DIESELDIESELA System for Generating A System for Generating

Cash Flow During Cash Flow During RetirementRetirement

Goals of Today's Goals of Today's PresentationPresentation

Distinguish between “cash flow” and Distinguish between “cash flow” and income.income.

Show historical data that challenges the Show historical data that challenges the concept that very low withdrawal amounts concept that very low withdrawal amounts from fixed income-oriented portfolios from fixed income-oriented portfolios should be a standard portfolio strategy for should be a standard portfolio strategy for clients seeking retirement income. clients seeking retirement income.

Provide evidence that a more broadly Provide evidence that a more broadly diversified portfolio can produce a diversified portfolio can produce a sustainable withdrawal that is materially sustainable withdrawal that is materially larger than the generally accepted level of larger than the generally accepted level of 3-4%. 3-4%.

Goals of Today's Goals of Today's PresentationPresentation

Challenge current actuarial assumptions that Challenge current actuarial assumptions that posit life expectancies based on stale data.posit life expectancies based on stale data.

Challenge the idea that retirees will demand Challenge the idea that retirees will demand increasing withdrawals based on an inflation increasing withdrawals based on an inflation index.index.

Detail the D.I.E.S.E.L. process which stands for Detail the D.I.E.S.E.L. process which stands for Dividends, Interest and Equity SElect Dividends, Interest and Equity SElect Liquidations, which can facilitate the Liquidations, which can facilitate the distribution of “retirement paychecks” each distribution of “retirement paychecks” each month to retired clients through a process month to retired clients through a process that emphasizes stability and total return.that emphasizes stability and total return.

Bonds, Inflation and Bonds, Inflation and LongevityLongevity

Bonds are NOT the Answer!Bonds are NOT the Answer!

Primarily fixed-income-oriented Primarily fixed-income-oriented portfolios should NOT be a standard portfolios should NOT be a standard portfolio strategy for clients seeking portfolio strategy for clients seeking retirement income. retirement income.

Bonds are certain, they are not safe.Bonds are certain, they are not safe.

The trade off for certainty is a much lower return.The trade off for certainty is a much lower return.

If people retire earlier and live longer, then bonds If people retire earlier and live longer, then bonds won’t work.won’t work.

Bonds are a diversifier, not a solutionBonds are a diversifier, not a solution..

Retirees Do Not Need Income!Retirees Do Not Need Income!

What investors need is “cash flow,” not What investors need is “cash flow,” not incomeincome

The difference is that income is associated The difference is that income is associated with interest-bearing investments like bonds, with interest-bearing investments like bonds, and to a lesser extent dividend-paying stocks.and to a lesser extent dividend-paying stocks.

Cash flow makes no distinction as to the origin Cash flow makes no distinction as to the origin of the money; it could come from a number of of the money; it could come from a number of sources including interest, dividends, and the sources including interest, dividends, and the liquidation of securities. liquidation of securities.

The Problem With Inflation The Problem With Inflation AssumptionsAssumptions

Inflation assumptions are tricky and any Inflation assumptions are tricky and any assumption on inflation may prove to be assumption on inflation may prove to be unrealistic as this number cannot be predicted unrealistic as this number cannot be predicted in advance. in advance.

Obviously, any study that increases withdrawals Obviously, any study that increases withdrawals by the 1972 – 1981 inflation rates and uses the by the 1972 – 1981 inflation rates and uses the returns from a hypothetical portfolio during the returns from a hypothetical portfolio during the same period is going to get into trouble and will same period is going to get into trouble and will likely deplete. likely deplete.

The use of these metrics is the reason why most The use of these metrics is the reason why most historical studies show portfolios depleting historical studies show portfolios depleting unless the withdrawals are kept low and is the unless the withdrawals are kept low and is the source of the 4% safe withdrawal.source of the 4% safe withdrawal.

