Though the recession has thinned the ranks of other generations in the workforce, more people older than 55 are employed than ever before, according to the latest figures from the Bureau of Labor Statistics.

The reasons for the surge of older workers are complex, experts said, but one of the primary economic forces behind it is the growing fear among older Americans that they lack the means to support their retirement needs.

The phenomenon is closely linked to the broad shift in the United States that began in the ’80s away from reliance on company pensions toward the adoption of 401(k) plans and other personal savings.

“Fear is a wonderful motivator,” said Alicia Munnell, director of the Center for Retirement Research at Boston College. “Some of these people are just clinging by their fingernails to jobs.”

Fear is a wonderful motivator?  It’s horrible that people have relied on cultural guidance to spend, instead of the guidance of a qualified financial advisor to save and invest.  As the article mentions, many people are still working only because they have not saved enough, whether in their 401k or in their personal accounts.

If you are a financial advisor, here is a way for you to have a huge positive impact on the lives of your clients–become their savings and investment coach and you will never lack for business.

The 0.2% are the fraction of investors that have more than $1 million in their 401k plan.  Are they doing anything differently than other employees?

“The one characteristic that differentiates the winners from the non-winners here is contribution rate — a high percentage of those million-dollar savers had constant participation and high contribution rates,” he [Jack VanDerhei, Employee Benefit Research Institute's research director] says.

This is probably worth a New Year’s resolution.  Call your HR department or whoever handles the 401k in your office and bump up your contribution rate.  Combined with intelligent financial management, something that a qualified advisor should be able to help you with, it shouldn’t be that difficult to get to $1 million over the course of a working career.

If your neighbors aren’t saving much (and trust me, they aren’t), that means a less productive economy in the future–and more people trying to claim a very limited supply of public funds. You don’t want to be among them.

The whole article will make you think twice about the legitimacy of your rationalizations for failing to adequately save.

…while the boomers have been accumulating wealth at much the same pace as their parents, the world has changed in four important ways.

1) The prevalence of defined benefit pension plans has declined dramatically over the last 25 years.

2) Real interest rates have fallen significantly, so a given amount of wealth will now produce less retirement income.

3) Life expectancy has increased, so accumulated assets must support a longer period of retirement.

4) Health care costs have risen substantially and show signs of further increase, indicating a need for greater accumulation of retirement assets.

So, yeah, it’s somewhat discouraging to think that you will have to save even more since the onus of retirement has now been put entirely on your shoulders.  It just points out the need to find a competent advisor early and get cracking.  It might make a good resolution for the New Year.

Like a institutional pension fund, an individual’s retirement savings has a very long life span—because it is, in fact, your pension fund.  A recent article by Andrew Ang of Columbia University and Knut Kjaer points out some of the chief advantages of long horizon investing:

Long horizon investors have an edge. They can ride out short-term fluctuations in risk premiums, profit from periods of elevated risk aversions and short-term mispricing, and they can pursue illiquid investment opportunities. The turmoil we have seen in the capital markets over the last decade has increased the competitive advantage of a long investment horizon. Unfortunately, the two biggest mistakes of long horizon investors—procyclical investments and misalignments between asset owners and managers—negate the long horizon advantage. Long horizon investors should harvest many sources of factor risk premiums, be actively contrarian, and align all stakeholders so that long horizon strategies can be successfully implemented. Illiquid assets can, but do not necessarily, play a role for long horizon investors, but investors should demand high premiums to compensate for bearing illiquidity risk and agency issues.

I put their recommendations in bold.  For individuals, aligning stakeholders shouldn’t be a huge problem.  You’re the only stakeholder, which is another advantage over an institution.

It makes perfect sense to harvest multiple factor risk premiums.  Historically, relative strength is among the largest of these, but lots of them are worthwhile.  Value is a well-known factor and minimum volatility also seems promising.  A big benefit of these two factors is that the excess returns are often negatively correlated with relative strength.  You can build better equity exposure by combining uncorrelated factors.

