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Minerva Planning
Client Newsletter March 2008
In This Issue
A Bear Market Road Map
Planning for Ups and Downs
Quick Links
Press and Events
Business Week - Micah appeared in Business Week this month in an online article discussing bargains in the bond market.

Midtown Tour of Homes- Minerva Planning Group is sponsoring the 2008 Midtown Tour of Homes taking place in Midtown Atlanta on April 5th and 6th.

As I write this, news has just broken that Bear Stearns is no more. JP Morgan has agreed to buy it, and while the stock holders won't be left with stock that is completely worthless, the deal values the stock at less than one-tenth of its value just a few days ago. The Fed has wisely stepped in to back the deal, and while action from all involved has been swift, it is still  likely that market turmoil will continue as the credit crisis unwinds.

We're mindful of the fact that even the most rational long-term investor can find periods like we're experiencing difficult. Our goal with this newsletter is to lessen your potential concerns, first by looking back at past market downturns to put where we are now - and where we might go - in proper perspective.  In the second article, we explain how we design client plans to survive downturns.

One final piece of the puzzle we don't address in this newsletter - but which we will revisit in April's edition - is why we don't attempt to time the market. This is a natural question - after all, if it's obvious that the market is going through a rough time, why not simply liquidate stocks and hold cash until things get better? Unfortunately, the approach is not that simple, and in next month's newsletter I'll explain why in more depth. I'll also cover why a market timing approach makes it less likely that you'll meet your financial goals instead of  simply choosing a long-term allocation and sticking with it through the markets ups and downs.

I hope the articles help calm any concerns you might have about the market's impact on meeting your financial goals. Our primary goal here at Minerva is to craft strategies to help you meet your goals. However, it is key to ensure that you understand and are comfortable with these strategies, particularly in market downturns. If you have any questions or just want to discuss our approach in more detail, don't hesitate to contact us.

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Micah Porter, CFA
A Bear Market Road Map from the Past
By Micah Porter, CFA
The past week served as a reminder of how volatile markets can be. On Tuesday, the Fed announced that it would accept mortgages as collateral from banks and brokers in an attempt to provide liquidity to both the institutions holding mortgages and the mortgage-related security market itself. The market cheered the move, sending the S&P 500 up 3.7%. Just a few days later, on Friday, news broke that the Fed move came too late for Bear Stearns, a Wall Street bank that had invested heavily in the mortgage market. The Fed had to announce a bail-out which essentially assured creditors that their debts would be covered until such time as a buyer for Bear Sterns could be found. The S&P's response to news about Bear was a loss of 2.1% on Friday, wiping out the gains for the week.

With so much volatility, it's almost impossible to extrapolate the long-term from short-term market moves. While it might be tempting to try, we think it's more useful to take a look at what past bear markets have looked like, and where we stand relative to those. Since 1968, there have been nine bear markets, including the current one. Here are a few relevant statistics:
  • The average length of the bear market was 13.6 months.
  • The average loss for the S&P 500 was 25.9%
  • The average loss for a portfolio invested 60% in the S&P 500 and 40% in the bond market was 14.1%
To give some idea of where we stand in comparison to the average bear market over the last 40 years, this bear market began roughly in October, or a little over five months ago. The S&P is down 16.7%, and the average 60/40 portfolio as described above is down 8.4%.

The good news is that gains in bull markets generally more than offset losses in bear markets. Here are the statistics on bull markets since 1968:
  • The average length of the bull market was 45.4 months.
  • The average gain for the S&P 500 is 133.2%.
  • The average gain for a 60/40 portfolio as described above is 92.3%
If this bear market is comparable to the average, we've got about nine months remaining and the S&P 500 will see an additional loss of a little over 9%, while a 60/40 portfolio consisting solely of the S&P 500 and bonds would see a further loss of roughly 6%. But what if this downturn is worse than average? Since 1968, the lengthiest downturn was 25 months. However, nearly every client that is taking income on a regular basis to support him or herself has enough cash and fixed income to cover a minimum of three years' identified cash needs. Thus, unless this downturn is the longest we've seen in 40 years - and admittedly, it could be - those clients won't need to liquidate stocks to cover identified cash needs.

For those of you not yet taking distributions, there is good news as well. The worst loss for our hypothetical diversified portfolio occurred during the 73/74 downturn. Over that timeframe, the portfolio was down 30.5%. However, over the course of the ensuing bull market, the portfolio gained 69.0%, leading to a gain of over 17% during the entire four year period.