The Problem With Inflation The Problem With Inflation AssumptionsAssumptions

Does it make sense to increase withdrawals each Does it make sense to increase withdrawals each year based on the CPI and do retirees actually do year based on the CPI and do retirees actually do that? that?

In practice our clients rarely ask for “pay raises”. In practice our clients rarely ask for “pay raises”. Not once in 29 years in the industry, has a client Not once in 29 years in the industry, has a client cited to me or any of the five other members of cited to me or any of the five other members of our planning staff, that the CPI was a benchmark our planning staff, that the CPI was a benchmark or reason for any increase in cash flow from a or reason for any increase in cash flow from a portfolio. portfolio.

We chose not to adjust the portfolio withdrawals in We chose not to adjust the portfolio withdrawals in our study each year based on the CPI. We instead our study each year based on the CPI. We instead chose to smooth out the changes by using ¾ of chose to smooth out the changes by using ¾ of the 47 year CPI average. the 47 year CPI average.

Conclusions? Conclusions?

The need for an inflator of withdrawal The need for an inflator of withdrawal amounts in these studies is clear; amounts in these studies is clear;

however the need to use the actual CPI however the need to use the actual CPI as that inflator, is less clearas that inflator, is less clear

The probability that retirees will make a The probability that retirees will make a change in withdrawals every year, based change in withdrawals every year, based

on the CPI, is very lowon the CPI, is very low

The Real Wildcard - LongevityThe Real Wildcard - Longevity

Current life expectancy tables on which many Current life expectancy tables on which many planners rely may be incorrectly calculating planners rely may be incorrectly calculating average life expectanciesaverage life expectancies

All the historical big killers are off the radar All the historical big killers are off the radar screen.screen.

Cancer and cardiovascular disease mortality Cancer and cardiovascular disease mortality rates are improving.rates are improving.

Life expectancy assumptions have not been Life expectancy assumptions have not been adjusted.adjusted.

More people will live longerMore people will live longer

Many people will live VERY long.Many people will live VERY long.

We assume people live to 100.We assume people live to 100.

Underinvesting – The Greatest Risk Underinvesting – The Greatest Risk For RetireesFor Retirees

Investors are focused primarily on portfolio Investors are focused primarily on portfolio risk when their greatest danger is outliving risk when their greatest danger is outliving their money.their money.

Higher returns are essential if cash flow is to Higher returns are essential if cash flow is to be sustained.be sustained.

Lower volatility is essential so that portfolios Lower volatility is essential so that portfolios are less likely to suffer steep declinesare less likely to suffer steep declines

Can you have both?Can you have both?

Why DIESEL WorksWhy DIESEL Works

The D.I.E.S.E.L. system is based on historical The D.I.E.S.E.L. system is based on historical evidence that properly diversified portfolios evidence that properly diversified portfolios containing an optimum mix of asset classes containing an optimum mix of asset classes and sub classes have generated an average and sub classes have generated an average total return greater than a bond or mostly total return greater than a bond or mostly bond portfolio and have done so with bond portfolio and have done so with acceptable volatilityacceptable volatility

Why DIESEL WorksWhy DIESEL Works

The D.I.E.S.E.L. portfolio’s goal is to combine The D.I.E.S.E.L. portfolio’s goal is to combine investments that can potentially produce modest but investments that can potentially produce modest but consistent total returns in a low volatility portfolio consistent total returns in a low volatility portfolio from which occasional “harvesting” can occur. This from which occasional “harvesting” can occur. This “harvesting” process generates the cash flow needed “harvesting” process generates the cash flow needed to fund “retirement paychecks.” to fund “retirement paychecks.”

Properly asset-allocated hypothetical portfolios could Properly asset-allocated hypothetical portfolios could have sustained and increased their withdrawal rates have sustained and increased their withdrawal rates using the D.I.E.S.E.L. method. using the D.I.E.S.E.L. method.

This can be attributed to the relative low volatility This can be attributed to the relative low volatility combined with returns that were higher than certain combined with returns that were higher than certain less ‘risky’ alternatives. less ‘risky’ alternatives.

