Why We Invest

September 14, 2015

From Bob French of McLean:

Inflation is a fact of life. A dollar buys less today than when you were a kid, and it will buy even less in the future. There’s no way around it. To maintain your current standard of living in the future, you’ll need to spend more than you do today. We don’t know how much more because the inflation rate is always changing, but we can put it in perspective. Over the 30-year period from 1985 to the end of 2014, the annualized US CPI inflation rate was 2.71% year. That means that a dollar in 1985 is worth a little bit less than 44 cents today. You need to account for inflation when you think about your financial goals.

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The Exception to the Rule

August 11, 2015

Most professional athletes seem to blow through millions in the blink of an eye.  Not Ryan Broyles:

 Ryan Broyles grabs his cell phone every morning over breakfast and pores over the latest transactions. What the Detroit Lions wide receiver is looking at, though, has nothing to do with football.

Over the past three-plus years, Broyles has become immersed in the financial world. His financial planning throughout his career allowed him to make a lot of investments. So when he laments the S&P 500 has “been sideways” most of the year, he has good reason.

It all started after a meeting with a financial adviser soon after being drafted in 2012. The adviser gave Broyles some advice he used to shape his life: Spend as you would like over the next few months. Figure out your means. Then set a budget, live within it and invest the rest.

Broyles signed a contract worth more than $3.6 million after being taken in the second round. More than $1.422 million was guaranteed. But Broyles knew the other statistics — ones reinforced when he went to the rookie symposium.

He knew NFL players, and athletes in general, go bankrupt. He saw athletes blow through millions. He was determined not to have that happen to him.

He came up with a budget. Broyles said he and his wife, Mary Beth, have lived on $60,000 a year, “give or take”, throughout his career. Everything else has gone to investments, retirement savings and securing Broyles’ post-football monetary future.

Broyles wanted to make sure his NFL career, however long it lasts, really did set him up for life.

“Then you know how much you can invest, how risky you can be,” Broyles said, as he enters the last year of his rookie contract with no guarantee he’ll make the Lions’ roster. “Then, when I was hitting the same budget over three, four, five months, it was all right, this is what your budget is and I had some spending money.

“I didn’t hold myself back at all on those terms. That’s what I tell people when they want to start to invest, I tell them to live your life and see where you stand and then pull back. Don’t pull back without even knowing.”

He has no problem driving a red Ford Focus rental car during training camp this year. It’s why he and his wife drive Mazdas — he recently bought a new one — and he still has his 2005 Chevrolet Trailblazer from college.

Broyles wouldn’t go into specifics about his investments — just smiling wide when asked. Despite some big changes in his life this offseason — the couple bought their first home in Texas and had their first child, Sebastian — he doesn’t feel any more pressure to succeed on the field because he has an extra mouth to feed.

“The pressure I put on myself is just being the best player I am,” Broyles said. “I would never play [just] for money, you know what I mean, that’s not my intentions whatsoever.

“Whatever comes, it’s just a blessing. But I got the mindset of a businessman off the field, I’ll tell you that.”

Broyles immersed himself in the financial world. In March, he went to Washington, D.C., with New Orleans running back Mark Ingram to speak to students about financial planning. Broyles worked with VISA and the NFL on promoting a Financial Football video game in classrooms to help teach financial security and planning in both D.C. and his home state of Oklahoma.

“I studied as much as I could,” Broyles said. “Talked to people wealthier than me, smarter than me. So that definitely helps.”

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Crash Dieting for Savers

June 17, 2015

From Crash Dieting Doesn’t Work for Savers, Either, by Anthony Isola:

Sure, deprivation diets can work temporarily. Brides preparing for weddings rely on this short-term effect, as do celebrities who want to fit into designer gowns for awards shows. But the more we deny ourselves, the more we crave what we deny.

Result? According to Bloomberg, the share of the population classified as obese has ballooned from 14% in 1960 to 36% in 2010. That’s a problem. Here’s another: CBS Moneywatch reports that 26% of people ages 50-54 and 14% of those over 65 have no savings. Boosting savings is critical, but just as you can’t live long-term on a starvation diet, you can’t realistically expect to build up a nest egg for tomorrow by starving yourself financially today.

I am still convinced that that the only savings plan anyone needs is to save 15% of every dollar ever earned (and invest that money wisely).  Learn this as a teenager and live it throughout your life and personal finances will be a breeze.

HT: Abnormal Returns

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Retirement by Choice or by Necessity?

April 21, 2015

Yahoo! Finance raises questions about the theory that you can always get serious about saving for retirement later on:

Americans may be feeling more confident than ever about their chances of securing a comfortable retirement, but there’s one thing we are seriously delusional about: when we will finally call it quits.

