The 4 Percent Rule -- What is the Right Amount to Withdraw from Your Retirement fund each year?
With stagnant incomes and roller-coaster investment returns over the past decade, individuals
on the brink of retirement might wonder what became of all those “rules of thumb” affecting how
they handle their nest egg once they walk away from their jobs.
They’re still there. But the question of how well they work comes down to the individual.
Chief among them is the “Four Percent Drawdown Rule” first revealed by CERTIFIED
FINANCIAL PLANNER™ professional William Bengen in the October 1994 issue of the
Financial Planning Association’s Journal of Financial Planning. Bengen wrote that retirees who
took out no more than 4.2 percent of their mostly stock-based portfolio in the initial year and
adjusted their remaining portfolio toward a 60/40 split in stocks and bonds each year, that
money could last an average of 30 years. That approach made Bengen’s work a gospel in the
financial planning industry.
But after this decade, which ended with the worst recession in 70 years, some experts are
taking a new look at the 4 percent rule.
1990 Nobel Laureate William Sharpe of the Stanford Graduate School of Business reported last
month that this particular rule can be harmful to many simply because of its level of risk tied to
stocks and other assumptions including lifespan. He suggests that planners and investors need
to do a better job of assessing client risk tolerance and consider more stable investment choices
like TIPS (treasury inflation protected securities) among other low-risk options as a foundation
for post-retirement drawdowns.
In other words, consider client risk tolerance and the content of the portfolio more, a standard
percentage of drawdown less. In fact, Sharpe points out that investors actually risk wasting
money by adhering to a percentage drawdown that actually could leave more money behind
after a few good investment years – in essence, the annual strict drawdown concept could lower
a retiree’s standard of life unnecessarily.
So what do you do? You work on the big questions first, not the numbers, and the best time to
do this is as far in advance of your retirement date as possible. Here are some conversation
starters for key discussions you should have with your financial planner as well as your tax and
Set a vision of retirement and revisit it every year before and after you’re retired: If you’ve
already been working with a good investment manager or financial planner, you might have
already done this. But retirement goals change as most life goals do, so treat the subject
organically. Talk about the fun stuff, but state your objectives for a post-retirement work picture
if you want to create a new career or simply want healthier finances. Set your lifestyle
expectations now and revisit them as necessary.
Track your working-life expenses for 3-6 months and examine how well your current
retirement nest egg and other resources could support that spending: This is where your
imagined vision of retirement becomes real -- or falls apart. A thorough examination of your
current spending habits is a great first step in determining how realistic your preparation for
retirement has actually been. It will also provide a picture of what else has to be done.
Consider worst-case scenarios: For many retirees, increasing healthcare expenses and the
cost of end-of-life-care account for significant spending. As a result, many retirees may pay for
expensive experimental treatments to fight disease or long-term home or nursing home care.
Current statistics from AARP show that the average home health care aide makes $18 an hour
and a private nursing home room costs $78,000 a year. While public aid picks up medical
expenses for those who exhaust their assets in most states, most of us desire more than
minimal standards of care. Health care reform is not even close to solving this problem, so it’s
time to plan.
Build a phased-in retirement: Many companies are becoming more open-minded about
keeping older workers on the payroll or actually hiring more workers over age 60. Keep
apprised of such opportunities and the skills it will take to take advantage of them – a successful
phased-in or post-retirement work plan will require more than sensible financial planning. It may
also require training and other personal investments, so keep your ear to the ground and always
be ready to consider a fresh perspective on your value in the workplace.
Originally written July 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planningcommunity, and is provided by Don Martin, CFP, a local member of FPA.
Hong Kong consulting firm GaveKal said in their Checking the Box Newsletter on January 21, 2011 regarding China’s growth: 15% loan increases in 2003-07 brought 12% economic growth, then in 2009 loans increased 33%, 2010 they increased by 19% but that resulted in lower growth. My opinion is that China’s economy is reaching a point where economic growth caused by loans is diminishing in proportion to the capital used. Also, an extraordinary increase in lending occurred post-2008 crash, which implies that China’s boom is unsustainable.
GaveKal is optimistic that China will continue to grow and that inflation won’t be that bad. Excess inflation would result in a monetary tightening, so they feel moderate inflation would not result in excessive tightening.
Use independent investment advice to find the answers to complicated questions.
Municipal Bonds Looking Riskier
This week articles by Brian Pretti, a CFA at FinancialSense.com and Gillian Tett in the Financial Times have both hinted that there is increasingly less respect by investors for sovereign debt. Investors are starting to require that sovereigns post collateral for a loan because they are no longer seen as different from an ordinary debtor. Then today the New York Times had an article about policymakers preparing to allow states to file for bankruptcy. So the tide has turned against municipal bonds. They are too risky and should be viewed like junk bonds. Some of them yield about the same junk bonds after adjusting for the tax benefit. When a bond yields the same as a junk bond then it should be viewed as a junk bond. Junk bonds have a history of losing 30 to 70% of their value as a permanent loss during a recession, so when this loss is averaged over time the total return on a junk bond is less than the return on an investment grade bond.
I have found that investors get too emotional about tax benefits when evaluating investments and they take too much risk to obtain a tax-advantaged investment. The tax benefit warps people's judgment. So I would avoid municipal bonds until the debt-deflation-deleveraging crisis has been completed, which may be several years from now. The book by Rogoff and Reinhardt "This Time Is Different: Eight Centuries of Financial Folly" said it takes seven years to resolve a debt-deflation crisis so that means roughly in 2015 the matter will have reached bottom and can then improve.
Independent investment advice is the way investors can get insights to protect themselves.
China’s inflation rate last month was slightly lower than the month before, but the moderate increase may have been due to a high base used previously. Some had thought prices would increase a lot in the first quarter of 2011, which would incur the risk that a sharp slowdown would be needed to cool off inflation.