Bear markets can be difficult times for investors. But if the past is any indication, they tend to be short in duration, and even when they are lengthier, subsequent bull markets have erased losses suffered during the downturn. Further, to augment performance, we've worked to position client portfolios more defensively in anticipation of a downturn so losses should be lower than a comparable S&P/bond only portfolio. While these facts may not provide a great deal of comfort as we work through this down market, we're confident that the steps we've taken will allow clients to weather this and future downturns, and meet their financial goals.
Planning for Ups and Downs
By Micah Porter, CFA

When we attempt to measure portfolio performance, we look at two measures. First, we compare portfolio returns to the broader markets, in the form of a composite benchmark to determine how well the portfolio is being managed. There is a second measure that is  arguably more important for clients, and that is whether portfolio performance will allow a client to meet his or her stated financial goals. This second measure is particularly applicable during down markets. After all, there's not much comfort if "outperforming" the broader markets still leads to a loss that jeopardizes your ability to meet your financial goals.

To avoid such a situation, there are a number of tools that we use to test clients' ability to meet their financial goals, even if the market undergoes an extended downturn. Given recent market performance, we thought it would be useful to review these tools with you.

The first and most straightforward tool is the safe withdrawal rate. The safe withdrawal rate approach is the simplest approach to use for those who are in retirement and want to minimize the likelihood that they will outlive their portfolio. While we've explained the underpinnings of the safe withdrawal rate in the past, it bears repeating here.

The originator of the safe withdrawal rate was Bill Bengen, a long-time NAPFA member and M.I.T. graduate who has done a great deal of research on identifying a safe withdrawal rate. To determine this rate, he initially examined market returns from 1926 to 1975 and assumed a hypothetical retiree retired on January 1st of each year during that 69-year period.

His goal was to identify the highest withdrawal rate, expressed as a percentage of total portfolio value, at which all retirees would still have money left in their portfolio after 30 years. So for example, if he chose a rate of 5%, and all retirees except for those retiring in 1972 and 1973 had money left in their portfolio at the end of the year, he'd then move to a lower withdrawal rate and test that. The withdrawal rate Bengen identified for clients with a 30-year time horizon was 4.4%, with the rate varying upward or downward depending upon whether a client's time horizon was longer or shorter, respectively.

If you're in retirement and using a safe withdrawal rate as a rough yardstick of how much you can spend, the current downturn may be of some concern to you. If this is the case, take a look at the timeframe Bengen examined - his study went back over 80 years. Every single hypothetical retiree met his or her retirement goal over the period, regardless of when they retired. Could the current downturn and subsequent market and economic performance be worse than any period in the last 80 years? It could, but the fact that the study included such a long time frame - encompassing a depression, a world war, the Cold War, 14 Presidents and 14 down markets - does give us comfort.

But what about those of you that aren't in retirement or are in retirement and don't use the safe withdrawal rate approach? Your planning projections are more complex, and because of this we use our planning software. While the software provides straight-line projections that incorporate all data provided and then assumes a steady, constant rate of return year-after-year. While such a projection is easy to understand and is useful for planning illustrations, the market doesn't behave like this, which is why our planning software also allows us to run stress tests on client portfolios. The stress tests examine the probability that plan goals will be achieved under widely varying market conditions, and these tests are particularly useful in market downturns. The stress tests we run include the following:

  • Back testing - takes the client portfolio and financial goals and uses the sequence of actual returns and historical inflation beginning in 1973. That year was chosen as the beginning year as it represents the worst scenario we've seen in the last 40 years for someone hoping to retire and fund retirement with substantial assets. The reason is that from 1973 through 1975 a sharp market downturn was followed by very high inflation - so portfolios lost value, and what remained after the downturn lost a good deal of spending power. This test shows the degree to which a client's goals are funded and the safety margin in term of money remaining at the end of the plan.
  • Rolling periods - a variation on the back testing above, it examines how a client's plan fares if it begins at various years. We typically start at 1926 and look at how the plan fares, and then start at 1931 and so on in five-year increments. Returns and inflation are assumed to follow the actual sequence they followed beginning the year in question. For each period, the software examines to what percent the plan is funded and what the safety margin is in terms of assets remaining at the end of the plan.
  • Bad timing - typically, plans fare the worst if a market downturn occurs just as a client needs to fund a goal such as retirement. To examine the impact to a client's plan, the bad timing test assumes two consecutive years of portfolio losses just as a client retires. Typically, we examine the impact of two years back to back of losses of a minimum of 15%, with market returns returning to normal over the long-term. It's worth noting that such a downturn would exceed any downturn we've seen over the last 40 years for the 60/40 portfolio we typically recommend for clients that are retiring or are early in retirement.
  • Monte Carlo - the Monte Carlo test differs from other stress tests in that it doesn't use an actual sequence of market returns, but rather creates multiple permutations of market returns, such that the return equals the long-term market returns, but the sequence of returns for individual years differs. Given that the sequence of returns is key in meeting financial goals, the Monte Carlo output is an excellent test of the likelihood of success for a plan. The output shows what percentage of the scenarios created result in a successful plan, and we usually look for a minimum of 70% of successful scenarios, with a higher probability preferable.

Our goal is to update plans for all clients for whom it is applicable as we meet with them this year. However, if you'd like for us to update your plan sooner, or if you've got any questions about the stess testing we do, just let us know.