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Short-term and Long-term Investing Update Douglas Carlsen, DDS

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Short-term Investing Strategies
Dr. Max D. Spence, 55 years old, has weathered the college-fee onslaught for his two daughters, has an adequate retirement nest egg funded, yet has near-term expenses to fund before retirement. He needs $50,000 in an emergency fund, $30,000 every four years to purchase a new auto, has two daughters with weddings planned at $40,000 apiece in four to seven years, and wants to purchase a slightly used $35,000 Triton TR 200 bass fishing boat in two to three years.

In pre-retirement, dentists often desire a system for short term financial needs. Those needs might include an emergency fund of six month's personal expenditures ($40,000+) and funds for marriages, automobile purchases, special trips and other large one-time expenses.

The funding allocations below get involved, yet I will offer simplification at the end and address Dr. Spence's situation.

Short-term Bucket #1: For emergency funds, the most secure allocation is a must. Spence's $50,000 should be in money market funds. No CDs or bonds. All advisers agree with this allocation.

Many dentists can combine their emergency fund with their auto fund. If a family emergency drains the fund, one can delay auto purchases. Depending on spending, dentists normally need between $40,000 and $75,000 in this short-term "bucket."

Short-term Bucket #2: This fund still needs safety, yet doesn't have to be as liquid or secure as Bucket #1. For purchases that will be needed within two years, CDs or short-term treasuries are advised by most planners.

Short-term Bucket #3: For funds needed within two to seven years, Consumer Reports Money Adviser¹ advocates an allocation of:
  • one-third of funds in a short-term bond ladder with one-to three-year maturities
  • one-third in a mix of corporate and municipal bonds
  • one-third in Treasury Inflation-Protected Securities (TIPS)
Alternatively, Merriman Advisors² recommends:
  • one-quarter of funds in Vanguard Short-Term Investment Grade (VFSTX)
  • one-quarter of funds in Vanguard Intermediate-Term Investment Grade (VFICX)
  • one-quarter of funds in Vanguard GNMA(VFIIX)
  • one-quarter of funds in Vanguard High-Yield Corporate (VWEHX)
Remember, these short-term funds are needed in addition to your long-term retirement savings needs.

The above Consumer Reports and Merriman strategies are prudent, but might prove too complicated for some, especially when one needs to track a retirement portfolio allocation also. How can this be simplified?

For Short-term Bucket #3 (funds needed in two to seven years), safety is vital. Therefore, stock funds are not advised. Larry Swedroe in The Only Guide to Investment Strategy You'll Ever Need, compares short- to intermediate-term fixed-income investments utilizing the Sharpe Ratio, a measure of relative risk-to-return. His assessment: short-term fixed-income investment vehicles provide a better return-to-risk ratio than intermediate- term or long-term fixed investments. Intermediate-term or long-term corporate bonds, U.S. Treasury bonds, municipal bonds or high-yield bonds don't justify the added risk involved.³

Thus, for short-term (up to seven years) funds:
  1. Emergency funds need to be in a money market fund, period. The best rates can be found at www.bankrate.com. Remember, online banking is safe.
  2. Keep non-emergency funds you might need within two years in money market funds or short-term CDs; funds needed from two to seven years in short-term bond funds or laddered CDs. Alternatively, one might follow the above Consumer Reports or Merriman allocations for two- to seven-year funds.
Either Vanguard Short-Term Bond Index Fund (VBISX), which is 72 percent U.S. Government short-term funds, or Vanguard Short-Term U.S. Treasury Fund (VFISX) is normally a good choice for two- to seven-year funds. CD rates for various terms can be evaluated at Bankrate.com.

Dr. Spence has now provided an elegant solution. His emergency fund/auto fund of $50,000 is in the Bankrate.com-found Discover Bank of Delaware money market account receiving 1.24 percent interest.