There’s a big gap between when workers expect they will retire and when people who’ve actually retired say they left the workforce, according to the latest retirement confidence survey from the Employee Benefit Research Institute. Half of retirees say they retire earlier than they planned.

Fewer than one in 10 workers say they expect to retire before age 60, when in fact 36% of retirees say they stopped working before 60. Comparatively, only 29% of workers retired between the ages of 60 and 64 and only 9% retired at the traditional age of 65. The odds of making it until age 70 and still working — which more than one-quarter of workers say they want to do — are even slimmer. A mere 6% manage to last that long.

“Most retirees retired earlier than they planned predominantly due to health problems,” says Luke Vandermillen, vice president of the Principal Financial Group, a co-sponsor of the study. “All you can do is try to control what you have planned, how you have saved, and whether you’ve taken steps to prepare for retirement as best you can.”

What’s clear is that the vast majority of premature retirees did not leave work because they wanted to. Sixty percent of premature retirees cited health issues or a disability as the reason. Others had little choice in the matter — their company downsized or closed, leaving them out of a job (27%), or they needed to care for a spouse or family member (22%).

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Saving Earlier

August 4, 2014

More great research from the Center for Retirement Research at Boston College.  Click here for their latest piece How Much Should People Save?  One of the more interesting parts of the research to me was the massive benefits of saving earlier and retiring later.  Common sense, but the table below makes it clear how much easier retirement planning becomes when one starts early.

Table 5. Saving Earlier

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Unlucky Umberto

July 25, 2014

One reason to invest in our Global Macro portfolio: Decrease the chances that you are “Unlucky Umberto.”  Click here to read more (NYT).

A brief description of our Global Macro portfolio is as follows:

This global tactical asset allocation strategy seeks to achieve meaningful risk diversification and investment returns.  The strategy invests across multiple asset classes: Domestic Equities (long & inverse), International Equities (long & inverse), Fixed Income, Real Estate, Currencies, and Commodities.  Exposure to each of these areas is achieved through exchange-traded funds (ETFs).

The idea of risk diversification is that by expanding the number of asset classes in the investment universe and by giving yourself the flexibility to overweight and underweight those asset classes based on relative strength an investor can seek to avoid extended periods of time with poor returns, especially in the later decades of an investor’s life.

E-mail andyh@dorseywright.com to request a brochure on our Global Macro portfolio.

A relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is no guarantee of future returns.

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Why Bother With Active?

July 14, 2014

National Geographic makes a provocative claim about longevity on one of its recent covers:

national geographic may 13 600x375 Why Bother With Active?

Our genes harbor many secrets to a long and healthy life.  And now scientists are beginning to uncover them.

While it might be a stretch that life expectancy in the US will be approaching 120 any time soon, what is not a stretch is that life expectancy continues to increase.  Among many other aspects of increased longevity, the financial implications of being a good investor are becoming more pronounced.

To illustrate, consider a simple example.  Suppose that when the baby on the cover of the magazine graduates from high school at age 18 he decides to take a summer job selling alarm systems door-to-door.  This boy is a very good salesman, and is able to pull in $100,000 before he heads off to college.  He decides to take that sum of money and invest it in the stock market.  Suppose that this boy ends up never needing to use that money and so throughout his very long life that money just stays invested and is able to earn 9 percent a year.  Compare that return to a different person who, over the same time frame, invests $100,000 and earns only 6 percent a year.

Table 1 Why Bother With Active?

With this simple example, it becomes easy to see how greater longevity can have an outsized reward for those investors who are able to generate even a couple percent excess return over time.  After only 10 years of investment results, the investor earning 9 percent a year only has 1.3 times more money than the investor earning 6 percent.  However, after 100 years there is an enormous difference of 16.3 more money.

Something to think about next time you hear someone say that it is not worth it to try to find an active strategy that is able to generate a couple percent in annual excess return over time.

This example is presented for illustrative purposes only and does not represent a past recommendation.  A relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

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Trend Toward Professionally Managed 401(k) Portfolios

July 2, 2014

From U.S. News comes some interesting insight for any who might have thought that all a 401(k) participant needs is an roster of index funds with no additional guidance:

Another positive trend noted by Vanguard is the increased use of professionally managed portfolios. At the end of 2013, 40 percent of participants enrolled in Vanguard plans had their entire balance invested in a single target-date fund, balanced fund or managed account advisory service. Vanguard projects that 58 percent of all plan participants and 80 percent of new plan participants will be fully invested in some form of a professionally managed portfolio by 2018.