In the FT an article “Fears grow that China is overheating”, written on January 20, 2011 said monetary conditions are “…extraordinarily loose…” These were caused by an attempt to stimulate the economy to fix the recession of 2008.
The FT article also said “Last year, Chinese banks moved trillions of renminbi in loans off their balance sheets and repackaged them as wealth management products, allowing them to evade the government’s restrictive lending quotas.”
So if the banks are doing more lending than the government is aware of then the money supply would be increased excessively, leading to a false boom, which will end in a recession or a crash. Remember what happened in America where Lehman and others repacked loans as investments which moved them off the bank’s balance sheets. It made the banks look health and it overstimulated the economy, and then when the financing ended then a hard crash occurred.
Independent investment advice is what investors need to be prepared for recessions.
The Shanghai market dropped nearly 3% Thursday because of fears that an overheating Chinese economy would result in monetary tightening. Even though the authorities tried to slow down the economy they were unable to cool it down, which implies harsher measures will be imposed, leading to a slowdown. China was expected to slow down but didn’t, so this surprise hurt the market.
Lombard Street Research report by Diana Choyleva called “Beijing loses control of China’s red hot economy”. She said “China’s overheating worsened significantly in Q4 as both domestic demand and export growth surged. Policymakers are behind the curve and need to act decisively if they are to curb inflation. The longer growth stays above trend, the worse the necessary downswing is set to be. China’s violent cycle could be highly destabilizing for the world.”
Monetary policy in China is still very lax, despite the obvious need for tightening in response to a negative real rate of 2 to 3%.
SocGen forecasted risk has risen to 30% that monetary policy will result in a hard landing in 2012 or late 2011.
Independent investment advice is important to get the clearest perspective oabout today's markets.
The real estate crash that won’t go away.
Stock market bulls have dominated and shaped public opinion into believing that all is well with the economy. The bulls tell news media that since equities, excluding banks, are now at the same price as the peak in 2007 that the bear case is dead. Bullish stock market analysts try to build a case that real estate has finally bottomed out based on a NAR affordability index that is the lowest (best) in 45 years. However, the index does not consider that underwriting rules have morphed into a very strict new paradigm in 2008, so the previous 25 years of mortgage lending is not comparable with today’s market because lender’s underwriting rules are perhaps the toughest in decades. Further, consumers may be aware that if interest rates are artificially low today and then go up in a few years then that will hurt the ability of today’s buyers to sell to tomorrow’s buyers, which could hurt the housing market.
Various charts published in the news media show that house prices need to drop roughly an additional 10% to return to a trend line. And since lenders have very tight underwriting then home values could even go below trend line. Typically when a bubble bursts the market overshoots its target and goes down below fair value, which means instead of going down an additional 10%, it could go down more.
Assuming 20% of homebuyers during bubble times could not qualify for today’s stricter underwriting standards and assuming that an extra 6% of the population became unemployed after the crash, then roughly a fourth of the population can’t qualify for a loan. Further, if one member of a two-income home lost their job then the total impact on households not qualifying for a loan could be even greater. The way for the market to heal itself would be to replace these missing potential buyers who would otherwise be buying owner occupied homes by having those homes bought by investors. But investor loan underwriting has really tightened up with even stricter requirements than owner-occupied homes, so that also suppresses demand.
Real estate is 40% of the economy and is budgeted by underwriters to consume about 40% of income in jumbo markets. When that large of a portion of the economy is in a depression then how can the economy justify having a stock market (excluding bank stocks) that has returned to the old highs?
I asked a very experienced Realtor and mortgage broker about the market in Silicon Valley and he felt that it is extremely depressed in terms of the number of sales transactions despite the employment opportunities afforded by Google, Apple, Facebook.
This is an example of why independent financial advice is vital.
The income method of investment analysis is the best way to analyze an investment. This method involves looking at income and using a multiple to estimate the value of an investment. A similar technique is used in evaluating investment real estate or loan applications. Assets that have no income stream such as commodities, collectables, or new dotcom stocks are intrinsically riskier because they lack this ability to be analyzed by their income thus forcing investors to make huge leaps of faith using various dubious metrics. So the type of investors who invest in things with no income stream could be less rational and more emotional than investors who confine their investing to things that have an income stream. The advantage of investing in assets with an income stream is that the income often is relatively stable and reliable if smoothed out over five or ten years. For example, a person with a job as an engineer making $120,000 a year may have had the same salary, after adjusting for inflation, over the past ten years. He may have had two good years where he obtained a stock option bonus, but that income should be viewed as a one-time windfall and not a reliable, consistent source of income. That person may try hard to improve his salary but may find due to competition that he simply can’t get a significant pay raise. Also wages are often “sticky” during recessions and don’t fall as fast as stock prices or consumer goods. So the engineer may find his income stream, ignoring options as a bonus income, is relatively constant. This income flow if averaged out over many engineers over many years is a far more reliable flow of data to make a decision than simply using the comparable sale method for collectables. This income flow is used by banks to make lending decisions. Banks are highly leveraged with assets 12 times their net worth, so they are more dangerous than hedge funds and thus have to develop the best possible methods of valuing an investment. A loan created by a bank is really simply another investment. This method has worked well for banks, and by contrast simply looking at asset values or net worth does not work well. For example if someone has a lot of equity in a property and they get a new first mortgage with a low LTV of 60% that may appear to be low risk. But later the borrower could hollow out the equity with his home with a new second mortgage and then the borrower may find later that he has negative equity during a crash so he decides to put the property into foreclosure. Then when the bank sells the property at a lower value and with substantial foreclosure costs the first mortgage lender could lose money even with a 60% LTV. However, if the income method was the main reason for granting the loan then only well qualified borrowers would obtain a loan and the probability of foreclosure would be much lower. So when you are contemplating a stock market investment, simply imagine yourself to be a lender who is contemplating a making a loan instead of an investment and ask yourself, what is the most thorough and reliable way to evaluate a loan application? The answer: the income method, not the assets or net worth. (It was the banking industry’s failure to use the income method that led to the mortgage crisis. The banks foolishly discarded the income method and looked at the assets and net worth, but those balance sheet items are subject to boom and bust cycle that can produce severely warped and emotional charged data). The reason the income method works better than asset comparability method is that every day thousands of consumers decide who to buy goods and services from and at what price, which results in an income stream for a corporation. However the corporation’s assets may fluctuate wildly in value due to bubbles, further the corporation with a lot of surplus cash could waste the cash with foolish acquisitions or simply give it to stockholders, thus the balance sheet analysis method is less reliable.