Properly Asset Allocated Properly Asset Allocated Portfolio?Portfolio?

Properly asset allocated means Properly asset allocated means it must it must contain all four asset classescontain all four asset classes

EquitiesEquities

DebtDebt

Hard AssetsHard Assets

Cash EquivalentsCash Equivalents

The Components of DIESEL StudyThe Components of DIESEL Study

January 1972 – January 2007January 1972 – January 2007

Study Portfolios Contained:Study Portfolios Contained:S&P 500 Index; S&P 500 Index; DFA Small Cap Index; DFA Small Cap Index; MSCI EAFE Index (dollars); MSCI EAFE Index (dollars); National Association of REIT’s; National Association of REIT’s; Goldman Sachs Commodity Index; Goldman Sachs Commodity Index; Citigroup Composite Bond Index;Citigroup Composite Bond Index;Three Month U.S. Treasury Bill Index.Three Month U.S. Treasury Bill Index.

Rebalanced quarterly with quarterly withdrawals, taken proportionately Rebalanced quarterly with quarterly withdrawals, taken proportionately from each asset class after rebalancing. from each asset class after rebalancing.

7% of beginning value per year. 7% of beginning value per year.

Withdrawals increased 3% annually.Withdrawals increased 3% annually.

No taxes, no fees or transaction costs includedNo taxes, no fees or transaction costs included..

Hard Assets/ Real

Estate

10.0%

Cash Equivalents

2.5%

US Stocks Mid

15.0%

US Stocks Large

25.0%

Bonds/ Bond

Funds

15.0%

Foreign Stocks

22.5%

US Stocks Small

10.0%

The DIESEL Study Portfolio:The DIESEL Study Portfolio:

Risk – A Closer LookRisk – A Closer Look

Understanding risk and explaining it Understanding risk and explaining it to clients is paramount.to clients is paramount.

The range of returns of portfolios for The range of returns of portfolios for rolling periods is the appropriate rolling periods is the appropriate pedagogical tool for this pedagogical tool for this

Performance metrics of the DIESEL Performance metrics of the DIESEL portfolio show that perception of risk portfolio show that perception of risk by most investors is greater than the by most investors is greater than the reality.reality.

Number of Compound

Rolling Periods Best Worst Range Return

1 Year 408 55.42% -30.29% 85.71% 12.36%

3 Year 384 31.07% -6.78% 37.85% 13.06%

5 Year 360 27.49% 0.84% 26.65% 13.10%

10 Year 300 19.95% 7.96% 11.99% 13.65%

# % # % # %

1 Year 337 82.6% 301 73.8% 253 62.0%

3 Year 363 94.5% 345 89.8% 273 71.1%5 Year 360 100.0% 345 95.8% 261 72.5%10 Year 300 100.0% 300 100.0% 275 91.7%

# % # % # %1 Year 71 17.4% 43 10.5% 15 3.7%3 Year 21 5.5% 2 0.5% 0 0.0%5 Year 0 0.0% 0 0.0% 0 0.0%10 Year 0 0.0% 0 0.0% 0 0.0%

HYPOTHETICAL PORTFOLIO WITH MG TARGET ALLOCATION

1/ 1/ 1972 THROUGH 12/ 31/ 2006 QUARTERLY REBALANCING

Periods With a Gain Periods With a Gain > 5% Periods With a Gain > 10%

Periods With a Loss Periods With a Loss > -5% Periods With a Loss > -10%

Portfolios in the StudyPortfolios in the Study

Allocated PortfoliosAllocated Portfolios

All Equity CombinationsAll Equity Combinations

Conclusions? Conclusions?

These data show that certain combinations of These data show that certain combinations of asset classes would have historically supported a asset classes would have historically supported a 7% withdrawal with a 3% annual increase per year 7% withdrawal with a 3% annual increase per year while others would not. while others would not.