If one thing is obvious from the sordid history of 401(k) plans, it’s that most participants are incapable of putting together a globally diversified portfolio in a suitable asset allocation on their own, using low management fee index funds. Of course, this assumes that low management fee index funds are even an option. Although they are available in Vanguard plans, these funds are more the exception than the rule in 401(k) plans “advised” by brokers and insurance companies. (my emphasis added)

We are happy to be working with Pat Church of Church Capital on what we believe will be part of the solution to this challenge.  Click here and here to learn more.

Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.

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Hoarding Cash

June 15, 2014

I would never argue against holding some cash (say 6-9 months worth of non-discretionary expenses), but holding this much??

According to new research on investors in 16 countries by State Street’s Center for Applied Research, retail investors globally were holding an average of 40 percent of their assets in cash, up from 31 percent two years ago. That’s a compounded annual growth rate of a whopping 13 percent.

The lowest levels of cash holdings were in India, at 26 percent, and China, at 30 percent; the highest was 57 percent in Japan. The United States was in the middle at 36 percent, but that was an increase of 10 percentage points in just two years. The survey, done by State Street, one of the world’s largest asset managers and custodians, was conducted in the first quarter of this year. It considered cash to be money held in savings and checking accounts as well as cash equivalents like money market funds.

Despite the run-up in equity markets, people have resisted rushing into stocks and have instead added to cash. They’ve done this regardless of their age or amount of wealth. The study found that millennials who are under 33 and have the longest time to invest their money were increasing their cash positions at the same rate as baby boomers, who will need to draw on their investments soon.

So, the amount of cash being held has gone up over the past two years even though there has been a rising market…doesn’t really support the position of some that we’re starting to see risk-taking come back in a major way.  It also doesn’t strike me as the type of behavior you might see at a major market top.

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Retirement Planning Essentials

March 26, 2014

Back to the basics with Andy Kiersz at Business Insider:

We recently pointed out that starting to save early for retirement is extremely helpful, and also a useful chart showing how much you should have saved at different stages of your career to ensure a comfortable retirement.

To show how these ideas work, we figured out how much money you would have to set aside monthly, starting at different ages, and under different rates of return, to end up with $1,000,000 in savings when you are ready to retire at 65.

Here is how much you would need to save each month at a 6% annual rate of return, starting at different ages.

So if you’re 20, and you want to retire a millionaire, you should be socking away $361 per month. If you’re starting at 25, that jumps to $499. You can see how as you get older, you need to be saving much, much more:

monthly savings chart new Retirement Planning Essentials

Bottom line: It is much better to start saving young. Two things are happening here. First, by starting to save at 20 instead of 40, you have many more individual monthly payments, and can spread out your total principal investment over a longer period of time.

Second, and much more importantly, by saving earlier, you can better take advantage of compound interest. If you start saving when you are 20, your first payment of $361.04 will, at 6% return, grow into $5336.16 when you are 65.

How much you need to save also depends on  the return rate. This chart shows how much you need to put into your savings account each month for a variety of annual return rates:

monthly savings table good Retirement Planning Essentials

A solid grasp of (and commitment to act on!) the basics of savings and compound interest are fundamental to achieving a secure retirement.  This becomes ever more important as life expectancy continues to increase. From the WSJ earlier this week:

The Society of Actuaries recently updated its mortality tables for the first time since 2000 to reflect the longer life spans of today’s retirees. Based on the update, the average man who turns 65 this year is expected to live to 86.6, up from 82.6 in 2000. Women are expected to live to 88.8, up from 85.2.

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401k Spotlight: An (Enlightened) Alternative to Target Date Funds

March 24, 2014

Of the approximately $12 trillion of employer-based retirement plans, over $500 billion is now in target date funds.   The opportunity to show value to a plan sponsor by analyzing asset allocation solutions may be the source of credibility that wins a plan for the 401k advisor.  Target Date Funds are based on the notion that an increasing shift to bonds over time will produce the ultimate asset allocation solution.    In fact, it is implied by the labeling of the target date fund that all one must do is select the year in which they desire to retire and plug in a computed savings level to reach the magic number.     If nothing else, give the financial institutions creative credit for deflection marketing by providing a series of product such as: 2025, 2035, 2045, and 2055.  The labeling presumes accepted strategy and steers focus toward the desired end result.

Dynamic Asset Allocation

A quick browse into the Fidelity Freedom Funds website (Fidelity’s target date series) shows a caption of “Dynamic Asset Allocation”, which is then defined as the gradual glidepath away from stocks and toward bonds and short term notes as retirement nears.  Those of us who use the phrase dynamic know it to be a little more comprehensive than a simple shift from stocks to bonds.    Further, the primary premise of target date funds is put into much different perspective by  Robert Arnott, author of “The Glidepath Illusion.”    He points out that the rebalancing within a static allocation significantly outperforms a gradual shift from stocks to bonds.  Specifically, he maintains that adjusting the risk profile within stock and bond portfolios rather than across  asset classes reins in risk more constructively than glidepath solutions.

