Category Archives: Retirement Planning

Ideas to help preserve and grow your money

Rates Must Rise To Avert The Next Crisis

200+year interest ratesMy Comments: Interest rates are the price paid for using money owned by someone else. The rise and fall of that price, which we call interest, is a critical element when it comes to deciding how your money should be invested. For over 30 years they have been trending down and you will soon see that trend reversed. Being prepared will result in greater financial freedom for you.

By Scott Minerd, Chairman of Investments, Guggenheim Partners
As appeared in the Financial Times global print edition, July 16, 2015

In 1898, Swedish economist Knut Wicksell argued that there existed a “natural” rate of interest that balanced the supply and demand of credit, assuring the appropriate allocation of saving and investment.

Should market interest rates remain below the natural rate for an extended period, investors will borrow excessively, allocating capital into less productive investments, and ultimately into purely speculative ones.

This is what the US economy faces today after years of meagre borrowing costs. Policymakers have created a Wicksellian dilemma where investment spurred by low interest rates is driving economic growth, but these inefficient investments support growth at the expense of lower productivity in the economy.

In recent years, this investment has flowed into housing, commercial real estate, and equities, driving asset prices higher, exactly the goal of the Federal Reserve in the wake of the financial crisis. But as the recovery in real estate and equities matures, a darker side of this imbalance between natural and market rates is beginning to emerge. Many investments today using artificially cheap capital are not increasing productivity – they are being made, because money is cheap and the profit motive is strong.

Consider the evidence. This year likely will witness record US stock buybacks; the second biggest year for mergers and acquisitions; the highest percentage of non-investment grade borrowers among new issuers of corporate debt; and a record for covenant-light loan issuance.

In the midst of all this, stock prices are appreciating at the slowest pace since the financial crisis. Why? Because top-line growth is low and productive investments in core businesses are wanton.

Over time, the natural rate of interest should roughly equate to the average return on new capital investment. Distortions in economic activity begin to occur when the natural rate varies materially from the market rate.

The aftermath of the current period of corporate borrowing and splurging will be nasty. Consider that the majority of defaults of US high-yield bonds during 2008 and 2009 were loans originated between 2005 and 2007 – the final three years of the last credit cycle when M&A and leveraged buyouts peaked. Similar to today, credit remained cheap and the Fed was slow to raise interest rates.

We are not back in the frothy days of 2007, but we are leaving the realm of smart investment decisions and moving into the “silly season” when investors become convinced that recession is nowhere on the horizon and market downside is limited.

It is a world where asset prices continue to appreciate and confidence remains strong, while capital chases a shrinking pool of productive investment opportunities. Similar to the run-up to 2007, rising asset prices and malinvestments today may be sowing the seeds of the next financial crisis.

The harsh reality is extended periods of malinvestment result in declining productivity growth, lower potential output, and slower increases in living standards. A failure to normalize market interest rates soon will result in more capital plowed into investments that are less productive and more speculative.

As productivity declines, long-term growth will be stunted. Eventually, inflationary pressures will build, forcing market interest rates to rise. The longer market rates remain below the natural rate the greater the purge will be once higher rates induce a recession, causing a sharp rise in defaults among malinvestments made during the period of cheap credit.

Today looks a lot like 2004 or 2005, when investors were blissfully ignorant of what awaited. It is still early, but I get increasingly concerned the longer I see undisciplined investors clamoring for bonds with suspect credit worthiness at ludicrously low yields. Higher rates, higher prices, or both are on the horizon. Before long, some of those bonds may become toxic waste.

The good news is there remains time to take action. Policymakers can still make adjustments to avoid the worst phase of the credit cycle. To reduce the continued accommodation of these marginal investments, the US central bank should normalize rates soon. For investors, the time has come to consider opportunities to book gains in assets that in the reasonable light of day a prudent investor would never buy.

Social Security: When to Claim at 66

SSA-image-2My Comments: Many of my close friends, clients and associates have long since started taking their Social Security benefits. For those of you who have not, there are probably some issues you need to explore before you sign on the dotted line.

A generation ago, 65 was the automatic full retirement age. Rembember the phrase Full Retirement Age or FRA; it’s that point in time when it first all comes together for you. Based on your past contributions to the system, the FRA represents the base line number to determine how much you’ll receive for the rest of your life.