When returns are randomized some portfolios When returns are randomized some portfolios have a higher failure rate than others. This may have a higher failure rate than others. This may indicate a lower probability of sustainability. indicate a lower probability of sustainability.

The D.I.E.S.E.L. portfolio has a failure rate of 9.1%, The D.I.E.S.E.L. portfolio has a failure rate of 9.1%, the lowest of the group, which supports the the lowest of the group, which supports the contention that investors seeking higher contention that investors seeking higher sustainable withdrawals should consider broadly sustainable withdrawals should consider broadly diversified portfolios. diversified portfolios.

The DIESEL SystemThe DIESEL System

How We Do It?How We Do It?

Consolidation!Consolidation!

Consolidation allows easy, one stop shopping for Consolidation allows easy, one stop shopping for all investment and financial activities. all investment and financial activities.

Consolidation has huge benefits for retirees Consolidation has huge benefits for retirees primarily related to the simplification of overall primarily related to the simplification of overall money related responsibilities. money related responsibilities.

Simplification becomes increasingly important as Simplification becomes increasingly important as retirees age and become less interested in the retirees age and become less interested in the

details of their financial processes.details of their financial processes.

Consolidation!Consolidation!

To the extent possible, all investment and banking To the extent possible, all investment and banking

accounts should be transferred to a consolidation account accounts should be transferred to a consolidation account

at a single institution. at a single institution.

IRA’s 401ks, 403b’s, etc. should be consolidated to one IRA’s 401ks, 403b’s, etc. should be consolidated to one

IRA when these accounts are available for transfer. IRA when these accounts are available for transfer.

Other, non qualified banking, brokerage and mutual fund Other, non qualified banking, brokerage and mutual fund

accounts should also be placed at the same institution. accounts should also be placed at the same institution.

We also recommend direct deposit of all other retirement We also recommend direct deposit of all other retirement

income such as pensions and social security to the income such as pensions and social security to the

consolidation account thus allowing the retiree a full and consolidation account thus allowing the retiree a full and

complete picture of his or her money flows.complete picture of his or her money flows.

Generating Retirement PaychecksGenerating Retirement Paychecks

D.I.E.S.E.L. cash flow is produced by maintaining a D.I.E.S.E.L. cash flow is produced by maintaining a balance in a “withdrawal account” (usually the balance in a “withdrawal account” (usually the consolidation account’s money market checking consolidation account’s money market checking account) equal to five months of the retiree’s cash account) equal to five months of the retiree’s cash flow requirement. [This allocation is in addition to flow requirement. [This allocation is in addition to what would be designated for the cash allocation what would be designated for the cash allocation pursuant to the client’s Investment Policy pursuant to the client’s Investment Policy Statement (IPS)]. Statement (IPS)].

The withdrawal account is usually a money market The withdrawal account is usually a money market fund that is part of the consolidation account. fund that is part of the consolidation account.

Retirees can get their retirement paychecks by Retirees can get their retirement paychecks by having money electronically transferred to an having money electronically transferred to an operating checking account each month or by operating checking account each month or by simply writing checks from the withdrawal simply writing checks from the withdrawal account.account.

Harvesting, Pruning & Harvesting, Pruning & RebalancingRebalancing

Once the client has been designated a “D.I.E.S.E.L. Income Once the client has been designated a “D.I.E.S.E.L. Income Recipient” (DIR), agreed upon a monthly withdrawal Recipient” (DIR), agreed upon a monthly withdrawal amount, and the withdrawal account has been seeded, amount, and the withdrawal account has been seeded, withdrawals can begin. withdrawals can begin.

The account is reviewed every 90 days to determine how The account is reviewed every 90 days to determine how much needs to be added to the withdrawal account to bring much needs to be added to the withdrawal account to bring it in line with the three to five month threshold figure. it in line with the three to five month threshold figure. Once this amount is determined, our portfolio managers Once this amount is determined, our portfolio managers review the account for appropriate “harvest” candidates. review the account for appropriate “harvest” candidates.