Dorsey Wright ETF Global Growth and Dorsey Wright ETF Global Balanced Collective Funds

Fee based 401k advisors:   If you are a fee based 401k advisor charging fees on plan assets or flat fees, you may wish to consider the Church Collective funds two ETF asset allocation solutions.  It is a way to educate plan sponsors about the value of relative strength and implementing it in a unique way via an asset allocation strategy.   Not only are these great solutions to play a part in a participant’s overall portfolio, they serve as a more comprehensive option than a single selected target date fund.   There are few plan sponsors who have been explained the logic of having the asset allocation risk managed within the asset class rather than across asset classes.

The Church Capital ETF Global Growth and Church Capital ETF Global Balanced has hired Dorsey Wright & Associates as sub-advisor for these relative strength-driven ETF asset allocation funds. They are currently available on the following platforms:

Frontier Trust
TD Ameritrade
Wilmington Trust
Mass Mutual
Reliance Trust
MG Trust Company

Collective Investment Funds

CIF’s are specific to retirement plans only and registered under the banking regulations enforced by the office of Comptroller of Currency, which is part of the U.S. Treasury. CIF’s are issued cusip numbers and trade over the NSCC. CIF’s are created and administered by trust companies. The Church Capital funds use Altatrust, Denver, CO as their trust company. CIF’s are a natural fit for ETF money managers such as Dorsey Wright because they allow for unique strategy flexibility and inexpensive to create and manage.

These funds are portable to any 401k platform and Altatrust continues to complete new agreements with various 401k providers. In addition to making relative strength strategies available to any 401k plan, Church Capital and Altatrust provide a side benefit to plan sponsors of these plans by signing off as 3(38) fiduciaries for the management of these funds.

Church Capital ETF Global Growth, Global Balanced (QDIA)

By providing two different ETF asset allocation funds, the majority of 401k participant risk profiles can be met. Each fund retains a static asset class allocation, but provides the dynamic relative strength rotation management of ETF’s within the asset class allocation.

Click here to view the Church Capital brochure for more information.

A relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Past performance is no guarantee of future returns. Potential for profits is accompanied by possibility of loss.  Dorsey Wright & Associates is the sub-advisor for the Church Capital ETF Global Growth, Global Balanced CITs.

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Time and Discipline

March 16, 2014

I love this image from Carl Richards of Behavior Gap:

Time and discipline Time and Discipline

Experience teaches us that the image above is true.  Anyone can get it right in the short run.  We’ve all seen it.  The gambler at the slot machines who walks out with a few thousand dollars, the sports fan who successfully bets on his home team over the higher ranked opponent, the investor who makes some money buying stock in a company recommended by his brother-in-law.  Yet, will any of the previous approaches end well in the long run?  Not likely.

Relative strength happens to be our discipline of choice.  It has been extensively tested.  It is logical.  It has been effective over time.  There are other disciplines that have also been effective over time.  There are many approaches that fall in the category of undisciplined.  One example: the quant manager who incorporates many different return factors into an ever-changing investment model.  A tweak here.  A tweak there…

When building allocations meant to last and designed to make a meaningful difference for a client over time, advisors and their clients would be well served to build allocations around effective disciplines and leave the rest by the wayside.

A relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value. Past performance is no guarantee of future returns. Potential for profits is accompanied by possibility of loss. 

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The Power of Buying Pullbacks

February 5, 2014

Buying pullbacks is a time-tested way to boost returns.  From time to time, we’ve discussed the utility in buying pullbacks in the market.  Buying the dips—instead of panicking and selling—is essentially doing the opposite of how most investors conduct their affairs.  In the past, much of that discussion has involved identification of market pullbacks using various oversold indicators.  (See, for example, Lowest Average Cost Wins.)  In a recent article in Financial Planning, Craig Israelsen proposes another good method for buying pullbacks.

The gist of his method is as follows:

The basic rule for investment success is as old as the hills: Buy low, sell high. But actually doing it can be surprisingly difficult.

Selling a stock or fund that has been performing well is tough. The temptation to ride the rocket just a little longer is very strong. So let’s focus on the other element: Buy low.

I propose a disciplined investment approach that measures performance against an annual account value target. If the goal is not met, the account is supplemented with additional investment dollars to bring it up to the goal. (For this exercise, I capped supplemental investment at $5,000, in acknowledgement that investors don’t have endlessly deep pockets.)