Finally, they suggest being actively contrarian.  I read this as being willing to add to a strategy when it is out of favor, something they euphemistically term as “short-term fluctuations in risk premiums.”  When relative strength has underperformed, add to it.  When value has underperformed, plump up your portfolio in that area.  Although the fluctuations can often be hair-raising, they are very correct about what a big mistake procyclical investments can be.  (Procyclical is just a fancy word for buying high and selling low.)

Their conclusion is also worth reiterating:  The turmoil we have seen in the capital markets over the last decade has increased the competitive advantage of a long investment horizon. 

As an individual investor, you have some handicaps relative to institutions.  But if you work from the standpoint of a long investment horizon, you also have a big potential competitive advantage.  Whether you turn that potential into reality or not is a function of how successfully you implement their recommendations–constructing a portfolio to capture several return factors and adding to a strategy on dips.

Conventional wisdom states that, when it comes to retirement planning, the 4%  “safe withdrawal rate” (SWR) rule is the platinum standard. That rule, dating back to William Bengen’s 1994 article in Journal of Financial Planning, says that a new retiree can safely withdraw 4% of their savings in the first year of  retirement and adjust this amount for inflation in subsequent years.  Bengen found that this strategy is safe in the sense that the strategy will not lead the retiree to exhaust all of his or her remaining assets for at least 30 years.

The 4% rule has been widely  adopted by the popular press and financial planners as an appropriate general  rule of thumb for retirees. Since Bengen’s paper, numerous researchers have  developed strategies to allow retirees to safely exceed a 4% withdrawal rate.  Though the SWR fluctuates a bit from study to study, depending on the dataset  and assumptions used for its calculation, my own research suggests a safe  withdrawal rate for the US of 4.02%. That was the highest amount that could be  sustained in the worst-case retirement year. I find that using the Dimson,  Marsh, Staunton Global Returns Data for 17 developed market countries since  1900.

The problem with SWR research based on historical data, however, is that most  every study has been based on the same Ibbotson Associates dataset on US financial market returns since 1926. The time period covered by such data may have been a particularly fortuitous one for the United States that will produce dangerously overinflated SWRs if asset returns fail to be so stunning in the  future.

Indeed, over the time period in question the US  consistently enjoyed among the highest inflation-adjusted returns and lowest volatilities for stocks, bonds, bills and inflation.

From an  international perspective, the US enjoyed a particularly favorable climate for  asset returns in the twentieth century, and to the extent that the US may  experience mean reversion in the current century, SWRs as presently calculated  may no longer seem so safe.

The results have shown that from an international perspective, a 4% withdrawal  rate has been problematic. The calculated SWR exceeds 4% in only three of the  other 16 countries: Canada, Sweden, and Denmark. As for other countries, the  most unfortunate retiree of all was a Japanese person retiring in 1940, whose  maximum SWR was a miserably low 0.47% as high inflation and low real returns  plagued Japan during and after the war. Six countries experienced withdrawal  rates below 3%: Spain, Italy, Belgium, France, Germany, and Japan. In Italy,  the 4% rule failed 62.5% of the time, and in Japan, such high withdrawals were sustainable for only three years in the worst-case scenario.

I’ve excerpted some of the important conclusions of the article and bolded a crucial point.  The US markets dataset that has typically been used to calculate withdrawals included some very, very good markets.  It seems to be more the historical exception rather than the rule.  If we really do have low prospective returns to look forward to in the US—think about a Japan-type scenario—that 4% number is going to be too high.

What conclusions can we draw from all this?

• Save as much as you can.  There’s no guarantee that US returns will be as high as they have been historically.  You might need a cushion.
• If US returns are not as high as they have been historically, you are going to get killed buying a straight index fund of whatever variety.
• If US returns are not as high as they have been historically, you should strongly consider a more global, tactical investment policy.  You’re going to have to grab returns wherever and whenever you can find them.
• Withdrawal concepts based on fecundity  may be a better way to go, rather than a straight percentage withdrawal based on history unlikely to repeat.
• Markets simply give you the opportunity to compete; you are not entitled to a positive outcome.  Earning even a “gentleman’s C” is difficult in the financial markets.