Start at age 62 and you get considerably less; wait until age 70 and you’ll get a lot more. But there’s a catch. You have to remain alive to get more since the SSA is not going to intentionally send a monthly amount if you’re dead.

I have access to software that will help you explore the various options, and there are more than you think, that will help you make the best timing decision less confusing. Here are a few to start you thinking.

by Donald Jay Korn JUL 6, 2015

“It’s most common for our clients to begin Social Security benefits at age 66,” says Brandon Jones, a senior wealth manager at Accredited Investors, a fee-only planning firm in Edina, Minn.

If sexagenarian clients still have substantial earned income, starting earlier would trigger an earnings penalty. When they reach 66, seniors now reach “full retirement age (FRA),” for Social Security purposes. (Any reduction in cash flow from the earnings penalty may be temporary, as seniors subsequently will get makeup benefits.)

FULL RETIREMENT AGE
“At 66, someone can earn any employment amount and still receive the full Social Security benefit,” says Marilyn Capelli Dimitroff, director of wealth management and principal at Bloomfield Hills, Mich.-based Planning Alternatives, a wealth advisory firm.

“Therefore, the 66-year-old who waited receives a significantly higher monthly check than the 66-year-old with the same earnings record who began payments at 62, the earliest starting date. The differential continues for life.”
Starting at 66 avoids the 25% benefit reduction imposed at age 62, so the early bird with a $1,800 monthly check could have received $2,400 a month by waiting until 66.

“For the majority of people, postponing the receipt of Social Security to at least FRA is a smart move,” says Dimitroff. “Most seniors will need to work to 66 or later to maintain financial security in very old age.”

IMMEDIATE GRATIFICATION
Waiting even longer, until as late as age 70, would increase benefits even more, yet many clients start at 66 anyway. “We human beings value a ‘bird in the hand,'” says Dimitroff, so some people want to collect from Social Security as soon as practical.

In addition, Dimitroff notes, monthly Medicare premiums are due for many people, starting at age 65, and it’s easier to have the payments subtracted from Social Security direct deposits rather than writing checks periodically. “A third reason for starting at 66,” she says, “is that most people underestimate how long they are likely to live.” Some people just invest their unneeded Social Security checks, she adds, hoping to exceed the 8% annualized increase they would have received for waiting beyond age 66.

SPOUSAL STRATEGIES
Moreover, 66 can be a key milepost for spousal claiming strategies. For married couples, says Dimitroff, delaying the benefit start from 62 to 66 increases the spousal benefit as well as the worker’s benefit.

“For a one-earner couple,” says Jones, “we may recommend that the earning spouse file at FRA and immediately suspend the benefit, allowing the other spouse to begin claiming a spousal benefit. Meanwhile, the earning spouse’s benefit continues to grow, with the intent of beginning benefits at age 70.”

Jones adds that a similar strategy can work if one spouse has considerably more lifetime earnings than the other spouse.

Which Asset Allocation Mix Outperforms?

retirement-exit-2My Comments: Here are two charts, associated with the authors comments, that show very clearly that good financial planning for retirement is as much a matter of luck as it is skill. The first chart has numbers that reflect 45 years, which seems like a long time, until you remember that so many of us now live to be 100.

I’ve talked before about how interest rates have been declining slowly for the past 25 years. Soon (another variable), they will start trending upward. A 45 year average taken 10 years from now may show a very different number.

Creating the right mix of investments is, in my opinion, less of a challenge than is having the discipline to find a rational solution and stick with it. While “hope” is not a very good investment strategy, you can only hope to make good decisions, to find someone who will help you as a fiduciary, unless you’re prepared to go it alone, and live your life as well as you can.

It would be nice if there was a magic bullet, but there isn’t one.

by Craig L. Israelsen JUN 1, 2015

Over the past several decades, the number of investable asset classes has increased significantly, changing the world of portfolio management dramatically.

The challenge of asset allocation now is no longer having too few ingredients to consider but rather selecting among an ever increasing array of sector-specific mutual funds and exotic ETFs.