Perhaps the most reliable income flow in equities would be the overall performance of the SP500 smoothed out over time. This is because the SP500 has about 75% of the nation’s economy.
During boom time’s commodities and collectables such as rare art, etc. can go up dramatically higher and then during crashes they can go down significantly. The techniques used to value them are to simply compare the asset to the most recent sale of a similar item and make some adjustments. But if the previous sale was an emotional “bubble” transaction of a unique item then that method is not reliable because it lacks that copious, consistent flow of data that the income method offers. The reason why large cap stocks are safer than small caps is because they have a collection of thousands of diversified income streams from sales thousands of different products, whereas the small cap firm may have a only a few products to sell which thus result in a lesser amount of data to analyze. The S&P 500 has tended to produce a total return of 9% annually over many decades, so this makes it possible to use the income stream multiplied by a Price-Earnings (PE) ratio to get an estimate of value.
So investments, ranked by ease of using the income method have more reliable valuations than investments that can’t be evaluated by the income method. The spectrum ranges from easiest: Treasuries, SP 500 stocks and bonds issued by those companies, medium cap equities, small cap equities, investment real estate, to harder: commodities and collectables and exotic assets like the VIX index. Since harder to evaluate assets are riskier then easier to evaluate assets then they should be only purchased at a discount so as to allow a margin of safety, further they should only be purchased with enough expected profit to produce a higher rate of return than that estimated for publicly traded large cap equities. Thus one should invest sparingly, if at all, in commodities and collectables and should do so only during the worst moments of a significant market crash. However, when investing in stocks of commodity producing companies they should not be evaluated as a commodity, but rather should be evaluated as a stock.
Regardless of whether one seeks to use the income method or the asset comparison method they should get independent investment advice.
Michael Pettis, a Shenyin Wanguo Securities (Hong Kong) financial expert says that China’s central bank has a choice of either fighting inflation by raising interest rates, which would cause a crash in China, or if they don’t raise rates then imbalances in China will continue to grow, ultimately leading to a more significant crash.
My opinion is that when interest rates are lower than inflation this situation is called negative real rate, which is what China has now. Negative rates cause the economy to be overstimulated by making it encouraging businesses to build an excessive amount of industrial capacity (factories, commercial real estate, etc.) This excess capacity will result in excessive amounts of goods being manufactured, which is deflationary.
My own independent investment advice is that China may not be a bullish factor for the world’s economy, especially for commodities, and a sudden downside surprise in the Chinese economy could cause the rest of the world to fall into a recession.
In the 1980’s the bond vigilantes would raise interest rates when it was feared that inflation was returning. Today people ask when they see inflation with no reaction by the bond market “where are the bond vigilantes?” The answer is that the bond vigilantes have responded to the threat of inflation by going underground and morphing into other forms. For example when the marketplace wants to protect itself from inflation, capital flees into traditional inflation hedges like gold, silver, base metals, commodity futures, rare art, etc. But capital also flees from the threat of inflation into any perceive hedge including common stocks that are not connected to commodities. Barron’s article of 1-17-2011 had a panel of investment experts, including Mark Faber, who said that he is bearish on everything but invests in stocks as away to protect from inflation. “Since I am ultra-bearish, my preferred assets are equities and hard assets: real estate commodities, precious metals and collectibles.”
This is an interesting conundrum: because Faber is bearish he prefers equities and hard assets. So have bond vigilantes morphed into equities buyers in an attempt to protect themselves from inflation? Is it possible that most investors, including Faber, tried so hard to protect themselves from inflation that they are overpaying for any asset, including equities, that can be used to protect themselves from inflation? Did these investors forget Ben Graham’s rule that an investment should be bought at a discount so as to have a margin of safety? What if the perceived threat of inflation is a false alarm and it never occurs? Then if investors have overpaid for inflation protection assets what will happen if the market decides that these investments have a lower intrinsic value? Then if the investments go down that will be deemed to be a deflationary or disinflationary event.
The inflationists have a conundrum to solve: if inflation and growth return then interest rates will go up. This will slow down the economy and hurt the stock market thus making inflation hedges go down in value. If inflation is going to come back and if traditional inflation hedges are overpriced then when inflation does come back the supposed inflation hedges may backfire and go down in value. Often inflation sensitive investments work best before inflation hits when cheap money is available. However, once inflation occurs then interest rates will rise and the inflation sensitive instrument will misbehave. So a contrarian scenario would be to search for an unloved, unappreciated asset to hedge against inflation and buy that: the two year Treasury Note. During the great inflation of the 1970’s that asset did well because it could simply be rolled over every two years into a new higher rate, and no one overpaid for it, the way people occasional do for real estate, rare art, gold, silver, etc.
The bearish experts suggest that equities are 30 to 50% overpriced using metrics like Tobin’s Q, Schiller’s 10 year CAPE, a few bears claim they are 100% above intrinsic value. If they are right that will reduce inflation, promote disinflation and destroy inflation hedges. This is an example of independent investment advice.