Very simply, the clients will “buy low” in years when the account value is below the target. If, however, the target goal is met at year’s end, the clients get to do a fist pump and treat themselves to a fancy dinner or other reward.

One benefit of this suggested strategy is that it is based on a specific performance benchmark rather than on an arbitrary market index (such as the S&P 500) that may not reflect the attributes of the portfolio being used by the investor.

In the article, he benchmarks a diversified portfolio against an 8% target and shows how it would have performed over a 15-year contribution period.  In years when the portfolio return exceeds 8%, no additional contributions are made.  In years when the portfolio return falls short of 8%, new money is added.  As he points out:

It’s worth noting that the added value produced by this buy-low strategy did not rely on clever market timing in advance of a big run-up in the performance of the portfolio. It simply engages a dollar cost averaging protocol – but only on the downside, which is where the real value of dollar cost averaging resides.

Very smart!  (I added the bold.)  It’s a form of dollar-cost averaging, but only kicks in when you can buy “shares” of your portfolio below trend.  He used an 8% target for purposes of the article, but an investor could use any reasonable number.  In fact, there might be substantial value in using a higher number like 15%.  (You could also use a different time frame, like monthly, if that fit the client’s contribution schedule better.)  Obviously you wouldn’t expect a 15% portfolio return every year, but it would get clients in the habit of making contributions to their account in most years.  Great years like 2013 would result in the fancy dinner reward, while lousy market years would result in maximum contributions—hopefully near relative lows where they would do the most good.

This is an immensely practical method for getting clients to contribute toward some kind of goal return—and his 15-year test shows good results.  In six of the 15 years, portfolio results were below the yardstick and additional contributions were made totalling $13,802.  Making those additional investments added an extra $12,501 to what the balance would have been otherwise, resulting in a 7.7% boost in the portfolio total.  Looked at another way, over time you ended up with nearly a 100% return on the extra money added in poor years.

Of course, Israelsen points out that although his proposed method is extremely simple, client psychology may still make it challenging to implement.  Clients are naturally resistant to committing money to an underperforming market or during a period of time when there is significant uncertainty.  Still, this is one of the better proposals I have seen on how to motivate clients to save, to invest at reasonable times, and to focus on a return goal rather than on how they might be doing relative to “the market.”  You might consider adding this method to your repertoire.

Rollercoaster3 zps2aa050fa The Power of Buying Pullbacks

Buy pullbacks and use the rollercoaster ride of the market to your advantage.

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Equity as the Way to Wealth

January 3, 2014

According to a recent Gallup Poll, most Americans don’t think much of the stock market as a way to build wealth.  I find that quite distressing, and not just because stocks are my business.  Stocks are equity—and equity is ownership.  If things are being done right, the owner should end up making more than the employee as the business grows.  I’ve reproduced a table from Gallup’s article below.

equityasthewaytowealth zps879479fb Equity as the Way to Wealth

Source: Gallup  (click on image to enlarge)

You can see that only 37% felt that the stock market was a good way to build wealth—and only 50% among investors with more than $100,000 in assets.

Perhaps investors will reconsider after reading an article from the Wall Street Journal, here republished on Yahoo! Finance.  In the article, they asked 40 prominent people about the best financial advice they’d ever received.  (Obviously you should read the whole thing!)  Two of the comments that struck me most are below:

Charles Schwab, chairman of Charles Schwab Corp.

A friend said to me, Chuck, you’re better off being an owner. Go out and start your own business.

Richard Sylla, professor of the history of financial institutions and markets at New York University

The best financial advice I ever received was advice that I also provided, both to myself and to Edith, my wife. It was more than 40 years ago when I was a young professor of economics and she was a young professor of the history of science. I based the advice on what were then relatively new developments in modern finance theory and empirical findings that supported the theory.

The advice was to stash every penny of our university retirement contributions in the stock market.

As new professors we were offered a retirement plan with TIAA-CREF in which our own pretax contributions would be matched by the university. Contributions were made with before-tax dollars, and they would accumulate untaxed until retirement, when they could be withdrawn with ordinary income taxes due on the withdrawals.

We could put all of the contributions into fixed income or all of it into equities, or something in between. Conventional wisdom said to do 50-50, or if one could not stomach the ups and downs of the stock market, to put 100% into bonds, with their “guaranteed return.”

Only a fool would opt for 100% stocks and be at the mercies of fickle Wall Street. What made the decision to be a fool easy was that in those paternalistic days the university and TIAA-CREF told us that we couldn’t touch the money until we retired, presumably about four decades later when we hit 65.

