2012 in review

Happy New Year everyone. Hard to believe its 2013 already. Time to look back at 2012 and see how I did versus my retirement goals. For those interested the 2011 review is here and the 2010 review is here. This marks the end of our 3rd year living the full time RV lifestyle and all I can say is bring on year number 4! OK, lets get right down to a review of 2012 from an investing perspective.

As a reminder my overall goal in retirement is pretty simple in principle. I stated it pretty clearly last year;

Before I jump in to the performance numbers, its important that I make clear what my yearly goal is for my investments. I only have one goal every year,plain and simple. Here it is – its so important that I’ll make it separate, bold, and italic… 

• Investment goal: to increase my total net worth, every year, after all spending, fees, taxes.

That’s it. Simpler than you thought? Notice that there is nothing about beating the market, or beating some benchmark that someone says is really important. If I meet this goal, who cares about the market or some benchmark? This goal insures that I never run out of money and always grow my net worth. For me, that’s what retirement investing is all about. What about inflation you may ask? That is automatically embedded in this goal. Inflation will drive spending during a given year so as long as the goal is met, inflation is taken into account.

An important point about this goal is that it does not mean that if I don’t meet this goal that I cannot continue my retirement. After all, the4% SWR rule, states that you can withdraw 4% from your portfolio every year, adjusted for inflation, and be OK. It has worked throughout history and I think will work in the future. But under the 4% rule you can and will have year to year decreases in your net worth which can be worrying. There are no guarantees. So, I have set for myself a harder goal of increasing net worth every year and actively manage my portfolio to achieve this goal. If I fail in one year its not that big a deal. I will learn from that experience and try and do better.

For 2012 as a whole I met my investment goal of increasing total net worth after spending, fees, and taxes. That makes 3 years in a row, 5 years in a row if I include my 2 year trial run before cutting the cord completely from work. Total net worth at the end of 2012 was up about 2% from 2011 after all spending, taxes, and fees. I achieved my overarching goal. Now, lets break it down a bit more into investing and spending.

You have 2 big levers to pull in retirement, the first being spending. Most of the time spending is pretty flexible and controllable. But there are some years where things are outside your control. 2012 was one of those years for us and we spent 30% more than our planned budget, all the increase being on medical bills. I don’t worry too much about these year to year fluctuations but try to concentrate more on a 3 or 5 year average of spending. For 2013 we don’t foresee any major medical bills and we’re looking to get back to our normal budget. Obviously, the high spending this year made the investment return side of the equation a bit more challenging.

On the investment side, your second lever in retirement, I was pleased with the results. The overall return of the portfolio was approximately 6% for the year. This was more than enough to cover all our spending needs, outsized though they were. Now, when measuring investment returns it is dollar weighted returns that matter. This means looking at your total portfolio among all assets, cash, bonds, stocks, real estate. What does it matter if you made 40% on your stock investments if they were only 10% of your portfolio? The 6% overall return was with an average allocation of 70% cash throughout the year with the rest of the 30% mostly in equities but with some bonds as well. Unfortunately cash these days makes next to nothing, about 0.3% in 2012 in SHY for example. The bond allocation was all munis which returned about 9% for the year in the leveraged muni CEFs that I own. I was very pleased with the equity returns of just over 20% in 2012. The big winners were EPD, AFL, and WMB for me and there were no major losers (by design – i.e. cutting losses early). The VIX was too low for most of the year to make option selling a  good risk/reward play as well. In the retirement accounts the IVY timing model returned just under 2% for the year. The 2012 performance for the asset allocations I track are below.

My biggest disappointment in 2012 was being under invested. A 70% average allocation to cash throughout the year is high even in the uncertain environment we are in. I was very focused on managing risk in 2012 and maybe I did it too well. During the year my max drawdown was less than 3%. My major plan for 2013 is to work on bringing my cash allocation down to a more reasonable level, even if it ends up being still at 40-50% of assets. My view of most risk assets remains the same as last year – they’re over valued based on history. In 2012 most of the market return was from multiple expansion which made them more richly valued (see here). On the other hand many foreign markets are undervalued on the same metrics. So, I’ll remain conservatively positioned but look for value where I can find it with a focus on dividend payers, undervalued bonds, etc…

In summary, 2012 was another successful year. The overall goal of growing net worth after spending was met despite a very high year in spending and being too conservatively allocated. In 2013, I’ll be working on both of these levers.