My independent investment advice for the week: This past week has bought no evidence that would overthrow my pro-deflation paradigm. There has been a large drop in the US 10 year real 10-year growth rate lately. “Something has clearly gone very wrong.” Said Gavyn Davies in FT.com on 1-12-2011. He pointed out that it will be harder than usual to recover from the recession due to the high level of consumer and government debt, and low ability of consumers to save, plus high unemployment. So it may take many years before we reach a sustained recovery, in his opinion.
His opinion supports my deflationist views that it will be a long time before the economy is back to normal. During that long wait it may be best to invest in bonds rather than in equities due to the likelihood of continued low interest rates.
And there is the risk that traditional inflation hedges maybe over-priced so it won’t do any good to rush out and buy them, especially if there are no dips in their price to provide a buying opportunity. We have already see that futures markets cost too much compared with spot markets, especially when compared to the “yield roll” available during the commodities boom of the 1970’s. This yield roll was a key component of profit for inflation speculators in the 1970’s, but today that is not available. History is full of stories of people who overpaid for an otherwise sound investment and lost money even though the basic concept was correct.
If China is in a moderate bubble then eventually their economy will cool off or worse. They have never had a soft-landing when the Central Bank tightened monetary policy, so when they finally get around to suppressing inflation with fully adequate tightening measures I see no way for China to have a soft landing and thus a crash will occur. This will result in commodities and commodity producing countries going down. So even if China’s cooling does not occur until 2012 or 2013 that delay in cooling will not be enough to prop up an otherwise weak, soft world economy that most likely will be weak until mid-decade. If anything, a China crash in 2013 could hurt the developed world just as it was beginning to make progress on crawling out of the soft depression.
Risk-aware investing means to judge an investment by its risk adjusted rate of return. This means using Sharpe ratio or Information ratio to see how much reward did you obtain in return for the risk you took. The goal is to spot investments that had a high performance but were so risky that they really did not make enough profit to offset or to justify taking the risk. Using this technique means an investor may make less than another investor who takes on excessive risk however an investor who uses risk-aware techniques may be able to reduce the probability of serious losses. However, nothing about investments is guaranteed and past performance is not indicative of the future.
The theory behind risk aware investing is to take reasonable risks and to avoid unreasonable risks. A simple technique would be to sort investments by Standard Deviation and reject those in the highest quartile, or possibly reject those in the highest half. This would result in a lower rate of return but would increase the probability of avoiding catastrophic risks. Some experts believe that the most important goal in investing is to avoid losing money. For example, if you have $100 invested and lose 50% then when the investment that is now worth $50 later goes up by 50% you now have only $75.
How does the Sharpe ratio work? It subtracts the T-Bill rate of return from the investment’s return and divided by Standard Deviation of the investment. This shows how much alpha (excess return) you got divided by the amount of risk. This allows you compare reward in proportion to risk. The problem is that today T-Bills are close to zero yield. Further, the excess or alpha return that you got from the investment should be compared to the same asset class. For example, if you invest in large cap domestic stock then instead of using T-Bill rate to determine alpha, use the large cap average rate of return to determine what your investments alpha was. This is done using the “Information ratio”, which uses a benchmark that is similar to the asset class you are examining to determine alpha. This is a crucial difference between the Sharpe ratio versus Information ratio during eras when the Fed is making interest rates artificially low.
The challenge is that past booms can lead to bubbles so that the investment with the best Sharpe or Information ratio in the past may have reached its peak and will be ready for a crash if it is overpriced. So you can’t simply look at what stock had the best Sharpe or Information ratio, you also have to examine the intrinsic value by looking at the 10 year P.E. ratio to see if it is reasonably priced and you need to look at the possibility of the “value trap” phenomenon which occurs when a stock is declining the p.e. ratio looks better but the stock is in danger of collapsing. In addition it is important to look at corporate financial health, corporate moat, return on equity, growth rate of sales and earnings. Also, if interest rates are set by the Fed at historic lows then they may have temporarily and artificially increased the value of the stock market, which will put downward pressure on stocks, once the Fed raises rates to normal levels.
This is an example of independent investment advice.
Book Review: The Age of Deleveraging Author A. Gary Shilling
This book, by bearish economist A. Gary Shilling, PhD, shows how various bubbles and booms ultimately crashed. The author discusses the inventory build u and recession of the early 1970’s, the Japan boom and crash of the 1980’s, the dotcom bubble and the housing bubble, all of which he says he warned about in advance.
Slow growth for the world is what he forecasts with chronic weakness for the housing industry, moderate deflation of 2 to 3% a year, weak levels of government spending.
He said history favors market timing over “buy and hold” investing, and even more so in today’s shaky economy. He shows how avoiding losses caused by crashes is more important than chasing after a boom.
He recommends avoiding investments in Japan, junk bonds, emerging market stocks and bonds, bank stocks, collectables, commercial real estate.
He is in favor of investing U.S. Treasuries, big dividend paying stocks, stocks of money management companies, stocks of staples producing companies, stocks of companies that produce small luxuries, low cost housing providers, and health care, North American energy producers.
The author prefers to implement investment ideas by buying ETF’s of favored industry groups. He tends to view investments from a broad macro top down approach and let the ETF’s handle the details. He shows his favorite chart figure 12.2 on page 436 of U.S. Treasury Zeros versus the SP from October, 1981 to March, 2010 Treasuries retuned 18.8% annually versus 11.9% for the SP.
I agree with him about most of what he said, although I disagree about his implementing investment positions using passive ETF’s because I believe in using actively managed open-end mutual funds. The book is easy to read, contains no dry technical jargon, and is level headed, balanced, with no doom and gloom “end of the world is coming” hysteria. The book supports the same macroeconomic ideas that I have been advocating for several years. Dr. Shilling is a good example of why I like independent investment advice.