Aware of modern finance theory’s findings that long-term returns on stocks should be higher than returns on fixed-income investments because stocks were riskier—people had to be compensated to bear greater risk—I concluded that the foolishly sensible thing to do was to put all the money that couldn’t be touched for 40 years into equities.

At the time (the early 1970s) the Dow was under 1000. Now it is around 16000. I’m now a well-compensated professor, but when I retire in a couple of years and have to take minimum required distributions from my retirement accounts, I’m pretty sure my income will be higher than it is now. Edith retired recently, and that is what she has discovered.

Not everyone has the means to start their own business, but they can participate in thousands of existing great businesses through the stock market!  Richard Sylla’s story is fascinating in that he put 100% of his retirement assets into stocks and has seen them grow 16-fold!  I’m sure he had to deal with plenty of volatility along the way, but it is remarkable how effective equity can be in creating wealth.  His wife discovered that her income in retirement—taking the required minimum distribution!—was greater than when she was working!  (The italics in the quote above are mine.)

Equity is ownership, and ownership of productive assets is the way to wealth.

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Longevity Risk Increases With Age

November 13, 2013

Insightful post by Wade Pfau on longevity risk:

What the figure shows, for a same-age couple, is their median remaining life expectancy for each age beyond 50. For a 50-year old couple, there is a 50% chance that at least one member of the couple will live at least for just under another 42 years to age 92. By the time they reach 75, there is a 50% chance that at least one will live for a little more than 17 more years to age 92. This is the age range where mortality starts to pick up. If both are still alive at age 92, there is a 50% change that at least one will live for at least 4.6 more years to 96.6, and so on.

What is also shown in the figure are the remaining life expectancies at the 90th and 10th percentiles as well. At 50, 10% of couples will see at least one spouse live for more than another 50.3 years, and 10% of couples will experience both spouses dying in less than 30.7 years. And so on.

What is important to highlight is that the relative gap between median life expectancy and the 90th percentile grows with age. This is because mortality rates are lower at younger ages, and the differences between the median and 90th percentiles only start to build up by staying alive at the higher ages.

So at age 50, 50% of couples will see someone live another 41.8 years, while 10% of couples will see someone live another 50.3 years. It’s not that big of difference, relatively speaking.

However, by age 100, for instance, the median remaining life expectancy is 2.1 years, while the 90th percentile is 5.7 years. This is a big relative difference. The implication is that a variable strategy in which withdrawal rates are guided by remaining life expectancy, which I think is an important component of developing an optimal strategy, become much more exposed to longevity risk at the higher ages.

lifeexpectancy Longevity Risk Increases With Age

As people become familiar with the basics of longevity risk they will naturally become increasingly serious about an effective savings and investment plan to build an adequate nest egg.  Furthermore, thinking about the very real possibility of living to 90+ can also temper the appetite for unsustainable spending patterns in retirement.

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Your Plan vs. Reality

November 12, 2013

Great pic from @ThinkingIP:

plan thinkingip1 Your Plan vs. Reality

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10 Reasons You’re Not Rich Yet

August 1, 2013

Jocelyn Black Hodes of DailyWorth lists 10 Reasons You’re Not Rich Yet.  Essential advice that you should embrace (if you haven’t already).

  1. You spend money like you’re already rich.
  2. You don’t have a plan.
  3. You don’t have an emergency fund.
  4. You started late.
  5. You’d rather complain than commit.
  6. You live for today in spite of tomorrow.
  7. You’re a one trick investor.
  8. You don’t automate.
  9. You have no sense of urgency.
  10. You’re easily influenced.

Being “rich” can mean different things to different people, but I believe it means having the financial freedom to achieve your goals and live the life you want.

The whole article is well worth the read.

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Early Take on How Boomers Are Faring

July 10, 2013

All those dire predictions about the level of  retirement readiness of the Baby Boomers may be incorrect, says Mary Beth Franklin in Investment News.

One of the most closely watched areas focused on retirement readiness as boomers navigated a changing labor market that saw the demise of traditional pensions and the rise of the 401(k). Now many of the oldest boomers — those born in 1946 — have moved into retirement. Despite the dire predictions of their dismal retirement prospects, many of them are doing just fine.

Premature assessment, isn’t it?  Yes, of course they are doing just fine now (just a few years into retirement)!  The test comes in if they have saved enough money to be doing just fine in 20 years.  To be fair to the author of the article, she does present some studies that discuss the varying levels of retirement preparedness of the Baby Boomers.

The reality is that some of the Baby Boomers saved adequately and will be just fine and many will be struggling and relying on others for help.  I have great confidence in humanity so the vast majority of those in need will find help from children, churches, or the government, but many will probably wish they had put more thought and action into a disciplined savings and investment plan.