Choosing an asset allocation model for your clients’ portfolios is not so much about picking the right one — there’s no way to know which model will be right in advance of future performance — as it is about selecting a prudent one. Being prudent and thoughtful is certainly something an advisor can — and must — do in order to meet a fiduciary duty.
Toward that end, I reviewed a series of asset allocation models over the past 45 years, from 1970 through the end of 2014, to see how they fared.

Reviewing the historical performance of various core asset allocation models delivers a useful analysis of the relative merits of different allocations. The analysis should better equip advisors to evaluate a wide variety of investment models — particularly in the online investment advisory space, where new robo advisors are promoting models designed to appeal to a wide audience.

COMPARING MODELS
By definition, an asset allocation model must include more than one asset class. In this analysis, I have identified three asset allocation models: a 50% cash/50% bond model, a 60% stock/40% bond model and a seven-asset model. Two single asset classes (cash and large-cap U.S. stock) are also evaluated to serve as bookend benchmarks.

The first portfolio option shown in the “Asset Allocation Spectrum” chart below is a 100% cash model, composed completely of 90-day U.S. Treasury bills. As cash is viewed as the risk-free asset class in modern portfolio theory — inflation risks notwithstanding — we will use its returns and volatility as the base for comparison.
Ass-Alloc-Spectrum
The 45-year annualized return for cash was 5.11%, with a standard deviation of annual returns of 3.45%. The average 10-year annualized rolling return was 5.64% over the 36 rolling 10-year periods between 1970 and 2014.

From there I looked at progressively more complex allocation models.

The first is a very simple one: 50% cash/50% U.S. aggregate bonds, rebalanced at the start of each year. Compared with 100% cash, this 50/50 allocation improved performance 143 basis points while only increasing volatility by 70 bps — a performance-to-risk trade-off of two to one. The average 10-year rolling return was just shy of 7%.

Next, I looked at a classic balanced fund: 60% large-cap U.S. stock and 40% U.S. bonds, rebalanced at the start of each year. Performance, as expected, was boosted significantly to 9.82%; the average rolling 10-year return also rose, to 10.35%. But there was a concomitant increase in volatility, with the standard deviation rising to 11.28%.

The third model used seven asset classes — large-cap U.S. stock, small-cap U.S. stock, non-U.S. developed-market stock, real estate, commodities, U.S. bonds and cash — in equal proportions, rebalanced annually.

The average annualized return was 10.12%, with a standard deviation of annual returns of 10.18% — a rare one-to-one return-to-risk trade-off. The average 10-year rolling return was 10.88%, 53 bps higher than the 60/40 model.

The final investment asset was 100% large-cap U.S. stock. As anticipated, it had a higher level of return — an annualized 10.48%, with average 10-year rolling return at 11.21% — but not by much. Meanwhile, with a standard deviation of 17.43%, volatility was far higher than both the 60/40 model and the seven-asset model.

MAKING THE PORTFOLIO LASTRetirement-Survival
The second part of this analysis compares three allocation models when used in a retirement portfolio — which is very sensitive to timing of returns, particularly large losses. (For that reason, I didn’t include a retirement portfolio consisting of 100% large-cap U.S. stock, as that approach is not prudent.)

The retirement portfolio was simulated over 21 rolling 25-year periods starting in 1970. The first 25-year period was 1970 to 1994, then 1971 to 1995, etc. A total of $455,741 was withdrawn during each rolling 25-year period. The ending balance after each 25-year period is shown in the “Retirement Survival” chart below.

This analysis assumed an initial nest egg balance of $250,000 — quite comfortable back in 1970, although fairly modest now — with an initial withdrawal rate of 5% (or $12,500 in year one) and an annual cost of living adjustment of 3%. Thus, the second-year withdrawal was 3% larger (or $12,875), and so on each year.

As a baseline, I included a retirement portfolio consisting of 100% cash, which fared reasonably well during the early periods (1970s and 1980s). Beginning with the 25 years starting in 1982, however, interest rates began a steady decline downward and an all-cash retirement portfolio began to crumble.

In fact, during the last two 25-year periods, the all-cash portfolio failed to last the full 25 years; hence the zero balance. An all-cash portfolio would also have been unable to keep up with inflation. The median ending account balance for an all-cash retirement portfolio was $332,615.