According to David Rosenberg’s citing today of economists Ken Rogoff’s and Carmen Reinhart’s book “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises”, of 12 European countries that have defaulted on government debt the median one defaulted 24% of the time; the worst defaulted 51% of the time.
Economist David Rosenberg also said today that households invest only 1.6% of their assets in U.S. Treasuries and 4.4% in other bonds. Thus, as he has said in the past, there is room for households to acquire more Treasuries, which implies we are not in a bond bubble.
Also today in the Financial Times Ken Rogoff wrote that Eurozone has high chance of medium sized meltdown. See http://www.ft.com/cms/s/0/bd4a8af0-1e59-11e0-bab6-00144feab49a.html#axzz1AcE9dGsL
This is why I like independent investment advice including fee-only financial advice.
Regarding the U.S. housing depression: can we have a recovery in the non-housing part of the economy even if housing remains depressed?
What about economy’s ability to recover from the real estate crash? How can people be so bullish on the economy with 10% of homes in foreclosure? Is that just a one-time 7% loss in the nation’s liquid wealth in the form of bank loan losses and MBS losses, and which would be feasible for wealthy and upper-middle class investors to digest? For example, if a lower middle class ex-homeowner was not sued for loss caused by foreclosure then he can consume other goods as usual after foreclosure, thus it is tempting to think that the economy, except for those who lost investments because they had an excessive allocation to MBS or cash based real estate investors, will be ok.
Assuming that most of the owner-occupied tragedy was in moderate income housing and that those people have already adjusted to a lower standard of living then perhaps there worst is over in terms of those damaged consumers motivation to reduce consumption. If so this could help the bull’s case that the non-housing part of the economy is OK and will justify high stock market valuations. But I still think there has been a huge paradigm shift where American workers are taking pay cuts, plus an extra 6% of them are unemployed. (The unemployment rate went from 4% to almost 10%)
I think the full effect of the huge overhang of excessive housing inventory and shadow inventory of owners who intend to sell but who are waiting until better times to sell will be a drag on the economy for a long time. It is not possible to directly compare housing affordability statistics with the past because in the past there were more jobs and there were negative amortization loans with low introductory rates, “easy qualifier” or “liars loans” that enabled people to buy more than they could afford. Now those aggressive, risky loans are not being offered, which is a big change compared to when they were first offered in about 1984.
Hong Kong investment advisor GaveKal says, per N.A.R. chart showing that affordability ratio that U.S. housing is cheapest in many decades, but they forgot that today’s buyers are getting an artificially low cost of capital. In the future buyers will pay higher loan rates and if they can’t afford those higher rates then prices will need to go down. I think what outweighs their faith in the affordability ratio chart is that there is a huge surplus of foreclosed housing that needs to be liquidated at fire sale prices (banks are required by regulators to get rid of foreclosed property and not hold on waiting for a buyer) and they don’t realize how bank foreclosure sales are not normal type of sale, further the housing glut is unprecedented. The proper way to calculate affordability is to look at long term rates and ask what will a buyer’s cost of capital be in five or ten years? If 2 to 3% higher than the current 4%, this is a 50% increase in cost (or maybe 33% when counting property tax and insurance), so that means affordability at today’s prices with normal interest rates is not that affordable in terms a future buyer’s ability to buy a house at today’s prices levels. Various charts show housing needs to go down 10-20% to return to trend lines, and the Dallas Fed estimated a 23% decline may yet occur using mean reversion.
Using independent investment advice I think the economy will still be weak for years. However, it could grow slowly from this point, but even so the stock market is overpriced. Thus stocks could go down even if the economy gets better because the Schiller P.E. is 22.7 and should be 15, which implies a 33% drop in value.
Reuters said today that Zillow said U.S. house prices fell for 4.5 years, which is a longer time than the downward part of the Great Depression from 1928-1933. The market is still falling, with significantly more shadow inventory to be placed on the market.
My independent investment advice about this topic is that eventually stock market investors will realize this situation can't happen in a vacuum and that it must therefore affect the rest of the economy, which will be bearish news for equities. Thus stocks will go down and by contrast bonds will go up in value.
Scottish hedge fund manager Hugh Hendry interviewed on Bloomberg today at http://www.bloomberg.com/video/65772716/ He continues to be a bearish contrarian and said U.S. Treasuries may be worth owning for a decade due to depressed economic conditions.
Hendry is an example of truly independent investment advice. He has been bearish for several years and is now trying to short China's economy by buying credit default swaps on Japanese companies, figuring that if China's economy weakens, then so will Japan's.
Economist David Rosenberg of www.gluskinsheff.com said today: CDS pricing implies “…Greece has a 70% chance of defaulting, 51% for Ireland, 44% for Portugal and a nontrivial 31% for Spain. Both Greece and Ireland are now paying over 80% of their export revenues towards external debt payments, which is not sustainable by a long shot.”
In my opinion, this supports my concerns that the Eurozone is very weak and will get surprising weaker, leading to further support of U.S. Treasury bond prices and the dollar, as capital flees to the safe haven of the U.S.
Rosenberg is a good example of why independent investment advice is better than Wall Street’s product sales driven (with conflicts of interest) advice.