For Spence's $115,000 needed later on for the weddings and the bass boat, he finds that both Vanguard Short-Term funds listed previously currently offer a paltry 0.2 percent annual rates as of February 2011! CD rates for two years peak at 1.60 percent; three years, 1.91 percent; and five years, 2.61 percent. To lock in income for two plus years at rates not significantly above 1.24 percent doesn't seem prudent. He will place $115,000 in the money market fund for now, evaluating rates for CDs and short-term funds every three months.

In other words, Spence's total of $165,000 is currently safe with the best risk-to-return ratio in the Bank of Delaware money market fund.

Long-Term Investing Strategies
Last year I provided a sample portfolio for tax-deferred funds from Paul Merriman's Fundadvice Web site found at www.fundadvice.com/portfolio.html#TD. The allocation has done extremely well over the last 10 years, providing a yield of 6.1 percent annually. It assumes you invested on January 18, 2001, and did nothing but reinvest all dividends and rebalance to the given fund ratios once a year.

Fundadvice's portfolio is a winner with lowest-cost Vanguard funds and great diversification. Yet, rebalancing eleven funds is a tough task and takes me several hours to calculate and enter all transactions. Yes, Vanguard is willing to do, yet the charge is around 0.5 percent of the portfolio total, or in many dentists’ cases, more than $5,000.




There are easier allocation alternatives found at Paul Farrell's Lazy Portfolios at www.marketwatch.com/lazyportfolio. Eight funds, offering from three to eleven funds each, easily beat the S&P 500 over the last decade averaging from 3.7 percent to 6.2 percent annually.

Above are my two favorites: Margaritaville is provided by Scott Burns of the Dallas Morning News and Coffeehouse is the invention of a former Smith Barney broker, Bill Schultheis. Please consider the portfolios along with your own personal goals and risk tolerance. The exact percentages are not important; being in the ballpark is what is significant along with rebalancing once a year.

Also consider the percentages as combined for both tax-deferred and taxable accounts. Based on tax-efficient investing, bond funds are placed in tax-deferred accounts and equities in taxable accounts whenever possible. Many dentists' portfolios have significant tax-deferred exposure. In that case, having some equity funds tax-deferred is appropriate.

Retirement Income
In the first section, "bucketizing" one's short-term funding needs was covered. For additional "bucketizing" strategies for retirement distributions, Ray Lucia, CFP offers good advice. The Ray Lucia Show is broadcast by 30 radio stations nationwide, normally during weekday hours. Find a nearby station at http://radiotime. com/options/p_20588/The_Ray_Lucia_Show.aspx or access podcasts entering "The Ray Lucia Show" on iTunes.

Ray and his "brain trust" offer commentary on funding for retirement and proper estate planning. I do recommend anyone with an interest in how to protect and distribute funds in retirement to listen in.

Ray's "Buckets of Money" strategy can be found in a popular book with the same name at Amazon or Barnes and Noble.4

References
  1. "Investing for a Lifetime," Consumer Reports Money Adviser, April 2010, pgs. 1,4,5.
  2. Go to www.fundadvice.com/portfolio.html#TD for allocations. Downloaded 1/20/2011.
  3. Larry E. Swedroe, The Only Guide to Investment Strategy You'll Ever Need, Truman Talley Books, 2005, pgs. 118-125.
  4. Ray J. Lucia, Buckets of Money, John Wiley and Sons, Inc., 2004, find at Amazon or B&N
Author’s Bio
Douglas Carlsen, DDS, founder of Golich Carlsen, has provided independent financial education to dentists since retiring from his practice in 2004 at age 53. Golich Carlsen, an approved AGD PACE organization, delivers common sense consulting, efficient CE lectures, and smart continuing education CD/workbooks – all backed by academic research. Visit www.golichcarlsen.com for archived articles, information on services and to sign up for Dentist's Financial Poll and Newsletter. To learn more or to schedule Dr. Carlsen to speak at your dental society or study club, contact drcarlsen@gmail.com or 760-535-1621.
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