How long do you need to recover the loss of real value in your equity portfolio?



This is a picture about the destruction of American savings, the difficulty and timing pertaining to the recovery of those values, and the punitive impact that taxes impose on that process.

This is likely your story if you had any investment in equities via:

  • savings for your retirement, or
  • your kids' educations or
  • eldercare,
  • a pension, SEP, Roth or regular IRA; or
  • are a business or institutional portfolio manager or
  • if you simply own a house (the numbers change a bit, but it’s generally the same story)

You likely won’t recover the real value of the portfolio value until 2039 and that seems to be a reasonably favorable scenario. It is clear that the increases of long term capital gains and dividend income taxes as proposed by the administration won't be helpful. Of course, if income and capital gains taxes are eliminated, it shortens the recovery from 2039 to about 2024.  You can make your own call on that one.

The chart shows the decline of VTI, Vanguard's Total Stock Market Index ETF, from peak value on $78.26 on October 12, 2007 to $45.32 on July 7, 2009.  VTI basically represents the entire US stock market, and the peak to trough decline you see is real.  Thereafter, we assume a 7% nominal, pre-tax return on US equities.  We may have over or under estimated future returns, but many managers would have been happy with 7% for the last few years and perhaps would be for the next few as well.  We stipulate the forecast is primitive, but people can see and understand it.  Monte Carlo simulation would be better, but it's harder to understand, and the zip code of the results won't change.

We assume a series of 366 day holding periods to simplify taxes. We also assume our initial basis to equal the proceeds of our first periodic sale, so all subsequent long term capital gains are taxed at the proposed federal rate of 28%.  Dividends are taxed at the 28% proposed federal tax rate, and we added a 6% state income tax for the home team. 

Play around with the assumptions if you like, but it won’t change fundamental and very sobering nature of the out outcomes: we’ve sacrificed the savings of several generations. In a steady state scenario, anyone over the age of about 27- 28 will likely run out of time and earnings capacity to catch up.

"So? I already knew I had a problem." Ok, in our next posting we'll talk about what this means for investment (and life) strategy going forward.


2.64% dividend yield (ticker: VTI)

4.36% + expected price appreciation

7.00% = expected nominal pre tax equity return

0.90% less income tax on dividend

1.22% less LT cap gain (366 day holds)

4.88% = after tax equity return

3.00% less inflation

1.88% = real after tax equity return


3%   inflation

34% fed dividend income tax as proposed at 28%+ 6% state

28% fed LT capital gains taxes proposed, no state



Should you buy municipal bonds individually or in a fund?

J. Hunter Brown's comment on the municipal bond market

"Individual investors that are unfamiliar with indentures and some of the embedded risks - interest rate, credit, or liquidity, many of which are appropriately noted here - should stick to reputable mutual funds or ETFs. And there aren't a lot of them around...A major problem for individuals with the muni market is that there is little to no price transparency. The inefficient structure and informational risk of the market can put the individual investor at the mercy of a dealer trying to monetize an informational monopoly or unload a risk position."

is cited in WSJ: Should You Buy Municpal Bonds Individually or in a Fund? (Wall Street Journal, The Wallet, Feb. 3, 2009)

"A 2004 investigation by the National Association of Securities Dealers — now known as FINRA – assessed a total of more than $610,000 in fines and restitution on Charles Schwab, Edward Jones, First Trust Portfolios, Merrill Lynch, Morgan Stanley, Prudential Equity Group, UBS Financial Services and Wachovia Securities for buying municipal bonds from clients at unfairly low prices....According to the NASD, the fair market value of the bonds was 97.02, but a UBS broker executed the trade at 40.00 – meaning that more than half of the bonds’ total value ended up in the broker’s pocket. (All the firms settled the case without admitting or denying the charges.) That’s an extreme case of the problem that reader J. Hunter Brown points to in his comment: How can you know whether you get a fair price when you buy or sell an individual muni?"



Why not double down?

"Mr. Geithner, who was closely involved with the AIG bailout, offers no change ... His latest scheme is called the Public-Private Partnership Investment Program. But there is actually very little private skin in this game: It gives a handful of wealthy financiers huge nonrecourse loans to enable them to purchase toxic assets that the market supposedly won't buy at a "fair" price. As the housing crisis has shown, providing subsidized nonrecourse loans creates asset bubbles, not true price discovery. And bribing buyers to ramp up prices smacks of market manipulation." Amar Bhide


The new program offers non-recourse debt financing at ~20x leverage to the hedge fund crowd. It is a free option of unprecedented macro scale: a massive call option on the taxpayer wallet at a 5% premium.   'Heads they win, tails the taxpayer losses again'.

So, form a hedge fund, buy the maximum you can. If it works, you're rich. If it doesn't, just walk away. You only have 5% down.  It's your best shot.

"a little song, a little dance, a little seltzer in the pants..." - Chuckles the Clown

If the hedge fund isn't working for you, consider buying TIPS & selling long dated treasuries.


What the large print giveth, the small print taketh away

From the H-15 schedule published by the Fed:

"Trade data insufficient to support calculation of the 90-day A2/P2 nonfinancial rate for April 6, 2009. "

There is a hole in the bucket: this market is closed.

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