Thomas Stanley’s book Stop Acting Rich…And Start Living Like A Real Millionaire offers some fascinating data on the behaviors of millionaires. The great thing about his book is that the conclusions made are all data-driven (Dr. Stanley has spent decades intensively studying the affluent in America).

I suspect that many would be very surprised by the following points made in his book:

• More than two-thirds of those who are country club members are not millionaires.
• Real millionaires pay about $16 (tip included) for a haircut.
• The median price paid for motor vehicles among millionaires surveyed was $31,367.
• 70% of millionaires in America have never owned a boat or a yacht or even a raft.
• 64% of millionaires did not own a second home.
• Most millionaires do not live in homes that have a market value of $1 million or more.  About 90 percent live in homes valued at under $1 million.
• The majority of millionaires report that their spouse is more frugal than their frugal husband (in the case where the males were the bread winners).
• Only 7 percent of millionaires own a bottle of wine that costs more than $100.
• 67 percent of millionaires own wine that costs somewhere in the range of $10-$25.
• Millionaires usually pay $19.59 (median) for the dinner that they order at their favorite restaurant.
• Toyota make of automobile was found to be the number one in market share among millionaires (10.9 percent).

The reality is that it is ultimately those individuals that embrace a frugal lifestyle who are able to enjoy a life of financial independence.  As discussed in Dr. Stanley’s book, the affluent understand that what brings happiness in life is not the watch on your wrist, but life activities, relationships, the peace of mind associated with financial independence, and the ability to donate to charitable causes.

Finally, I did enjoy the following quote from his book (a philosophy taken at face value by so many…)

Anyone who lives within their means suffers from a lack of imagination. –Oscar Wilde

Regardless of gender or education level, Americans become considerably less literate about all things money after age 60, according to a new study.

The scores on a test measuring knowledge of investments, insurance, credit and money basics fell about 2% each year starting after age 60, falling from about 59% correct — hardly a passing grade — for those in their 60s to a dismal 30% for those 80 and older, according to Michael Finke, an associate professor at Texas Tech University and a co-author of the study.

Here’s what’s even worse: Our confidence in our financial decision-making abilities rises with age. We are not older and wiser. Rather, we are older, less smart and overconfident.

This notion of confidence rising while financial literacy is falling spells trouble for that group of Americans that now represents more than 12% of the population and controls half of all the financial wealth in America, according to Finke, who is also head of Texas Tech University’s Ph.D. in financial-planning program.

Obviously, there are noteworthy exceptions to this tendency.  In fact, it is likely that each of us could immediately think of a number of people who seem to defy this trend.  However, it would be unwise to disregard these results.  The very population with the bulk of the financial wealth in this country is also the population that can benefit most from good financial advice and money management.

Bottom line: current valuations might have a big impact on the withdrawal rates, since what happens early in retirement is much more critical than what happens after a portfolio has had an opportunity to grow for many years.

Dr. Pfau’s findings dovetail nicely with work from James Garland.  I do think that it’s useful to consider withdrawals in a relative sense.  From an earlier article here at Systematic Relative Strength:

Sustainable spending is a tricky concept.  Dozens of studies have been performed on historical data that suggest that the proper spending rate is 3 to 5%.  A lot of endowments use 4%, for example.  In reality, I think the sustainable spending level depends quite heavily on financial conditions at the time.  A stock market with a 6% dividend yield is going to support more spending than a market yielding 3%.  In other words, I tilt toward a relative calculation first developed by James Garland.  He shows that you can generally spend more than just your dividend and interest income, but far less than your total earnings yield.  His rule of thumb is that sustainable spending is about 130% of the yield on the major stock indexes.  (You can use this link to find the current dividend yield on the major stock indexes.)

Recommended reading for all advisors with clients hoping to retire!