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The Rising Cost of Long-Term-Care Insurance

July 2, 2013

Today’s WSJ article “Long-Term-Care Insurance Gap Hits Seniors” should provide plenty of motivation for anyone who may be inclined to skimp on their savings.

The long-term-insurance industry now is shrinking, premiums are soaring and there is no fix in sight. At the same time, government safety-net programs, already under cost-cutting pressure, are bracing for demand from more of the 77 million aging baby boomers.

Currently, Medicare pays for only short stays in nursing homes or in-home care under limited conditions. For the most part, seniors who need care have to burn through their savings to pay for it. Only after they are impoverished will Medicaid—the government health program for poor people—pay for a basic level of care.

Insurers have been aware of this gap for decades, and many began selling long-term-care policies in the 1980s and 1990s. They vowed to provide policyholders with better access to high-quality nursing homes and home-based health care than Medicaid.

But insurers underestimated how fast medical costs would rise, and how many seniors would actually use the benefits. And they underpriced the insurance premiums. Making matters worse, some insurers that were “hungry for market share” charged too little at first and planned to increase premiums later, says Joseph M. Belth, editor of the Insurance Forum newsletter and professor emeritus of insurance at Indiana University.

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Cage Match: Pension vs. 401k

June 26, 2013

Chuck Jaffe recently had a good retirement article on Marketwatch.  He covered a number of topics, especially longevity estimates, but he also had the most succinct explanation of the difference between how a pension and a 401k plan works.  Here it is:

In the days when corporate pensions were the primary supplement to Social Security, Americans were able to generate a lifetime income, effectively, by putting everyone’s lifetime in a pool, then saving and managing the pooled assets to meet the target.

The individuals in a pension plan would live out their lives, but the actuaries and money managers would adjust the pool based on the life experience of the group. Thus, if the group had a life expectancy of living to age 75 – which statistically would mean that half of the pensioners would die before that age, and half would die afterwards – longevity risk was balanced out by the group experience.

Now that we have shifted to making individuals responsible for generating their lifetime income stream, there is no pool that shares the risk of outliving assets.

The bold is mine, but the distinction should be pretty clear.  With a pension plan, you’re covered if you live a long time—because your extra payouts are covered by the early mortality of some of the other participants.  It’s a shared-risk pool.

In a 401k, there’s only one participant.  You.  In other words, you’re on your own.

With a 401k, the only way to cover yourself adequately is to assume you are going to live a long time and save a lot to reserve for it.  If you’ve got enough assets to cover yourself to age 100, the most negative outcome is that your heirs will think very fondly of you.  If you are covered for only a few years of retirement, you’ll need to either keep working, eat Alpo, move in with your kids, or possibly take up motorcycle racing and sky-diving.  None of those sound like great options to me.

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The Million-Dollar Illusion

June 11, 2013

Over the weekend, the New York Times had an article about retirement and the million-dollar illusion.  What, you may ask, is the million-dollar illusion?  Quite simply it’s the idea that $1 million dollars will be ample for retirement.  Jeff Sommer writes:

…as a retirement nest egg, $1 million is relatively big. It may seem like a lot to live on.

But in many ways, it’s not.

Inflation isn’t the only thing that’s whittled down the $1 million. The topsy-turvy world of today’s financial markets — particularly, the still-ultralow interest rates in the bond market — is upending what many people thought they understood about how to pay for life after work.

“We’re facing a crisis right now, and it’s going to get worse,” said Alicia Munnell, director of the Center for Retirement Research at Boston College. “Most people haven’t saved nearly enough, not even people who have put away $1 million.”

The article proceeds to go through the math of low interest rates and increasing longevity.  This is not new, but sometimes it is difficult to get clients to focus on the big picture.

The big picture is not whether the most recent quarterly return on their balanced account was +6.3% or +6.4%, but whether that account balance was $300,000 or $3 million.

Since industry sources suggest that only 3% of retail accounts ever have balances over $2 million, it’s probably most important to focus on savings.  This might be particularly important with younger clients, who, by and large, do not have defined benefit pensions to supplement Social Security.  (In fact, it’s not clear how Social Security might be modified or eliminated by the time they get around to collect it.)  The one thing younger clients do have on their side is time—time to contribute steadily to their 401k and to an outside investment account. With enough nagging from a qualified investment advisor and a reasonable investment plan, there is no reason that clients shouldn’t succeed.

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The Defining Decade of Adulthood

May 13, 2013

The financial industry spends little focus on 20-somethings for the obvious reason that they don’t tend to have much money.  It’s a shame because this really is “the defining decade of adulthood.” Habits, like saving and investing, established in this decade lay the foundation for success for the long run.  Although the TED talk below (Meg Jay: Why 30 is not the new 20) focuses on a number of topics, including career and marriage, it serves up plenty of food for thought for us in the financial industry about how we serve this demographic.

