Thursday, September 13, 2012

SEC Charges Ray Lucia's Buckets of Money


The following is a press release from the SEC with my commentary:

> SEC Charges Radio Personality for Conducting Misleading Investment Seminars
>
> FOR IMMEDIATE RELEASE
> 2012-177
>
> Washington, D.C., Sept. 5, 2012 – The Securities and Exchange
> Commission today charged a nationally syndicated radio personality and
> financial advice author for spreading misleading information about his
> “Buckets of Money” strategy at a series of investment seminars that he
> and his company hosted for potential clients.
>
> The SEC’s Division of Enforcement alleges that investment adviser Ray
> Lucia, Sr. claimed that the wealth management strategy he promoted at
> the seminars had been empirically “backtested” over actual bear market
> periods. Backtesting is the process of evaluating a strategy, theory,
> or model by applying it to historical data and calculating how it
> would have performed had it actually been used in a prior time period.
 

 I haven't written much about Buckets of Money here. The only time it came up was in a book review I wrote about Asset Dedication just a little over a year ago. I began that review by saying:

This book is very interesting and speaks to some very important issues for retirement planning and so it is hard to know where to begin in discussing it. First of all, this book suggests an approach to retirement planning that is similar to Raymond J. Lucia’s Buckets of Money. I’ve read that book as well, but from my perspective of wanting to simulate things to see how they work for myself, I find Asset Dedication to provide a clearer framework.  The many possible permutations and variations of Buckets of Money leave me a bit overwhelmed to know where to start testing it.
Not digging deeper into the history besides what Mr. Lucia had written, it seemed that backtesting Buckets of Money was impossible. There were so many possible permutations and so many exotic financial product choices which lack historical data that it would have been an extremely vast undertaking to try to show whether it worked.

Unfortunately, I still have not found the time to do the following, which I suggested that I hope to do in that earlier review:


When I read Buckets of Money and Asset Dedication, the main issue that concerned me is that in some scenarios (though it doesn’t have to be this way, as I will explain), the stock allocation for retirees can creep up to 100% before  shorter-term buckets are refilled / new assets are dedicated to short-term expenses.

Huxley and Burns are quite upfront about this issue, as they believe strongly in the “stocks for the long-run” idea that stocks provide superior performance for sufficiently long periods of time.

That makes me nervous.  One thing is quite clear from the U.S. historical data though, which is that stocks have performed best.  I’ve seen this time and again in my research.  100% stocks support higher maximum sustainable withdrawal rates, largest wealth accumulations at retirement, lowest safe savings rates, and so on.  But before fully embracing the Asset Dedication approach, I do want to consider Monte Carlo simulations that allow for more scenarios to compare Asset Dedication to traditional asset allocation, in order to see how they perform in worst-case scenarios.   The superior performance of Asset Dedication shouldn’t just happen because it has a higher stock allocation, but because there really is something meaningful going on with its differing approach to the asset allocation question. 

As is a recurring theme here at this blog, Moshe Milevsky has already done everything. He wrote a column in 2007 called "Spending Buckets and Financial Placebos" with a simple example of the buckets of money style approach and showed that it is just sort of random whether or not buckets of money will beat a portfolio invested from a total returns perspective, as it just depends on the particular sequence of returns experienced by the investor.

Back to the SEC press release...

> Lucia, who lives in the San Diego area, and his company formerly named
> Raymond J. Lucia Companies Inc. (RJL) allegedly presented a lengthy
> slideshow at the seminars indicating that extensive backtesting proved
> that the Buckets of Money strategy would provide inflation-adjusted
> income to retirees while protecting and even increasing their
> retirement savings. However despite the claims they made publicly,
> Lucia and RJL performed scant, if any, actual backtesting of the
> Buckets of Money strategy.
>
> “Lucia and RJL left their seminar attendees with a false sense of
> comfort about the Buckets of Money strategy,” said Michele Wein Layne,
> Regional Director of the SEC’s Los Angeles Regional Office. “The
> so-called backtests weren’t really backtests, and the strategy wasn’t
> proven as they claimed.”
>
> According to the SEC’s order instituting administrative proceedings
> against Lucia and RJL, they held the seminars highlighting their
> Buckets of Money strategy in an effort to obtain advisory clients who
> would be charged fees in return for their advisory services. They
> promoted the seminars on Lucia’s radio show and on Lucia’s personal
> and company websites.
>
> According to the SEC’s order, a backtest must utilize actual data from
> the time period in order to get an accurate result. Lucia and RJL have
> admitted during the SEC’s investigation that the only testing they
> actually performed were some calculations that Lucia made in the late
> 1990s – copies of which no longer exist – and two two-page
> spreadsheets.
 

Two two-page spreadsheets provided all the support for all the various permutations in his book? That is sad. The investing public deserves better.

> According to the SEC’s order, the two cursory spreadsheets that Lucia
> claims were backtests used a hypothetical 3 percent inflation rate
> even though this was lower than actual historical rates. Lucia
> admittedly knew that using the lower hypothetical inflation rate would
> make the results look more favorable for the Buckets of Money
> strategy. These alleged backtests also failed to account for the
 

Though I can't think of any examples off-hand, I have read some other marginal studies which use historical data except for oddly using a 3% inflation rate instead of actual inflation. That is misleading. The worst-case scenarios happened for retirees in the late 1960s who experienced high inflation throughout the 1970s. With constant inflation-adjusted spending, assuming a 3% inflation rate provided a lot of relief against having to raise spending, making portfolio survivability much easier. Basically, Mr. Lucia said he did a test showing that buckets would support inflation-adjusted spending, but his test assumed spending that would have trailed far behind actual inflation in the 1970s.

> negative effect that the deduction of advisory fees would have had on
 

What's interesting here too... remember that the 4% rule is based on an assumption that investors can earn index returns without paying any sort of fees. The original studies do highlight that assumption, but it gets lost in lots of the press reports that make it to the public.

> the backtesting of their investment strategy, and their “backtesting”
> did not even allocate in the manner called for by Lucia’s Buckets of
> Money strategy. The slideshow presentation that Lucia and RJL used
> during the seminars failed to disclose the flaws in their alleged
> backtests and was materially misleading.
 

I'm curious about what they actually tested, since I found buckets to be so broad that it could include a whole lot of ground.

> According to the SEC’s order, Lucia and RJL also failed to maintain
> adequate records of the backtesting as they were required to do under
> an SEC rule. The pair of two-page spreadsheets was the only
> documentation of their backtesting calculations, and those
> spreadsheets failed to duplicate their advertised investment strategy.
>
> The SEC’s order finds that RJL violated Sections 206(1), 206(2) and
> 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-1(a)(5)
> thereunder. The order finds that Lucia willfully aided and abetted and
> caused RJL’s violations of Sections 206(1), 206(2) and 206(4) of the
> Advisers Act and Rule 206(4)-1(a)(5) thereunder. The SEC’s Division of
> Enforcement is seeking financial penalties and other remedial action
> in the proceedings.
>
> The SEC’s investigation was conducted by Peter Del Greco of the Los
> Angeles Regional Office. John Bulgozdy will lead the litigation. Bryan
> Bennett and John Kreimeyer conducted the SEC examination that prompted
> the investigation.

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