Evaluating gold has been a difficult topic. Edward Chancellor of GMO had a good article in the FT on 1-7-2011 that articulated how my opinion. He said that gold is overpriced and a fair value would be about $1,000."This is not to say gold will not rise over the coming year or that there is no need to hedge inflation risks. Rather that prudent investors should look to other, less meretricious, assets to protect the purchasing power of their savings." http://www.ft.com/cms/s/0/33aba278-1a96-11e0-b100-00144feab49a.html#axzz1Aai1Tco0
My opinion is that gold should be judged like any other investment or inflation protection asset: it can cause losses if one overpays for it. Therefore one should search for relatively undervalued assets and buy a basket of those rather than simply become obsessed with gold and silver as an alleged hedge against inflation. During the bimetallism era of the 19th century gold and silver did not always protect people from inflation nor did gold and silver trade in a manner that always set the value of money at a fair price. Just because paper money has had its credibility weakened by the misbehavior of the world's Central banks that does not automatically mean that precious metals are a better store of wealth. During the inflationary 1970's counter intuitively one of the best investments was the two year U.S. Treasury Note. This was because no one overpaid for it, and when inflation increased the investor merely had to wait two years to get his money back and then invest in a new higher yielding note and with no credit risk, no state income tax, complete liquidity, no significant bid-ask spread. So the loss due to inflation was smaller than the loss suffered by traditional inflation hedges that were overpriced. For example: suppose you buy a two year T-Note and after a year the market rate has increased by 2% due to higher inflation, then you would lose 2%; by contrast if you overpaid by 30 to 50% for a traditional inflation hedge you would have wasted money. Look what happened to the Hunt brothers when silver went to record highs in 1980. This reminds me of investment lessons: avoid investments with excessive risk or high standard deviation or extreme, faddish tendencies. The lowly 2 year T-Note had less standard deviation than a gold mine or the Dow Jones or silver bullion but it did better.
One of the biggest lessons of the recent economy is that many people who thought they were financially ready for retirement…weren’t.
The amount of money, investments and government support you’ll need to retire comfortably is as individual as you are. Some people plan to work in retirement. Others have health issues or other financial responsibilities – kids’ college bills, financial support for a senior relative -- to juggle with the everyday living expenses they’ll face in retirement.
However, one thing is true for every potential retiree. It makes sense to get customized advice from qualified financial, tax and estate planning professionals at least one year before a retirement date is set. Here are some preparatory steps to take before you seek that advice and finally set a retirement date.
Figure out where the money is: The days of single-employer careers have been over for decades. And nearly 30 years into the world of widespread IRAs, 401(k) and other self-directed retirement plans, many potential retirees can’t reliably state where all their retirement resources are. Start pulling together all available paperwork tracking personal, government and employer-based retirement assets get them into order. It’s OK if you don’t know immediately whether you have enough to retire – experts can help you with that. What’s important right now is to identify everything you have so you can properly evaluate alternatives.
Identify debt: If you have significant home or consumer debt, that’s a tough burden to take into retirement because most retirees find their income will be somewhat or significantly lower. That also goes for big car payments, tuition debt, medical debt or elder support. Debt is the first major reality check on retirement for most people.
Adopt a downsizing budget: Too many people wait until retirement to learn how to live like retirees. If you have a budget, review it for unnecessary spending that could mean anything from cutting back on lattes to selling a bigger, more expensive car and going with public transit or a used vehicle. If you’ve never made a budget, now’s the time. Budgeting for retirement doesn’t mean cutting out every treat and luxury – it simply means extinguishing debt, setting priorities and determining which current expenses can be cut or eliminated. As the real estate market recovers, you may want to plan to sell your current home in favor of a smaller one that can be bought for cash or minimally financed, or possibly you might decide to rent. You might want to try “going smaller” with vacations, cars, clothes and other needs or wants that can move to a lower price point. Do this while you’re working, bank the money you save and you’ll have excellent training wheels for retirement.
Evaluate your support from the government: A good rule of thumb is, “If you need Social Security or Medicare to retire, it’s best to keep working.” While both of these programs remain enormous help to many retirees, there’s always a chance of significant change in these programs, not to mention the continued discussion of moving the official retirement age well past 65. Definitely evaluate your government benefits, but do so in the context of what you’ve accumulated privately so you can maximize your government benefits when you need them.
Consider healthcare and long-term care NOW: If you’re lucky, your health is in great shape. But family history and events out of the blue may change that. If you retire before age 65, you won’t qualify for Medicare unless you are officially disabled. That means that you’ll have the responsibility to maintain private insurance that adequately meets your needs without huge financial risks that can come from uninsured care or procedures. Even as healthcare reform adds certain protections for under-65 policyholders, it’s more important now than ever to give attention to health matters and whether your current insurance strategy is adequate. As for long-term care, many Americans still forget that the bulk of home-based and nursing home care must be paid out of pocket. While long-term care insurance exists, age and health needs can potentially make it very expensive, so this is another important financial planning issue.
Find out if your dream retirement really works: It’s important to test your retirement dream. While many people dream of moving to a particular place, it’s important to vet that choice for financial and lifestyle repercussions. A particular location might have cheap housing and great healthcare options, but what about cultural attributes and tax issues? There are literally dozens of factors that should enter into your post-retirement lifestyle decision, and to jog your thought process, Nolo provides a checklist that might help.
January 2011 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Don Martin, CFP, a local member of FPA.
As the economy recovers, homeowners are faced with the good news/bad news prospect of a better real estate market with the likelihood of higher mortgage interest rates. For many, that leaves three choices – sell, refinance or sit tight with the mortgage they have now.
Despite the average 30-year mortgage rate that stood at 4.8 percent in late December, the decision to refinance isn’t always a great idea. In fact, it should be considered as part of an overall financial plan that is as individual as you are.
It makes sense to confer with financial and tax experts before you make such a move because there are more questions to consider beyond “How do I get that low rate!” Among them:
What are your current financial goals? If you’re planning to stay in your home for the next 20 years, your outlook is far different than someone who wants to retire and move in the next five. Many people focus on paying off their mortgage instead of planning for retirement or education savings for their children. It’s important to get advice on this question that fits your overall lifestyle and financial needs. The important question is when you’ll get to breakeven on the cost of the refinance – generally 3 to 6 percent of the total loan amount. If your breakeven is at 12 months and you plan to stay in the home five years or longer, it will probably be worth doing.