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From the Archives: Life Expectancy at Retirement

May 13, 2013

retirement From the Archives: Life Expectancy at Retirement

Source: The Economist, via Greg Mankiw.

Americans, as well as citizens of many other advanced nations, now spend about twice as many years in retirement as they did a generation or two ago.  Aggressive saving and adherence to a well-thought-out investment plan are more important today than they have ever been.  It is a big mistake for today’s 65-year olds to no longer consider themselves to be “long-term investors.”

—-this article originally appeared 3/1/2010.  As you can see from the graphic, the average US 66-year old retiree spends another 15-20 years in retirement.  That’s long enough that investment performance is going to be important.

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Retirement Success

April 30, 2013

Financial Advisor had a recent article in which they discussed a retirement success study conducted by Putnam.  Quite logically, Putnam defined retirement success by being able to replace your income in retirement. They discovered three keys to retirement success:

  1. Working with a financial advisor
  2. Having access to an employer-sponsored retirement plan
  3. Being dedicated to personal savings

None of these things is particularly shocking, but taken together, they illustrate a pretty clear path to retirement success.

  • Investors who work with a financial advisor are on track to replace 80 percent of their income in retirement, Putnam says. Those who do not are on track to replace 56 percent.
  • Workers who are eligible for a workplace plan are on track to replace 73 percent of their income while those without access replace only 41 percent.
  • The ability to replace income in retirement is not tied to income level but rather to savings level, Putnam says. Those families that save 10 percent or more of their income, no matter what the income level, are on track to replace 106 percent of their income in retirement, which underscores the importance of consistent savings, the study says.

I added the bold.  It’s encouraging that retirement success is tied to savings level, not income level.  Everyone has a chance to succeed in retirement if they are willing to save and invest wisely.  It’s not just an opportunity restricted to top earners.  Although having a retirement plan at work is very convenient, you can still save on your own.

It’s also interesting to me how much working with a financial advisor can increase the ability to replace income in retirement.  Maybe advisors are helping clients invest more wisely, or maybe they are just nagging them to save more.  Whatever the combination of factors, it’s clearly making a big difference.  Given that the average income replacement level found in the study was 61%, working with an advisor moved clients from below average (56%) to well above average (80%) success.

This study, like pretty much every other study of retirement success, also shows that nothing trumps savings.  After all, no amount of clever investment management can help you if you have no capital to work with.  For investors, Savings is Job One.

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Current Income

April 12, 2013

Investors lately are in a frenzy about current income.  With interest rates so low, it’s tough for investors, especially those nearing or already in retirement, to come up with enough current income to live on.  A recent article in Advisor Perspectives had a really interesting take on current income.  The author constructed a chart to show how much money you would have to invest in various asset classes to “buy” $100,000 in income.  Some of these asset classes might also be expected to produce capital gains and losses, but this chart is purely based on their current income generation ability.  You can read the full original article to see exactly which asset classes were used, but the visual evidence is stunning.

100mIncome zps66939722 Current Income

Source: Advisor Perspectives/Pioneer Investments (click to enlarge)

There are two things that I think are important to recognize—and it’s hard not to with this chart.

  1. Short-term interest rates are incredibly low, especially for bonds presumed to have low credit risk.  The days of rolling CDs or clipping a few bond coupons as an adequate supplement to Social Security are gone.
  2. In absolute terms, all of these amounts are relatively high.  I can remember customers turning up their noses at 10% investment-grade tax-exempt bonds—they felt rates were sure to go higher—but it only takes a $1 million nest egg to generate a $100,000 income at that yield.  Now, it would take more than $1.6 million, even if you were willing to pile 100% into junk bonds.  (And we all know that more money has been lost reaching for yield than at the point of a gun.)  A more realistic guess for the typical volatility tolerance of an average 60/40 balanced fund investor is probably something closer to $4.2 million.  Even stocks aren’t super cheap, although they seem to be a bargain relative to short-term bonds.

That’s daunting math for the typical near-retiree.  Getting anywhere close to that would require compounding significant savings for a long, long time—not to mention remarkable investment savvy.  The typical advisor has only a handful of accounts that large, suggesting that much work remains to be done educating clients about savings, investment, and the reality of low current yields.

The pressure for current income might also entail some re-thinking of the entire investment process.  Investors may need to focus more on total return, and realize that some capital gains can be spent as readily as dividends and interest.  Relative strength may prove to be a useful discipline in the search for returns, wherever they may be found.

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