A 50% cash/50% bond retirement portfolio was a considerable improvement, surviving in every one of the 25-year periods, with median ending account balances of just over $570,000. However, in recent 25-year periods, the ending balance was far below that median figure.

The classic 60/40 stock/bond retirement portfolio has served retirees well over the past 45 years. The median ending balance for the 60/40 portfolio was in excess of $1.5 million. In fact, over one buoyant period — from 1975 to 1999 — this portfolio finished with an ending account balance of $3.9 million.

During that same 25-year period, an all-cash retirement portfolio ended with a balance of $391,702, and a 50% cash/50% bond portfolio finished the 25-year period with a balance of $611,308.

The superior approach, however — with a median ending balance of over $2.1 million — is the model using seven different asset classes.
RISING RATES

I found it particularly interesting that, during the inflationary periods of the 1970s, the seven-asset model had considerably better performance as a retirement portfolio — finishing with a balance of $2,086,863 for the 1970 to 1994 period, while the 60/40 model ended up at $1,090,081. The pattern recurs in the first four 25-year periods.

Why that’s worth considering: Over the past 33 years — after the U.S. economy began to decline in 1982 — U.S. bonds have enjoyed an era of unusual prosperity. The average annualized return of U.S. bonds was 8.39% from 1982 to 2014.

But during the 34 years from 1948 to 1981, when interest rates were rising in the U.S. economy, bonds produced an average annualized return of 3.83%.

When interest rates eventually do rise, the performance tailwind for U.S. bonds that has been fostered by declining interest rates could turn into a stiff headwind. An asset allocation model that has a large commitment to U.S. bonds (such as the classic 60/40 portfolio) may be at risk — because if interest rates rise, bond returns will likely be far lower than over the past three decades.

This suggests that a more broadly diversified portfolio is prudent — both in the accumulation years and in the retirement years.

Craig L. Israelsen, a Financial Planning contributing writer in Springville, Utah, is an executive in residence in the personal financial planning program at the Woodbury School of Business at Utah Valley University. He is also the developer of the 7Twelve portfolio.

Biggest Retirement Mistakes

cookie jar

My Comments: This is a dramatic headline, intended for those of us already retired or thinking about it. Most of us already understand that “retirement” today is very different from what it was 25 years ago. The changes that we see are influencing my life and millions of others.

Many people plan on supplementing their retirement funds by working past 65, but this plan may not be as sound as it seems. Bloomberg’s Suzanne Woolley breaks down the expectations and often unfortunate truths of working through retirement.

The video, which lasts about 60 seconds, appears on a web site that features many videos by a Barry Ritholtz and if you click the image just above, you should be able to see and hear it. I haven’t asked Barry for his permission so I may get in hot water, but hopefully he’ll not give me a hard time as the intent is to help you as you wrestle with the idea. Using a video is my attempt to present ideas using visual and audio rather than have you simply read some words. Let me know if you have issues with any of this.

Sine of the Times

200+year interest ratesMy Comments: Many of you have read my comments about interest rates lately. (Yesterday!) For many, many months, the Fed has used its powers to keep them low to encourage economic growth. Now that growth is again endemic, sooner rather than later, pressures will exist to cause interest rates to increase.

The chart at the top of this post shows interest rates in this country going back to the late 1700’s. You can expect the curve to start changing its direction soon. When that happens, you should not own many long term bonds, unless you’re happy watching your net worth decline.

Commentary by Scott Minerd, Guggenheim Partners, April 24, 2015

For the past 30 years, 10-year U.S. Treasury yields have shown a clear downward linear trend, falling from over 10 percent in 1985 to less than 2 percent today. Around this linear trend, yields have also exhibited a fairly consistent cyclical fluctuation, with the size of the fluctuation about 200 basis points from peak to trough, and with the cycle repeating every six years. This fluctuation can be thought of as a sine function, allowing us to model 10-year yields by combining the sine function with the linear trend:Chart-of-the-Week-04232015_600px

If we assume the secular, linear downward trend in yields will continue in the near term, we can predict the short-term outlook based on the model of cyclical fluctuations. This model currently shows that rates are just beginning to undershoot the linear trend, with the model predicting that rates will bottom at 0.82 percent in March 2016. What’s even more interesting is that the average actual bottom in rates has been 73 basis points lower than the model predicts, which would put rates at just 0.09 percent.