What’s your current debt load? If you’re swimming in debt, don’t expect to get the lowest, most attractive rate available on the market. While the credit crunch is loosening, many mortgage lenders are being quite picky about whom they’ll offer their most affordable loans to and many are still turning away borrowers in significant trouble. It’s best to try and cut your level of credit card and other consumer debt before applying for any loan.
When was the last time you checked your credit reports and credit score? You have the right to get all three of your credit reports – from Experian, TransUnion and Equifax – once a year for free. You can do so by ordering them at http://www.annualcreditreport.com/. Yet don’t order all three at the same time. By staggering receipt of each of your credit reports at different points in the year, you’ll get a continuous picture of how your credit picture looks. Also, you’ll have the opportunity to focus on possible errors in a single report, which will give the other two credit agencies time to update their files.
Consider biweekly payments on your current loan… Your current lender might have sent you an offer for a biweekly mortgage loan program that will save you considerable money over the life of that loan. Discard their offer – many lenders make big fees off these programs – and see if you can do it yourself. Some lenders won’t allow it, but see if you can break up your payments in a way that will equally divide the principal and interest payments so you’re whole by the end of the month. Otherwise, they might apply the first half-payment to principal and still insist on the full monthly payment by the due date.
…or consider adding a 13th payment for the year: Either by adding the equivalent of 1/12th of what you typically pay per month to principal or simply double-paying your mortgage one month a year when you’re flush, you’ll pay your loan off faster.
Fixed or variable? Given the recent uncertainty in the mortgage market and the current loan environment, it makes sense to try and go for a fixed rate since rates remain at historic lows. Higher rates mean higher payments if rates go higher.
Second mortgages can be problematic: As many lenders have gotten stricter about doing business, they may not be as willing to take second-fiddle status behind an older second mortgage, which happens in a refinancing process if not addressed. If the borrower can’t roll the two loans into a single loan during the refinancing process, it may delay or kill the deal based on what the two lenders are willing to do.
Are you on top of your tax issues? Remember that lenders are looking as broadly as they can these days for signs of financial trouble. If you have any late payments of current property taxes or any other potential disputes with state or federal tax authorities, those issues can complicate matters. Make sure you’re current.
January 2011 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Don Martin, CFP®, a local member of FPA.
According to an article in MSN.com January 3, 2011 the average stock ownership lasts 22 seconds due to computerized trading. That’s right: 22 seconds, not 22 days or 22 weeks!
My opinion is that this supports my theory that a huge amount of stock investing is done by hedge funds that have access to margin loans with a nearly zero percent cost of capital so they can afford to buy with enormous leverage, thus pushing up or supporting stock prices that are too high. Hedge funds leverage is between 4 to 10 times their net worth. If this support from hedge funds were to be withdrawn due to their inability to get financing, or to buy Put options, etc. then they would need to sell their stocks. And that would create a massive wave of selling where they would face margin calls and then they would be able to sell poor quality stocks and would be forced to sell good quality stocks at fire sale prices. If margin requirements or the price of Put options or interest rates were to increase then this house of cards would tumble down very fast and stay down.
I have wondered for years why the stock market has been so high compared to 100 year trend lines for things like P.E. ratios, etc. I think the answer is that in the last 20 years there has been an enormous amount of hedge fund investing using a very cheap cost of borrowed money and it has gotten progressively cheaper to borrow over the past 20 years, also Put option costs have gone down recently, with the VIX at record lows. Further the bailout of Long Term Capital management in 1998 and Bear Stearns has encouraged hedge funds to take on excessive risk.
One way to protect oneself from this is to use independent investment advice, instead of getting advice from giant Wall Street oligopolies.
If someone graduated with a BA degree in Nursing at age 21 and worked 80 hours a week with double pay rate for overtime they could theoretically make about $360,000 a year. This assumes a base pay of $120,000 a year for a 40 hour work week. If they did this while living with their parents and saved half of their before-tax income they would save $180,000 a year times 9 years = $1.6 million saved.
$2.02 million would be the compounded amount saved assuming 6% total return before-tax and 4.8% after-tax compounded return. This does not count a future tax on unrealized capital gains and assumes 50/50 stock bond investment with no stock sales. The assumption is that taxes would be 40% on a yield of 3% (from bonds and stocks). Of course if a depression occurred during this scenario then rates of return would be lower and the investor could lose money. Or if extreme inflation were to occur the bond part of the portfolio would be hurt.
Obviously the quality of life would be rather poor for this hypothetical person. Few Americans could live rent free with their parents at age 30, or work 80 hours a week for 9 years. But I know people who have worked this hard or who have lived cheaply as adults with their parents, so it is possible. There was a nurse employed by the San Francisco City and County government who earned this much, which was disclosed by the City's list of top earning employees.
Of course a person working this hard should get fee-only financial planning, with independent financial advice, since they might be a bit too tired to manage their portfolio.
John Taylor, of FX Concepts, LLC, was interviewed on Bloomberg and said the Euro will go down against the dollar with more trouble expected. He said the market has not discounted the problems of the Euro. He favors Brazil's and Australia's currencies. He said the U.S. has a trade deficit with only one country: China.
Pierre Gave of GaveKal, a Hong Kong investment advisor, said that they expect the Euro to decline against the dollar which would stimulate export industries in the PIIGS region of south Europe.
My independent investment advice is that there has been an economic model since 1945 that when the world economy goes into recession the U.S. economy becomes the least weak and thus becomes a safe haven for investing, which makes the dollar go up during recessions. It appeared that the U.S. had so many problems that during the current recession that model appeared in doubt, however, we now see that this model is working as usual. It is because America is more entrepreneurial, has more economic freedom, more immigration of professionals, more fossil fuels (we export LNG), more agricultural exports, and more determined to solve problems (compared to Japan, for example) that we have earned the right to be the safe haven currency.
