gone.  I'll have very little risk to this stash, not a care in the world, and since I plan on holding each bond to maturity I'll receive my original principal back in full.

2) Keep 60% invested in the market through various alternative investments, VTSAX, and real estate holdings.

3) The other 5% will be the stuff that I own (sailboat, dog, flip flops, & cold beer)

Just really looking to hear from your take on if this is a crazy idea & what I might be missing in my logic.  Thanks!

talltexan

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Re: Sequence of Returns risk and Muni Bonds
« Reply #1 on: June 09, 2016, 08:33:37 AM »
So it sounds as though the bonds give you your income, while the stocks ought to appreciate enough over time to allow you to buy additional bonds as inflation requires it? Is inflation your biggest worry? Should you have a tranche of TIPS?

If you're planning on spending 4 years operating in other currencies, you may be grateful for having that income stream in dollars.

« Last Edit: June 09, 2016, 08:38:55 AM by talltexan »

Financial.Velociraptor

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Re: Sequence of Returns risk and Muni Bonds
« Reply #2 on: June 09, 2016, 08:54:35 AM »
I carry munis in FIRE.  They give me great peace of mind.  I don't do a ladder though.  I buy Closed End Funds.  I get the benefit of some leverage that way so yield is around 6%.  See IIM, IQI, NEA, NVG.

TRiAGE

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Re: Sequence of Returns risk and Muni Bonds
« Reply #3 on: June 09, 2016, 09:35:27 AM »
I carry munis in FIRE.  They give me great peace of mind.  I don't do a ladder though.  I buy Closed End Funds.  I get the benefit of some leverage that way so yield is around 6%.  See IIM, IQI, NEA, NVG.

I own some Muni CEFs too - you can get some great returns but there is risk due to the leverage.
* If interest rates rise then the net asset values will fall dramatically. Fine if you don't plan to sell but what if the manager winds up the fund or merges with another fund - some potential for the income to fall. I think "duration" is the concept you want to be aware of.
* Also make sure you understand discounts/premiums before investing in these - I wouldn't touch anything with a double digit premium (i.e. the market is paying 10%+ above the net asset value of the underlying bonds, makes no sense to me).
* Fees - most CEF's have 1%+ management fees on top of the interest costs.
* Potentially safer to invest in MUB (the vanguard muni ETF, no leverage, super low fees) but returns are half what a leveraged CEF will give you.

I get the benefit of some leverage that way so yield is around 6%.  See IIM, IQI, NEA, NVG.
* http://www.cefconnect.com/closed-end-funds-daily-pricing is a great site to research CEFs
* All of the tickers you list currently pay less than 6% based on today's prices.
* So I suspect you've made some capital gains on the underlying funds - congrats but keep in mind the risks above. 

Back to the OP's question - I like the sound of directly buying a bond ladder but here are some considerations:
* what are your transaction costs? You will pay higher fees than a fund and if you are not buying new issues (at the broker auction? can you even do this as a civilian?) then you will pay a hefty spread since the market is not very liquid. This will eat into your returns.
* muni bonds can default (Puerto Rico currently, other states in the past) - how diversified are you planning to be? You would want quite a few bonds to spread the risk but then the transaction fees build up.
* what is the return you can achieve taking into the account the above? I'd compare to whats available in ETFs/CEFs, might be less hassle.

Aphalite

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Re: Sequence of Returns risk and Muni Bonds
« Reply #4 on: June 09, 2016, 09:45:02 AM »
You should go with this plan only if you are knowledgeable enough to assess the riskiness of individual muni bonds (for example, are the demographics trending up or down? will the municipality adequately cover expenses and interest payments from taxes? How is the muni's debt load and are there any upcoming maturities the muni will have to refinance?). Inflation shouldn't be a huge worry with your time frame of travel (4-5 years will not result in any meaningful inflation erosion to your wealth).

Finally, there's nothing wrong with holding cash, if your annual expenses are covered by only 40% of your networth in muni bonds, just carry the 5-10% of your total networth you need for the next 4 years in cash.

zz_marcello

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Re: Sequence of Returns risk and Muni Bonds
« Reply #5 on: June 09, 2016, 10:07:51 AM »
First of all: Congratulations to your financial achievements and I wish you a wonderful sailing trip!

I share the opinion that in the long term Munis are more risky than stocks (for example Illinois is a disaster waiting to happen....) and the current yield (without leverage) is not reflecting this risk sufficiently.
If something like 2-4% yield from 35% of your nest egg is sufficient for covering your living expenses why not put 100% in stocks+ real estate and live from the dividends/cash flow? Vanguard VTI yields 2,2%, VYM yields 3.2% and the Vanguard REIT ETF VNQ yields close to 4%. Inflation is covered in the long term with all this funds because its equity.

Even if a new 1966-1982 inflationary+low profit margin environment would happen and dividends are reduced by ~25%, your would be safe and don't have to touch any principle; or?

Im two years behind you regarding age. I will retire with my family in ~2 years with a 2,5-3% withdrawal rate achieved with dividends from worldwide stock ETF's and REITS.
Thats 100% save; I want complete peace of mind.

All the best!
« Last Edit: June 09, 2016, 10:17:50 AM by zz_marcello »

tonysemail

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Re: Sequence of Returns risk and Muni Bonds
« Reply #6 on: June 09, 2016, 10:35:20 AM »
Yes, congratulations on pulling the plug!

The strategy is not crazy and I think it sounds very similar to a DIY annuity.
Try researching this option on the web and see if it matches what you're thinking.
http://www.investopedia.com/articles/retirement/12/build-your-own-annuity.asp

ol1970

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Re: Sequence of Returns risk and Muni Bonds
« Reply #7 on: June 10, 2016, 11:19:49 AM »
Thank you for the responses!  So to answer a few of the questions and respond back to a couple of the points.

- Yes it would be slightly more expensive to create a sizeable personal portfolio of bonds.  Without going into all of the details my fees would be approx. 0.5% to set up and manage this portfolio.  My return net of fees would be 4% tax free.
-I completely understand owning a bond fund (with leverage built in) would definitely return higher, but with every investment if/when interest rates take off these will go down precipitously and you can/will lose your invested capital.  Also they are less advantageous in certain cases tax wise.  If I own the actual bond and rates rise, my par value will go down yes, but I would not lose because I hold the bond to its full maturity.  I would not go beyond 4-5 years maturity.
-Regarding long term risk...you bet there is!  But I would have no more than 5%~7% position in any single bond purchased of the total amount.
-Why not just put it all in VTSAX and live off the 2% it throws off?  Good question...probably cause I'm a wimp.  Plus the way I look at it I have other investments (the bulk of my stash) that are pedal to the metal.  Doing this give me the piece of mind that as I float away, I have a "paycheck" and a known soft landing for when I come home.

Anyway, very helpful hearing your opinions, thank you!