Now, I am not necessarily predicting that U.S. 10-year Treasury yields will test zero like its counterpart the German 10-year bund, which currently stands at around 16 basis points and I believe could provide negative yields at some point. What I am saying is that there are many powerful secular and fundamental forces at work that signal the risk to U.S. interest rates remains to the downside.

With Federal Reserve tightening drawing closer, the continuation of this downward trend could be called into question. However, a number of factors, including lower first quarter gross domestic product (GDP) growth, high demand from overseas investors (with yields approaching negative territory in much of Europe), and expectations of a slow liftoff by the Fed, are working to exert downward pressure on U.S. yields, thus limiting any upside in rates in the near term.

The prospect of a stronger dollar as a result of upcoming U.S. rate hikes only serves to heighten foreign demand for U.S. Treasuries. International investors are likely to seek to preempt Fed action and invest while their currency has greater relative strength. Betting against the downward trend in U.S. rates has proved to be a widow-maker trade for many years—and with fundamental and technical factors pointing to downside risks in rates in the near term, there appear to be few reasons to bet against the trend now.

 

Get Ready For The Biggest Margin Call In History

My Comments: Like a broken clock that is right twice every 24 hours, I’ve been talking about the probability of us having a severe market correction for the past 12 months or more. It’s obviously not happened yet.

But every time I turn around, there are new observations from people who understand this better than I do. Most of them agree it’s going to happen. Each of us in our own way, depending on where we are in life and what we expect to achieve with our savings and investments, need to pay attention. There are ways to protect yourself and it won’t cost an arm and a leg to make it happen.

Chris Martenson | Apr. 20, 2015

Economist Steen Jakobsen, Chief Investment Officer of Saxo Bank, believes 2015 will be another “lost year” for the economy. And he predicts the Federal Reserve will indeed start to raise rates later this year, surprising the market and taking the wind out of asset prices.

He recommends building cash and waiting to see how the coming storm – which he calls the “greatest margin call in history” – plays out:
0% interest rates at $0 down has not created the additional momentum to the economy The Fed was hoping for. The trickle down effect, the wealth effect, has instead made for bigger inequality in society. So I think we’re set for a rate hike in either in June or in September. I think this will be the biggest margin call in history on the asset inflation created by the Fed.

That’s where I differ from most Fed watchers. Everyone else is looking at employment, inflation targeting. I don’t think Fed is at all looking at those. They are saying “Listen, the 0% interest rate is getting us absolutely nowhere, we think it’s very, very important for us to move to a more neutral place”. At the same time we will communicate that we are open-minded to additional programs or whatever needs to be done to secure the long term growth of the economy. But that will be on the down side, not on the up side. And as year has progressed, and I’ve said this publicly, I think 2015 is already lost in terms of recovery here. And that will take the market by surprise.

The market will ask in September when the Fed hikes: “Why are you hiking interest rate when growth is below target, inflation below target”? Well, the Fed’s response will be “Because this is the biggest asset inflation we’ve seen in human history and we need to address it“.

What the Fed is saying is that we have unintended consequences of low interest rates. Money is chasing yield: it’s going to real estate making it over-valued, and flowing into the equity markets making them over-valued. And then the Fed says “Well, we have two choices. We can allow the market to run into a bubble, or we can burst the bubble and start all over again”. But they wrongly, in my opinion, believe they can actually micro manage that, even macro manage this. So what they would rather do is “lean up against the market”. To take some of the excess out of prices by going in and telling in the market “We are concerned, we don’t want you to have more leverage. We want you to have less. And we certainly would like to see that market become flat-lined for a while in terms of return.” Which by all metrics of measurements is actually also the expected return of the stock market. Don’t forget three, five and seven years expected return at the present multiples is exactly 0%.

Given this, at a bare minimum, I recommend taking the leverage out of your own portfolio so you sit with a nice pot of cash if the market does correct. If it doesn’t, you’re not really losing out much because again, they expect a return is 0% for the next couple of years.