Excellent article in FT.com written by Richard Milne on 1-3-2011 “Battles loom between creditors and borrowers”.
“It is definitely looking more systemic,” says Kenneth Rogoff, who was chief economist at the International Monetary Fund. “Whenever there is a wave of banking crises, a wave of sovereign debt crises follows a few years later.”
Mr. El-Erian of Pimco sees that at least some of the Eurozone countries will do restructuring (the equivalent of defaulting) to reduce their debt by 2013.
Mr. King of Citi said “The long-term resolution will almost certainly be a big transfer of wealth from creditors to debtors." (This implies a "haircut" where bond holders lose part of their investment). As creditor countries try to enforce debts issued by debtor countries, they will then default or there will be further QE's.
My opinion: the article confirms my bearish views on the world economy and thus supports my advice to invest in high quality bonds. We are still in a bond bull market. It is very important to avoid poor quality bonds. It is important to get independent investment advice from a fee-only investment advisor.
I read an excellent article today by Ambrose Evans-Pritchard in the Telegraph at www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/8230654/Overheating-East-to-falter-before-the-bankrupt-West-recovers.html India and China are overheated and need to cool down and this will happen before the West recovers from its slump. Thus the world will be mired in a big slump with no country able to pull the world out of the slump. Because the bubble of the past decade was debt induced then it will take an equal amount of time to recover, which implies a decade long recession as in Japan.
He warned that bond haircuts will cause a problem for Europe’s banks as they try to refinance $1 trillion by 2012, in competition with desperate sovereign governments. The youth jobless rate in Spain is now at 43%. Because weaker members of the Euro can’t devalue they are doing an `internal devaluations’ that create wage cuts that will lead to more problems.
The article confirms my opinion that there will be a long period of low growth or recession which means a long period of low interest rates for U.S. Treasuries. This is why I recomemnd independent investment advice.
The cost of the 2008 financial industry bailout using $787 billion TARP funds should be seen as something that happens every 20 years. Compare it to and average with the $300 billion inflation adjusted 1990 Savings & Loan bailout. This is about $550 billion every 20 years or $1,830 per capita divided by 20 years equals $91.67 a year or $1.78 per week per person, less than coffee at Starbucks.
Now compare this to the fact that banks have an artificially low cost of capital because of the FDIC insurance. The insurance may cut their cost of capital by about 2%. So if the average person uses $100,000 in debt times a 2% annual lower cost of capital (assuming the banks passed on the savings to the borrower) then consumers save thousands a year but have to pay $91.67 a year in taxes for bank bailouts. So the cost of bailouts is much smaller than the value of the system provides to consumers. This does not mean that banks should be encouraged to repeat their bubble causing mistakes, but it shows that people should calm down and relax about the 2008 panic and crash and focus on having a positive mental attitude towards rebuilding the economy.
Using independent investment advice one can see that eventually the economy will get better. However, one must be careful in case the market crashes due to its being built on false stimulus like QE2, even though the GNP s improving.
Should investors seek professional independent investment advice for a fee during a bear market or should they try to “save” money by not using an advisor and simply putting all their funds into an insured CD?
When an investor hears that an advisor is bearish the investor maybe tempted to think he can save money by simply parking his assets in an insured CD and thus avoid paying for investment advice. However, the investor risks missing advice about when is the right time to get back into the market. The investor may miss advice on contrarian strategies that may be feasible during a range bound bear market. An investor who shuns the advice of a bear market advisor may end up being fooled by a bubbly bullish demagogue who encourages buying stocks at the top of the market, which would result in losses.
Perhaps the most important rule in investing is to avoid losing money. This is because for example, if you lose 50% then you need to make 100% to get back to even. Also if you suffer big losses you may feel too frustrated to invest and then miss the rally that occurs after a crash. So for this reason it is more important to get professional advice from a bear market advisor than it is to get bullish advice during a boom time.
Albert Edwards of the French bank Société Générale was quoted in The Guardian article of 1-3-2011. He is a good example of independent investment advice. He said “…China is basing a growth model on the most unstable part of GDP. Something has to give – and probably sooner than most people assume. … In reality, China is a much more potentially volatile economy than people think. The Chinese situation is the one that could come out of nowhere because people are not considering it…. China has produced such strong growth for such a long time that investors assume the process will last indefinitely’…. "There is too much confidence in the lack of volatility.” End quotes.
These comments remind me of Nassim Taleb’s black swans. The comments support my opinion that China, as one of the three pillars of the world’s economy, will weaken and thus the world economy will go back into recession. Edwards also forecast the yield on UK Gilts would go from 3.5% to 2.0% and the stock market would retouch the lows of March, 2009, which is something I have been expecting. U.S. Treasuries would behave in a similar way. When China’s economy cools down then commodities will plummet and so will countries like Australia and Brazil that export commodities to China.
Yale Professor Robert Schiller who is well known for independent investment advice, said yesterday that "real" corporate earnings increased over 100 years at 1.5% annually. He forecasts the SP in ten years will be at about 1300 in real terms and with inflation it will be about 1400 in nominal terms. It is now about 1250. So in real terms he is forecasting over ten years the only reward for owning the SP will be the 2% annual dividend.
My opinion is that since 30 year U.S. Treasuries pay 4.3%, free of state income tax, which is like getting 4.7%, then Treasuries would beat equities, assuming inflation remains low. Treasuries have in the past certainly outperformed equities on a risk-adjusted basis since Treasuries have a standard deviation of about 17 versus 20 for the SP.
Schiller used the earnings from 1890 to 1990 because the last 20 years was a bubble that produced excessive earnings. My opinion is that we are parallelling the 20 year Japanese crash from 1990-2010 and we have several more years of bearish performance before things get better.