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A young lady in 1926 whose  husband has just died!

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David Loeper, CEO of Wealth Capital Management picture
The following is my overview of a white paper by Dave Loeper, CEO of Wealth Capital Management in Richmond, VA.  Dave was one of the very early adopters of the Monte Carlo modeling technology in building portfolios and communicating volatility more meaningfully to clients.

Dave is attempting to calculate the benefit of a financial planner who tends your investment portfolio, and constantly rebalances back, not just to the original tolerances, but to the equity exposure you would need in order to achieve your goals. 

This exposure is a moving target; in times like these, in times like these, when the markets have put many of you behind your retirement goals, there would need to be a higher allocation to equities.  Other times, when you are ahead of the game, the planner would give you a reasonable chance of success with fewer equities.  The net effect is to broaden clients’ exposure during down markets, when there is an expected recovery, and reduce clients’ exposure as they achieve their goals and effectively take them out of the way of whatever bear market might set them back.

The paper runs to 40 pages, so I'll offer a quick summary of the high points.  If you would like to see the total paper, let me know and I will send it to you.

Dave's central thesis is that advisors should manage client wealth instead of client returns, and that they should make their asset allocation decisions on an ongoing basis based on their evaluation of where a client is relative to his/her funding goals.  In many cases, he says, clients are already overfunded, and should not be heavily weighted in equities; the advisor should lock in their achievement of the goal.  Clients who are underfunded should be encouraged to save and invest more money in the markets, to freeze spending and/or raise the allocation to equities.  The asset allocation decisions are based on each client's funded status, with the full recognition that we don't know what the markets will do in any given year or decade.

The test Dave chose is a woman who happened to be widowed in 1926.  She needs to generate $5,000 a year in real (inflation-adjusted) income (about $50,000 in today's dollars), from the proceeds of a $100,000 life insurance policy left to her by her deceased husband.  As it happens, she will live to the year 2006; as Dave puts it, her blood pressure runs out when she turns age 100.

At the moment the life insurance settlement is paid out, the universe splits into five different branches, and in each branch the woman works with a different money manager. 

  1. The first checks out the widow's risk tolerance and creates an asset allocation which will run more or less constantly throughout her life. 
  2. The second adopts a target-date equity allocation which Dave sets as 100 minus the widow's age--starting at 80% and dropping from there. 
  3. A third manager decides to put the entire portfolio into stocks. 
  4. The fourth sets a long-term asset allocation and then manages to beat it by 1.5% a year. 

The fifth runs a Monte Carlo analysis with historical inputs, and decides to set the portfolio at an allocation which produces an 82% confidence rate of reaching the widow's stated long-term goal.  Each year, this manager will re-run the analysis and, over the next 100 years, he will be required to make nine changes to the allocations--all in the first 20 years of her life. A table in the white paper shows these changes, but basically the percentages shift from 80% equities in the first two years to 45% in 1928, to 30% in 1929, to 80% in 1930 (we're now in catchup mode), to 100% in 1931, back to 30% in 1938, back to 45% in 1942, to 60% in 1943, and then back down to 30% in 1945, when the portfolio appears highly likely to meet the widow's funding goals.

Overall, advisor 1 maintains a stock allocation of 38%, and achieves a compound return of 8.29% each year. 

Advisor 2 is gradually lowering exposure but, over 80 years, he/she has an average stock allocation of 41% and a slightly higher compounded return of 8.42%. 

The third manager, who owns nothing but stocks (I won't calculate the average annual stock exposure for you), generates an impressive 10.36% rate of return. 

The fourth manager has the same average allocation as the first one, but because he can beat this index each year, he manages to achieve a 9.8% compounded yearly return. 

The wealth manager has an average annual allocation of 38% and a very low 30% allocation for all of the Post-WWII years, and manages to generate 8.58%, compounded, a year.

You might think that the terminal wealth of the portfolios can be sorted neatly according to the compounded annual return, but that wouldn't take into account the sequence issue; the sequence of returns matters greatly to overall wealth. 

Now here's the punch line: If the widow continues to take her inflation-adjusted income out of the portfolios:

  1. In the universe of the first manager she will be broke at age 51. 
  2. She spends her last dime at age 50 in the universe of manager two. 
  3. She runs out of money at age 55 with manager three.
  4. The fourth manager, who can consistently beat the market, fares much better; the widow dies leaving an inheritance of $1,072,678. 
  5. The fifth manager?  With him watching over the portfolio, adjusting the stock allocations up a bit when the market is down, down a bit when the market has taken her closer to her funding goals, she dies with $4,878,522 in her portfolio. 

His allocations never produced superior returns in any one year, never beat the indices, but it did manage to capture a bit more of the upside, a bit less of the downside, and basically iced down the portfolio when the widow had essentially achieved her funding goal.  Of course, the other managers contributed to their own defeat, by continuing to invest aggressively when they could have taken the widow's risk off the table, and by refusing to become more aggressive themselves when the funding goal was slipping out of their reach.

I think the results would have been much more dramatic if Dave had assumed that the widow had earned some income during this 80-year time period and managed to save a bit more and increase funding during times when the portfolio returns had threatened her funding goals.  This, of course, is the kind of flexibility that pre-retired clients have and, in fact, the opportunity that clients have at this very moment, when more money could be deployed when virtually every asset class is on sale, often at screaming bargains.

Do you know the difference between an Elderly Lady and an Old Woman?  Money!


A poor bag lady living on the streets. An elderly rich Lady holding a beautiful red rose.

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