Some time the best advice to anybody is to do nothing. And of course being, part of an online bank I’m not exactly popular with management for putting this advice out there. But I have to give the advice I believe in and share what I do myself; and I’m certainly reducing whatever equity I have in my portfolio to a minimum. So I’m scaling back to where I was in January last year.

I’ll put it another way. I’m advising a hedge fund in London, analyzing 10,500 stocks from the bottom up. How many do you think of these 10,500 world stocks are cheap? Only 23. Which means 98% of all stocks are either fairly-priced or expensive.

Click the link below to listen to Chris’ interview with Steen Jakobsen (40m:27s)

https://www.youtube.com/watch?v=fnp5ETnKylU

Rioting In The Streets Of Gainesville?

retirement_roadMy Comments: The blog post title above comes from me; the one that actually accompanied the article is Public Pensions Face New Challenges As We Live Longer. Huh?

As a financial planner, I try to make people aware of the existential threats we face as we all grow older. These threats are things that “might” happen, may not happen, but if they do can be devastating to individuals and families. If you are already dead, you can skip this blog post, but if not, then…

No one seems upset that modern medicine has resulted in more of us living longer lives than could have been expected when we were born. Along the way, many of us worked for organizations such as the State of Florida or somewhere in corporate America. Or maybe the City of Gainesville or the Sherrif’s Department. We participated in a pension plan that promised benefits based on our years of service and sometimes our level of pay.

The promise typically included a schedule of monthly payments for either our lifetime, a number of years, and might have included a contingency benefit to our spouse. All well and good. But the calculations to make those promises did not take into account the fact that our lives now end much later than they did in years past.

The net effect of this is a shrinking of the pool of money available to make those payments. I’m not talking about Social Security here, where there is an obvious parallel, but the pensions paid to the millions of Americans who toiled for years at large companies like General Motors and the hundreds of thousands of smaller places.

Non-public pension plans are grossly underfunded across this nation. Part of that is the very low interest rates that ‘safe’ investments earn and have earned for the past decade. And pension funds are required to invest their pools of money in ‘safe’ investments. Revenue is going to have to come from somewhere or there is likely to be rioting in the streets.

My personal opinion, having watched this growing problem for a number of years, is that the author is somewhat blind to the problem and suggesting there is no reason for alarm. Tell that to the elderly couple whose pension check from a local plumbers union somewhere in Ohio just got cut in half.

There are millions of people across these 50 states with situations like this and to pretend they don’t exist is a potential violation of the social contract all of us have as citizens of these United States. Unfortunately, too many of them rely on Fox News to help them interpret what is going on.

April 10, 2015  by Marlene Y. Satter

Certain mortality projections would increase life expectancy by 2.3 years and reduce the funded ratio of the nation’s public pension plans to 67 percent.

That’s according to a just-out brief from the Center for State and Local Government Excellence, “How Will Longer Lifespans Affect State and Local Pension Funding?” which concludes that, while the impact of longer lives is not exactly a positive for funds, there’s no imminent threat to pension funding levels.

It explores what public plan liabilities and funded ratios would look like under two alternative scenarios:

1. If public plans were required to use the new mortality tables designed for private sector plans; and

2. if public plans were required to go one step further and fully incorporate expected future mortality improvements.

The brief’s key findings include:
• Using the private-sector standard, public plans underestimate life expectancy by only 0.5 years, reducing the 2013 funded status of state and local plans from 73 percent to 72 percent.
• Incorporating future mortality improvements would increase life expectancy by 2.3 years and reduce the funded ratio of public plans from 73 percent to 67 percent.
Plans’ liabilities are affected, of course, by the longevity of their members, and the brief explores the degree to which liabilities are affected, calculating that “state and local pension plans would see their liabilities increase by 3.5 percent for each additional year of life expectancy.”

When the differences among longevity tables are factored in, it becomes clear that some plans, because of the way they calculate life expectancy, will be more greatly affected by a change from one table to another, while other plans will not see such drastic effects.

The public sector, the brief said, is going to great efforts to make sure its life expectancy assumptions are up to date. Reassuringly, the brief said, “The question underlying this analysis is whether outdated mortality assumptions are a serious problem among state and local plans. The answer appears to be ‘no.’