Generally, these liquidations are done in such a way as to Generally, these liquidations are done in such a way as to rebalance the portfolio back to its target allocation by rebalance the portfolio back to its target allocation by liquidating positions that are out of proportion, out of favor, liquidating positions that are out of proportion, out of favor, or will generate a needed tax loss.or will generate a needed tax loss.

Harvesting, Pruning & Harvesting, Pruning & RebalancingRebalancing

Although “harvesting” occurs quarterly, paychecks Although “harvesting” occurs quarterly, paychecks are generated monthly. This allows a monthly are generated monthly. This allows a monthly withdrawal while minimizing transaction costs and withdrawal while minimizing transaction costs and allowing for smaller balances in low yielding money allowing for smaller balances in low yielding money market funds. market funds.

Since the differences between quarterly and monthly Since the differences between quarterly and monthly were minor in our study, we chose quarterly to limit were minor in our study, we chose quarterly to limit transactions, paperwork and record keeping. transactions, paperwork and record keeping.

Taxes can be withheld from these “paychecks,” often Taxes can be withheld from these “paychecks,” often obviating the need for those pesky quarterly obviating the need for those pesky quarterly estimated payments and adding further to the estimated payments and adding further to the convenience of account consolidation. convenience of account consolidation.

Types of Investments?Types of Investments?

D.I.E.S.E.L. works best when a portfolio is D.I.E.S.E.L. works best when a portfolio is

invested in mutual funds. invested in mutual funds.

Funds allow for efficient asset allocation, Funds allow for efficient asset allocation,

reinvestment of distributions and incremental reinvestment of distributions and incremental

liquidity that lends itself to cash flow liquidity that lends itself to cash flow

generation and rebalancing.generation and rebalancing.

D.I.E.S.E.L. works best in a fee based, no D.I.E.S.E.L. works best in a fee based, no

transaction fee (NTF) environment or a wrap transaction fee (NTF) environment or a wrap

arrangementarrangement..

What About Taxes?What About Taxes?

Taxes associated with the D.I.E.S.E.L. system Taxes associated with the D.I.E.S.E.L. system depend on a number of factors. depend on a number of factors.

Obviously in qualified accounts there are no real tax Obviously in qualified accounts there are no real tax planning opportunities. However, in taxable planning opportunities. However, in taxable accounts tax efficiency is a consideration.accounts tax efficiency is a consideration.

In seasoned accounts that have been invested for In seasoned accounts that have been invested for more than one year, and using the average share more than one year, and using the average share cost method for gain calculations, most liquidations cost method for gain calculations, most liquidations of securities will result in long term capital gain of securities will result in long term capital gain treatment on a portion of the proceeds with the treatment on a portion of the proceeds with the remainder being non taxable return of principal.remainder being non taxable return of principal.

Personnel?Personnel?

The D.I.E.S.E.L. retirement paycheck arrangement The D.I.E.S.E.L. retirement paycheck arrangement must be systematized and staff persons properly must be systematized and staff persons properly trained in the process. trained in the process.

One group is assigned to review and calculate the One group is assigned to review and calculate the required funds for each DIR and one group is required funds for each DIR and one group is assigned to make the portfolio changes necessary assigned to make the portfolio changes necessary to generate these funds for the withdrawal account. to generate these funds for the withdrawal account.

Easy alternatives?Easy alternatives? Variable AnnuityVariable Annuity

Asset Allocation / Lifestyle fundsAsset Allocation / Lifestyle funds

Conclusion?Conclusion?

Financial professionals can provide a Financial professionals can provide a systematic withdrawal program that produces systematic withdrawal program that produces

retirement paychecks for their clients. This retirement paychecks for their clients. This program requires account consolidation, an program requires account consolidation, an asset-allocated portfolio, properly trained asset-allocated portfolio, properly trained

support personnel, and some client education. support personnel, and some client education.

Thank You!Thank You!